Risk-Adjusted Inside Debt

Compensation theory holds that executive aggression is related to both the level and riskiness of “inside debt” - promises from firms to pay their executives fixed sums of cash in the future, including pensions and deferred compensation. However, previous researchers have only examined the level of inside debt. We provide an inside debt metric that is conceptually superior to previously used metrics, as it incorporates the riskiness of inside debt. For the entire sample, our metric offers modest improvement in fit over past metrics, where the dependent variable is future equity return volatility. Furthermore, the relation between future volatility and our risk-adjusted inside debt metric is more prominent for non-investment grade firms, firms experiencing credit rating downgrades, and firms with high credit risk