Deferred compensation withdrawal decisions and their implications on inside debt

Deferred compensation constitutes a significant portion of inside debt. Unlike pension plans, deferred compensation can be vested before retirement. If entrenched CEOs take advantage of this attribute of deferred compensation and withdraw it when the firm is in financial distress, the beneficial roles of deferred compensation as a tool for aligning the CEO's interests with those of debtholders are undermined. Moreover, there would be a need to reexamine existing empirical studies in this area which obtain the amount of inside debt by simply adding the monetary value of pension and deferred compensation. This study examines whether deferred compensation can serve as inside debt in real world practices. Using a large sample of S&P 1,500 firms, I find that entrenched CEOs tend to restrict the decision of deferred compensation withdrawal in order to protect debtholders’ value when a firm's distress risk is significant. Therefore, deferred compensation serves as an important alignment role with debtholders in spite of the existence of withdrawal flexibility.