The Contract Year Phenomenon in the Corner Office: An Analysis of Firm Behavior During CEO Contract Renewals

32 Pages Posted: 11 May 2014 Last revised: 14 Aug 2019

See all articles by Ping Liu

Ping Liu

Krannert School of Management, Purdue University

Yuhai Xuan

University of California, Irvine - Paul Merage School of Business

Date Written: August 3, 2019

Abstract

This paper investigates how executive employment contracts influence corporate financial policies during the final year of the contract term, using a new, hand-collected data set of CEO employment agreements. On the one hand, the impending expiration of fixed-term employment contracts creates incentives for CEOs to engage in strategic window-dressing activities. We find that, compared to normal periods, CEOs manage earnings more aggressively when they are in the process of contract renegotiations. Correspondingly, during CEO contract renewal times, firms are more likely to report earnings that meet or narrowly beat analyst consensus forecasts. Moreover, CEOs also reduce the amount of negative firm news released during their contract negotiation years. On the other hand, we find that merger and acquisition deals announced during the contract renegotiation year yield higher announcement returns than deals announced during other periods, suggesting that the upcoming contract expiration and renewal can also have disciplinary effects on potential value-destroying behaviors of CEOs. In addition, we show that firms whose CEOs are not subject to contract renewal pressure do not experience such corporate policy changes and that CEOs who engage in manipulation during contract renewal obtain better employment terms in their new contracts, in terms of contract length, severance payment, and salary and bonus. Overall, our results indicate that job uncertainty created by expiring employment contracts induces changes in managerial behaviors that have significant impacts on firm financial activities and outcomes.

Suggested Citation

Liu, Ping and Xuan, Yuhai, The Contract Year Phenomenon in the Corner Office: An Analysis of Firm Behavior During CEO Contract Renewals (August 3, 2019). Available at SSRN: https://ssrn.com/abstract=2435292 or http://dx.doi.org/10.2139/ssrn.2435292

Ping Liu

Krannert School of Management, Purdue University ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States
7654944691 (Phone)

Yuhai Xuan (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

4291 Pereira Drive
Irvine, CA California 92697-3125
United States

HOME PAGE: http://yuhai.merage.uci.edu/

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