ScienceDirect Publication: Finance Research Letters
Wed, 04 Dec 2019 00:01:37 GMT language
Publication date: Available online 28 November 2019
Source: Finance Research Letters
Author(s): Stefano Colonnello
I model the joint effects of debt, macroeconomic conditions, and cash flow cyclicality on risk-shifting behavior and managerial wealth-for-performance sensitivity. The model shows that risk-shifting incentives rise during recessions and that the shareholders can eliminate such adverse incentives by reducing the equity-based compensation in managerial contracts. Moreover, this reduction should be larger in highly procyclical firms. These novel, testable predictions provide insights into optimal shareholder responses to agency costs of debt throughout the business cycle.