The Effect of CEO Option Compensation on the Capital Structure: A Natural Experiment

Onur Kemal Tosun

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Corporate Finance and Governance Financial Analysis and Corporate Governance Corporate Insolvency and Governance

Abstract

Firms simultaneously choose both their capital and their executive compensation structure. Using the Internal Revenue Code 162(m) tax law as an exogenous shock to compensation structure in a natural experiment setting, I identify firm leverage changes as a result of chief executive officer (CEO) option compensation changes. The evidence provides strong support for debt agency theory. Firms appear to decrease leverage when CEOs are paid with more options and when CEO options become a higher percentage of future cash flows. The findings are robust to controlling for corporate governance and convertible debt.

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1976Theory of the firm: Managerial behavior, agency costs and ownership structure 2003Corporate Governance and Equity Prices 1988The Determinants of Capital Structure Choice 2005Managerial incentives and risk-taking☆1980Optimal capital structure under corporate and personal taxation 1995Executive compensation structure, ownership, and firm performance 1997Managerial Entrenchment and Capital Structure Decisions 2005Do Firms Rebalance Their Capital Structures?

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