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Capital structure and executive compensation contract design: A theoretical and empirical analysis

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  • Lin, Hsuan-Chu
  • Chou, Ting-Kai
  • Wang, Wen-Gine

Abstract

Compensation contracts including incentive instruments not only provide executives with positive incentives to increase shareholder wealth, but also create a negative value-dilution effect for existing shareholders. This study investigates this dilemma by conducting a benefit-cost analysis under a proposed structural form valuation framework. Our design mechanism shows that, given their firms’ current capital structure, shareholders are always capable of designing an optimal compensation contract to maximize their wealth. Due to the different research issue and assumptions, unlike findings of most previous studies, our model proposes that in a firm with a higher leverage ratio shareholders should provide a contract with higher incentive intensity for managers, and this proposition is supported by the empirical analyses which examine the sample of S&P index firms over the period 1992–2006 after adopting an updated fixed effects model.

Suggested Citation

  • Lin, Hsuan-Chu & Chou, Ting-Kai & Wang, Wen-Gine, 2012. "Capital structure and executive compensation contract design: A theoretical and empirical analysis," Journal of Banking & Finance, Elsevier, vol. 36(1), pages 209-224.
  • Handle: RePEc:eee:jbfina:v:36:y:2012:i:1:p:209-224
    DOI: 10.1016/j.jbankfin.2011.07.008
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    More about this item

    Keywords

    Capital structure; Dilution effect; Compensation contract;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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