Promoting the Quiet Life or Risk-Taking? CEO Severance Contracts and
Managerial Decision-Making†
Chris Muscarella a, Jing Zhao b
a
Smeal College of Business, Pennsylvania State University, University Park, PA 16801, USA
Poole College of Management, North Carolina State University, Raleigh, NC 27695, USA
b
November, 2012
†
We wish to thank Charles Knoeber and David Yermack (AFA Discussant) for many helpful comments and
suggestions. We also appreciate helpful comments from Martin Boyer, Pierre Chaigneau (NFA Discussant), Michael
Cichello, Bartley Danielsen, Brian Du (FMA Discussant), Laura Field, Jasmin Gider (EFA Discussant), Bob
Hammond, Robert Kieschnick, Srini Krishnamurthy, Michelle Lowry, Karlyn Mitchell, Thayer Morrill, Walter
Thurman, Mark Walker, Richard Warr, and seminar participants at North Carolina State University, the 2011
Financial Management Association (FMA) Annual Meetings, the 2012 American Finance Association (AFA)
Annual Meetings, the 2012 Eastern Finance Association (EFA) Annual Meetings, and the 2012 Northern Finance
Association (NFA) Annual Meetings. Jing Zhao gratefully acknowledges research support from the Faculty
Research and Professional Development Grant (FRPD) at North Carolina State University.
E-mail addresses: [email protected] (C. Muscarella), [email protected] (J. Zhao).
Promoting the Quiet Life or Risk-Taking? CEO Severance Contracts and
Managerial Decision-Making
Abstract
Do ex-ante CEO severance contracts induce managerial shirking or valuable risk-taking? We
develop competing hypotheses within a principal-agent framework that considers severance
contracts as part of the incentive mechanisms employed by risk-neutral shareholders to monitor
and motivate managers who are risk-averse, and connect severance contracts with subsequent
managerial decision-making and firm value. We incorporate the dual roles of severance
agreements in the model: offering the manager a severance contract reduces managerial costs of
shirking while simultaneously decreasing the manager’s private costs of risk-taking. Using a
unique dataset on S&P 500 CEO severance agreements between 1992 and 2010, we empirically
examine the impact of ex-ante severance contracts on managerial investment, risk-taking, and
firm value. We find that firms with a CEO severance contract spend less on both discretionary
expenses including R&D, advertising, and SG&A, and capital expenditures and PP&E than their
peers without a contract, thereby hindering patent innovation and R&D efficiency. CEOs with
severance contracts are also more likely to seek less risk retaining larger employee count relative
to asset base or sales, lower leverage, and more industry but less international geographic
diversification, leading to lower future stock return volatilities relative to industry peers.
Subsequently, these firms suffer substantial declines in shareholder value, operating performance
and abnormal stock returns. This negative value effect of severance contracts, however, is
remarkably reduced in firms with stronger governance, greater growth opportunities, higher risk,
and in more competitive industries. Collectively, our findings suggest that severance agreements,
rather than motivating mangers towards risky but value-increasing decisions, reduce discipline,
induce managerial shirking and destroy shareholder value.
JEL Classification: G31; G32; G34; J33
Keywords: CEO severance agreement, Executive compensation; Shirking; Risk-taking;
Innovation
1. Introduction
Executive severance contracts, also referred to as “golden handshakes”, are usually
entered into at the time of an executive’s appointment and often entail multi-million dollar
payouts to managers upon job termination, e.g., following poor performance. As an example,
Hank McKinnell, the former CEO and Chairman of Pfizer, was ousted in July 2006 with an exit
pay of $200 million pursuant to his severance agreement. During Mr. McKinnell’s tenure as
CEO since 2001, Pfizer stock dropped more than 40%, whereas the S&P 500 index increased by
2%. Similarly, Robert Nardelli, the former CEO of Home Depot, was ousted in January 2007
with a $210 million severance package under his contract, despite the underperformance of
Home Depot relative to its industry peers.1 Shareholder activists, regulators and the media have
thus criticized executive severance agreements as “pay for failure”. A few recent high-profile
cases of separation pay have even triggered questioning from Congress. For instance, in
February 2008, upon being forced out subsequent to billions in subprime mortgage-related
losses, Charles Prince, former Citigroup Chairman and CEO, and Stanley O’Neal, former Chair
and CEO of Merrill Lynch, were requested to testify before the Congress regarding their
lucrative severance packages estimated at $150 million and $160 million respectively.2
While the actual ex post separation payment seems to contradict the pay-for-performance
paradigm, it is unknown whether ex ante these contracts are in the best interests of shareholders
when entered. Indeed, firms and compensation consultants often claim that severance contracts
are beneficial to shareholders because these agreements "help attract key talent and retain leaders
by mitigating their concerns about financial hardship in the event of termination,"3 and "help to
1
Appendix I summarizes the terms of severance agreements between these executives and their employers.
Los Angeles Times, 1/15/2008, pg. C.4.
3
Global Crossing Ltd. 2011 Proxy Statement.
2
1
secure the continued employment and dedication of our NEOs [named executive officers],
notwithstanding any concern that they might have regarding their own continued employment."4
These agreements may also align managerial interests with shareholders and encourage
appropriate risk-taking by "protect[ing] our named executives against circumstances over which
they have no control."5
In this paper we investigate whether and how ex-ante severance contracts influence
managerial investment decisions, risk-taking, and firm performance. Contrasting views have
been developed in the literature. The quiet life hypothesis suggests that severance contracts
shelter underperforming managers from the discipline of the market for corporate control as well
as internal governance mechanisms by increasing the costs of dismissal.6 Managers under
reduced discipline are more likely to shirk, or prefer a quiet life and avoid costly efforts. For
example, they may forgo some positive net present value (NPV) projects in order to avoid
private costs of effort and risk-taking, such as research and development investment (R&D),
capital expenditures, and technological innovations (Bertrand and Mullainathan (2003),
Atanassov (2012)). Subsequently firm profitability and productivity deteriorate (Bertrand and
Mullainathan (2003)). The quiet life hypothesis thus predicts that severance contracts induce
sub-optimal investment and inadequate risk-taking, leading to shareholder wealth reduction.
In contrast, several theoretical studies suggest that severance contracts can align the
interests and horizons of managers with shareholders, and lead to value-increasing decisions.
Notably, Almazan and Suarez (2003) show that severance contracts discourage the board from
changing CEOs too frequently. The lower probability of being replaced encourages managers to
4
Allied Waste Industries, Inc. 2008 Proxy Statement.
Ceridian Corp 2009 10-K.
6
The "quiet life" terminology comes from Hicks (1935), which states "The best of all monopoly profits is a quiet
life".
5
2
take personally costly, but shareholder value-increasing actions they might otherwise avoid.
Likewise, Berkovitch, Israel, and Spiegel (2000), Ju, Leland, and Senbet (2004), and Inderst and
Mueller (2005) posit that severance agreements provide insurance to CEOs on the downside and
induce risk averse managers to take on risk, thereby creating shareholder value. Narayanan
(1985), Knoeber (1986), and Stein (1988, 1989) suggest that severance contracts protect
managers in the adverse event of takeovers and dismissals, thus improving managerial incentives
for long-term, risky, but positive NPV projects they might otherwise forgo. Finally, Manso
(2011) postulates that severance contracts promote innovation by enhancing tolerance for early
failure and reward for long-term success. This stream of literature predicts that severance
agreements motivate managers toward risky and value-increasing decisions.
To disentangle these two opposing incentive effects, we develop a principal-agent
framework to advance our hypotheses. We consider severance contracts as part of the incentive
mechanisms employed by risk-neutral shareholders to monitor and motivate managers who are
risk-averse, and relate those severance contracts with subsequent managerial decision-making
and firm value. We incorporate the dual roles of severance agreements: offering the manager a
severance contract reduces managerial costs of shirking while simultaneously decreasing the
manager’s private costs or disutility of taking risk (or equivalently, increasing the reward for
risk-taking). Managerial incentives are determined in equilibrium by the disutility associated
with taking risk, the private benefits of shirking, and pay structure. Accordingly, the model
predicts that: (1) severance contracts increase managerial shirking due to attenuated costs
associated with shirking; (2) severance contracts induce managerial risk-taking as the disutility
of risk-taking is mitigated; (3) severance contracts are positively (negatively) related to incentive
3
(fixed) pay; and (4) firm value decreases (increases) as the incentive for shirking (risk-taking)
dominates.
Note that the two opposing incentive effects of severance agreements are not mutually
exclusive, hence it is an empirical question as to which effect is born out in the data. Using a
unique hand-collected data on S&P 500 CEO severance agreements during 1992-2010, we find
evidence consistent with the quiet life hypothesis. Specifically, CEOs with a severance contract
spend less in discretionary expenditures including R&D, advertising, and selling, general and
administrative expenses (SG&A), capital expenditures, and PP&E investments. Consequently,
severance contracts appear to stifle corporate innovation as measured by the number of patents
filed and ultimately granted, the future citations of patents, patent generality and originality, and
R&D efficiency. Further, CEOs with a severance contract tend to avoid difficult decisions
associated with cutting the employee base and downsizing, thereby maintaining larger employee
count relative to firm assets or revenue. CEOs with a severance contract also engage in corporate
policies that decrease firm risk via reducing leverage and diversifying firm operations across
industries but increasing international geographic focus across countries, leading to lower future
stock return volatility. Subsequently, these firms suffer substantial shareholder value loss, and
experience inferior operating and stock return performance than firms without a contract.
We also find that CEOs with a severance contract have larger incentive pay but smaller
fixed pay, suggesting that by enhancing the pay-for-performance sensitivity, the board attempts
to mitigate (but cannot fully counteract) the shirking incentive provided by severance contracts.
Finally, subsample analysis shows that the negative value impact of severance contracts
disappear in firms with stronger corporate governance, high growth potential, greater risk and
uncertainty, and in more competitive industries, indicating the critical role of internal and
4
external governance mechanisms in aligning managerial incentives with shareholders and
reducing managerial slack. Taken together, our findings suggest that severance contracts protect
managers from internal and external discipline and induce managerial shirking, leading to
shareholder value reduction.
Our results are robust after controlling for the endogenous nature of CEO severance
agreements. Largely consistent with severance agreements being used to protect CEO human
capital against downside risk, we first document that a CEO severance contract is more likely
when the firm is more vulnerable to takeovers, has recently underperformed, has more growth
options, larger past stock return volatility, greater institutional ownership; and when the CEO is
less powerful (recruited from outside the firm), or less experienced (shorter tenure), and thus
more risk averse. In light of the possible endogeneity between CEO severance contracts and
managerial decision-making, we adopt an instrumental variable/two stage least squares
regression design (IV/2SLS). We use two instruments for severance contracts that satisfy both
the relevance and exclusion criteria: an indicator variable for whether the current CEO's
predecessor has a severance contract, and the annual percentage of S&P 500 CEOs in the same
two-digit SIC industry that have a severance contract. Results remain unchanged if we employ
an additional instrument, i.e., the annual percentage of S&P 500 CEOs of firms headquartered in
the same state. Our choice of instrumental variables are motivated by prior literature (Rau and
Xu (2010), Bizjak, Lemmon, and Naveen (2008)), which suggests that a CEO is more likely to
have a contract if her predecessor had one or if her industry and local peers have one. There is no
obvious reason, however, as to why these variables are directly related to future firm policies and
performance other than through the impact of a severance contract.
5
Our results are robust to alternative explanations. To the extent that severance contracts
tend to be granted to outside hires in poorly-performing firms, it is possible that these contracts
may be offered to provide CEOs with incentives to "dress the firm up for sale", which is
consistent with cutting discretionary expenditures to enhance current earnings. 7 If our results are
primarily driven by this effect, then new CEOs with a severance contract, especially those
recruited from outside the firm, should exhibit a higher probability of their firms being taken
over and delisted from CRSP. We find that neither new CEOs, nor new outside CEOs, with a
severance contract are associated with a larger probability of their firms being taken over than
their counterparts in various comparison groups over one to three years in the future, suggesting
that our findings are not primarily driven by the "dressing up for sale" hypothesis. Our results are
also robust to different model specifications, various variable definitions, alternative control and
instrumental variables, the inclusion of industry, firm and executive fixed effects, and the
deletion of final partial year stock returns for delisted firms.
Our study makes several important contributions. First, given the extraordinary public
attention and outrage surrounding the events of executive termination pay following disastrous
corporate failures during the recent financial crisis; practitioners, investors and regulators have
called for a further understanding of the interaction between executive severance pay, board
governance, and managerial incentives. While some studies maintain that CEO compensation
contracts result from an efficient bargaining process between executives and the board and help
align managerial interests with shareholders (Murphy (2003), Murphy and Zábojník (2004)),
others suggest that severance contracts merely reflect CEO power over captive boards and
facilitate managerial entrenchment (Bebchuk, Fried, and Walker (2003)). The empirical results in
7
We thank David Yermack for suggesting this alternative interpretation.
6
this paper provide further insight into the efficacy of current compensation processes and the
effectiveness of board monitoring.
Second, we contribute to an emerging empirical literature that investigates the
characteristics of executive severance contracts and their impacts on managerial behavior.
Despite a vast literature on “golden parachutes”, which is compensation received by departing
executives whose firms are acquired (see Lambert and Larcker (1985), Lefanowicz, Robinson,
and Smith (2000), Agrawal and Walkling (1994), Agrawal and Knoeber (1998), and Hartzell,
Ofek, and Yermack (2004), among others), empirical studies on severance contracts are scant.
