Agency Cost of Debt and Inside Debt: The Role of CEO Overconfidence

Abstract

This study extends our understanding of CEO inside debt compensation under an agency problem perspective by considering the impact of a behavioural trait, namely CEO overconfidence. Using a sample of US firms in Standard & Poor's ExecuComp for the period 2006–2019, we find that overconfident CEOs exhibit greater inside debt incentives (i.e. incentives arising from defined-benefit pensions and deferred compensation). This relationship is more pronounced among firms with higher CEO overconfidence-induced agency cost of debt (e.g. financially unconstrained firms) managed by CEOs who are less able to align compensation with their own preferences (e.g. less powerful CEOs). The results are robust to endogeneity, self-selection concerns and alternative explanations. We contribute to the inside compensation literature that deals with agency problems under overconfident CEOs, and optimal contracting and managerial power theories.