Contract Horizon, Severance Pay, and Turnover
AFA 2018 Philadelphia Meetings Paper
53 Pages Posted: 1 Nov 2016 Last revised: 27 Jun 2018
Date Written: June 22, 2018
Firm executives are often hired with renewable fixed-term contracts. This paper asks why and what determines the length of such contracts. The paper develops a model in which the fit between a firm and its managers changes over time. Stipulating severance pay for premature dismissal in a given period mitigates managers' incentives to conceal a deteriorating fit but increases these incentives in preceding periods. By optimally choosing the length of renewable fixed-term contracts, boards can manage the use and effectiveness of severance pay. The relation between contract length, severance pay, and managers' outside options helps explain several puzzling stylized facts.
Keywords: contract length, contract horizon, severance pay, voluntary and forced turnover, renewable fixed-term contracts, asymmetric information
JEL Classification: G30, G34, D82
Suggested Citation: Suggested Citation