Yermack (2006b) examines ex-post actual separation payment to departing CEOs of Fortune 500
firms, and finds that consistent with efficient contracting, separation pay provides insurance for
the CEOs’ human capital and facilitates smooth transition between managers. Since these
payments are negotiated ex-post, they might have entirely different incentive implications for
managers than ex-ante severance agreements. Rusticus (2006), Rau and Xu (2010) and Gillan,
Hartzell, and Parrino (2009) find that severance or explicit employment agreements are more
likely to be used when the uncertainty about managerial ability is higher, the firm’s operating
environment is riskier, and managerial investment in human capital is more costly, suggesting
that these contracts are offered to protect managers for their human capital or from postcontractual opportunism. Sletten and Lys (2006), Huang (2011) and Cadman, Campbell, and
Klasa (2011) analyze the relation between severance contracts and firm risk in general, whereas
Brown, Jha, and Pacharn (2011) focus on the financial industry. Goldman and Huang (2010)
examine the difference between ex ante contractual and ex post actual separation pay following
CEO departure, and Zhao (2009) studies the effects of acquiring CEO employment contracts on
acquirer profitability and risk-taking in takeovers. While extant work provides important
7
implications on the characteristics of severance contracts and their determinants, and on the
association between these contracts and managerial behavior in certain industries or around
major corporate events, an attempt is still lacking to understand whether and how these contracts
in general affect managerial decision-making, corporate investment and financial policies, and
firm risk and performance. We aim to fill some of this gap in the literature.
In so doing, we also extend prior research examining the differential incentive effects of
various elements of CEO pay in an endeavor to seek the optimal compensation structure. To
date, the vast majority of this work has focused primarily on the effects of equity holdings on
managerial effort and risk-taking (see Murphy (1999), Guay (1999), Coles, Daniel, and Naveen
(2006), and Low (2009), to name a few). A nascent stream of research investigates the role of
managerial inside debt holdings (pension benefits and deferred compensation) in aligning
managers' incentives with debt holders (see, e.g., Jensen and Meckling (1976), Sundaram and
Yermack (2007), Edmans and Liu (2010), Anantharaman, Fang, and Gong (2010), Wei and
Yermack (2011), and Cassell et al. (2012)).8 We extend this line of work in that we explore the
ex ante incentive implications of contractual pay to CEOs upon dismissal, a much more common
and frequent corporate event than bankruptcy and less predictable than retirement; and that
contractual severance is not guaranteed (even in solvency) but typically contingent upon the type
of CEO departure rather than firm performance. Thus, our study sheds new lights on the
importance of individual components of CEO compensation in incentive alignment, and provides
implications beyond those explored in prior work.
8
Inside debt holdings are typically unsecured and unfunded (fixed) obligations of the firm, thus exposing the CEO
to insolvency risk similar to that faced by outside creditors. The overall evidence from this literature suggests that
consistent with the theoretical predictions (Jensen and Meckling (1976), Edmans and Liu (2011)), inside debt
holdings strengthen the alignment of CEO and debt holder incentives, reduce firm risk through more conservative
investment and financial policies, and result in a possible transfer of value from equity to debt holders.
8
Finally, this paper contributes to the earnings management and managerial myopia
literature. In particular, we examine discretionary expenditures, patent innovation, and R&D
efficiency because previous work shows that managers cut discretionary investments to meet
short-term earnings goals (Dechow and Sloan (1991), Roychowdhury (2006), and Barber,
Fairfield and Haggard (1991)). Generally Accepted Accounting Principles (GAAP) require
investments in intangible assets, such as R&D and advertising, to be expensed when incurred,
whereas the expected payoffs will not be recognized until realized. As such, managers whose pay
and future career are tied to current earnings or stock performance can enhance their labor
market reputation and short-term pay by cutting these expenditures (Dechow and Sloan (1991)).9
Our study sheds new light on whether severance contracts mitigate this myopic underinvestment.
The remainder of the paper proceeds as follows. In section 2 we develop the theoretical
link between severance contracts, managerial shirking, risk-taking, and firm value, and advance
our hypotheses. Section 3 provides an institutional background on CEO severance agreements,
and describes the data and variable construction. Section 4 contains research methodology,
empirical results, alternative explanations and robustness tests. Finally, Section 5 provides a
summary and conclusion.
2. Hypothesis Development
In this section, we develop a theoretical link that relates CEO severance agreements to
managerial shirking, risk-taking and firm value; and advance testable hypotheses. We consider a
traditional principal-agent framework in which shareholders employ a manager as their agent to
9
Indeed, a survey of 401 U.S. CFO’s reports that managers believe the labor market evaluates their capability based
on short-run stock prices and admit to sacrificing long-term value-increasing projects, such as R&D, to boost current
earnings (Graham, Harvey, and Rajgopal (2005)).
9
make decisions on resource allocation within the firm. The manager is risk-averse due to her
under-diversified wealth portfolio and thus a utility maximizer interested in both money income
and on-the-job consumption. Denote this consumption as a, which includes activity such as
shirking and consumption of job perquisites. Let V (a ) be the dollar value to the manager of the
private benefits or enjoyment of shirking. Consumption a by the manager incurs a cost on
shareholders, who in turn charge the manager a price or penalty. We denote the unit cost of
consumption a imposed on the manager as β. Thus for each unit of consumption a, the manager
bears a penalty of β, in the form of perhaps lost bonus or increased probability of dismissal. In
order to reduce the agency costs of managerial shirking, shareholders must design a
compensation contract that incorporates this price for shirking. Shareholders are also interested
in providing incentives for risk-averse managers to take on appropriate risk to maximize firm
value. Therefore, the compensation contract should also tie money income to risk-taking effort,
b, which entails private costs or disutility of undertaking risk, denoted as G (b) . This risk-taking
incentive is provided by offering the manager a fraction, α, of firm value, π . Note that while
promoting risk-taking, α also provides an incentive to reduce on-the-job consumption. We
assume that shirking decreases shareholder value while risk-taking increases shareholder value to
the extent that managers are risk-averse:
∂π
∂π
< 0 and
> 0 .10
∂a
∂b
2.1. Characterizing Managerial Compensation Contract
Let C be the certainty equivalence of the value to the manager of her compensation
contract, which has to be equal to the value of the outside option, W, e.g., the value of the next
10
Yermack (2006a) finds that perquisites such as personal jets are associated with inferior shareholder returns.
10
best opportunity. This implies that the manager is paid only enough to induce her to accept the
contract, that is, the Individual Rationality Constraint is just satisfied. This follows from
Hermalin and Weisbach's (1998) argument that competition between managerial candidates
reduces managers' bargaining power relative to the board, thereby driving away any possible
rents. The contract is characterized as follows:
W = C = S + απ (a, b) + V (a) − G (b) − β aˆ
(1)
where S is fixed pay including salary and bonus unrelated to performance, α is the equity
incentive as a percentage of firm value – the manager gets to share the increase (or decrease) in
firm value with stockholders, π is firm value as a function of shirking a and risk-taking b,
V (a ) is the value to the manager of private benefits of shirking, G (b) is the manager's private
costs of risk-taking, β is the penalty per unit of shirking, and â = a + ε is the estimated value of
a since the board cannot ex ante observe managerial behavior without error ( ε ).11
2.2. The Manager's Problem
We start our analysis by analyzing managerial compensation without a severance
contract. Given contract C, the manager chooses a and b to maximize her certainty equivalence
of the value of contract. Shareholders select α and β to provide incentives to the manager, first
11
To maintain C = W, any change in one component of the contract leads to changes in the others. For example, if
the penalty of shirking, β , decreases, the contract is now worth more to the manager, so salary, S, has to decrease
such that C = W holds. Alternatively, if equity incentive α increases, e.g., more pay is performance-based, S has to
decrease ceteris paribus.
11
without a severance contract. The Incentive Compatibility Constraint demands the first order
conditions be satisfied:
∂C
∂π
∂V
∂V
∂π
=0⇒α
−β +
=0⇒
= β −α
∂a
∂a
∂a
∂a
∂a
∂C
∂π ∂G
∂G
∂π
=0⇒α
−
=0⇒
=α
∂b
∂b
∂b ∂b
∂b
(2)
(3)
Equations (2) and (3) show that the manager maximizes the value of the contract by
choosing the respective levels of shirking, a, and risk-taking, b, such that the marginal benefits of
shirking,
∂V
∂π
∂G
, equal its marginal costs, β − α
, and the marginal costs of risk-taking,
,
∂a
∂a
∂b
equal its marginal benefits, α
∂π
. Managerial costs of shirking come from two sources: the
∂b
penalty paid by the manager, β , and the reduction in her pay through her share of loss in firm
value due to shirking, −α
∂π 12
. Managerial benefits of risk-taking reside in the manager’s share
∂a
of the increase in firm value due to improved risk-taking.
2.3. The Dual Role of Severance Contract
Thus far, we have not introduced the effect of a severance agreement on managerial
compensation to our framework. By granting the manager a severance contract, shareholders
potentially decrease both the penalty for shirking, β , and managerial private costs of risk-taking,
12
Note that since
∂π
∂π
< 0 , −α
∂a
∂a
>0.
12
G (b) . A lower β arises because a severance contract can entrench the manager by increasing the
costs of replacing her when a better candidate is available (Almazan and Suarez (2003)), or by
insulating her from the discipline of internal and external governance. This entrenchment will
weaken the penalty or consequences for shirking (Jensen and Murphy (1990), Bebchuk and Fried
(2003), and Bebchuk et al. (2003)). By contract, Almazan and Suarez (2003), Ju, Leland, and
Senbet (2004), and Berkovitsch, Israel, and Spiegel (2000) argue that ex-ante severance contracts
may motivate managers towards risky but value-increasing decisions by providing safety against
project failure, rendering it less costly to undertake risk (i.e., lower G(b)).
As β decreases, Equation (2) shows that the marginal costs of shirking, β − α
∂π
, also
∂a
decrease, therefore a increases since the manager now has more incentive to shirk. Firm value,
π , deceases as shirking, a, increases. Shareholders can be expected to partially compensate for
more shirking by increasing equity incentive α in an attempt to restore the marginal costs of
shirking (recall that
∂π
∂π
< 0, so increasing α will raise β − α
). Now that shareholders more
∂a
∂a
closely link managerial pay to firm value through a higher powered incentive, managers bear
more costs of shirking through her enlarged share of firm value. As equity incentive α increases,
the salary, S, has to decrease to maintain C = W. Meanwhile, because a severance agreement
reduces the disutility of taking risk, G (b) , risk-taking now becomes less costly, and thus the
manager is expected to pursue more risk, i.e., b increases; resulting in increased firm value (Eq.
(2)).
Since the two contrasting roles of severance are not mutually exclusive, on net whether
severance contracts promote shirking or risk-taking depends on the relative dominance of the
two effects. Likewise, whether firm value will increase or decrease also hinges upon the relative
13
dominance of the two opposing effects. An increase in firm value suggests an optimal contract
since this contract enhances (valuable) risk-taking more than shirking. Alternatively, a decrease
in firm value indicates an inefficient contract as it increases shirking more than risk-taking. To
summarize, our framework predicts the following hypotheses:
H1: Severance contracts increase (decrease) managerial shirking if the shirking (risktaking) incentive dominates.
H2: Severance contracts increase (decrease) managerial risk-taking if the risk-taking
(shirking) incentive dominates.
H3: Severance contracts are positively (negatively) related to firm value if the risk-taking
(shirking) incentive dominates.
H4: Severance contracts are positively (negatively) related to incentive (fixed) pay.
3. Data and Methodology
3.1. Executive Severance Agreements
A typical executive severance agreement provides compensation to a CEO upon departure
from the firm. We consider severance payment as the total contractual pay out due to executives
upon job termination.13 Executive terminations initiated by firms are classified as for-cause or
without cause. Voluntary terminations are categorized as departure with and without good
reason. CEOs who are fired without cause or leave with good reason are entitled to current
annual salary and bonus for several years following the termination as well as early vesting of
restricted stock and options. This is in stark contrast to what happens when executives leave their
firms without good reason or are fired for cause, in which case they forfeit most of the benefits
13
Typically, the total payout is comprised of multiple (e.g., 3 or 5) years of current salary and bonus, early or
immediate vesting of unvested portions of stock options and restricted shares, and other contracted fringe benefits
paid by the company, such as continued healthcare insurance and/or life insurance, office use, administrative
assistance, country club membership and automobiles paid by the company. In return, these executives may agree
not to compete against or solicit current employees from the firm via non-compete and non-solicitation clause.
14
provided in the contracts. The definition of “cause” is very narrow and typically includes moral
turpitude, willful misconduct and failure to perform duties. Rarely are CEOs fired for cause
unless they have been convicted of a felony, or involved with flagrant abuses. Interestingly, poor
performance on the job or incompetence is typically not considered cause for termination. For
example, Schwab and Thomas (2004) report that only 3.47% of the S&P 1500 CEO contracts list
incompetence as a cause for termination. Reasons most often defined as “just cause” for
termination include moral turpitude (72%), willful misconduct (69%), and failure to perform
duties (58%). “Good reason” typically refers to demotion, reduction in pay, and reallocation of
the CEO. Thus, CEOs with contracts who depart either without cause or with good reason are
paid tremendously to leave their posts.
