Paying for Performance in Bankruptcy: Why CEOs Should be Compensated with Debt

Abstract

While managerial performance always plays a critical role in determining firm performance, a manager's importance is elevated during bankruptcy. A manager in bankruptcy both runs the firm and helps form a plan of reorganization. In light of this critical role, one would expect that bankruptcy scholarship would place considerable emphasis on the role of CEO compensation in incentivizing managerial performance in bankruptcy; however, the opposite is true. Bankruptcy scholars and practitioners tend to emphasize other levers of corporate governance, such as the role of debtor-in-possession financiers, rather than the importance of CEO compensation. This Article seeks to revive CEO compensation as an important governance lever in bankruptcy. First, the Article examines current ideas and practices of managerial compensation in bankruptcy and finds them wanting. The Article next proposes a novel bankruptcy compensation plan-debt compensation-that provides better incentives for managers to perform efficiently. By granting managers a fixed proportion of unsecured debt in the bankrupt firm, debt compensation creates valueenhancing incentives similar to the incentives created by the stock grants and stock options that are heavily employed by solvent firms to compensate managers.