Marital Prenups? A Look at CEO Severance Agreements

49 Pages Posted: 18 Sep 2011 Last revised: 16 Mar 2012

See all articles by Peggy Huang

Peggy Huang

U.S. Securities and Exchange Commission - Division of Economic and Risk Analysis

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Date Written: September 15, 2011

Abstract

Using a hand-collected sample of 5,142 CEO severance agreements of S&P 500 companies between 1993 and 2007, I examine whether and how the existence and structure of severance agreements affect shareholder wealth and the risk-taking behavior of CEOs. I show that firms with severance agreements tend to perform worse than firms without severance agreements. Interestingly, the structure of severance agreements makes a significant difference in performance – firms that have cash-only severance contracts perform worse than firms that also include equity elements in the agreement. In addition, severance agreements encourage CEOs’ risk-taking behavior. Specifically, CEOs with severance contracts overinvest in R&D. The results remain robust after controlling for possible endogeneity through firm- and year-fixed effects, two-stage least square and propensity score matching. In event study analysis, shareholders react negatively when firms award CEOs severance contracts and positively when firms cease to do so. Results indicate that severance agreements, rather than promoting incentive alignment between CEOs and shareholders, actually exacerbate agency problems and cause overinvestment and poor subsequent firm performance.

Suggested Citation

Huang, Peggy, Marital Prenups? A Look at CEO Severance Agreements (September 15, 2011). Midwest Finance Association 2012 Annual Meetings Paper; Sixth Singapore International Conference on Finance 2012 Paper. Available at SSRN: https://ssrn.com/abstract=1928264 or http://dx.doi.org/10.2139/ssrn.1928264

Peggy Huang (Contact Author)

U.S. Securities and Exchange Commission - Division of Economic and Risk Analysis ( email )

United States Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
United States

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