Chief Executive Officer Inside Debt Holdings and Labor Investment Efficiency

• Author: Kyung Jin Park,Kyoungwon Mo,Young Jin Kim
• DOI: http://doi.org/10.1111/ajfs.12269
• Date: 01 August 2019
• Published date: 01 August 2019

Chief Executive Officer Inside Debt Holdings

and Labor Investment Efficiency*

Kyoungwon Mo

School of Business Administration, Chung-Ang University, Republic of Korea

Young Jin Kim

College of Business, Hawaii Pacific University, United States

Kyung Jin Park**

College of Business Administration, Myongji University, Republic of Korea

Received 31 January 2018; Accepted 4 December 2018

Abstract

We show how chief executive officer (CEO) inside debt holdings affect corporations’ labor

investment behavior. We empirically find a positive association between CEO inside debt

holdings shown to increase their conservatism and long-term horizons due to deferred pay-

ments and labor investment efficiency recognized as an integral factor in a firm’s long-term

survival and growth. Additional analyses reveal that CEO inside debt holdings lead to a

greater tendency to reduce net hiring amid excess labor availability than is observed when

levels are optimal. This tendency is especially marked when CEO power is strong and when

the firm has relatively high financial liquidity and leverage.

Keywords Inside debt; CEO pension; Labor investment; Agency problem; Financial liquidity;

Long-term survival

JEL Classification: M41

1. Introduction

A firm has two financing sour ces: debt and equity. Chie f executive officer

(CEO) compensation consi sts of debt- and equity-base d components, along with

a fixed salary. According to agency th eory, the optimal compensation str ucture

is that which solves the agency p roblem of shareholders and de bt holders; it is,

*The authors thank Xuan Tian and anonymous referees for helpful comments and sugges-

tions. This paper draws from author Kim’s PhD dissertation completed at KAIST. This work

was supported by the 2017 Myongji University research fund.

**Corresponding author: College of Business Administration, Myongji University, 34

Geobukgol-ro, Seodaemun-gu, Seoul 03674, Republic of Korea. Tel: +82-2-300-0755, Fax:

+82-2-300-0734, email: chichikj@mju.ac.kr.

Asia-Pacific Journal of Financial Studies (2019) 48, 476–502 doi:10.1111/ajfs.12269

476 ©2019 Korean Securities Association

thus, equal to the debt-to-e quity ratio of the firm, as the CEO ’s equity-like

compensation serves to al ign the CEO’s benefits with tho se of shareholders, and

the debt-like compensatio n matches the CEO’s incentives with tho se of creditors

(Jensen and Meckling, 197 6; Edmans and Liu, 2010). Ma ny researchers report

that equity-based compens ation induces managers to s erve shareholders better

and maximize firm value (Murphy , 1985; Morck et al., 1988; McConne ll and

Servaes, 1990; Ryan and Wiggi ns, 2002; Hanlon et al., 2003; Col es et al., 2006;

Wu and Tu, 2007; Low, 2009; Brockman et al., 2010). For ex ample, Lambert

and Larcker (1987) find tha t managerial compensati on is related to shareholder

wealth during acquisitio ns, and Low (2009) suggests tha t equity-based compen-

sation makes managers redu ce firm risk, which, in turn, aff ects shareholder

wealth.

CEOs’ debt-based compensa tion has received less attent ion than CEOs’

equity-based compensat ion in the compensation liter ature because a firm does

not issue debt in the form of loans or bonds to pay CEOs’ debt-ba sed compen-

sation, unlike in equity-b ased compensation. Howev er, many recent studies have

shed light on CEO pensions as an example o f debt-based compensation. The

CEO pension is recorded as a lia bility when its payment is det ermined and

when it is implemented in the long-t erm future. These characteri stics corre-

spond to debt and allow the CEO pension to be defi ned as inside debt (Kwak

and Mo, 2018). A CEO pension or inside de bt can induce the manager to focus

on the possibility of def ault or deadweight losses, as s/he may not receive her/

his pension payment if the fir m does not survive over the long term. Thus,

greater inside debt holdings are expected to make the manager more conserva-

tive and long-term oriented , whereas equity holdings will ma ke the manager

seek higher risk and short-term perf ormance (Jensen and Meckling, 1976 ; Sun-

daram and Yermack, 2007; Ed mans and Liu, 2010; Wang et al., 2010 ; Cassell

et al., 2012). The empirical evi dence shows that firms with hi gher CEO pensions

go bankrupt less frequent ly (Sundaram and Yermack , 2007), bear lower costs of

debt and higher costs of eq uity (Wang et al., 2010; Wei and Yerma ck, 2011;

Anantharaman et al., 2013), participate in less risky inv estments and try to

maintain higher financial liq uidity (Cassell et al., 2012), engage i n less merger-

and-acquisitions activit y (Phan, 2014), and adopt more conserv ative accounting

practices (Chen et al., 2010; Wang et al., 2 010). Inside debt holdings are a lso

shown to be related to lower managem ent earnings (He, 2015), higher fir m liq-

uidation value (Chen et al., 2010), and decreased cre dit default swap (CDS)

spreads (Bolton et al., 2015).

As Jensen and Meckling (1976) theorize, CEOs’ inside debt holdings decrease

the agency cost of debt between equity holders and debt holders by preventing

managers from taking excessive risk, which increases expected shareholder profits

and reduces default risk. This theory can also be applied to investment decisions.

Many researchers show that equity-based compensation increases management risk-

taking in investments (Ryan and Wiggins, 2002; Coles et al., 2006; Wu and Tu,

Inside Debt Holdings

©2019 Korean Securities Association 477