Essays on managerial incentive compensation and manager-shareholder-bondholder conflicts

The essays investigate the agency problem and governance issues in the corporate world. Chapter 1 exams the governance implications of a firm's capital structure and managerial incentive compensation and the substitutability of these two mechanisms in controlling the free cash flow problem. I show in a nonlinear simultaneous framework that the devices indeed curb overinvestment; and they act as substitutes in addressing this agency concern. In addition, incorporating this endogenous relation turns out to be economically important and leads to a much more meaningful governance effects of both debt and incentive compensation on overinvestment. Chapter 2 further relates capital structure and incentive compensation focusing on all-equity firms. Managerial risk-taking incentives may encourage financial risk taking hence greater leverage. On the other hand, increasing a manager's incentive to take risk increases the agency cost of debt and therefore lowers debt capacity. I provide empirical evidence supporting the second effect in all-equity firms where the potential asset substitution is more severe hence the agency cost of debt effect dominates. The incentive compensation in all-equity firms encourages greater investment risk taking than that used by levered firms, suggesting managers in all-equity firms seek to capture the benefit of risk-taking mainly through investment when financing risk-taking is not an option. In addition, equity-based compensation and incentives decrease upon firms' switching to levered firms from all-equity firms, indicating the change of compensation structure is associated with the change of capital structure. The last chapter explores the wealth effects to stockholders and bondholders of first time option and restricted stock grants to CEOs. The event study reveals large positive stock price reactions and large negative bond price reactions. Moreover the wealth effects are associated with the risk-taking characteristics of the grant showing direct evidence of the link between the incentives arising from compensation structure and the value of the firm's debt and equity claims.