بدهی داخلی مدیر عامل شرکت و تصمیمات مصون سازی: درس هایی از صنعت بانکداری آمریکا

Theoretical literature (Jensen and Meckling, 1976 and Edmans and Liu, 2011) argues that inside debt – pension benefits and deferred compensation – has debt-like payoffs, and can therefore curb executives’ excessive risk-taking incentives created by equity holdings. We test this theory in the banking sector by investigating whether CEOs with larger inside debt holdings compared to their equity-based compensation hedge more their banks’ interest rate risk. Our results show that CEO inside debt holdings have a positive effect on the extent to which a bank uses interest rate derivatives for hedging purposes, implying that debt-like compensation mitigates bank executives’ risk-taking incentives. Our results have important implications for financial regulation attempting to prevent financial crises due, at least partially, to perverse incentives provided to bank executives through compensation.

As the financial crisis continued to unfold, a quasi-consensus emerged among academics, regulators and consulting groups that compensation structures influence executives’ incentives and can induce excessive risk taking by banking organizations. Specifically, there is an agreement that the compensation practices of banks were a factor that contributed to the build-up of excessive risk, which, in turn, precipitated the recent global financial crisis1. Much of the blame is directed towards stock options, as numerous studies document a strong link between stock option holdings-and-incentives and risk-taking by financial institutions (Chen et al., 2006, John et al., 2007, Mehran and Rosenberg, 2007, Bebchuck and Spamann, 2010, Belkhir and Chazi, 2010 and DeYoung et al., 2010). Compensation contracts where stock options represent a significant component are said to promote short-termist behavior (Jensen, 2004, Jensen and Murphy, 2004, Graham et al., 2005 and Bolton et al., 2006)) and to insulate executives from downside risks of their actions (Bebchuck and Spamann, 2010). With compensation of bank executives pointed out as one of the flaws of the financial system, it is no surprise that the redesign of management compensation structures is mentioned as an important pillar in many financial regulation proposals aimed at fixing this system. For instance, the Dodd-Frank Wall Street Reform and Consumer Protection Act assigns to federal regulators the task of prescribing rules and regulations that prohibit any pay structure that “encourages inappropriate risks2”. In their effort to implement this recommendation, U.S. regulators (FRB, FDIC, SEC, etc.) came to an agreement that required deferred compensation would be an effective mechanism that reduces any incentives that bank managers have to pursue risky policies that may doom the safety of the institution3. In a book published in 2010, the Squam Lake Working Group on Financial Regulation recommended that systemically important financial institutions should be required to hold back a significant share of each senior manager's annual compensation for a period of time4. The authors also recommend that such retained compensation should be for a fixed dollar amount – not stock or stock options. Deferred compensation has therefore become central to any debate on reforming compensation structure in the banking industry. It is, however, worth recalling that the deferral of executives’ compensation by banks has been practiced for many years, as is shown by the latest disclosures of deferred compensation. Like other firms, banks can withhold two components of senior executives’ compensation for payment in the future, namely, pension benefits and voluntary deferred compensation. These two compensation components are at risk because they represent unsecured and unfunded liabilities of the bank. Executives stand in line with other unsecured creditors in case the bank came to default. This debt-like compensation is usually referred to as inside debt (Jensen and Meckling, 1976)5. This paper contributes to the ongoing debate on the merits of deferred compensation as a component of financial regulation by investigating whether debt-like compensation enhances managers’ incentives to hedge bank risk. Specifically, we examine whether inside debt – pensions and deferred compensation – enhances CEOs’ incentives to hedge more interest rate risk using derivatives contracts. To the best of our knowledge, this is the first study that tests the effect of inside debt holdings on executives’ risk-taking incentives through the channel of risk management. It builds on the idea that if the holding of inside debt influences executives’ risk preferences, this should be reflected in banks’ risk management decisions. Given their pay-off structure, CEOs holding inside debt are interested in operating with low levels of default risk. This is because CEOs holding inside debt bear the cost of their bank failure since their deferred compensation is forfeited if the bank becomes bankrupt. They will, therefore, make risk choices that help in keeping the bank's default risk at low levels (Bennett et al., 2012)6. Moreover, CEOs with inside debt holdings may seek to reduce the risk of default because they are not compensated with higher yields on their debt for the extra risk, unlike other debt holders. Finally, a greater risk exposure may increase the expected value of their equity-based holdings, but it also decreases the expected value of their inside debt holdings. As a CEO's inside debt rises compared to her equity-based holdings, the loss in the expected