Financial Market Developments and Management Compensation

• In Event: Debt Contracting I

Abstract

We examine whether the branching provisions in the Interstate Banking and Branching Efficiency Act (IBBEA) affect borrowing firms’ pay-risk sensitivities in executive compensation. We find that nonfinancial firms are likely to increase pay-risk sensitivities after IBBEA and that this increase is more pronounced for firms located in states with lower regulatory branch entry barriers. We further find that the increase in pay-risk sensitivities is more pronounced in states where the diversification benefits to the banks are the greatest. These findings together suggest that nonfinancial firms take advantage of banks’ enhanced ability to diversify credit risk geographically and their increased tolerance for borrowers’ risk taking as these firms can then adjust their compensation contracts. These findings not only suggest macro financial market developments affect firm corporate governance – in this case compensation structures – they also help us broaden our understanding of how financial market developments affect firm investment and innovation.

Authors

• Daniel A Bens, INSEAD

• Scott Liao, University of Toronto

• Barbara Su, University of Toronto - Rotman School of Management