3.2. Sample Selection
The full sample contains all S&P 500 companies in 2000 and 2004. For any CEO of our
sample firms (and their public predecessors) in office between 1992 and 2010, we hand collect
severance contract information from the Securities and Exchange Commission's (SEC) Edgar
online filings database. Thus, more than 500 different companies may exist in certain years. A
severance agreement may be either a standalone contract or it may be part of a more
comprehensive employment contract. The Securities Exchange Act of 1934, Regulation S-K,
Item 402 of the SEC requires that all public companies disclose in their proxy statements the
terms and conditions of any contract with their named executive officers, including severance
agreements.14 Compensation committees of public firms are also required to file an annual report
14
See the SEC website at http://www.sec.gov/divisions/corpfin/guidance/execcomp402interp.htm for detailed filing
requirements. Specifically, Standard Instructions for Filing Forms under the Securities Act of 1933, Securities
Exchange Act of 1934 and Energy Policy and Conservation Act of 1975, Regulation S-K, Item 402 - Executive
15
that must contain comprehensive disclosure of executive compensation related items and any
contractual relationships that have been established between the firm and its top executives. This
mandatory public disclosure is a relatively recent advancement in American securities law,
taking effect since SEC's proxy disclosure reforms of 1992.15 Firms may also attach an actual
copy of these agreements as exhibits to their 10-K, 10-Q, or 8-K. However, since firms are not
required to do so for every single year, nor are firms required to report contract related items in a
specific format prior to the SEC disclosure reforms in 2006, we rely primarily on the descriptions
of contract terms and conditions disclosed in the SEC filings, and where necessary supplement
them with those collected from the actual contract copies in the 10-K, 10-Q, or 8-K reports.16
Specifically, where the proxy statements indicate the existence of a severance agreement,
we search the proxy statements (DEF-14 or DEF-14A) for the descriptions of the contract terms
and conditions and the firm's 10-K, 10-Q, or 8-K forms for any missing contract information, via
an extensive keyword search.17 Due to the SEC disclosure rules, we follow Gillan et al. (2009) in
Compensation, Paragraph (h) stipulates: "Employment contracts and termination of employment and change-incontrol arrangements. Describe the terms and conditions of each of the following contracts or arrangements:
1. Any employment contract between the registrant and a named executive officer; and
2. Any compensatory plan or arrangement, including payments to be received from the registrant, with respect
to a named executive officer, if such plan or arrangement results or will result from the resignation, retirement
or any other termination of such executive officer's employment with the registrant and its subsidiaries or
from a change-in-control of the registrant or a change in the named executive officer's responsibilities
following a change-in-control and the amount involved, including all periodic payments or installments,
exceeds $100,000."
15
Our sample period begins in 1992 because ExecuComp starts coverage in 1992, and the SEC's proxy disclosure
reforms that require a full disclosure of executive contracts in proxy statements took effect in 1992.
16
Following the 2006 SEC comprehensive disclosure reforms, firms are required to tabulate and quantify in their
annual disclosures any ex-ante contractual severance payments to named executives upon termination of
employment, which is supposed to be captured by data item "TERM_PYMT" in ExecuComp for firms with fiscal
year end after December 15, 2006. However, as documented in Cadman et al. (2011), "TERM_PYMT" has various
problems preventing it from being accurate and useful as a measure of ex ante severance payment. For example, in
many cases, it fails to capture the total amount of contracted severance pay, and for the majority of observations, it
includes amount due to CEOs upon job termination, but regardless of the type of termination. Therefore, to be
consistent across different years in our sample period, and to avoid errors in the data entry process, our study relies
primarily on the disclosed qualitative descriptions of executive severance agreements.
17
We search extensively for myriad variants of keywords, and the majority of severance related information is
retrieved by variants of the following keywords: “Employment agreement”, “Employment contract”, “Employment
16
assuming that all firms with a contract should disclose so, otherwise they are in severe violation
of securities rules, and consider non-disclosing firms as those without contracts. 18 Note that we
consider severance agreements in more general terms, and exclude agreements that are only
applicable upon the change-in-control ("Golden Parachutes"). Our full sample consists of 1,685
unique CEOs in 591 different firms during 1992-2010. After excluding firm-years with negative
book assets or missing SIC codes, the full sample contains 9,690 firm-year observations, of
which 4,086 (42.2%) are classified as having a CEO severance contract and the rest as having
none.19
We obtain CEO characteristics from the proxy statements (such as the founder status,
CEO appointment and termination dates, and the Chairman start and end dates if applicable),
financial data from Compustat, segment data from Compustat Industrial Segment Data, stock
returns from CRSP, CEO compensation and ownership from the Standard and Poor’s
ExecuComp, institutional ownership from Thomson Reuters' Institutional Holdings (13f),
corporate governance from RiskMetric (formerly IRRC), and patent and patent citation data from
the NBER patent database compiled by Hall, Jaffe, and Trajtenberg (2001). Some variables may
arrangement”, “Termination of employment”, “Termination arrangement”, “Termination benefits”, “Severance
agreement”, “Severance arrangement”, “Severance plan”, “Severance policy”, “Change in control”, “Change-incontrol”, “Change of control”, “Separation plan”, “Separation agreement”, “Retention arrangement”, “Retention
agreement”, “Employee retention”, “Management continuation” “Management continuity”, “Contractual
obligation”, “Post-termination payment”, “Agreement”, “Contract”, “Termination”, “Severance”, “Separation”,
“Retention”, “Continuation”, “Continuity”, and “Employment”. Note that the more general terms (e.g.,
“Agreement”) guarantee a lower chance of missing relevant information, while the more specific words (e.g.,
“Severance agreement”) are more efficient and return less irrelevant information. We typically start with more
specific keywords, and resort to more general terms if necessary. If no relevant information can be found using the
keywords, we will search again using the executive's last name.
18
Typically, CEOs defined as having no severance include cases in which (1) the firm explicitly discloses that no
severance agreement exists and upon our search it is confirmed so, or (2) there is no evidence or disclosure in the
proxy statement that any severance arrangement of any kind exists.
19
Conceptually, it is possible that our search may fail to locate severance contract information for some firms and
classify them as one without a severance contract when actually they do have a CEO severance agreement.
However, we note that the proportion of CEOs with severance contracts in our study (42%) are consistent with the
literature, e.g., the proportion of explicit CEO employment agreements (37%) in Gillan et al. (2009), and the
proportion of executives with severance contracts (40% for S&P 500 CEOs) in Huang (2011) and (35% for top
executives and 59% for CEOs) in Rau and Xu (2010).
17
have fewer observations due to missing values.
3.3. Variable Construction
We construct several variables to capture managerial shirking, including intangible and
fixed investments, corporate innovation, and employee base. To measure risk-taking, we analyze
firm focus, financial leverage and future stock return volatility. We study Tobin's q, operating
and stock return performance to infer the value impact of severance contracts. Since many of our
outcome variables can only be changed gradually, such as diversification into new industries,
patent filings, and R&D programs, we examine them over multiple (up to five) years in the
future.
3.3.1. Measuring Managerial Shirking
Following prior literature, e.g., Bertrand and Mullainathan (2003), Atanassov (2012), and
Knoeber (1986), we consider several proxies for managerial shirking, including discretionary
spending, capital investment, patent innovation, and employee base. All except the employee
base are positively associated with managerial effort and hence inversely related to shirking.
A. Discretionary Spending: Discretionary expenditures include intangible investments
such as the levels of R&D expenditures to assets (R&D/Assets) and advertising expenses to
assets (ADV/Assets). Since a considerable number of firms have missing R&D and advertising;
we also examine selling, general, and administrative expenses (SG&A/Assets), following prior
studies such as Knoeber (1986) and Roychowdhury (2006). Besides advertising and R&D
expenditures, SG&A contains marketing, exploration, foreign currency adjustment, and other
expenses not directly related to production, such as employee training and education
18
(Roychowdhury (2006)). Following Coles et al. (2006), we assign zero to any missing value so
that the maximum number of observations available can be used.20 Total discretionary expense
(DISEXP/Assets) is defined as the sum of the three.
B. Patent Innovation: While a reasonable proxy for long-term risky investments, R&D
captures an input to these investments. High R&D spending may not necessarily lead to a
successful outcome or discriminate between the quality of investments. Therefore, an output
measure of successful R&D is needed to more accurately capture innovative activity. We
construct several metrics from the NBER patent and patent citation database.
Patent is the total number of patents filed by the firm (and ultimately granted) during the
next one, three, and five years, respectively. As suggested by Hall et al. (2001), the relevant year
is application or filing year, which is very close to actual innovation rather than grant year.
Patent is further divided by the average number of patents filed by all firms in the same USPTO
class and application years to correct for the truncation bias in patent grants, which arises
because patents have on average a two year lag from application to grant date, and some patents
that have been applied for may not have yet entered into the sample. LnPatent is the natural
logarithm of one plus adjusted Patent. While a simple patent count may not distinguish a radical
innovation from a marginal one, Cite measures the importance or future impact of a patent,
defined as the total number of citations received per patent. Patents that are more heavily cited
are viewed as having more impact or being more important. Cite is then scaled by the citations
received on all patents filed in the same USPTO class and application years to account for the
fact that earlier granted patents may have received more cites than recent ones. LnCite is the log
of one plus adjusted Cite.
20
Using a missing dummy or excluding missing values did not change our results.
19
Generality and Originality are constructed and bias corrected as in Hall et al. (2001) and
Hall (2001). Generality indicates the general impact of a patent to future innovations, which is
defined as one minus the Herfindahl index of future citations received on a patent across USPTO
technology classes. A greater Generality represents a patent that is cited by a technologically
broader array of future patents, and thus has a widespread influence. Originality signifies how
original a patented innovation is from past ones, and is defined as one minus the Herfinhahl
index of citations made by a patent across technology classes. A higher Originality score
indicates that a patent cites previous ones in a wider set of technology fields, and thus is more
original. Both measures are averaged across all patents filed in the next one through five years,
and scaled by the average scores of all patents filed in the same USPTO class and filing years.
R&D efficiency is defines in two ways. Patent/R&D is the total number of patents filed
divided by total R&D expenditures over the next one, three, and five years. Cite/R&D is the total
number of citations received on all patents divided by R&D. Both metrics are adjusted across
USPTO class and application years. Since the NBER patent database ends in 2006, tests based
on patent and discretionary expenses span 1992-2006.21 Following prior studies, we assign zero
to firms with no patent activity and include them in our analysis to mitigate any selection bias.
C. Capital Investments and Employee Base: Corporate investments in tangible assets
include capital expenditures to assets (Capex/Assets) and PP&E over assets (PP&E/Assets),
which inversely relate to managerial shirking. We use the total number of employees
(Employee), the ratio of employee count over assets (Employee/Assets), and the ratio of
employee count over sales (Employee/Sales) to measure employee base.22 Prior literature
21
Results remain similar if we extend the test period to 2010 for discretionary expenditures.
To the extent that the simple employee count may also capture firm size or empire building, we consider
Employee/Assets and Employee/Sales more relevant and precise measures for employee base.
22
20
suggests a positive relation between employee base and managerial shirking to the extent that
cutting employee base and downsizing is a difficult, challenging and unpleasant decision that
confronts the manager with unhappy employees and thus requires considerable managerial
initiative and effort (e.g., Bertrand and Mullainathan (2003)).
3.3.2. Measuring Managerial Risk-Taking
A. Firm Focus: Empirically, several measures can proxy for either managerial shirking
or risk-taking. We employ three proxies for risk-taking: firm focus, leverage, and future stock
return volatility. Following Berger and Ofek (1999) and Coles et al. (2006), we use the
Herfindahl index, defined as the sum of squared business segment sales over squared total firm
sales to measure focus across lines of business. Unlike shareholders, managers are underdiversified with a disproportionally larger stake in their firms, thus a greater industry focus of
operation exposes managers to a higher idiosyncratic risk. Since the larger the Herfindahl index,
the greater the focus, we expect a positive relation between risk-taking and Herfindahl index. We
also expect focus to be negatively related to agency costs of diversification and managerial
shirking. Analogously we construct the Herfindahl index of geographic segments across
countries.23 To the extent that managers overseeing business across various international
geographic locations may have to exert extra efforts learning the foreign market, culture, and
regulations, etc., a greater international geographic diversification may impose a higher risk due
to, e.g., information asymmetry, and demand more effort. As opposed to business segments, we
23
In Compustat Segment files, geographic segment corresponds to geographic presentation by country, and state
segment corresponds to the method of reporting information by U.S. domestic geographic locations. However, state
segments are covered only since 1998 and are not at all well populated. Since U.S. state segment information is
missing for the majority of our firm-year observations, we use international geographic segment information, which
is more advantageous and appropriate in capturing managerial effort, risk-taking, and initiative associated with
geographic dispersion of business or operation across various countries and/or regions.
21
expect international geographic focus to be negatively (positively) related to risk (shirking). We
also measure focus by the number of business and geographic segments.
B. Financial Leverage: Another way of changing firm risk is through capital structure
decisions, e.g., by altering firm leverage. The higher the leverage, the larger the financial distress
and bankruptcy risk. Following Berger, Ofek, and Yermack (1997) and Coles et al. (2006), we
use both book and market leverage, defined as the book value of debts to book or market value
of assets. Leverage may also capture managerial monitoring imposed by debt holders and hence
is negatively related to shirking.
C. Firm Risk: To more directly assess how severance contracts affect risk-taking, we
construct three variables for risk: industry-adjusted total risk, systematic risk, and idiosyncratic
risk. Industry-adjusted total risk is defined as the standard deviation of daily stock returns over
one, three and five years following current fiscal end minus the industry median of total risk,
where industry is based on the same two-digit SIC code for all Compustat firms in the same
fiscal year. We further decompose total risk into systematic risk, defined as the market beta from
the Fama-French three factor model using daily stock returns minus the industry median value of
beta, and idiosyncratic risk, defined as the standard deviation of the residuals from the FamaFrench three factor model minus industry median value of idiosyncratic risk.24 All three metrics
capture the ultimate effect of managerial risk-taking on firm risk. Moreover, previous studies
indicate that managerial risk-taking through innovation, new technology breakthroughs, and the
pursuit of growth options manifests itself in the form of idiosyncratic rather than systematic risk
24
Results using the CAPM and the Carhart four-factor model are essentially the same.
22
(Pastor and Veronesi (2009), Cao, Simin, and Zhao (2008)).25 Thus, we expect the effect of
severance contracts on firm risk to manifest more in idiosyncratic rather than systematic risk.
3.3.3. Measuring Firm Value and Performance
We use industry median adjusted Tobin’s q and operating income before depreciation
over assets (OPINC) to gauge firm value and operating performance, where industry is based
upon the same two-digit SIC code across all Compustat firms in the fiscal year. One caveat with
using accounting ratios as measures of firm value changes is that these numbers are susceptible
to managerial manipulation. To more accurately assess the value impact of severance contracts,
we follow prior literature and use buy-and-hold abnormal stock returns (BHAR) minus the value
(equally)-weighted average return on a matched size and market-to-book portfolio.26
3.4. Descriptive Statistics
Table 1 provides the sample distribution across time and twelve Fama-French industries.
