Severance Agreements and the Cost of Debt

44 Pages Posted: 20 May 2017  

Sattar Mansi

Virginia Tech

John K. Wald

University of Texas at San Antonio

Andrew (Jianzhong) Zhang

University of Nevada, Las Vegas - Department of Finance

Date Written: July 26, 2016

Abstract

Upon examining the language used in recent SEC filings, we find that severance agreements are often paid whether or not the CEO leaves the firm due to a change in control. We hypothesize that since severance agreements compensate CEOs in the event of termination, CEOs with these agreements will have an incentive to increase firm risk and decrease effort. Consistent with this hypothesis, we document a significant positive relation between the use of severance agreements and the cost of debt (10% higher yield spreads for firms with severance agreements). The results hold after controlling for the probability of takeover, the probability of CEO turnover, and whether the firm has investment or non-investment grade debt. These results can be explained by an increase in firm risk and a higher likelihood of CEO turnover associated with severance agreements. Overall, the evidence suggests that the effects of severance agreements extend beyond takeovers, and that these additional implications are primarily negative for the firm and for debt holders in particular.

Keywords: Severance agreements, cost of debt, takeover probability, firm risk, CEO turnover

JEL Classification: G32, G34, G38, K22

Suggested Citation

Mansi, Sattar and Wald, John K. and Zhang, Andrew (Jianzhong), Severance Agreements and the Cost of Debt (July 26, 2016). Available at SSRN: https://ssrn.com/abstract=2228300 or http://dx.doi.org/10.2139/ssrn.2228300

John K. Wald

University of Texas at San Antonio ( email )

1 UTSA Circle
San Antonio, TX 78249
United States
210-458-6324 (Phone)

Andrew (Jianzhong) Zhang

University of Nevada, Las Vegas - Department of Finance ( email )

4505 S. Maryland Parkway
Box 456008
Las Vegas, NV 89154-6008
United States

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