LAUSR

Abstract This study examines the contribution of CEO unobserved heterogeneity to CEO inside debt compensation. Using a three-way fixed effects model, we find that CEO fixed effects explain a majority of the variation in inside debt. The CEO inside debt compensation explained by CEO fixed effects is also positively associated with firm performance, while the distance from the predicted optimal inside debt is unrelated to firm performance. Further, firms appear to adjust inside debt toward their predicted optimums by minimizing year-over-year deviations. Collectively, our findings indicate that inside debt results from optimal-contracting and help align the interests of CEOs with those of debtholders.