Does Ex Ante Severance Pay Affect the Timeliness of Bad News Disclosure? The Role of Managerial Exit Costs
41 Pages Posted: 4 Jul 2016 Last revised: 24 Mar 2020
Date Written: September 16, 2019
Extant literature documents a positive association between ex ante severance pay and timeliness of bad news disclosure, suggesting that the provision of severance pay is consistent with efficient contracting. Relying on an empirically unexplored theory, we investigate whether and how managerial exit costs (i.e., financial and non-financial losses triggered by employment termination) affect the effectiveness of severance pay in curbing bad news withholding. We find that managerial exit costs attenuate the positive association between severance pay and timely disclosure of bad news. Moreover, we document that severance pay does not prompt managers to reveal bad news when their exit costs are sufficiently high (i.e., in the top quartile). This result suggests that exit costs erode the efficacy of ex ante severance pay in curtailing bad news withholding. Overall, our findings support the notion that an “one-size-fits-all” approach to structuring severance agreements undermines the potential of severance pay to benefit investors.
Keywords: ex ante severance pay; disclosure timeliness; managerial exit costs; bad news disclosure; efficient contracting
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