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Job Market Paper
New active blockholder and the adjustment of CEO inside debt-equity ratio
Using an extensive data set of CEO compensation in 5,775 U.S companies, I show that new active blockholders restructure CEO compensation to benefit both shareholders and debtholders. I measure CEO compensation structure by using the ratio between debt-like pay and equity-like pay, the inside debt-equity ratio. I benchmark this measure against a target structure which is optimal for total firm value. Deviation from the target structure is large before new active blockholders emerge, but significantly decreases once these investors are present in the companies. A company having a new active blockholder adjusts its CEO compensation to the target structure 2.5 times faster than the median company in the sample. On average, shareholders earn 12.91% and bondholders earn 3.09% over the two years of active holding period as the new active blockholders adjust CEO compensation to the target structure. The main findings hold no matter whether the initial compensation structure over-aligns CEO incentives to debtholders or to shareholders. These results suggest that new active blockholders mitigate the agency cost of debt, and by doing so, they enhance total firm value. I conduct additional tests to address the endogeneity issues. First, I rule out the possibility that reduced deviation could occur without the presence of active blockholders. I show that this adjustment is not found in companies where the active blockholders are passive ones or in non-targeted companies that have the same movement in deviation measures as do the targeted companies. Second, I construct an instrument for new active blockholder presence by utilizing the returns to past active investments. The instrument captures the potential gains to active monitoring, which can positively predict the presence of new active blockholders but should not correlate with compensation structure and other firm characteristics. The main finding is also robust to different designs to model the target structure and different ways to identify monitoring shareholders.
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