The Costs and Benefits of Long-Term CEO Contracts

Abstract

This paper uses a new data set of 3,954 US CEO employment agreements to study their contractual time horizon. Longer contracts offer protection against dismissals: turnover probability increases by 12% each year closer to expiration. This should encourage CEOs to pursue long-term projects, and CEOs with more contractual time indeed invest more. However, because longer contracts make it harder to dismiss managers, they also impose less discipline. Consistent with this argument, CEOs with a longer contractual horizon receive more salary increases. Overall, firm value does not differ across contract types.

Keywords: Underinvestment, investment horizon, CEO contracts, mergers and acquisitions, CEO turnover

JEL Classification: G32, G34, J41, J63