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The incentive to give incentives : On the relative seniority of debt claims and managerial compensation

Author

Listed:
  • Riccardo Calcagno

    (VU - Vrije Universiteit Amsterdam [Amsterdam])

  • Luc Renneboog

    (Tilburg University [Tilburg] - Netspar)

Abstract

We show that the relative seniority of debt and managerial compensation has important implications for the design of remuneration contracts. Whereas the traditional literature assumes that debt is senior to remuneration, there are in reality many cases in which remuneration contracts are de facto senior to debt claims in financially distressed firms and in workouts. We theoretically show that risky debt changes the incentive to provide the manager with performance-related incentives (a "contract substitution" effect). In other words, the relative degree of seniority of managers' claims and creditors' claims in case a bankruptcy procedure starts is crucial to determine the optimal incentive contract ex-ante. If managerial compensation is more senior than debt, higher leverage leads to lower power incentive schemes (lower bonuses and option grants) and a higher base salary. In contrast, when compensation is junior, we expect more emphasis on pay-for-performance incentives in highly-levered firms.

Suggested Citation

  • Riccardo Calcagno & Luc Renneboog, 2007. "The incentive to give incentives : On the relative seniority of debt claims and managerial compensation," Post-Print hal-02313020, HAL.
    • Handle: RePEc:hal:journl:hal-02313020
    DOI: 10.1016/j.jbankfin.2006.09.006
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    Cited by:

    1. Colonnello, Stefano & Curatola, Giuliano & Hoang, Ngoc Giang, 2017. "Direct and indirect risk-taking incentives of inside debt," Journal of Corporate Finance, Elsevier, vol. 45(C), pages 428-466.
    2. Liang, H. & Renneboog, Luc & Vansteenkiste, Cara, 2017. "Corporate Employee-Engagement and Merger Outcomes," Other publications TiSEM ab3f7a1d-a202-48b7-9c75-1, Tilburg University, School of Economics and Management.
    3. Liang, Hao & Renneboog, Luc & Vansteenkiste, Cara, 2017. "Cross-Border Acquisitions and Employee-Engagement," Other publications TiSEM 302b5e09-4d1d-4b32-9d74-7, Tilburg University, School of Economics and Management.
    4. João Paulo Vieito & António Cerqueira & Elísio Brandão & Walayet A. Khan, 2009. "Executive Compensation: the Finance Perspective," Portuguese Journal of Management Studies, ISEG, Universidade de Lisboa, vol. 0(1), pages 3-32.
    5. Edmans, Alex, 2011. "Short-term termination without deterring long-term investment: A theory of debt and buyouts," Journal of Financial Economics, Elsevier, vol. 102(1), pages 81-101, October.
    6. Liang, Hao & Renneboog, Luc & Vansteenkiste, Cara, 2020. "Cross-border acquisitions and employment policies," Journal of Corporate Finance, Elsevier, vol. 62(C).
    7. Martynova, Marina & Renneboog, Luc, 2011. "Evidence on the international evolution and convergence of corporate governance regulations," Journal of Corporate Finance, Elsevier, vol. 17(5), pages 1531-1557.
    8. Vittoria Cerasi & Sonja Daltung, 2017. "Managerial Compensation and Corporate Bond Yield with Active Shareholders," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 9(6), pages 111-123, June.
    9. Martynova, M., 2006. "The market for corporate control and corporate governance regulation in Europe," Other publications TiSEM 8651e281-4914-41f2-ac14-1, Tilburg University, School of Economics and Management.
    10. Renneboog, Luc & Vansteenkiste, Cara, 2017. "Leveraged Buyouts : A Survey of the Literature," Other publications TiSEM 573ebdd5-a720-4110-8ed1-e, Tilburg University, School of Economics and Management.
    11. Ruhnke, Carsten S., 2022. "Implications of the Creditors' Influence on Corporate Decisions," Junior Management Science (JUMS), Junior Management Science e. V., vol. 7(1), pages 150-184.

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