Executive Compensation and Debt Structure of REITs

This paper examines how executives’ compensation structure interacts with firm debt structure, and focuses on how executives’ compensation structure affects firm financing choice between secured debt and unsecured debt. Based on the compensation contracts, executives make corresponding investment and financing decisions for their firms. Therefore, different compensation structures may lead to different firm debt structures. First, a theoretical model is built to analyze the relationship between executive compensation and firm debt structure. Then U.S. equity Real Estate Investment Trust (REIT) data is used to test empirical implications of the model. Results show that when executive pay is more sensitive to firm stock price volatility (also known as V ega), the firm has more secured debt within their capital structure. Evidence also shows interesting links among sensitivity of executive pay to firm stock price (also known as Delta), firm investment, and firm secured debt usage. These findings offer a new perspective on firm collateral use, and provide insight on using executive compensation to mitigate the principal-agent problems between equity shareholders and executives.