Financial distress risk and new CEO compensation

Woo Jin Chang, Rachel M. Hayes, Stephen Hillegeist

Research output: Contribution to journalArticle

9 Citations (Scopus)

Abstract

We examine how ex ante financial distress risk affects CEO compensation. To disentangle the joint effects of performance on compensation and distress risk, we focus our analyses on new CEOs. Our results indicate that financial distress risk affects compensation through two channels. First, new CEOs receive significantly more compensation when financial distress risk is higher. This finding is consistent with CEOs receiving a compensation premium for bearing this risk since CEOs experience large personal costs if their firms later become financially distressed. Second, financial distress risk is associated with the incentives provided to new CEOs; distress risk is positively associated with pay-performance sensitivity and equity-based compensation and is negatively associated with cash bonuses. Further, financial distress risk is positively associated with pay-risk sensitivity for new CEOs. These findings suggest that financial distress risk alters the nature of the agency relationship in ways that lead firms to provide CEOs with more equity-based incentives. We also build on research that finds a positive relation between forced turnover risk and CEO compensation. Our analyses suggest the compensation effects of forced turnover risk appear to be mainly attributable to financial distress risk. Overall, our results indicate financial distress risk is an economically important determinant of new CEO compensation packages.

Original languageEnglish (US)
Pages (from-to)479-501
Number of pages23
JournalManagement Science
Volume62
Issue number2
DOIs
StatePublished - Feb 1 2016

Fingerprint

CEO compensation
Financial distress
Chief executive officer
Turnover
Incentives
Equity
Distress
Premium
Compensation packages
Costs
Bonuses
Pay-performance sensitivity
Cash
Risk sensitivity
Agency relationship

Keywords

  • CEO compensation
  • CEO incentives
  • Compensation premium
  • Financial distress risk

ASJC Scopus subject areas

  • Strategy and Management
  • Management Science and Operations Research

Cite this

Financial distress risk and new CEO compensation. / Chang, Woo Jin; Hayes, Rachel M.; Hillegeist, Stephen.

In: Management Science, Vol. 62, No. 2, 01.02.2016, p. 479-501.

Research output: Contribution to journalArticle

Chang, Woo Jin ; Hayes, Rachel M. ; Hillegeist, Stephen. / Financial distress risk and new CEO compensation. In: Management Science. 2016 ; Vol. 62, No. 2. pp. 479-501.
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