The proportion of firms with a CEO severance contract has risen from 30% in 1992 to 53% in
2005, and then declined to 43% in 2010. The drop over our later sample period may reflect
increasing public awareness of various agency issues with executive severance agreements and
shareholder activists' outcry for regulation on severance pay since the SEC disclosure reform in
25
Armstrong and Vashishtha (2012) show that stock options may provide risk-averse CEOs with an incentive to
increase firm total risk by enhancing systematic rather than idiosyncratic risk, since any (unwanted) increase in the
former (but not the latter) can be hedged by managers trading the market portfolio. This suggests that idiosyncratic
risk is a more precise measure of the ultimate risk born by the manager since it cannot be hedged.
26
To form the size/book-to-market (BM) benchmark, all NYSE-listed firms are divided into five quintiles based on
size, and five quintiles based on BM, where size and BM are defined as in Fama and French (1992, 1993), Lyon,
Barber, and Tsai (1999), and Daniel et al. (1997). The intersection of these groupings yields 25 size/BM portfolios.
Each sample firm is placed into its appropriate portfolio, and its return is adjusted for the value (equally)-weighted
average returns across all other firms in that portfolio, i.e., all firms on CRSP with size BM data after excluding
firms that have gone public, had an SEO or acquisition within the past three years.
23
2006. There appears to be considerable variation across industries in the use of CEO severance
agreements, e.g., 55.2% of CEOs in telephone and telecom and 52.4% in other: mines, hotel and
entertainment, compared to 27.7% in chemicals and 30.7% in non-durables. This variation is
consistent with the common practice of corporations to follow the industry median in setting
executive pay.
Table 2 reports summary statistics. "Severance" refers to firm-years with a CEO
severance contract and "No Severance" to those without. Variable definitions are provided in
Appendix II. All variables with the exception of the indicator variables are winsorized at the 1st
and 99th percentiles to mitigate the impact of outliers. Financial variables are measured at the
fiscal year end. Industry-adjusted variables are subtracted by the industry median across all
Compustat firms with the same two-digit SIC code in the same fiscal year.
Firms with a CEO severance contract invest significantly less than their peers without
contracts in all categories of discretionary expenses. As a result, these firms perform
significantly worse in all measures of corporate innovation, including patent quantity, quality,
generality, originality and R&D efficiency and productivity.27 Firms with CEO severance
contracts also spend less on capital expenditures and PP&E investments and maintain a larger
industry-adjusted employee count relative to assets or revenue.28 Although preliminary, these
findings suggest that CEOs with a severance contract tend to shirk, underinvest in both
27
Note that though the median values of some variables might be the same across the severance and no severance
subsamples, variable distributions can be significantly different as captured by the Wilcoxon rank sum test. This is
particularly true for R&D/Assets, LnPatent, LnCite, Generality, and Originality, which have many missing values
and therefore are assigned zero for missing observations as is done in previous work (Coles et al. (2006) and
Atanassov (2012)). In all of these cases, test results for differences between distributions are consistent with those
for differences between means. Excluding missing values from our sample produces similar results.
28
Albeit the absolute (industry-adjusted) employee count exhibits a reverse relationship, suggesting that severance
may lead to reductions in employee base. However, this evidence also indicates that firms that plan on cutting
employee base and downsizing may be more likely to give their CEOs a severance contract to alleviate risk aversion
and induce costly effort and risk-taking.
24
intangible and tangible assets, and avoid difficult decisions, thereby hindering corporate
innovation and impairing firm competitiveness.
CEOs with a severance contract are more likely to diversify operations across industries
or business segments, indicating that these managers implement less risky corporate strategies, to
the extent that industry diversification decreases firm risk. Alternatively, severance contracts
may lead to value destruction due to diversification (Jensen (1986), Stulz (1990), and Denis,
Denis, and Sarin (1997)). CEOs with a severance contract tend to reduce international
geographic diversification suggesting managerial reluctance to undertake risk or effort associated
with overseeing geographically disperse operations. Firms in the severance group maintain
higher book leverage, however, after adjusting for the industry median the relation is reversed,
indicating less risk-taking via leverage by CEOs with a severance contract. It is also consistent
with more entrenched mangers reducing leverage in an attempt to avoid monitoring from debtholders (Berger et al. (1997)). The severance group exhibits higher future stock return volatility,
suggesting that, inferring the sub-optimal behavior of managers with a severance, the market
views the future potential of these firms as highly uncertain and risky. It is also possible that
firms with larger stock return volatility are more likely to offer severance contracts to CEOs as a
safety net against future firm risk. This relationship is driven primarily by idiosyncratic risk.
Companies with a severance contract fare significantly worse than their no-severance
peers, suffering substantial declines in firm value (Tobin's q), inferior operating (OPINC) and
stock return (BHAR) performance up to five years following the deployment of corporate
policies. Consistent with our model prediction, CEOs with a severance have larger incentive and
smaller cash pay than CEOs without a contract, indicating that the board provides higher
powered incentive in an effort to ameliorate the perverse incentives (e.g., shirking) provided by
25
severance contracts.29 Compared to the no-severance group, firms with a CEO severance contract
are smaller, have lower ROA, higher cash flow, larger past return volatility, more anti-takeover
provisions (as proxied by the G-Index). They also have more independent and smaller boards,
which are considered to be more effective (Yermack (1996)), and larger institutional ownership.
CEOs with a severance are more likely to have smaller firm ownership, shorter tenure, are
younger, are hired from outside the firm, and are less likely to be a founder or the chair of the
board. Finally, a CEO is more likely to have a severance contract if her predecessor or the
majority of her industry or state peers have one.
4. Empirical Results
4.1. Addressing Endogeneity: IV/2SLS Regression
While the focus of our work is to study the impact of severance contracts on managerial
decision-making, it is important to investigate first the determinants of a severance agreement.
The purpose is two-fold. First, examining the factors behind the choice of a contract offers
further insight into the relative validity of the competing theories. Second, prior literature
suggests that the choice of a severance contract is by no means random or exogenous. Firms may
give their CEOs severance contracts to achieve certain strategic goals based on firm
characteristics, e.g., a high growth firm may be more likely to use a severance contract to
motivate its CEO towards risky and/or long-term projects than firms with few growth options
(Knoeber (1986)). Managers may demand a severance contract because they are more riskaverse, which is not directly observable, and risk-averse CEOs in turn may underinvest in risk.
29
For executives with missing equity or option grants but non-missing values for all the other components of
compensation from ExecuComp, we back out the equity and option incentives by subtracting all the other
components from total pay. This is especially the case for the period after 2006. However, results are qualitatively
the same if we delete any observation with missing equity and option grants.
26
Therefore, we control for endogeneity between severance and firm policies through instrumental
variable/two stage least squares regressions (IV/2SLS).
To find a valid instrument for severance, we need to identify a variable that is directly
related to severance but not directly related to corporate policies and performance, other than
through the impact of the contract. We use two instruments that satisfy both criteria. PreCEO
Severance is an indicator variable that equals one if the predecessor CEO has a severance
contract and zero otherwise. Previous studies such as Rau and Xu (2010) recognize that firms
rarely switch between having and not having a severance contract, and that managers whose
predecessor has a severance contract are more likely to have one. This is also confirmed in our
sample. On the other hand, whether the prior CEO has a contract or not should not impact
current manager's decision-making. The second instrument is %Industry Severance, defined as
the percentage of S&P500 CEOs in the same two-digit SIC industry that have a severance
contract. To the extent that firms follow the industry norm in establishing compensation
contracts for top executives (Bizjak et al. (2008)), %Industry Severance is expected to positively
predict the likelihood of a CEO severance contract. It is unlikely, however, this industry norm
directly affects an individual firm’s performance. In the first stage we run the regression of
Severance, an indicator variable equal to one if the CEO has a severance contract during the
fiscal year and zero otherwise, on instruments, controls, and year and industry fixed effects. The
second stage regresses various firm policy measures on Severance. We estimate the IV/2SLS
model simultaneously by instrumenting Severance with PreCEO Severance and %Industry
27
Severance.30 Since this is an overidentified model, we can formally test the validity of our
instruments.31
4.2. Determinants of CEO Severance Agreements
Table 3 reports the marginal effects from the probit regressions and coefficient estimates
from the OLS predicting the choice of a CEO severance contract. The dependent variable is
Severance and the explanatory variables include factors shown in prior literature to affect the
probability of a contract. Marginal effects are evaluated at the mean for continuous and at zero
for indicator variables. Results are consistent across model specifications. Both PreCEO
Severance and %Industry Severance are positive and significant at 1%. Specifically, having a
predecessor with a severance contract increases the odds of a contract for the current CEO by 31
to 44 percentage points. A one standard deviation increase in %Industry Severance (=0.19)
translates into an increase of 13 to 23 percentage points in the likelihood of a severance
agreement. On the other hand, PreCEO Severance and %Industry Severance are either weakly
related or uncorrelated to corporate policies and performance, satisfying the criteria for a valid
instrument. For instance, the correlation coefficient of PreCEO Severance is -0.03 with
R&D/Assets, -0.05 with Capex/Assets, -0.07 with industry-adjusted OPINC, -0.08 with industry-
adjusted Tobin's q, and zero with patent quality, firm focus, leverage and BHARs.32
Firm size is negative and significant. Since larger firms are less vulnerable to takeovers,
30
In the robustness section, we add another instrument %State Severance, defined as the annual percentage of S&P
CEOs headquartered in the same state that have a severance contract. Our primary results (for both the first and
second stage) remain essentially the same in general and become stronger in some cases.
31
Results from a probit first-stage in a treatment effects model to account for the binary nature of Severance are
similar. Both models produce consistent estimates but the 2SLS/IV results are more robust than the treatment-effects
estimator (Cameron and Trivedi (2009) and Maddala (1983)). The treatment effects model imposes more structure,
and in turn produces more precise estimation. However, the cost is of a greater chance of misspecification error
(e.g., in heteroskedasticity) than the regular IV model (Cameron and Trivedi (2009)).
32
More formal statistical tests confirm the same later.
28
managers of these firms are less likely to behave myopically and augment current earnings to
avoid a potential takeover, thereby reducing the need for a severance contract (Stein (1988)).33
Leverage is negative and significant, inconsistent with the hypothesis that severance is used to
insulate managers from financial risk but consistent with the notion that severance is more likely
to exist for growth firms to the extent that leverage is inversely related to growth opportunities.
Consistent with severance agreements being used to protect managerial human capital in an
adverse or volatile environment, Severance is negatively related to the cash to assets ratio and
prior year stock return, and positively related to past return volatility. Both sales growth and
R&D/Sales are positive and significant, supporting the view that severance contracts are used in
high growth firms to alleviate managerial risk aversion and the underinvestment problem.
Contrary to the managerial power argument, severance is negatively associated with the G-index.
A severance contract is more likely when institutional ownership is larger, indicating that the
pressure from institutional investors to deliver short-term profits may motivate the use of a
severance contract to mitigate managerial myopia (Bushee (1998)). A severance is more likely if
the CEO is less experienced and more risk-averse (a shorter tenure and outside hire), and is older
and has a shorter horizon in the labor market. Overall, the evidence is consistent with severance
contracts being used to protect CEO human capital against downside outcomes.
4.3. CEO Severance Agreements and Managerial Shirking (H1)
4.3.1. Discretionary Expenditures
This section examines the impact of CEO severance contracts on discretionary spending
including R&D, advertising, and SG&A, which, according to the GAAP, are expensed when
33
Alternatively, one may argue that large firms may be more subject to public pressure and hence myopia, due to
e.g., institutional voting and more analyst following.
29
incurred but the value of them are recognized only when the expected payoffs are realized in the
relatively distant future. As such, these investments are primarily characterized as long-term and
risky. Studies have shown that managers cut R&D and maintenance expenditures to meet
earnings target.34 Therefore, if severance agreements encourage risk-taking, we expect a positive
relation between severance and discretionary expenses. In contrast, Bertrand and Mullainathan
(2003) and Atanassov (2012) find that managers protected from the discipline of the corporate
control market prefer a quiet life and reduce risky investments, particularly in R&D and
innovation. This quiet life hypothesis predicts a negative relation between severance and
discretionary expenditures.
Table 4 provides IV/2SLS regression results of discretionary expenditures on Severance.
The dependent variables are R&D/Assets, ADV/Assets, SG&A/Assets, and DISEXP/Assets. We
control for variables shown in the literature to affect discretionary spending, year, and industry
fixed effects. Severance is instrumented by PreCEO Severance and %Industry Severance. The
two stages are jointly estimated. The first-stage results across all dependent variables are
consistent with Table 3; for brevity, we only report the first-stage estimates for R&D/Assets in
Panel A and omit the others. Panel A also reports statistical tests on the validity of instrumental
variables. The Durbin-Wu-Hausman (DWH) endogeneity test rejects (p-value=0.00) the null
hypothesis that Severance is exogenous, justifying the use of IV/2SLS model. The
overidentification test fails to reject the null at the 5% level that jointly our instruments are valid
and pass the exclusion test (p-value=0.196, 0.146, and 0.077 for one, three, and five years). The
first-stage F-test rejects the null of weak instruments (p-value=0.00), satisfying the criterion that
34
See, e.g., Healy and Wahlen (1999), Fudenberg and Tirole (1995), Dechow and Skinner (2000), Roychowdhury
(2006), and Graham et al. (2005).
30
our instruments are directly and strongly related to Severance. Tests on other policy and
performance measures produce similar results and are hence omitted.
