Marital Prenups? A Look at CEO Severance Agreements
49 Pages Posted: 18 Sep 2011 Last revised: 16 Mar 2012
Date Written: September 15, 2011
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.
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