value of the inside debt holdings due to a greater expected risk of default may outweigh the incremental equity value. One way for bank managers to reduce the risk of default is to hedge the bank's risks. The corporate risk management literature suggests that one of the motives that induce corporations to hedge is the reduction of their expected bankruptcy costs (Smith and Stulz, 1985 and Mayers and Smith, 1982)7. Hedging reduces the variability of cash flow and firm value and, therefore, lowers the risk of default. Stulz (1996) suggests that companies should hedge their risk in a way that renders financial distress highly unlikely. Purnanandam (2008) shows both theoretically and empirically that firms facing higher costs in the event of financial distress have more hedging incentives. Purnanandam (2007) finds that banks facing a higher likelihood of financial distress manage more their interest rate risk. Hedging is therefore one of the tools used by banks willing to reduce their risk of default. A CEO's incentives to reduce the bank's risk of default are greater when more of her own value is at risk in case of default; i.e., when her amount of inside debt is higher. Moreover, ex ante, the greater the risk of default and the more value is transferred from debt claims to equity claims. Since the value of the CEO's debt claim is not sensitive to risk, she should have more incentives to operate with a lower risk of default as her inside debt increases relative to equity to minimize this wealth transfer. Thus, greater inside debt can potentially induce bank CEOs to hedge more the bank's risks to keep a bank's risk of default at low levels. Whether CEO inside debt does matter for the risk management decisions of banks is an empirical issue that we address in this paper. We examine how banks where CEOs hold (more) inside debt hedge their interest rate risk using derivatives compared to those where CEOs hold no (or less) inside debt. Specifically, we use a regression analysis where a bank's extent of interest rate derivatives use for risk management purposes is regressed on measures of CEO inside debt. To account for the potential endogeneity of the CEO inside debt, we conduct the analysis in a two-stage framework. In the first-stage estimation, CEO inside debt is determined by a set of variables, including carefully selected instruments. In the second stage regression, the risk management model is estimated using the predicted value of the CEO inside debt measure as the main explanatory variable. We conduct the analysis on a sample of 150 U.S. publicly traded bank holding companies (BHCs) over the 2006–2010 period, making around 500 observations. We focus on interest rate derivatives for three main reasons. First, interest rate risk is one of the most important sources of bank risk. Banks face a high degree of interest rate risk due to the maturity mismatch between their assets and liabilities. Flannery and James (1984) document that the market returns of bank stocks are sensitive to the maturity gap between assets and liabilities. Second, Diamond's (1984) model suggests that banks acting as delegated monitors should take only risks where they have a monitoring comparative advantage. Only those risks are a source of profit for banks. Since monitoring cannot influence the level of interest rates, bearing interest rate risk only increases a bank's likelihood of default without generating any incentive benefits. Thus, it is optimal for banks attempting to reduce their default risk to remove interest rate risk through the use of derivatives8. Third, several studies suggest that interest rate derivatives are the largest used type of derivatives by U.S. banks. For instance, Purnanandam (2007) and Belkhir (forthcoming) report that, on average, interest rate derivatives represent 92.47% and 89.05%, respectively, of all derivatives used for risk management purposes by U.S. commercial banks9. Any effect of CEO inside debt holdings on the use of derivatives for risk management decisions would therefore be reflected in the use of interest rate derivatives10. The analysis indicates that CEO inside debt does matter for bank risk management decisions, as there is a positive effect of the CEO debt-to-equity ratio on the extent of interest rate derivatives use for hedging purposes by banks. Bank managers with more inside debt compared to their equity holdings seem to be more inclined to reduce bank risk through the channel of risk management. The analysis documents that a greater CEO debt-to-equity ratio increases the extent of interest rate derivatives use for hedging purposes. We interpret this result as evidence that inside debt holdings enhance a CEO's propensity to use derivatives for hedging purposes. By demonstrating how CEO inside debt holdings influence a bank's risk management decisions, this paper contributes to the financial economics literature in several ways. First, it adds to the banking literature that investigates the effects of compensation incentives on risk-taking in the banking industry. To date, this literature has focused almost exclusively on the impact of equity-based compensation (stock and stock options) on risk-taking (Houston and James, 1995, Brewer et al., 2003, Chen et al., 2006, John et al., 2007, Mehran and Rosenberg, 2007, DeYoung et al., 2010, Belkhir and Chazi, 2010 and Fahlenbrach and Stulz, 2011). We depart from this literature by focusing on a compensation component that provides different incentives to executives – inside debt – and find that inside debt holdings provide CEOs with incentives to