Bankruptcy does not happen out of the blue. Most bankruptcies are preceded by several years of financial distress. In this project, I investigate whether CEOs can avoid losses to their personal wealth by early-withdrawing their inside debt when their companies are financially distressed. If they can, then only a small fraction of "inside debt" is left when companies actually go bankrupt. Such a small amount might not be sufficient to encourage CEOs' efforts to protect the companies' liquidation value.
The theoretical incentive effect of inside debt strongly depends on the assumption that this type of compensation can be lost in case of bankruptcy. Empirical studies argue that supplemental retirement benefits generally satisfy this assumption, so these benefits constitute a fair proxy for inside debt. The more retirement benefits that CEOs hold, the more will they lose in case of bankruptcy, thus the more will they try to protect debtholders' value. This argument might no longer hold if CEOs can withdraw their retirement benefits before their companies actually go bankrupt.
One anecdote example of such ``questionable" withdrawals is that of Mesa Air Group Inc. This company filed for Chapter 11 bankruptcy on January 05, 2010. One year before this bankruptcy filing, Mr. Jonathan G. Ornstein - Mesa's CEO - withdrew nearly US$ 2.4 million from his non-qualified deferred compensation plans, leaving only US$ 392,392 in the account. (See "Proxy statement of Mesa Air Group Inc.", SEC EDGAR filing database, accessed on July 2020, link)
Inside debt payment for retired CEOs strongly depends on subsequent firm performance, of which these retired executives have no control. In most bankruptcies, old executives normally lose most of their inside debt, i.e. supplemental and non-qualified retirement benefits. PBGC, if this agency agrees to step out, only covers the qualified benefits, which typically account for less than 10% of the retired executives' total benefits. In a very recent bankruptcy filed by McClatchy Co., the news reveals: "It (McClatchy) has asked the federal government to take over its standard plan, known as qualified pensions. The supplemental pensions are not covered by the government, so the pensioners are asking the bankruptcy judge to force McClatchy or its new owners to honor past promises. But the numbers show the weight of the special pensions on the company's bottom line". (See "McClatchy reveals names of former executives with $118 million in special pension claims", by Kevin G. Hall, accessed in July 2020, link)
Therefore, near-retirement-age CEOs who have large inside debt might choose or try to influence the searching committees to choose successors more carefully. The searching time might be longer than that of the industry norms. These old CEOs might prefer internal successors because they know the working styles and competencies of these candidates. If they have to choose external successors, they will ensure that overconfident candidates or those with "bad-risk" reputations are not selected.
Existing studies on determinants of CEO inside debt-equity structures so far work on a one-period model. Firm characteristics at the beginning affect compensation structures at the end of the period. However, CEO inside debt-equity structures can also affect firms' policies and, thus firm characteristics. Therefore, a dynamic model of how CEO inside debt-equity structures are determined might better explain the observed compensation practices. For example, this dynamic model might be able to explain why 40\% of U.S. public companies do not pay inside debt, despite its effectiveness in reducing the cost of borrowing.