The Impact of Executive Stock-Based Compensation on Default Risk

This paper analyzes the impact of the incentive effects on firm's capital structure and default risk. Applying the measure of default probability in Bharath and Shumway (2008), we estimate the default probability for the public firms in the U.S. We focus on the impact of the incentive effects of stock-based compensation for top managers of each firm. The empirical results show that firms reduce their debt financing when they grant more stock to their executives. In addition, the results also show that the incentive effects would reduce the default probability directly after controlling the indirect impact of capital structure. Finally, only the incentive effects from the executive's stock holding, however, do have a significant influence on capital structure and default probability. Because there is rare evidence in the literature on the impact of executive compensation on default risk, we contribute to the existing literature by providing the related empirical evidence on this issue.