The 2008 financial crisis has left researchers investigating the inefficiencies that prompted the collapse of the credit and investment markets. This study considers the implications of excessive executive pay on capital structure during the years 2005 through 2007. The hypothesis proposes that for firms in the financial sector, executives awarded generous compensation packages compared to salary implemented a higher use of debt in their firm's capital structure. Agency theory, capital structure composition, the Efficient Market Hypothesis, and behavioral finance principles represent key economic theories supporting the hypothesis. The study examines data on 31 firms in the financial sector and 31 firms in the manufacturing sector to empirically test the relationship between executive pay and leverage. Cross-sectional analysis of nine models reveals that compensation is a significant determinant of a firm's total debt-to-total assets ratio for the financial sector, while the manufacturing sector yielded insignificant findings. The results further evidence that within the financial sector, the greatest relationship between compensation and leverage occurred when a one- or two-year lag between executive pay and the debt ratio was in effect. These findings reveal sources of agency conflicts and behavioral biases within the financial sector during the three years preceding the financial collapse.
Bibliography : pages 79-82