Credit Stimulus, Executive Ownership, and Firm Leverage

Abstract

We show that executive ownership is a significant driver of the demand for credit following credit expansion policies. Our focus on credit demand is in contrast to most studies that have focused on credit supply factors such as bank capital. Our identification exploits the large and unexpected Chinese credit expansion in 2008. This setting offers a unique advantage as in 2008 the Chinese government had almost complete control over the banking sector and it directed the banks to increase credit supply. Thus, in this setting, demand, rather than supply, largely drives the observed changes in firms’ borrowing. We provide extensive robustness tests to validate our results. This paper was accepted by Kay Giesecke, finance.

A model of managerial compensation, firm leverage and credit stimulus

“…Our …ndings receive empirical support in the study by Chakraborti et al (2022) who show the underlying mechanism for a positive relationship between executive compensation and …rm leverage. They argue that this positive relationship is due to the fact that equity is a residual claim, while debt is a …xed claim.…”

“…They argue that this positive relationship is due to the fact that equity is a residual claim, while debt is a …xed claim. Chakraborti et al (2022) also argue that both leverage and CEO compensation are endogenous. For a shareholder, the …rm's leverage and the executive's e¤ort are complements.…”

“…In addition, after the credit stimulus, the variable component of CEO compensation increases as shareholders encourage their executives to borrow more to increase the …rm value. Consequently, the CEO with high equity stakes reaps the bene…ts of increase in …rm value by borrowing more following a credit stimulus (Chakraborti et al, 2022). It is worth pointing out that compensation contracts that provide a CEO with incentives to borrow more may not be socially optimal.…”