The Effect of Executive Compensation on Recoveries

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By Andrea Pawliczek, Leeds School of Business, University of Colorado – Boulder


The structure of executive compensation will influence an executive’s behavior. For debt holders, this influence becomes especially important when a firm nears bankruptcy because this is when the debt holders’ value is at risk.


Consider the actions of an executive of a financially distressed firm depending on his compensation. As bankruptcy becomes likely, an executive with only equity compensation (i.e. stock and options) is likely to gamble for solvency as his wealth is entirely dependent on the firm’s stock price. For example, RadioShack, whose CEO had no debt-like compensation, undertook such a strategy, purchasing a 2014 Super Bowl ad for $4 million when the company was already in significant financial distress. Although the ad was popular and resulted in a 12% jump in the firm’s stock price the next morning, it did not help the fortunes of the company, which declared bankruptcy just over a year later on February 15, 2015.  Alternatively, an executive with debt-like compensation (e.g., pensions and deferred compensation) does not lose everything in the case of bankruptcy. This executive would have incentives to preserve firm value (i.e. assets that have value in liquidation or more value to the reorganized firm) to generate higher recoveries for himself and other debt holders in the event of bankruptcy.


While this prediction is established theoretically, there is no prior empirical evidence supporting this idea. Using a sample of 104 Chapter 11 bankruptcies of large public firms, I find that debt-like compensation – specifically Supplemental Executive Retirement Plans (SERPs) – is associated with higher recoveries to unsecured debt in bankruptcy. (SERPs are in almost all cases a form of unsecured debt that is at risk in bankruptcy. The only exception is if SERP assets are held in a secular trusts. Secular trusts are rarely used in compensation of executives at large public firms, however, because they result in the loss of tax deferral.) Recoveries to unsecured debt are 22% higher for a firm whose CEO holds sample mean levels of debt-like compensation compared to a firm whose CEO holds no debt-like compensation. I also document that debt-like compensation is associated with efforts to preserve more liquid assets prior to bankruptcy (e.g., cuts to research and development expenses).


The complete paper can be downloaded here.