CEO Severance Pay and Risk Taking in the Banking Industry

56 Pages Posted: 17 Jan 2011

See all articles by Kareen Brown

Kareen Brown

Brock University

Ranjini Jha

University of Waterloo - School of Accounting and Finance

Parunchana Pacharn

Brock University

Date Written: January 16, 2011

Abstract

We examine 354 CEO severance contracts relating to 138 S&P 500 firms from the banking sector during the period 2002-2008 to study the impact of severance agreements on risk-taking in the banking sector. We find that the existence of severance contracts induces risk-taking as measured by total and idiosyncratic return volatility and encourages excessive risk-taking as measured by the default likelihood, after controlling for CEO pay-performance sensitivity (delta) and the sensitivity of CEO compensation to stock return volatility (vega). We also report a positive association between changes in firm-level risk (and the default likelihood) and the existence of a severance contract. Third, we show a significant positive contemporaneous and causal relation between the amount of severance pay and conventional and excessive risk-taking after controlling for the incentive effects of cash and equity-based compensation. Finally, our results are robust when we control for self-selection bias and endogeneity issues. Our results support the risk-shifting argument and suggest that severance agreements induced excessive risk-taking in the banking sector and provide support for recently enacted reforms on severance pay.

Keywords: Managerial compensation, Severance pay, Risk Taking

JEL Classification: G32, G34

Suggested Citation

Brown, Kareen and Jha, Ranjini and Pacharn, Parunchana, CEO Severance Pay and Risk Taking in the Banking Industry (January 16, 2011). CAAA Annual Conference 2011, Available at SSRN: https://ssrn.com/abstract=1741961 or http://dx.doi.org/10.2139/ssrn.1741961

Kareen Brown (Contact Author)

Brock University ( email )

500 Glenridge Avenue
St. Catherines, Ontario L2S 3A1
Canada

Ranjini Jha

University of Waterloo - School of Accounting and Finance ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1 N2L 3G1
Canada

Parunchana Pacharn

Brock University ( email )

500 Glenridge Avenue
St. Catherines, Ontario L2S 3A1
Canada

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