After addressing for endogeneity, severance contracts are negatively related to all
discretionary expenditures. For example, granting the CEO a severance contract results in a
decline in R&D/Assets by 1.3, ADV/Assets by 0.5, SG&A/Assets by 3.3, and DISEXP/Assets by 5
percentage points within three years. For an average sample firm with a R&D/Assets of 2.5%,
ADV/Assets of 1.2%, SG&A/Assets of 17.3% and DISEXP/Assets of 21.2%, these declines
translate into reductions in R&D/Assets by 52% (1.3/2.5), ADV/Assets by 42% (0.5/1.2),
SG&A/Assets by 19.1% (3.3/17.3), and DISEXP/Assets by 23.6% (5/21.2), which are both
statistically and economically significant. Therefore, severance contracts do not seem to alleviate
managerial myopia as postulated in Stein (1988, 1989), Knoeber (1986), Narayanan (1985), and
Almazan and Suarez (2003). Rather, the evidence suggests that these contracts induce shirking
and exacerbate myopic underinvestment in discretionary expenditures.
4.3.2. Patent Innovation and R&D Productivity
This section examines the output of R&D and innovation, including patent quantity,
quality, generality, originality, and R&D efficiency. Table 5 presents the second-stage regression
results, where the dependent variables are respectively one, three, and five-year LnPatent,
LnCite, Generality, Originality, Patent/R&D, and Cite/R&D. Panel A reports that CEO
severance contracts lead to fewer (successful) patents being filed for over next one, three, and
five years (LnPatent). Moreover, a severance contract also results in lower patent quality as
measured by future citations received (InCite), the general impact on subsequent patents
(Generality), and how original and radical this patent is compared to prior inventions
31
(Originality). Finally, severance agreements appear to impair R&D efficiency as proxied by the
number of patents and the number of citations received on the patents denominated by R&D
expenses (Patent/R&D and Cite/R&D). Taken together, the results suggest that severance
contracts motivate managerial shirking, hindering innovation and impairing R&D efficiency.
4.3.3. Capital Expenditures, PP&E, and Employee Base
Table 6 studies the impact of CEO severance on industry-median-adjusted capital
investments including capital expenditures and PP&E to assets (Capex/Assets and PP&E/Assets).
After controlling for endogeneity, Severance is significant and negative up to three years
following current fiscal year. Specifically, giving the CEO a severance contract leads to a future
decline of 0.4 (2.1) percentage points in Capex/Assets (PP&E/Assets) over next three years,
equivalent to decreases in Capex/Assets by 39.6% (0.4/1.01) and PP&E/Assets by 79.5%
(2.1/2.64) for an average sample firm. Table 7 shows that Severance is positively associated with
the industry-median-adjusted number of employees (lnEmployee) and the industry-adjusted ratio
of employee count to total assets, indicating that CEOs with a severance contract tend to avoid
costly effort and opt for a quiet life, given that reducing employee base and downsizing
represents a challenging and difficult decision that demands substantial initiative and effort
(Bertrand and Mullainathan (2003)).35
4.4. CEO Severance Agreements and Managerial Risk-Taking (H2)
This section presents evidence on whether and how CEO severance contracts affect
managerial risk-taking as measured by firm focus, leverage, and future stock return volatility.
35
Results using Employee/Sales are qualitatively the same.
32
4.4.1. Firm Focus
We analyze the impact of CEO severance on a firm’s decision to diversify assets across
many lines of business or geographic areas. Following Berger and Ofek (1999) and Coles et al.
(2006), we use Herfindahl index of sales across business segments as the measure of business
concentration. The greater the industry focus, the larger the idiosyncratic risk the manager is
exposed to. Since a larger Herfindahl index represents a greater focus, we expect a positive
relation between risk-taking and Herfindahl index across business segments. To the extent that
industry diversification represents agency costs (e.g., Jensen (1986) and Denis et al. (1997)), we
expect a negative relation between business Herfindahl index and shirking. We also construct the
Herfindahl index of sales based on geographic segments across countries. Unlike industry focus,
we expect a negative (positive) relation between international geographic focus and risk-taking
(shirking), to the extent that supervising business across many countries and/or regions requires
considerable managerial effort and initiative in learning about foreign markets, clients,
regulations and cultures. Further, firms operating in many foreign geographic areas may be at a
disadvantage in certain aspects to their local competitors due to, e.g., information asymmetry,
which entails higher risk.36
Table 8 contains IV/2SLS regression results of firm focus on Severance. Panel A shows
that Severance is significantly and negatively associated with Herfindahl index across business
segments, suggesting that CEOs with a severance contract are more inclined to diversify assets
36
Indeed, Masulis, Wang and Xie (2012) find that U.S. firms with foreign directors make superior cross-border
acquisitions when target firms are from the home country of the foreign directors, suggesting that the knowledge and
familiarity with foreign (non-local) markets can help mitigate information asymmetry. Likewise, Uysal, Kedia, and
Panchapagesan (2008) report that acquirers of local targets enjoy higher returns, possibly due to information
advantages arising from geographical proximity.
33
across industries either to reduce idiosyncratic risk (May (1995), Amihud and Lev (1981)) or to
enjoy private benefits of diversification (Jensen (1986) and Stulz (1990)).37 Panel B reports that
CEOs with a severance contract tend to reduce the geographic dispersion of operations across
countries, suggesting that these CEOs prefer an easy and quiet life and are reluctant to take
costly effort expanding business geographically. Results are similar if we use the number of
segments.
4.4.2. Firm Leverage
Since higher leverage imposes larger financial risk, we consider leverage as a measure of
corporate risk-taking. Higher leverage is also associated with more managerial monitoring by
debt holders and hence less agency costs such as managerial shirking and perquisites. Indeed,
Coles et al. (2006) document that managers with larger risk-taking incentives (vega) tend to
increase firm leverage. Berger et al. (1997) and Garvey and Hanka (1999) show that entrenched
managers are more likely to reduce leverage. Thus, we expect leverage to be positively
(negatively) related to risk-taking (shirking).
Table 9 demonstrates that after controlling for the endogeneity between severance
contracts and capital structure decisions, Severance is negative and significant across all horizons
in explaining the industry-median-adjusted book and market leverage.38 For example, Severance
decreases book leverage by 2.3 to 4.5 percentage points over next one through five years, which
are economically nontrivial considering the mean industry-adjusted book leverage at 2.5%. The
coefficient estimates on control variables are consistent with prior work (Berger et al. (1997)).
37
These private benefits include, e.g., enhanced prestige or career prospects with managing a bigger and more
complex firm, increased pay, and greater opportunities and benefits of entrenchment and shirking.
38
Welch (2004) notes that market leverage may change simply because of changes in stock price instead of any
changes in corporate policies or managerial decisions. Thus, book leverage is a less noisy measure of risk-taking.
34
Our findings suggest that CEOs with a severance contract prefer a financial policy that reduces
leverage and financial risk. This decrease in leverage may also weaken managerial oversight by
debt holders, exacerbates the agency costs of free cash flow (Jensen (1986)), and induces
managerial slack.
4.4.3. Firm Risk
Thus far, we have examined the effect of ex ante CEO severance contracts on corporate
policies. Managers can alter these investment and financial policies in order to achieve their
desired level of firm risk. Ultimately, decisions about investment, innovation, employee base,
firm focus, and capital structure should affect firm risk. We now directly evaluate the impact of
CEO severance on the outcome of risk-taking: firm risk. To exclude any industry effect, we
construct three industry-adjusted measures of risk, where industry is based on the same two-digit
SIC code across all Compustat firms for the fiscal year. Total risk is the standard deviation of
daily stock returns over future one, three, and five years, respectively, minus the industry median
total risk. To the extent that different components of total risk may capture differential risktaking incentives (Armstrong and Vashishtha (2012)), we further decompose total risk into the
systematic and idiosyncratic risk, where the systematic risk is the market beta and idiosyncratic
risk the standard deviation of the residuals estimated from the Fama-French three factor model,
minus respectively the industry median systematic and idiosyncratic risk.
Table 10 shows that after controlling for endogeneity, Severance is significantly and
negatively associated with firm total risk across all horizons, supporting the hypothesis that
severance contracts lead to lower future stock return volatility. Consistent with Armstrong and
Vashishtha (2012), severance contracts appear to have differential effects on systematic versus
35
idiosyncratic risk. While firms with a CEO severance contract experience decreases in both risk
components, the effect is stronger for idiosyncratic risk, which cannot be hedged by the manager
and hence is personally more costly and undesirable.
4.5. CEO Severance Agreements, Firm Value, and Performance (H3)
Severance agreements may affect firm value and performance through their impact on
CEO incentives, investment decisions, and financial policies. By exploring the relationship
between severance contracts and firm performance, we can further and more completely
understand the role of severance contracts in managerial decision-making. In this section, we
examine the impact of severance contracts on firm value (the industry median adjusted Tobin's
q), operating performance (the industry median adjusted OPINC), and the abnormal stock returns
(BHAR) over future one through five years, where industry is based on the same two-digit SIC
code across all Compustat firms in the same fiscal year.
Panel A of Table 11 contains IV/2SLS regression results for Tobin’s q. Severance is
negative and both statistically and economically significant, confirming that severance contracts
are value-decreasing and their effect remains persistent over time. Specifically, a severance
contract reduces industry-adjusted q by 0.30 (53.6%) over one, 0.38 (67.9%) over three, and 0.43
(76.8%) over five years, considering an average sample firm with an industry-adjusted q of 0.56.
Panel B shows that a CEO severance contract reduces industry-adjusted OPINC by 2.2, 2.5, and
2.4 percentage points, respectively, over the future one, three and five years. These reductions
translate into declines of 31% to 35% for an average firm with an industry-adjusted OPINC of
7.2%. Panel C analyzes respectively the three-, four- and five-year BHAR, defined as daily buyand-hold abnormal stock returns subtracted by the value (equally)-weighted average return on a
36
matched size and book-to-market portfolio.39 After addressing endogeneity, Severance is
significant and negative. On average, shareholders lose 8.3 (9.1) percent over three years, 11.9
(13.7) percent over four years, and 21.5 (22.4) percent over five years for a value (equally)weighted benchmark portfolio if their CEO has a severance agreement.
Rather than encouraging risky but value-increasing decisions, CEO severance agreements
appear to destroy shareholder value. Combined with our earlier evidence on corporate
investment and risk-taking, severance contracts seem to induce managerial shirking, thereby
stifling risky investments in intangible assets, capital expenditures, and patent innovation. This
sub-optimal behavior has a long-lasting adverse impact on firm value and growth potential. Our
evidence highlights the urge for shareholders and corporate boards to design efficient
compensation contracts to create but not destroy shareholder wealth.
4.6. CEO Severance Agreements and Compensation Structure (H4)
Table 12 analyzes the relationship between CEO severance agreements and compensation
structure. Total pay is comprised of salary, bonus, other annual pay, restricted stock, stock
options (valued by S&P’s Black-Scholes model), long-term incentive payouts, and all other total.
Fixed compensation is defined as cash (i.e., salary and bonus) to total pay, and performancebased pay is equity incentive (i.e., the total value of restricted stocks and stock options valued by
S&P’s Black-Scholes model) to total pay. To account for the substantial dominance of options in
managerial incentive compensation (Murphy (1999)), we also use stock options to total pay ratio
as another measure of incentive pay. Consistent with H4, both the OLS and IV/2SLS results
show that CEOs with a severance contract have a higher proportion of total pay in equity and
39
Matching on size, BM, and momentum produces similar results.
37
options while a lower portion in cash. Since a higher equity pay offers a higher pay-forperformance sensitivity (delta), our findings suggest that corporate boards are more likely to give
a higher powered incentive to CEOs with a severance contract, perhaps in an effort to ameliorate
(to some extent) managerial shirking associated with severance contracts.
4.7. Subsample Analysis
One important implication from our model is that the relative dominance of shirking
versus risk-taking incentive of severance contracts depends on the marginal benefits and costs of
shirking and risk-taking. Presumably, shirking is more costly to managers and hence less likely
in firms with stronger corporate governance and under more pressure from the product market
competition (characterized by a higher penalty for shirking, β).40 Managerial shirking should also
be attenuated in risky and fast growth firms, since in these firms a severance contract may
decrease the disutility of risk-taking, G(b) more than it does β. Table 13 conducts subsample
analysis where we divide the full sample into sub-groups below and above the median value of
various conditional variables. These include corporate governance as measured by the G-Index,
institutional ownership, CEO ownership, past three year average industry-adjusted book
leverage, and CEO-Chair duality, market competition, regulation, firm risk, and growth
opportunities. For each subsample, we regress one- and three-year industry adjusted OPINC on
Severance along with controls, year and industry fixed effects in an IV/2SLS design as specified
in models (4) and (5) of Table 11.
Panel A shows that the negative value impact of severance contracts disappears in firms
with stronger corporate governance, as proxied by lower G-Index, larger institutional ownership,
40
For instance, Giround and Mueller (2010, 2011) show that product market competition substitutes for good
corporate governance and mitigates managerial slack.
38
greater CEO ownership, higher leverage and hence more monitoring from the creditors and less
agency issues of free cash flow (Jensen (1986)), and the separation of CEO and Chairman. This
suggests that more effective corporate governance mechanisms may potentially increase the
penalty for shirking and attenuate managerial slack. Panel B reports that firms under more
product market competition (lower industry Herfindahl index of sales), in regulated industries
where managers are more vulnerable to risk out of their own control (energy, telephone/telecom,
utilities, financial, and mines, hotels and entertainment), in a riskier and more volatile
environment (greater past stock return volatilities), and with more growth opportunities (larger
industry-adjusted R&D/Assets and sales growth) cease to suffer the negative value effect of
severance. Thus, the subsample analysis indicates that internal and external governance
mechanisms play a critical role in aligning managerial incentives with shareholders, and can
effectively reduce agency problems, such as managerial shirking. 41
4.8. Alternative Explanations and Robustness
4.8.1. Dressing up for Sale
To the extent that severance contracts tend to be awarded to outside hires in poorlyperforming companies, it is possible that contracts may be used to provide these CEOs with
incentives to “dress the firm up for sale”, which is consistent with cutting discretionary spending
and thereby boosting current earnings in order to strike a better deal.42 If our results are mainly
driven by this effect, we should expect the proportion of new CEOs with a severance contract,
especially those recruited from outside the firm, to be associated with a higher likelihood of their
41
Our main results are robust to using the interactive terms between severance and each conditional variable in
regressions to capture the simultaneous effect of severance and various conditional variables on firm performance.
