New Active Blockholders and the Adjustments of CEO Inside Debt-Equity Ratios

Abstract

Do 13D investors incentivize CEOs to increase total firm value or to increase only equity value? By using the hand-collected data of 5,775 U.S. public companies between 2006 and 2017, my paper documents evidence that these active blockholders restructure CEO compensation in a way that benefits both shareholders and debtholders, thus increasing total firm value. Active blockholders are more like to arise when the ratios between CEO debt-like and equity-like compensations, a.k.a. the CEO inside debt-equity ratios, are not properly set up to maximize firm value. The speed of adjustment towards the appropriate ratios triples in the presence of active blockholders, but returns to the normal level once these investors ``exit". Such compensation adjustments are associated with annualized abnormal stock (bond) returns of 9.2\% (2.3\%). Superb stock-picking skill, a mean-reverting process of compensation changes, or co-founding firm characteristics cannot explain the coincidence of strong compensation adjustments and active blockholders' presence. Instead, these blockholders actively affect CEO compensation structures by appointing their favored directors into the boards of the targeted firms, especially into the Compensation or Governance committees.

Keywords: Blockholders, CEO Compensation, Inside Debt, Agency Cost of Debt

JEL Classification: G14, G23, G32, G34, M12