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Negative Hedging: Performance-Sensitive Debt and CEOs’ Equity Incentives

Published online by Cambridge University Press:  15 February 2011

Alexei Tchistyi
Haas School of Business, University of California at Berkeley, 545 Student Services Bldg. #1900, Berkeley, CA 94720.
David Yermack
Stern School of Business, New York University, 44 W. 4th St., Ste. 9-160, New York, NY 10012.
Hayong Yun
Mendoza College of Business, University of Notre Dame, 242 Mendoza College of Business, Notre Dame, IN 46556.


We examine the relation between chief executive officers’ equity incentives and their use of performance-sensitive debt contracts. These contracts require higher or lower interest payments when the borrower’s performance deteriorates or improves, thereby increasing expected costs of financial distress while making a firm riskier to the benefit of option holders. We find that managers whose compensation is more sensitive to stock volatility choose steeper and more convex performance pricing schedules, while those with high delta incentives choose flatter, less convex pricing schedules. Performance pricing contracts therefore seem to provide a channel for managers to increase firms’ financial risk to gain private benefits.

Research Articles
Copyright © Michael G. Foster School of Business, University of Washington 2011

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