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Capital Structure and Managerial Compensation: The Effects of Renumeration Seniority

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  • Calcagno, R.
  • Renneboog, L.D.R.

    (Tilburg University, Center for Economic Research)

Abstract

We show that the relative seniority of debt and managerial compensation has important implications on the design of remuneration contracts.Whereas the traditional literature assumes that debt is senior to remuneration, we show that this is frequently not the case according to bankruptcy regulation and as observed in practice.We theoretically show that including risky debt changes the incentive to provide the manager with stronger performance-related incentives ("contract substitution" effect).If managerial compensation has priority over the debt claims, higher leverage produces lower powerincentive schemes (lower bonuses) and a higher base salary.With junior compensation, we expect more emphasis on pay-for-performance incentives.The empirical findings are in line with the regime of remuneration seniority as the base salary is significantly higher and the performance bonus is lower in financially distressed firms. Series: CentER Discussion Paper

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2004-120.

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Date of creation: 2004
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Handle: RePEc:dgr:kubcen:2004120

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Web page: http://center.uvt.nl

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Keywords: seniority of claims; remuneration contracts; financial distress; insolvency; leverage;

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Cited by:
  1. Chalevas, Constantinos G., 2011. "The Effect of the Mandatory Adoption of Corporate Governance Mechanisms on Executive Compensation," The International Journal of Accounting, Elsevier, vol. 46(2), pages 138-174, June.
  2. Vittoria Cerasi & Sonja Daltung, 2006. "Financial structure, managerial compensation and monitoring," LSE Research Online Documents on Economics 24634, London School of Economics and Political Science, LSE Library.

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