Getting Rich By Getting Fired? An Analysis of Severance Pay Contracts

Abstract:     
We analyze a sample of over 2,000 severance pay agreements in place at 862 firms to examine whether severance agreements are designed to reduce managerial human capital risk or whether they merely reflect managerial power in setting their own pay. We find that severance pay increases with the riskiness of a firm's business. This relation is especially strong for firms with a high degree of idiosyncratic risk - small firms and firms in industries with a high risk of takeover. The CEO is also granted higher severance pay in firms with higher institutional ownership. Severance pay is significantly higher when termination results from a change of control and the change-in-control (CIC) clause is more likely to be used by firms with a high institutional ownership when the contracting executive is the CEO or Chairman. Our results are largely consistent with the risk compensation hypothesis, and inconsistent with the managerial rent extraction hypothesis.

Keywords: Managerial compensation, Severance pay

JEL Classifications: G32, G34

Working Paper Series