Mergers and acquisitions and CEO debt-like compensation

Abstract

Prior research examining the effect of CEO compensation schemes on M&A decisions overlooks the fact that a significant portion of CEO compensation is debt-like (e.g., deferred compensation and defined benefit pensions). Theory suggests that debt-like compensation aligns CEOs' incentives with those of debtholders. I examine whether CEOs with higher debt-like compensation relative to equity compensation are more aligned with debtholders than equityholders when making M&A decisions. Supporting the incentive alignment argument, I find that acquirers with higher CEO relative debt-like compensation tend to pick less risky targets and are more likely to use debt financing, which is consistent with their CEOs being less risk-seeking and therefore having lower cost of debt. I also find that post-merger stock return volatility is lower for these acquirers. In addition, I document a lower correlation between bond returns and stock returns to M&A announcements for acquirers with high level of CEO relative debt-like compensation than for those with medium level. However, I do not find same results for acquirers with low level of CEO relative debt-like compensation. Overall, my study suggests that, when examining effects of CEO incentives on their decision-making, it is important to consider the relative incentive alignment between CEOs and both groups of stakeholders.