Secured debt and managerial incentives
Michael J. Alderson
Brian L. Betker
Published online: 9 May 2013
Ó Springer Science+Business Media New York 2013
Abstract Financial theory holds that ﬁrms can control agency costs through the use of
short-term and secured debt. We examine the relation between the use of secured debt and
the incentive of the manager to increase the risk of the ﬁrm, as measured by vega. We ﬁnd
that ﬁrms utilize secured debt to a lesser extent when managerial volatility sensitivity is
higher. Our results suggest that these same ﬁrms employ short-term debt as the primary
tool to control risk-shifting. Managers with a high risk appetite avoid secured debt, but
appear to do so without compromising the interests of the shareholders.
Keywords Secured debt Á Managerial incentives Á Executive compensation Á
JEL Classiﬁcation G30 Á G32
Finance theory demonstrates that agency costs generated by risk-shifting can be controlled
through the use of either short-term or secured debt. Short-term debt mitigates agency costs
by providing lenders with the means to defund harmful investment policies (Barnea et al.
1980; Rajan and Winton 1995; Leland and Toft 1996). Secured debt limits the incentive of
the manager to increase ﬁrm risk because its valuation characteristics restrict the potential
for wealth expropriation (Stulz and Johnson 1985). Brockman et al. (2010) demonstrate
that ﬁrms employ more short-term debt when the CEO has a greater incentive to increase
the risk of the ﬁrm. The purpose of this paper is to explore whether ﬁrms employ secured
debt in a similar fashion. Our ﬁndings suggest that they do not.
In their seminal article ‘‘An Analysis of Secured Debt,’’ Stulz and Johnson (1985)
identify two central functions for the role of secured debt in corporate capital structures.
They demonstrate that managers can increase the value of the ﬁrm by ﬁnancing new
M. J. Alderson Á N. Bansal Á B. L. Betker (&)
Department of Finance, Saint Louis University, 3674 Lindell Boulevard, St. Louis, MO 63108, USA
Rev Quant Finan Acc (2014) 43:423–440