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

Abstract

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

Vladimirov, Vladimir N., Contract Horizon, Severance Pay, and Turnover (June 22, 2018). AFA 2018 Philadelphia Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2862057 or http://dx.doi.org/10.2139/ssrn.2862057

Vladimir N. Vladimirov (Contact Author)

University of Amsterdam Business School ( email )

Roetersstraat 18
Amsterdam, 1018WB
Netherlands

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