Management compensation and earnings-based covenants as signaling devices in credit markets

Management compensation and earnings-based covenants as signaling devices in credit markets A firm seeks to raise capital in credit markets to fund risky operating activities. The firm has private information about the future cash flows from such activities. Firm owners delegate operating decisions to a manager who privately learns further information about the distribution of those cash flows subsequent to contracting, but before taking actions. Those actions include the selection of which operating activities to pursue and how much hidden effort to exert. At issue initially after introducing the problem is the efficient design of the manager's compensation as a device for signaling private information to lenders as well as for inducing operating decisions. Our results provide conditions under which a Bayesian Nash separating equilibrium satisfying the Cho–Kreps intuitive criterion exists. Broadly speaking, these results suggest that contracts that resolve internal adverse selection and moral hazard problems may serve as signaling devices in efficiently resolving information asymmetries with external parties. Next, we show how earnings-based debt covenants and the selection of conservative accounting methods may eliminate signaling costs altogether. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Corporate Finance Elsevier

Management compensation and earnings-based covenants as signaling devices in credit markets

Loading next page...
 
/lp/elsevier/management-compensation-and-earnings-based-covenants-as-signaling-ta2TrBYyST
Publisher
Elsevier
Copyright
Copyright © 2005 Elsevier B.V.
ISSN
0929-1199
D.O.I.
10.1016/j.jcorpfin.2005.08.002
Publisher site
See Article on Publisher Site

Abstract

A firm seeks to raise capital in credit markets to fund risky operating activities. The firm has private information about the future cash flows from such activities. Firm owners delegate operating decisions to a manager who privately learns further information about the distribution of those cash flows subsequent to contracting, but before taking actions. Those actions include the selection of which operating activities to pursue and how much hidden effort to exert. At issue initially after introducing the problem is the efficient design of the manager's compensation as a device for signaling private information to lenders as well as for inducing operating decisions. Our results provide conditions under which a Bayesian Nash separating equilibrium satisfying the Cho–Kreps intuitive criterion exists. Broadly speaking, these results suggest that contracts that resolve internal adverse selection and moral hazard problems may serve as signaling devices in efficiently resolving information asymmetries with external parties. Next, we show how earnings-based debt covenants and the selection of conservative accounting methods may eliminate signaling costs altogether.

Journal

Journal of Corporate FinanceElsevier

Published: Oct 1, 2005

References

You’re reading a free preview. Subscribe to read the entire article.


DeepDyve is your
personal research library

It’s your single place to instantly
discover and read the research
that matters to you.

Enjoy affordable access to
over 18 million articles from more than
15,000 peer-reviewed journals.

All for just $49/month

Explore the DeepDyve Library

Search

Query the DeepDyve database, plus search all of PubMed and Google Scholar seamlessly

Organize

Save any article or search result from DeepDyve, PubMed, and Google Scholar... all in one place.

Access

Get unlimited, online access to over 18 million full-text articles from more than 15,000 scientific journals.

Your journals are on DeepDyve

Read from thousands of the leading scholarly journals from SpringerNature, Elsevier, Wiley-Blackwell, Oxford University Press and more.

All the latest content is available, no embargo periods.

See the journals in your area

DeepDyve

Freelancer

DeepDyve

Pro

Price

FREE

$49/month
$360/year

Save searches from
Google Scholar,
PubMed

Create lists to
organize your research

Export lists, citations

Read DeepDyve articles

Abstract access only

Unlimited access to over
18 million full-text articles

Print

20 pages / month

PDF Discount

20% off