reduce risk. In this respect, our paper relates more to Tung and Wang (2011) and Bennett et al. (2012), which study the role of CEOs’ inside debt incentives on bank risk-taking during the most recent financial crisis. Specifically, both studies investigate whether pre-crisis CEO inside debt incentives (year 2006) had an effect on bank risk measures during the crisis period – mid-2007 till the end of 2008. Their results reveal a negative effect of CEO inside debt on bank risk measures such as the idiosyncratic risk and loan loss provisions (Tung and Wang, 2011) and default risk (Bennett et al., 2012). Yet, while our focus on CEO inside debt and bank risk-taking is similar to Tung and Wang (2011) and Bennett et al. (2012), we approach this issue from a different and novel perspective, which is hedging. We therefore add to this nascent literature on inside debt and bank risk-taking by looking at whether more inside debt holdings provide further incentives to CEOs to hedge more a type of risk that is inherent to the banking activity – interest rate risk. Whereas Tung and Wang (2011) and Bennett et al. (2012) establish a direct link between CEO inside debt incentives and bank risk measures, we turn to examining the effect of CEO inside debt incentives on hedging which is a tool aimed at reducing bank risk. We also adopt a different empirical framework that accounts for the potential endogeneity of CEO inside debt. Second, our paper makes a substantial contribution to the risk management literature by documenting the role of another component of the compensation mix – inside debt – in a bank's risk management decisions. The role of this compensation component in firm risk management decisions has not been explored before in the financial economics literature. As much as is known, this study pioneers the analysis of the effect of inside debt holdings on firm hedging behavior; extant studies investigated only the role of executive stock and option holdings on firm risk management decisions (Tufano, 1996, Knopf et al., 2002 and Haushalter, 2000: Graham and Rogers, 2002 and Rogers, 2002)11 and on banks’ use of derivatives for hedging purposes (Whidbee and Wohar, 1999, Adkins et al., 2007 and Purnanandam, 2007). Third, we contribute to the nascent literature examining the effect of inside debt holdings on risk-taking by identifying a channel through which inside debt contributes to reducing firm risk-taking. Most of this literature documents a mitigating effect of executive inside debt on firm risk (Sundaram and Yermack, 2007, Chava et al., 2010, Chen et al., 2010, Tung and Wang, 2011, Wang et al., 2010, Anantharaman et al., 2011, Wei and Yermack, 2011 and Cassell et al., 2012). Our results show that risk management is one of the tools that help in achieving the risk-taking preferences of executives with greater inside debt holdings. Finally, our findings, which suggest that inside debt holdings dampen bank CEOs’ risk-taking appetite, are particularly relevant in light of the current debate on optimal financial regulation seeking to protect the financial system from excessive risk-taking attitudes. We expect our findings to be of interest to regulators and lawmakers seeking evidence on the positive role of inside debt holdings – executive deferred compensation – in curbing excessive risk-taking by bankers. The remainder of the paper is organized as follows: Section 2 discusses the theoretical link between inside debt and risk management decisions and develops the main hypothesis of the paper. Section 3 presents the empirical methodology. Section 4 describes the data and the construction of the variables. Section 5 presents the results of the analysis. Finally, Section 6 concludes the paper.

This paper studies the impact of executive debt-like incentives – CEO inside debt – on the hedging decisions of BHCs. We analyze this relation within an empirical setting that accounts for the endogeneity of the CEO inside debt ratio. We document strong evidence of a positive effect of the CEO relative debt-to-equity ratio on the extent of derivatives use for hedging purposes. Specifically, at BHCs that use interest rate derivative contracts for hedging purposes, greater CEO inside debt holdings lead to further use of these derivatives to hedge interest rate risk, in line with the hypothesis that inside debt holdings enhance executives’ incentives to reduce a bank's default risk. These results have important policy implications. First, there is robust evidence that greater inside debt holdings by CEOs only improves the hedging incentives of a BHC. It follows that, if bank executives are provided with further incentives to hold significant amounts of inside debt, this can be an effective mechanism to curb bankers’ incentives to take excessive risks. Our first-stage model shows that tax incentives are a significant determinant of inside debt holdings by CEOs. CEOs facing greater tax rates on capital income and lower tax subsidies on mortgage investments elect to defer greater amounts of their compensation to be received in the future. This, in turn, enhances their incentives to operate their banks in a more conservative way, by way of greater hedging with derivative contracts. Tax regimes on bank executive compensation can therefore be reviewed in order to serve as an incentive tool to induce better risk choices by banks. Second, regulators contemplating the use of executive pay structure as a regulatory tool may also want to look closely at deferred compensation as it may contribute in inducing better risk-taking incentives for bank executives.