42
We thank David Yermack for suggesting this alternative interpretation.
39
firms being taken over (and hence delisted from CRSP) in the next few years. To test this
conjecture, we separate our CEO sample into four contract events: (1) new CEOs hired with a
severance (event date = contract effective date), (2) new CEOs hired without a severance (event
date = CEO appointment date), (3) continuous CEOs who get a severance from previously
having none (event date = contract effective date), and (4) continuous CEOs who cancel an
existing severance (event date = contract cancellation date).43 We also consider whether the CEO
is recruited from outside the firm. We find that neither new CEOs with a severance nor new
outside CEOs with a severance are associated with a higher probability of their firms being taken
over and hence delisted from CRSP than their counterparts in various comparison groups over
two years following the event date.44 For example, the p-value for the difference in the odds of a
takeover between a new outside CEO who is hired with a severance and (1) all other CEOs is
0.37, (2) all other new CEOs is 0.19, and (3) new outside CEOs hired without a severance is
0.75. While the “dressing up for sale” hypothesis may seem possible, it is unlikely that our
results are primarily driven by this alternative explanation.
4.8.2. Delisting Returns
Out of the 591 unique companies in our full sample, 182 (30.8%) are delisted and
43
Specifically, we define a CEO as one hired with a severance (category 1) if the contract effective date is no later
than six months after the CEO appointment date; a CEO as one who cancels her existing contract (category 4) if the
contract cancellation date is more than six months prior to the CEO departure date; and a CEO as one who gets a
contract from previously having none (category 3) if she is given a contract more than six months prior to the CEO
departure date since otherwise the contract cannot be considered as an ex ante severance but rather an ex post
negotiated separation pay. All results hold for alternative definitions. We note that these contract events are not
mutually exclusive since a CEO may be hired with a severance (category 1) and then cancel it later (category 4), or a
CEO may be hired with no severance (category 2) but get one several years later (category 3). Thus, in total, we
have 1,867 contract events for 1,658 unique CEOs (209 switches) over our sample period, out of which, 760 in
category (1), 898 in (2), 150 in (3), and 59 in (4). However, results are robust to mutually exclusive classifications.
44
Results continue to hold if (i) other time horizons are used, e.g., one or three years; (ii) only CEOs appointed in
1992 or later are included, i.e., 1,285 contract events in total for 1,177 unique CEOs (108 switches), out of which,
634 in category (1), 543 in (2), 62 in (3), and 46 in (4); and (iii) the events of both new and continuous CEOs getting
a severance are combined together as one event type, i.e., the contract type.
40
disappear from our sample in mid-stream.45 To alleviate the concern that the negative effect of
severance contracts on BHAR may be driven by delisting returns, we delete the last one, two, or
three quarters of data for any firm delisted before our sample period ends. Results are similar.
4.8.3. Alternative Instrument
To further ensure the robustness of our findings, we construct an additional instrumental
variable, %State Severance, defined as the annual ratio of S&PCEOs headquartered in the same
state that have a severance contract. We expect this variable to be positively related to the odds
of a CEO severance contract since prior studies suggest that firms tend to follow their local peers
or competitors in management compensation design (e.g., Bizjak, Lemmon, and Naveen (2008)).
However, there is no obvious reason as to why this state density should directly affect a firm's
performance. Our main results remain virtually the same.
4.8.4. Additional Robustness
Our primary findings are robust to (1) scaling discretionary expenses by sales; (2) using
industry median (mean) adjusted discretionary expenditures; (3) including firm and/or executive
fixed effects to control for unobservable firm and executive characteristics (Bertrand and Schoar
(2003), Graham, Li, and Qiu (2010));46 (4) inclusion of additional controls such as board size and
board independence;47 (5) excluding financial and utilities firms; (6) employing alternative
measures of operating performance such as ROA and ROE; and (7) adopting alternative metrics
for long-run stock return performance such as buy-and-hold and cumulative abnormal returns
45
Of these 182 firms, 150 (25.4% of 591) are delisted due to a takeover.
We note that including firm and executive fixed effects is similar to using only switching firms and CEOs while
ignoring the cross-sectional differences among non-switchers. However, results are qualitatively similar.
47
Including board variables reduces our sample size since they are only available from RiskMetrics since 1996.
46
41
benchmarked on contemporaneous CRSP value (equally)-weighted returns, and on matched size,
book-to-market, and momentum portfolio returns. 48
6. Conclusion
Using a unique dataset on S&P 500 CEO severance agreements between 1992 and 2010,
we examine the effects of these agreements on corporate investment, financing and risk-taking
decisions as well as firm performance. Echoing the recent outrage and concerns of popular
media, regulators, and law scholars about the flamboyant exit packages for failing managers, we
find that firms with a CEO severance agreement invest significantly less in discretionary
expenditures including R&D, advertising, and SG&A, and capital and PP&E expenditures, and
maintain larger employee count relative to assets. Over several years pursuant to these
suboptimal strategies, severance contracts appear to stifle patenting innovation and R&D
efficiency. Furthermore, firms with a CEO severance contract appear to seek less risk-taking via
lower leverage and more industry diversification, resulting in lower future stock return volatility.
Subsequently, these companies suffer significant deterioration in shareholder value and firm
performance. However, well-governance, risky, high growth firms, and firms in a more
competitive industry do not appear to suffer the negative value effect of severance, highlighting
the importance of internal and external governance mechanisms in regulating managerial
incentives and reducing managerial shirking.
Overall, our findings stand counter to the notion that by protecting against the downside,
severance contracts encourage managers to undertake risky and value-increasing projects. In
contrast, the empirical evidence suggests that CEO severance agreements induce managerial
48
All results in this section are available upon request.
42
shirking and destroy shareholder wealth. Our study helps researchers and regulators gain a better
and more complete understanding of severance agreements and their role in designing an
efficient executive compensation. It is of ample importance for corporate boards to consider the
effects of severance provisions on managerial incentives when structuring managerial
remuneration packages.
43
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49
Appendix I
Severance Agreements Disclosed in Company Proxy Statements
1. Agreement between Dr. McKinnell and Pfizer (Pfizer Inc. 2002 Proxy Statement):
In 2001, we entered into an employment agreement with Dr. McKinnell that provides for his
employment as Chief Executive Officer of the Company through February 29, 2008. Dr.
McKinnell's agreement provides that he will receive an annual base salary of at least
$1,350,000, and will be eligible to receive an incentive bonus in accordance with the
guidelines established by the Executive Compensation Committee, as well as to participate
in our executive benefit and incentive plans (including stock-based plans).
Under the terms of the agreement, if Dr. McKinnell's employment is terminated by reason of
death, disability or retirement, he is entitled to receive (a) a payment equal to his base salary
through the date of termination to the extent not already paid, (b) a prorated portion of his
incentive bonus based on his prior year's incentive bonus, (c) his actual earned incentive
bonus for any period not already paid, (d) amounts to which he is entitled under our benefit
plans, (e) vesting of outstanding unvested stock options and other equity-based awards, and
(f) continued coverage in our health benefit plans. If Dr. McKinnell's employment is
terminated by the Company without cause or by Dr. McKinnell for good reason (as defined
in the agreement), he is entitled to receive (a) a payment equal to his base salary earned but
unpaid through the date of termination, a prorated portion of his incentive bonus based on
the prior year's incentive bonus, and any incentive bonus amount earned but not yet paid, (b)
a payment equal to his annual base salary plus the most recent year's incentive bonus
multiplied by the greater of (i) two or (ii) the number of years remaining on the contract, (c)
vesting of outstanding stock options and equity-based awards, (d) benefits under all plans
for a period of two years following termination, as well as vesting of all awards under the
plans, and (e) continued coverage in the Company's health benefit plans.
If any payment or distribution by the Company to Dr. McKinnell is determined to be subject
to the excise tax imposed by Section 4999 of the Internal Revenue Code, he is entitled to
receive from the Company a payment on an after-tax basis equal to the federal, state and
local income and excise taxes imposed, and any penalties and interest. The agreement also
contains provisions that restrict Dr. McKinnell's ability to engage in any business which is
competitive with the Company's business for a period of one year following his retirement
or termination for cause or without good reason or to solicit Company employees for a
period of two years following such retirement or termination.
50
2. Agreement between Mr. Nardelli and Home Depot (Home Depot Inc. 2002 Proxy Statement)
The Company has an Employment Agreement dated as of December 4, 2000 with Robert L.
Nardelli retaining him as the President and Chief Executive Officer of the Company. The
initial term of the agreement expires on December31, 2005, and, beginning on January 1,
2003, the term automatically extends so that the remaining term is always three years.
To compensate Mr. Nardelli in part for forfeiting retirement benefits made available by his
former employer, the Company agreed to provide him with deferred compensation upon any
termination of his employment. Beginning on the later of his 62nd birthday or termination
of employment, Mr. Nardelli will be entitled to a cash benefit in an annual amount equal to
50% of his salary as of the date of his termination and his most recent annual bonus (or, if
greater, the then-current target amount for his bonus), subject to offset for certain pension
benefits paid or payable to Mr. Nardelli by the Company or his prior employers. The
amount of the benefit may be reduced if Mr. Nardelli's employment is terminated under
certain circumstances, such as if Mr. Nardelli is terminated by the Company for cause or if
Mr. Nardelli terminates his employment without good reason, prior to his 62nd birthday
and/or prior to the fifth anniversary of the date of the employment agreement.
In addition, if Mr. Nardelli's employment is terminated either by the Company for cause or
by Mr. Nardelli other than for good reason, then the Company will pay him all cash
compensation accrued but not paid as of the termination date. If Mr. Nardelli's employment
is terminated by the Company other than for cause, by Mr. Nardelli for good reason or for
any reason within12 months after a change in control or due to death or disability, Mr.
Nardelliwill receive certain benefits, including: (1) all cash compensation accrued but not
paid as of the termination date; (2) $20,000,000; (3) immediate vesting of unvested equitybased awards and deferred compensation; (4) for each year prior to 2006 for which an
annual option award has not yet been granted, a fully vested stock option award in
accordance with the agreement; and (5) immediate forgiveness of any outstanding principal
and accrued interest of the loan. If Mr. Nardelli's employment terminates due to his
retirement after he attains age 62 or upon a change in control of the Company, all equitybased awards made under his employment agreement or otherwise will fully vest and
remain exercisable through the end of their original term.
51
Appendix II
Variable Definitions
Variable
Definition
Panel A:Managerial Shirking, Risk-Taking, and Firm Risk, Value, and Performance
R&D/Assets
Research and development expenditure over assets [Max(data46, 0)/data6].
ADV/Assets
Advertising expenditure to assets [Max(data45, 0)/data6].
SG&A/Assets
Selling, general and administrative expenses over assets [Max(data189, 0)/data6].
DISEXP/Assets
Discretionary expenses over assets defined as the sum of R&D, Advertising, and Selling, general and administrative
expenses over assets [(Max(data46, 0)+Max(data46, 0)+Max(data189, 0))/data6].
LnPatent
Natural logarithm of one plus total number of patents filed by the firm over next one, three, and five years scaled by the
average number of patents filed across all firms in the same USPTO class and application years.
LnCite
Natural logarithm of one plus the number of citations received per patent over next one, three, and five years for the
firm, where the number of citations is scaled by the total number of citations received for all patents filed in the same
USPTO class within the same application years.
Patent Generality
Average generality across all patents filed in next one, three, and five years for the firm , where the generality measure
for each patent is scaled by the average generality of all patents filed in the same USPTO class and application years
(bias corrected using Hall (2001)).
Patent Originality
Average originality across all patents filed in next one, three, and five years for the firm, where the originality measure
for each patent is scaled by the average originality of all patents filed in the same USPTO class and application years
(bias corrected using Hall (2001)).
Patent/R&D
Total number of patents filed over next one, three, and five years for the firm divided by the total amount of R&D
expenditure ($mn) over the same time horizon, where the number of patents is scaled by the average number of patents
filed across all firms in the same USPTO class and application years.
Cite/R&D
Total number of citations received over next one, three, and five years on all patents of the firm scaled by the total
amount of R&D expenditures ($mn) over the same time horizon, where the number of citations is scled by the average
number of citations received by all firms in the same USPTO class and application years.
Capex/Assets
Capital expenditure to assets [data128/data6].
PP&E/Assets
Net property, plant and equipment to assets [data8/data6].
Employee-Ind. Adj. (000)
Number of employees (000) [data29] minus the industry median across all Compustat firms with the same two-digit SIC.
Employee/Assets-Ind. Adj.
Number of employees (000) over total assets ($mn) [data29/data6] minus the industry median Employee/Assets ratio.
Employee/Sales-Ind. Adj.
Number of employees (000) over sales ($mn) [data29/data12] minus the industry median Employee/Sales ratio.
Herfindahl Index-Business Segment
Sum of squared segment sales across business segments divided by squared total firm sales, where business segment
corresponds to the method of reporting by product line or divisions
Herfindahl Index-Geographic Seg.
Sum of squared segment sales across (international) geographic segments divided by squared total firm sales, where
geographic segment corresponds to the method of reporting by country.
Book Leverage
Book value of debts over book value of total assets [(data34+data9)/data6]
Market Leverage
Book value of debts over market value of total assets [(data34+data9)/(data6-data60+abs(data199)*data25)].
Total Risk-Ind. Adj.
