Debt-Based Pay May Give Much-Needed Balance Harvard Case Solution & Analysis

When it takes a bad turn, managers whose compensation is only ever contains such equity instruments, such as shares and options, often tend to take more risks in a last ditch attempt to save their companies. But even if the company goes down in flames, these managers usually start with fewer scars than those unhappy bondholders burdened by debt. Litany of corporate bankruptcies in the United States and other countries is still fresh in everyone's mind. This article is based on a paper originally written with Qi Liu Wharton, forthcoming in the Review of Finance, which has attracted considerable attention for being the first to show that the debt payment may be the best part of executive compensation, particularly when a company is facing financial difficulties. Instead of the typical practice of paying executives with stock hard, the author suggests giving them a debt as securities, such as bonds, pension or deferred compensation, bonuses or linking them to the price of the debt or credit rating or credit company default spread. He suggests that the share of compensation of the manager is to be issued in the debt: equal proportions of debt / equity if the manager only when he takes the project selection decisions, especially in a situation where the general manager has to make decisions that "effort" is one of the key variable, depending on the effort has a greater effect on the solvency of the firm value or liquidation value. With new evidence emerging that some 13 percent of managers hold a higher percentage of debt than equity in their firms, as well as recent developments AIG and others in the same direction, the author believes that this compensation model an idea whose time has come. "Hide
by Alex Edmans Source: IESE-Insight Magazine 6 pages. Publication Date: December 15, 2010. Prod. #: IIR039-PDF-ENG

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Debt-Based Pay May Give Much-Needed Balance

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