Direct and Indirect Risk-taking Incentives of Inside Debt
We develop a model of managerial compensation structure and asset risk choice. The model provides predictions about the relation between credit spreads and different compensation components. First, we show that credit spreads are decreasing in inside debt only if it is unsecured. Second, the relation between credit spreads and equity incentives varies depending on the features of inside debt.
Exit Expectations and Debt Crises in Currency Unions
IWH Discussion Papers,
Membership in a currency union is not irreversible. Exit expectations may emerge during sovereign debt crises, because exit allows countries to reduce their liabilities through a currency redenomination. As market participants anticipate this possibility, sovereign debt crises intensify. We establish this formally within a small open economy model of changing policy regimes. The model permits explosive dynamics of debt and sovereign yields inside currency unions and allows us to distinguish between exit expectations and those of an outright default. By estimating the model on Greek data, we quantify the contribution of exit expectations to the crisis dynamics during 2009 to 2012.
Executive Compensation Structure and Credit Spreads
SAFE Working Paper, Heft 60,
We develop a model of managerial compensation structure and asset risk choice. The model provides predictions about how inside debt features affect the relation between credit spreads and compensation components. First, inside debt reduces credit spreads only if it is unsecured. Second, inside debt exerts important indirect effects on the role of equity incentives: When inside debt is large and unsecured, equity incentives increase credit spreads; When inside debt is small or secured, this effect is weakened or reversed. We test our model on a sample of U.S. public firms with traded CDS contracts, finding evidence supportive of our predictions. To alleviate endogeneity concerns, we also show that our results are robust to using an instrumental variable approach.