Contract Horizon, Severance Pay, and Turnover

AFA 2018 Philadelphia Meetings Paper

61 Pages Posted: 1 Nov 2016 Last revised: 24 Apr 2019

See all articles by Vladimir Vladimirov

Vladimir Vladimirov

University of Amsterdam Business School

Date Written: April 22, 2019

Abstract

Renewable fixed-term contracts are wide-spread in executive compensation. This paper analyzes why these contracts are optimal and what determines their length. When managers' match-quality changes over time, offering severance pay for premature dismissal can discourage managers with deteriorating match-quality from window dressing to avoid dismissal. However, to be effective, severance pay must increase with the contract's length. Thus, the trade-off is that shorter contracts help economize on severance pay during a contract's term, but can lead to more window dressing close to its end/renewal when dismissal is cheap. Evidence from CEO contracts supports the predicted determinants of contract length.

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, Contract Horizon, Severance Pay, and Turnover (April 22, 2019). AFA 2018 Philadelphia Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2862057 or http://dx.doi.org/10.2139/ssrn.2862057

Vladimir Vladimirov (Contact Author)

University of Amsterdam Business School ( email )

Roetersstraat 18
Amsterdam, 1018WB
Netherlands

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