Managerial Compensation and Capital Structure

We investigate the interaction between nancial structure and managerial compensation and show that risky debt affects both the probability of man-agerial replacement and the manager’s wage if he is retained by the rm. Our model yields a rich set of predictions, including the following: (i) The market values of equity and debt decrease if the manager is replaced; moreover, the expected cash ow of rms that retain their managers exceeds that of rms that replace their managers. (ii) Managers of rms with risky debt outstand-ing are promised lower severance payments (golden parachutes) than man-agers of rms that do not have risky debt. (iii) Controlling for rm’s size, the leverage, managerial compensation, and cash ow of rms that retain their managers are positively correlated. (iv) Controlling for the rm’s size, the probability of managerial turnover and rm value are negatively cor-related. (v) Managerial pay-performance sensitivity is positively correlated with leverage, expected compensation, and expected cash ows