Executive Compensation and the Cost of Debt

We examine how executive compensation affects the cost of debt financing. Analyzing CEO pay data from the UK, we find that debt-like and equity-like pay components have opposite effects on the cost of debt. An increase in defined benefit pensions is associated with lower bond yield spread, while an increase in executive stock options intensifies it. In addition, we find some evidence that cash bonus is negatively associated with the cost of borrowing. We do not observe any relation between restricted stock grants and the cost of debt financing. Our results suggest that bondholders are fully aware of both risk-taking and risk-avoiding incentives created by various executive pay components.