The standard deviation of daily stock returns over one to five years following the fiscal year end minus industry median.
Systematic Risk-Ind. Adj.
Estimated market beta from the Fama-French three factor model using daily stock returns, minus industry median beta.
Idiosyncratic Risk-Ind. Adj.
The standard deviation of error terms estimated from the Fama-French three factor model using daily stock returns,
minus industry median idiosyncratic risk.
52
Appendix II - continued
Variable
Tobin’s q
OPINC
BHAR-vw(ew)
Panel B: Firm Characteristics
Assets ($mn)
MVE ($mn)
ROA
Cash/Assets
Sales
Sales Growth
Stock Ret [-t]
Vol [-t]
HI
HI2
Firm Age
Definition
Market value of total assets over book value of total assets [(data6-data60+abs(data199)*data25)/data6].
Operating income before depreciation over total assets [data13/data6].
Daily buy-and-hold abnormal returns subtracted by the value (equally)-weighted average return on a matched size and
book-to-market portfolio over next one (365) through five (1825) years, respectively, following current fiscal year end.
Book value of total assets [data6].
Market value of equity defined as the number of shares outstanding multiplied by share price [abs(data199)*data25].
Return on assets [data18/data6].
Cash over book value of assets [data1/data6].
Sales for the fiscal year [data12].
Natural logarithm of current over previous sales [Ln (Salest /Salest-1)]
Market-adjusted (CRSP value-weighted return) buy-and-hold daily return during the previous t year.
Standard deviation of market-adjusted (CRSP value-weighted return) daily stock returns over the previous t year.
The Herfindahl Index of sales across all firms in the same 2-digit SIC industry.
The square of HI.
The number of years since the firm is first listed in CRSP.
Panel C: CEO Characteristics, Compensation and Corporate Governance
%Industry Severance
Percentage of firms in the same 2-digit SIC industry that have a CEO severance contract during current fiscal year.
%State Severance
Percentage of firms headquartered in the same state that have a CEO severance contract during current fiscal year.
PreCEO Severance
Dummy variable: 1 if the previous CEO has a severance contract, 0 otherwise.
Board Independence
The number of independent directors divided by total number of board directors.
Board Size
Total number of board directors.
Tenure
Number of years the executive has worked for the firm.
CEO Tenure
Number of years the executive has worked for the firm as a CEO.
Outside Hire
Dummy variable: 1 if the executive has joined the firm for less than three years when becoming the CEO, 0 otherwise.
Founder
Dummy variable: 1 if the CEO is a founder or from a founding family, 0 otherwise.
CEO-Chair
Dummy variable: 1 if the CEO is also the Chairman of Board, 0 otherwise.
CEO Age
CEO age in years.
CEO Age >= 65
Dummy variable: 1 if the executive is older than 65, 0 otherwise.
TotPay ($000)
Total compensation for the fiscal year, comprised of salary, bonus, other annual, restricted stock granted, stock options
granted (valued by S&P’s Black-Scholes model), long-term incentive payouts, and all other total.
Equity/TotPay
The total value of new restricted stocks and stock options granted for the fiscal year as a percentage of annual total pay.
Option/TotPay
Value of stock options granted (valued by Black-Scholes) for the fiscal year as a percentage of annual total pay.
Cash/TotPay
The total value of salary and bonus granted during the fiscal year as a percentage of annual total compensation.
CEO Ownership
The percentage of the company’s shares owned by the executive.
Institutional Ownership
The percentage of the company’s shares outstanding owned by institutional investors.
G-Index
The anti-takeover provisions index from Gompers, Ishii, and Metrick (2003).
53
Table 1
Sample Distribution
Sample distribution across time and Fama-French industry. Severance denotes firm-years with a CEO severance contract. Frequencies with sample % are shown.
Year
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Total
Full Sample
(%)
480
(4.95)
498
(5.14)
512
(5.28)
524
(5.41)
546
(5.63)
549
(5.67)
549
(5.67)
556
(5.74)
566
(5.84)
552
(5.70)
540
(5.57)
542
(5.59)
535
(5.52)
509
(5.25)
482
(4.97)
468
(4.83)
434
(4.48)
429
(4.43)
419
(4.32)
9,690
(100)
Severance
(%)
144
(1.49)
149
(1.54)
160
(1.65)
170
(1.75)
191
(1.97)
201
(2.07)
218
(2.25)
235
(2.43)
253
(2.61)
258
(2.66)
257
(2.65)
264
(2.72)
274
(2.83)
270
(2.79)
250
(2.58)
231
(2.38)
197
(2.03)
184
(1.90)
180
(1.86)
4,086
(42.17)
No Sever.
(%)
336
(3.47)
349
(3.6)
352
(3.63)
354
(3.65)
355
(3.66)
348
(3.59)
331
(3.42)
321
(3.31)
313
(3.23)
294
(3.03)
283
(2.92)
278
(2.87)
261
(2.69)
239
(2.47)
232
(2.39)
237
(2.45)
237
(2.45)
245
(2.53)
239
(2.47)
5,604
(57.83)
%Severance
per year
30.00
Fama-French 12 Industry
1. Consumer Non-Durables
29.92
2. Consumer Durables
31.25
3. Manufacturing
32.44
4. Energy: Oil and Gas
34.98
5. Chemicals and Allied Products
36.61
6. Electronics: Computers, Software
39.71
7. Telecom, Telephone & TV Transmission
42.27
8. Utilities
44.70
9. Shops: Wholesale & Retail
46.74
10. Healthcare, Medical & Drugs
47.59
11. Money: Finance
48.71
12. Other: Mines, Hotels & Entertainment
51.21
Total
Full Sample
(%)
664
(6.85)
271
(2.80)
1,240
(12.80)
456
(4.71)
340
(3.51)
1,578
(16.28)
261
(2.69)
703
(7.25)
1,010
(10.42)
694
(7.16)
1,704
(17.59)
769
(7.94)
9,690
(100)
Severance
(%)
204
(2.11)
88
(0.91)
464
(4.79)
212
(2.19)
94
(0.97)
654
(6.75)
144
(1.49)
326
(3.36)
429
(4.43)
285
(2.94)
783
(8.08)
403
(4.16)
4,086
(42.17)
No Sever.
(%)
460
(4.75)
183
(1.89)
776
(8.01)
244
(2.52)
246
(2.54)
924
(9.54)
117
(1.21)
377
(3.89)
581
(6.00)
409
(4.22)
921
(9.50)
366
(3.78)
5,604
(57.83)
%Severance
per industry
30.72
32.47
37.42
46.49
27.65
41.44
55.17
46.37
42.48
41.07
45.95
52.41
53.05
51.87
49.36
45.39
42.89
42.96
54
Table 2
Summary Statistics
Summary statistics on the key variables. Severance refers to firm-years with a CEO severance contract, and No Severance otherwise. Variables are defined in
Appendix II. Industry-adjusted variables are subtracted by the industry median across all Compustat firms with the same two-digit SIC code. All except the
indicator variables are winsorized at the 1st and 99th percentile. The t-statistics for the difference between means and the z-statistics from the Wilcoxon rank sum
tests for the difference between distributions are reported. ***, **, and * denote significance at the 1%, 5%, and 10% levels in two-tailed tests.
N
Managerial Shirking: Discretionary Expenditures
R&D/Assets (%)
9,690
ADV/Assets (%)
9,690
SG&A/Assets (%)
9,690
DISEXP/Assets (%)
9,690
Full Sample (1)
Mean
Median
2.51
1.24
17.33
21.18
N
Severance (2)
Mean
Median
N
No Severance (3)
Mean
Median
Difference (2)-(3)
t-stat.
Wilcox. z
0.00
0.00
11.89
14.32
4,086
4,086
4,086
4,086
2.31
1.12
16.73
20.27
0.00
0.00
10.80
12.35
5,604
5,604
5,604
5,604
2.66
1.33
17.77
21.84
0.00
0.00
12.61
15.40
-3.69***
-3.48***
-2.68***
-3.40***
-5.73***
-0.66
-3.69***
-4.54***
Managerial Shirking: Patent Innovation and R&D Efficiency
LnPatent
7,458
0.86
LnCite
7,458
0.27
Generality
7,458
0.21
Originality
7,458
0.41
Patent/R&D
4,047
0.06
Cite/R&D
4,047
0.26
0.00
0.00
0.00
0.00
0.01
0.03
3,044
3,044
3,044
3,044
1,557
1,557
0.62
0.21
0.15
0.33
0.05
0.21
0.00
0.00
0.00
0.00
0.00
0.00
4,414
4,414
4,414
4,414
2,490
2,490
1.02
0.32
0.26
0.46
0.06
0.29
0.00
0.00
0.00
0.00
0.02
0.07
-12.64***
-11.64***
-11.50***
-8.58***
-4.32***
-4.54***
-12.35***
-12.37***
-12.95***
-10.11***
-7.18***
-8.46***
Managerial Shirking: Capital Investments and Employee Base
Capex/Assets (%)
8,667
5.42
Capex/Assets-Ind. Adj. (%)
8,647
1.01
PP&E/Assets (%)
9,436
28.49
PP&E/Assets-Ind. Adj. (%)
9,416
2.64
Employee-Ind. Adj. (000)
9,452
35.65
Employee/Assets-Ind. Adj. (%)
9,452
-0.04
Employee/Sales -Ind. Adj. (%)
8,848
-0.07
4.42
0.34
21.98
0.92
14.38
-0.02
-0.06
3,633
3,621
3,956
3,944
3,945
3,945
3,683
5.13
0.75
27.34
1.60
30.52
-0.02
-0.04
4.03
0.13
19.98
0.40
12.73
-0.02
-0.04
5,034
5,026
5,480
5,472
5,507
5,507
5,165
5.63
1.20
29.32
3.40
39.33
-0.06
-0.09
4.78
0.50
23.53
1.30
16.03
-0.02
-0.08
-5.40***
-5.47***
-4.06***
-5.73***
-7.53***
5.79***
7.32***
-8.77***
-6.69***
-5.16***
-6.25***
-5.55***
3.05***
7.76***
3,228
3,618
3,267
3,618
4,047
4,035
3,721
3,709
3,575
3,575
3,575
0.75
2.58
0.71
2.66
24.45
1.95
16.84
2.16
-0.85
0.21
-0.96
0.71
2.00
0.72
2.00
22.66
1.13
13.51
0.68
-0.70
0.15
-0.80
4,457
4,965
4,574
4,965
5,571
5,563
5,171
5,163
4,997
4,997
4,997
0.72
2.45
0.69
2.79
23.75
2.90
15.51
1.99
-0.96
0.20
-1.09
0.75
2.00
0.64
2.00
22.83
0.87
12.58
0.05
-0.79
0.14
-0.93
0.79
3.07***
2.89***
-2.99***
2.04**
-3.00***
4.57***
0.62
3.85***
1.44
4.76***
-2.88***
3.57***
4.49***
-6.44***
-0.52
-1.01
3.71***
2.50**
3.78***
1.69*
5.46***
Managerial Risk-Taking: Firm Focus, Financial Leverage, and Firm Risk
Herfindahl Index-Business
7,685
0.73
0.73
No of Business Segment
8,583
2.50
2.00
Herfindal Index-Geographic
7,841
0.70
0.68
No of Geographic Segment
8,583
2.73
2.00
Book Leverage
9,618
24.05
22.76
Book Leverage-Ind. Adj. (%)
9,598
2.50
0.93
Market Leverage
8,892
16.07
12.94
Market Leverage-Ind. Adj. (%)
8,872
2.06
0.34
Total Risk (3-yr)-Ind. Adj. (%)
8,572
-0.91
-0.75
Systematic Risk (3-yr)-Ind. Adj.
8,572
0.21
0.14
Idiosyncratic Risk (3-yr)-Ind. Adj. (%)
8,572
-1.04
-0.87
55
Table 2 - continued
N
Full Sample (1)
Mean
Median
N
Severance (2)
Mean
Median
N
No Severance (3)
Mean
Median
Difference (2)-(3)
t-stat.
Wilcox. z
Firm Value and Performance
Tobin's q
Tobin's q-Ind. Adj.
