Executive Equity Risk-Taking Incentives and Firms’ Choice of Debt Structure

Research output: Journal Publications and Reviews (RGC: 21, 22, 62)21_Publication in refereed journalpeer-review

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Original languageEnglish
Article number106274
Journal / PublicationJournal of Banking and Finance
Online published27 Jul 2021
Publication statusPublished - Dec 2021


We examine how executive equity risk-taking incentives affect firms’ choice of debt structure. Using a longitudinal sample of U.S. firms, we document that when executive compensation is more sensitive to stock volatility (i.e., has higher vega), firms reduce their reliance on bank debt financing. We utilize the passage of the Financial Accounting Standard (FAS) 123R option-expensing regulation as an exogenous shock to management option compensation to account for potential endogeneity. In cross-sectional analyses, we find that the documented effect of vega is amplified among firms with higher growth opportunities and more opaque financial information; we also find vega's effect is mitigated in firms with limited abilities to tap into public debt market. Supplemental analyses suggest that firms with higher vega face more stringent bank loan covenants. We conclude that, by encouraging risk-taking, higher vega reduces firms’ reliance on bank debt financing in order to avoid more stringent bank monitoring.

Research Area(s)

  • Executive equity incentives, Vega, Bank debt, Debt structure

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