CEO Inside Debt Compensation and European Banks? Default Risk: Evidence from GMM Panel Analysis

This paper examines the impact of chief executive officer (CEO) inside debt compensation on bank default risk by using the two-step system generalised method of moments (GMM). The selected sample features 30 European banks, with 180 observations from 2007 to 2012. Merton?s distance was used as a default model (DD), showing that increased inside debt compensation positively influences bank distance to default. This analysis indicates that debt-like compensation limits bank risk and encourages executives to reduce risk and improve bank stability. Additional further analysis shows that increased CEO inside debt holding is associated with a lower probability of insolvency. These findings support the argument that inside debt compensation is among the more effective tools seeking to align CEO incentives with debtholders? incentives. In this way, it provides empirical support for European regulators and other related responsible parties seeking ways to improve the resilience of European banks.