*2.2. Liability-Based Incentive*

Although there has been a rigorous examination of executives' equity compensation in the literature, the exploration of liability-based compensation remains relatively limited after Jensen and Meckling (1976) first formulated a concept of debt-like compensation. Until recently, Bebchuk and Fried (2004) state that pension and other retirement benefits are considerably large in relation to executives' actual compensation. Sundaram and Yermack (2007) implement one of the first empirical research on debt-like compensations of large U.S. companies' CEOs. They find that when a CEO's incentive leverage (a ratio of liability-based compensation relative to equity-based compensation) exceeds the firm's leverage ratio, CEOs tend to manage firms more conservatively, such as investing on less risky projects, lowering the use of debt capital or choosing long-maturity debt, and trimming dividends payout. An event study by Wei and Yermack (2011) indicates that a wealth

transfer from stockholders to debtholders is associated with the announcements of granting pension and deferred compensation to CEOs. Additional examinations of the impact of CEO pension on firm policies include White (2012), Anantharaman et al. (2014), and Cassell et al. (2012). In particular Cassell et al. (2012) find a negative relationship between pension compensation and the volatility of equity returns, financial leverage or R&D expenditures, but a positive relation between debt compensation and firm diversification or asset liquidity. Anantharaman et al. (2014) find that CEOs' pension incentive is associated with a lower cost of debt financing and fewer restrictive covenants. Moreover, White (2012) examines how pension incentive affects the dividend policy. Overall, studies suggest that pension incentives have a significant influence on discouraging risk taking behavior.

#### *2.3. Hypothesis Development*

As suggested by Sundaram and Yermack (2007), the nature of unsecured and unfunded pension liabilities held by CEOs makes them in line with outside creditors. In other words, CEOs with greater pension benefits are expected to display lower levels of risk-seeking behavior since they are exposed to similar default risk. From risk management literature a well-known benefit of hedging is that hedging smooths firm performance, resulting in lower volatility of net income and cash flows (Smith and Stulz 1985). The probability of bankruptcy or financial distress is considerably higher when a firm's earnings or cash flows are more volatile. As hedging smooths cash flows or/and net incomes, bankruptcy risk will be reduced. Smith and Stulz (1985) suggest that hedging reduces a firm's cash flow volatility and consequently lowers the likelihood of bankruptcy. As a result, we conjecture that firms granting the higher level of pension incentive to CEOs are more likely to engage in hedging activities. Our first hypothesis is formulated as:
