Golden Parachutes, Severance and Firm Value

Abstract

Golden parachutes (“GPs”) are now standard contract provisions for public company CEOs. While they have become ubiquitous, they have also been severely criticized for harming shareholder value. As a result, GPs have been subjected to intense shareholder activism and uniquely penalized under both tax and securities law. Recent empirical work has suggested that they may indeed be associated with poor firm performance, confirming the steps taken to reduce or eliminate GPs.

This article offers reasons to rethink the consensus that has developed around GPs. First, we highlight a substantial endogeneity problem that earlier studies that link GPs and firm value fail to fully answer. Second, our novel empirical analysis suggests that the earlier evidence linking GPs with lower firm values is not robust to the use of more recent data and may have been driven by the omission of complete data regarding regular severance promises. It may be that regular severance promises rather than GPs drive poor performance and past results to the contrary are likely based on incomplete data in prior periods. These findings comport with a set of relatively uncontroversial arguments for severance’s dominance over GPs when it comes to shaping CEO incentives. Taken together, this suggests that GPs ought not to be singled out by law or market participants as uniquely problematic.

Keywords: Golden Parachute, Executive Compensation, Severance, Corporate Governance, Acquisitions, Takeovers, Agency Costs, Tobin’s Q, Dodd-Frank

JEL Classification: D23, G34, G38, J33, J44, K22, M52