A model of managerial compensation, firm leverage and credit stimulus

Chakraborti, Rajdeep; Dahiya, Sandeep; Ge, Lei; Gete, Pedro

Abstract

We study a model in which leverage and compensation are both choice variables for the firm and borrowing spreads are endogenous. First, we analyze the correlation between leverage and variable compensation. We show that allowing for endogenous compensation and leverage can explain the conflicting findings of the empirical literature. We uncover a new channel of complementarity between effort and leverage that induces a correlation sign opposite to what current theoretical models predict. Second, we study the dynamics of leverage and compensation design after a credit stimulus. We derive a set of new empirical predictions. For outward-shifts in credit supply, variable compensation is increasing in leverage growth. Moreover, variable compensation increases after the credit stimulus, especially for firms with low idiosyncratic risk.

Citation

Chakraborti, R., Dahiya, S., Ge, L., & Gete, P. (2024). A model of managerial compensation, firm leverage and credit stimulus. Journal of Financial Stability, 72, Article 101248. https://doi.org/10.1016/j.jfs.2024.101248

• Journal Article Type: Article
• Acceptance Date: Feb 26, 2024
• Online Publication Date: Mar 10, 2024
• Publication Date: 2024-06
• Publicly Available Date: Mar 14, 2024
• Journal: Journal of Financial Stability
• Print ISSN: 1572-3089
• Publisher: Elsevier
• Volume: 72
• Article Number: 101248
• DOI: https://doi.org/10.1016/j.jfs.2024.101248
• Public URL: https://durham-repository.worktribe.com/output/1168370