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CEO inside debt and hedging decisions: Lessons from the U.S. banking industry

  • Belkhir, Mohamed
  • Boubaker, Sabri

Theoretical literature (Jensen and Meckling, 1976; Edmans and Liu, 2011) argues that inside debt – pension benefits and deferred compensation – has debt-like payoffs, and can therefore curb executives’ excessive risk-taking incentives created by equity holdings. We test this theory in the banking sector by investigating whether CEOs with larger inside debt holdings compared to their equity-based compensation hedge more their banks’ interest rate risk. Our results show that CEO inside debt holdings have a positive effect on the extent to which a bank uses interest rate derivatives for hedging purposes, implying that debt-like compensation mitigates bank executives’ risk-taking incentives. Our results have important implications for financial regulation attempting to prevent financial crises due, at least partially, to perverse incentives provided to bank executives through compensation.

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Article provided by Elsevier in its journal Journal of International Financial Markets, Institutions and Money.

Volume (Year): 24 (2013)
Issue (Month): C ()
Pages: 223-246

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Handle: RePEc:eee:intfin:v:24:y:2013:i:c:p:223-246
DOI: 10.1016/j.intfin.2012.11.009
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