CEO Severance Pay and Corporate Tax Planning
54 Pages Posted: 30 Jun 2016 Last revised: 16 Aug 2017
Date Written: August 15, 2017
We examine the association between CEO severance pay (i.e., payment the CEO would receive if s/he is involuntarily terminated) and corporate tax planning activities. We predict and find that CEO severance pay increases corporate tax planning, consistent with CEO severance pay offering contractual protection against managers’ downside risk and thereby inducing otherwise risk-averse managers to engage in reasonable levels of tax planning. Furthermore, CEO severance pay provides stronger tax planning incentives in situations where we expect the downside risk protection provided by severance pay to matter more – when CEOs are more risk averse and when the CEO’s risk of dismissal is higher. Finally, we find that CEO severance pay reduces firms’ cost of equity capital, suggesting that investors perceive that the additional risks managers take, part of which comes from tax planning, reduce agency costs and increase firm value. Overall, our results suggest that CEO severance pay provides tax planning incentives and represents a form of efficient contracting with otherwise risk-averse managers that encourages risk-taking that is value increasing.
Keywords: Corporate Tax Avoidance; CEO Severance Pay; Risk-Taking Incentives
JEL Classification: M4, E62, M52
Suggested Citation: Suggested Citation