Two essays on incentives

I examine two sets of incentives faced by corporate CEOs to determine how they respond to those incentives. I compare firms that restate financial statements to firms that do not restate to test the hypotheses that bank monitoring should provide incentives to deter misreporting. For relatively less (more) severe misreporting, I find the likelihood of misreporting is positively related (unrelated) to bank borrowing, and that ex ante changes in bank debt are positive (unrelated) for misreporting firms versus control firms. These results suggest that bank monitoring is insufficient to deter or detect misreporting, rather that it may provide incentives for managers to engage in relatively less severe misreporting, consistent with the "debt covenant hypothesis". I next examine the incentives that CEOs have to increase firm value that result from their compensation packages and opportunities for advancement in the managerial labor market. Traditional methods for estimating pay-performance sensitivity exclude incentives that derive from opportunities for advancement in the managerial labor market and assume a linear relation between changes in pay and changes in performance. But results in recent literature imply that advancement opportunities may be a significant source of incentives and that the relation between changes in pay and changes in performance may depend upon the level of performance. I estimate payperformance sensitivities that incorporate these results. I find that although performance may be positively related to opportunities for advancement, the contribution to a CEO's total pay-performance sensitivity is too small to be economically significant. I also find that pay-performance sensitivities vary depending on the level of performance and may be higher or lower than estimates from linear models suggest. In sum, observed CEO pay packages may not be as suboptimal as some prior studies suggest.