Better Safe than Sorry? CEO Inside Debt and Risk-Taking in Bank Acquisitions

Abstract

Article:Srivastav, A orcid.org/0000-0003-4831-4458, Armitage, S, Hagendorff, J et al.(1 more author) (2018) Better safe than sorry? CEO inside debt and risk-taking in bank acquisitions. Journal of Financial Stability, 36. pp. 208-224. AbstractWidespread bank losses during the financial crisis have raised concerns that equity-based compensation for bank CEOs causes excessive risk-taking. Debt-based compensation, so-called inside debt, aligns the interests of CEOs with those of external creditors. We examine whether inside debt induces CEOs to pursue less risky acquisitions. Consistent with this, we show that acquisitions announced by CEOs with high inside debt incentives are associated with a wealth transfer from equity to debt holders. After the completion of a deal, banks where acquiring CEOs have high inside debt incentives display lower market measures of risk and lower loss exposures for taxpayers. JEL Classification: G21, G34, J33

CEO inside debt, market competition and corporate risk taking

“…First, it complements and extends the scant literature that explores the relation between CEO inside debt and corporate risk-taking (e.g. Cassell et al , 2012; Milidonis et al , 2017; Srivastav et al , 2018). These studies have either a small sample size or the analysis is conducted on a specific industry.…”

“…Jensen and Meckling (1976) conjecture that the conflict of interest between shareholders and debtholders can be mitigated by requiring the CEO to hold debt and equity in proportion to the firm debt-to-equity ratio. Following this conjecture, previous studies measure inside debt as the ratio of CEO personal debt to equity relative to firm debt-to-equity ratios (Sundaram and Yermack, 2007; Cassell et al , 2012; Srivastav et al , 2018). CEO inside debt is calculated as the sum of the present value of accumulated pension benefits and deferred compensation given in the Execucomp database.…”

“…Phan (2014) finds that when CEO inside debt is high, they undertake mergers and acquisitions that result in positive abnormal bond returns and negative abnormal stock returns. Similarly, Srivastav et al (2018) examine the impact of inside debt on bank risk-taking and find that acquisitions announced by CEOs with high inside debt incentives result in wealth transfer from equity to debtholders. The empirical results from these studies provide support to the theoretical predictions agency theory by finding a negative association between CEO inside debt and corporate risk-taking.…”

“…Sundaram and Yermack, 2007; Wei and Yermack, 2011; Choy et al , 2014; Cassell et al , 2012). Evidence from specific industries like property liability insurance firms (Milidonis et al , 2017) and bank acquisitions (Srivastav et al , 2018) also suggests a negative association between CEO inside debt and corporate risk-taking.…”

“…Cassell et al (2012) for example, use a small sample of 2,994 firm-year observations for the period 2006–2008. Milidonis et al ’s (2017) sample consists of 177 observations from 29 property liability insurance firms for the period 2007–2013 and Srivastav et al (2018) use 101 observations from banking mergers and acquisitions data. This study uses a large and extended panel of 8,066 firm-year observations from the non-financial, non-regulated industries for the period 2006–2015.…”