OPINC (%)
OPINC-Ind. Adj. (%)
BHAR-vw [+3] (%)
BHAR-vw [+5] (%)
BHAR-ew [+3] (%)
BHAR-ew [+5] (%)
8,945
8,925
8,889
8,869
8,022
7,942
8,022
7,942
2.15
0.56
14.6
7.17
10.16
14.47
9.52
14.02
1.63
0.13
14.0
4.37
-3.38
-6.09
-6.76
-11.80
3,751
3,739
3,730
3,718
3,292
3,251
3,292
3,251
1.99
0.42
13.5
6.15
8.09
9.33
6.18
6.41
1.5131
0.06
12.5
3.46
-3.66
-6.78
-7.44
-12.28
5,194
5,186
5,159
5,151
4,730
4,691
4,730
4,691
2.2702
0.67
15.4
7.91
11.61
18.04
11.85
19.30
1.7213
0.19
15.1
5.07
-3.20
-5.34
-6.03
-11.56
-8.73***
-8.47***
-10.88***
-7.54***
-1.75*
-2.76***
-2.71***
-3.83***
-10.15***
-9.51***
-12.66***
-8.86***
-1.00
-1.31
-2.07**
-2.30**
CEO Compensation Structure
Equity/TotPay (%)
Option/TotPay (%)
Cash/TotPay (%)
8,881
8,881
8,881
37.38
30.81
55.05
38.60
26.48
48.67
3,750
3,750
3,750
38.72
31.39
53.36
40.92
27.26
45.58
5,131
5,131
5,131
36.39
30.38
56.29
37.00
25.76
50.82
3.38***
1.57
-4.20***
3.16***
0.87
-4.86***
Control Variables: Firm Characteristics
Assets ($mn)
MVE ($mn)
Sales ($mn)
ROA (%)
Cash/Assets (%)
Sales Growth (%)
Stock Ret [-1] (%)
Vol [-1] (%)
Industry Sales HI
Firm Age
9,690
8,945
9,052
9,690
9,052
8,662
9,340
9,339
9,135
9,675
28,023.79
15,733.22
11181.96
5.22
11.77
10.16
6.95
2.06
0.25
31.17
7,687.96
6,369.80
5005.01
4.66
5.73
7.74
1.89
1.76
0.18
27.00
4,086
3,751
3,789
4,086
3,790
3,623
3,927
3,926
3,839
4,085
26,094.39
12,826.61
10055.87
4.42
11.83
10.11
6.92
2.12
0.24
29.65
7,877.36
5,873.40
4829.40
3.83
6.05
7.74
2.33
1.86
0.18
26.00
5,604
5,194
5,263
5,604
5,262
5,039
5,413
5,413
5,296
5,590
29,430.55
17,832.32
11992.67
5.80
11.73
10.20
6.98
2.01
0.25
32.28
7,583.80
6,758.70
5160.00
5.37
5.50
7.74
1.67
1.70
0.18
28.00
-2.54**
-8.73***
-5.09***
-9.94***
0.33
-0.20
-0.07
5.19***
-0.94
-5.69***
-1.15
-5.68***
-2.69***
-11.88***
2.96***
-0.38
0.14
7.04***
-0.19
-4.36***
3,587
2,822
2,847
4,029
3,288
4,085
4,086
4,082
4,086
4,086
4,086
4,086
2,788
4,086
3,696
9.71
71.28
10.92
67.74
0.89
14.03
6.25
55.36
7.81
40.04
12.70
71.29
71.77
51.30
58.86
10
75
11
70.43
0.14
11
4
55
4,975
3,548
3,566
5,458
4,535
5,593
5,604
5,594
5,604
5,604
5,604
5,604
3,460
5,604
5,030
9.58
70.22
11.26
62.95
1.91
21.58
7.30
55.78
7.39
13.88
19.47
72.88
27.17
36.05
30.23
10
72
11
64.59
0.14
22
5
56
2.15**
2.60***
-4.50***
12.77***
-10.94***
-31.69***
-7.16***
-2.95***
0.77
30.80***
-8.87***
-1.72*
39.18***
41.66***
59.16***
2.22**
3.33***
-6.47***
14.30***
-2.46**
-30.72***
-6.29***
-4.46***
Control Variables: Corporate Governance and CEO Characteristics
G-Index
8,562
9.63
10
Board Independence (%)
6,370
70.69
73.68
Board Size
6,413
11.11
11
Institutional Own. (%)
9,487
64.98
66.85
CEO Ownership (%)
7,823
1.48
0.14
Tenure (years)
9,678
18.39
17
CEO Tenure (years)
9,690
6.86
5
CEO Age (years)
9,676
55.60
56
CEO Age >= 65 (0/1, %)
9,690
7.56
Outside Hire (0/1, %)
9,690
24.91
Founder (0/1, %)
9,690
16.62
CEO-Chair (0/1, %)
9,690
72.21
PreCEO Severance (0/1, %)
6,248
47.07
%Industry Severance (%)
9,690
42.48
40.91
%State Severance (%)
8,726
42.36
42.86
48.65
52.50
37.21
33.33
36.37***
48.28***
56
Table 3
Predicting the Use of CEO Severance Contract
This table reports marginal effects from the Probit and coefficient estimates from the OLS regressions predicting the
use of a CEO severance contract. The dependent variable is Severance, which equals one if the CEO has a severance
contract and zero otherwise. The independent variables are defined in Appendix II and lagged by one year. The
partial derivatives from Probit models are evaluated at the mean for continuous and at zero for indicator variables.
Constant terms from the OLS are omitted for brevity. Industry and year fixed effects are included. The t-statistics
are shown in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels.
Dep. Var.=Severance
PreCEO Sever.
%Ind. Severance
Log (MVE)
ROA
Book Leverage
Tobin's q
Cash/Assets
Sales Growth
R&D/Sales
PP&E/Assets
Stock Ret [-1]
Log(Vol [-1])
G-Index
Inst. Own.
(1)
0.398***
(20.90)
1.139***
(16.46)
-0.028***
(-2.78)
-0.140
(-0.74)
-0.390***
(-5.24)
0.001
(0.12)
-0.261**
(-2.57)
0.083
(1.54)
0.806***
(3.89)
-0.046
(-0.76)
-0.038
(-1.50)
0.052
(1.59)
-0.008**
(-2.05)
0.274***
(3.70)
Board Indep.
Log (Board Size)
CEO Own.
Equity/TotPay
Tenure
Outside Hire
CEO-Chair
Founder
CEO Age
CEO Age>=65
Observations
Pseudo /Adj. R2
Industry FE
Year FE
Log Likelihood
0.316
(0.59)
-0.024
(-0.59)
-0.011***
(-10.11)
0.258***
(9.50)
-0.015
(-0.71)
-0.006
(-0.13)
0.006***
(3.40)
0.042
(0.80)
4,175
0.348
Yes
Yes
-1,860.26
Probit
(2)
0.397***
(19.20)
1.136***
(15.03)
-0.033***
(-2.82)
-0.147
(-0.73)
-0.404***
(-5.04)
0.000
(0.02)
-0.301***
(-2.71)
0.104*
(1.79)
0.761***
(3.42)
-0.058
(-0.88)
-0.033
(-1.21)
0.060*
(1.68)
-0.010**
(-2.33)
0.368***
(4.48)
0.095
(1.22)
0.005
(0.92)
0.766
(1.33)
-0.021
(-0.48)
-0.011***
(-9.18)
0.283***
(9.57)
-0.037
(-1.56)
-0.019
(-0.38)
0.008***
(3.82)
0.000
(0.01)
3,584
0.343
Yes
Yes
-1,614.81
(3)
0.439***
(30.50)
1.232***
(23.69)
6,248
0.250
Yes
Yes
-3,221.14
(4)
0.311***
(23.72)
0.699***
(18.51)
-0.019***
(-2.79)
-0.090
(-0.69)
-0.255***
(-5.15)
0.002
(0.24)
-0.182**
(-2.57)
0.062*
(1.67)
0.654***
(4.48)
-0.027
(-0.68)
-0.030*
(-1.74)
0.038*
(1.70)
-0.007***
(-2.83)
0.201***
(4.04)
0.310
(0.86)
-0.005
(-0.17)
-0.008***
(-10.61)
0.209***
(11.32)
-0.013
(-0.93)
-0.007
(-0.22)
0.005***
(3.89)
0.029
(0.82)
4,175
0.394
Yes
Yes
OLS
(5)
0.305***
(21.49)
0.683***
(16.71)
-0.022***
(-2.81)
-0.068
(-0.48)
-0.260***
(-4.88)
0.000
(0.03)
-0.215***
(-2.78)
0.079**
(1.97)
0.645***
(4.08)
-0.032
(-0.75)
-0.026
(-1.39)
0.041*
(1.69)
-0.009***
(-3.06)
0.255***
(4.60)
0.039
(0.74)
0.002
(0.67)
0.608
(1.57)
-0.003
(-0.11)
-0.008***
(-9.82)
0.222***
(11.05)
-0.028*
(-1.75)
-0.017
(-0.53)
0.006***
(4.27)
-0.005
(-0.12)
3,584
0.388
Yes
Yes
(6)
0.379***
(34.44)
0.840***
(26.90)
6,248
0.299
Yes
Yes
57
Table 4
CEO Severance Contract and Discretionary Spending: IV/2SLS Regression Analysis
This table provides IV/2SLS regression results of firm discretionary spending on severance contract. The dependent
variables are research and development expenditures over assets (R&D/Assets), advertising expenditures over assets
(ADV/Assets), selling, general and administrative expenses over assets (SG&A/Assets), and discretionary expenses,
which equal the sum of the R&D, Advertising and SG&A scaled by assets (DISEXP/Assets), measured at the fiscal
end of 1, 3, and 5 years subsequent to current fiscal year end. Severance is instrumented by PreCEO Severance and
%Industry Severance. The two stages are jointly estimated. The first-stage regression results predicting the use of a
severance contract in Panel B are consistent with Table 3 and Panel A, and thus omitted for brevity. All variables are
defined in Appendix II. Industry and year fixed effects are included in both stages. The t-statistics based on robust
standard errors are reported in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels.
Panel A: R&D/Assets
R&D/Assets 1-yr
First-Stage Second-Stage
Severance
RD/Assets
PreCEO Sever.
%Ind. Sever.
0.295***
(20.27)
0.751***
(16.96)
-0.013***
(-5.23)
Log (MVE)
-0.004
0.000
(-0.61)
(0.95)
Book Leverage
-0.240***
-0.034***
(-4.56)
(-9.12)
Tobin's q
0.003
0.004***
(0.55)
(10.01)
PP&E/Assets
-0.028
-0.014***
(-0.65)
(-4.63)
Stock Ret [-1]
-0.022
0.004***
(-1.20)
(2.75)
Log (Vol [-1])
0.068***
0.019***
(2.70)
(10.58)
G-Index
-0.003
-0.001***
(-0.92)
(-3.65)
Equity/TotPay
-0.030
0.010***
(-1.09)
(5.08)
Tenure
-0.013***
-0.000***
(-21.15)
(-3.93)
CEO-Chair
0.014
0.003***
(0.88)
(3.08)
CEO Age
0.006***
0.000
(5.51)
(0.02)
Constant
0.205
0.095***
(1.53)
(10.04)
Observations
3,402
3,402
R-squared
0.375
0.568
Industry FE
Yes
Yes
Year FE
Yes
Yes
Durbin-Wu-Hausman Endogeneity Test p-value:
0.000
Sargan Test of Overidentifying Restrictions p-value:
0.196
First-Stage F-stat. of Weak Instruments (p-value):
429.94 (0.000)
R&D/Assets 3-yr
First-Stage Second-Stage
Severance
RD/Assets
0.297***
(17.71)
0.808***
(15.83)
R&D/Assets 5-yr
First-Stage Second-Stage
Severance
RD/Assets
0.319***
(16.19)
0.829***
(13.67)
Severance
-0.013***
(-4.83)
0.001
(1.27)
-0.037***
(-8.85)
0.003***
(6.22)
-0.016***
(-4.91)
0.006***
(4.38)
0.017***
(8.64)
-0.001***
(-3.82)
0.008***
(3.94)
-0.000***
(-3.37)
0.003***
(2.63)
-0.000
(-0.64)
0.094***
(9.33)
2,591
0.573
Yes
Yes
-0.002
(-0.23)
-0.230***
(-3.80)
0.010
(1.48)
-0.039
(-0.81)
-0.014
(-0.70)
0.029
(1.01)
-0.003
(-0.84)
-0.037
(-1.19)
-0.013***
(-17.78)
0.022
(1.20)
0.007***
(5.02)
-0.050
(-0.34)
2,591
0.370
Yes
Yes
0.001
(0.08)
-0.211***
(-2.92)
0.015**
(2.02)
-0.028
(-0.52)
-0.028
(-1.22)
0.005
(0.14)
-0.002
(-0.70)
-0.030
(-0.81)
-0.012***
(-14.44)
0.019
(0.93)
0.005***
(3.32)
-0.160
(-0.92)
1,872
0.375
Yes
Yes
-0.011***
(-3.94)
0.001
(1.54)
-0.042***
(-8.75)
0.002***
(3.44)
-0.013***
(-3.62)
0.004***
(2.79)
0.021***
(8.46)
-0.001***
(-3.59)
0.004
(1.58)
-0.000**
(-2.41)
0.003**
(2.33)
-0.000**
(-2.38)
0.110***
(9.70)
1,872
0.595
Yes
Yes
0.000
0.000
0.146
0.077
351.61 (0.000)
286.42 (0.000)
58
Table 4 - continued
Panel B: Other Discretionary Expenses
Severance
Log (MVE)
Book Leverage
Tobin's q
PP&E/Assets
Stock Ret [-1]
Log (Vol [-1])
G-Index
Equity/TotPay
Tenure
CEO-Chair
CEO Age
Constant
Observations
R-squared
Year FE
Industry FE
1-yr
ADV/Assets
3-yr
5-yr
1-yr
SG&A/Assets
3-yr
5-yr
1-yr
DISEXP/Assets
3-yr
5-yr
-0.002
(-1.07)
0.002***
(3.75)
-0.003
(-0.92)
0.003***
(7.35)
0.004
(1.57)
0.002
(1.60)
0.003
(1.60)
0.000
(0.62)
0.000
(0.05)
-0.000
(-1.10)
0.006***
(5.61)
-0.000*
(-1.89)
-0.001
(-0.18)
3,402
0.277
Yes
Yes
-0.005**
(-1.97)
0.002***
(3.73)
-0.007*
(-1.81)
0.002***
(5.62)
0.002
(0.60)
0.001
(1.10)
0.002
(0.96)
0.000
(0.68)
0.000
(0.01)
-0.000
(-1.39)
0.007***
(6.11)
-0.000**
(-2.20)
0.001
(0.12)
2,591
0.283
Yes
Yes
-0.007***
(-2.96)
0.002***
(2.95)
-0.006
(-1.44)
0.002***
(4.61)
-0.001
(-0.36)
0.001
(0.58)
-0.000
(-0.11)
0.000
(0.51)
0.000
(0.10)
-0.000*
(-1.75)
0.007***
(5.80)
-0.000*
(-1.86)
-0.003
(-0.31)
1,872
0.264
Yes
Yes
-0.023**
(-2.13)
-0.022***
(-9.67)
-0.121***
(-7.18)
0.025***
(13.47)
-0.074***
(-5.54)
-0.006
(-0.94)
0.007
(0.87)
-0.003***
(-3.28)
0.001
(0.12)
-0.001***
(-2.77)
0.025***
(4.96)
-0.001**
(-2.52)
0.408***
(9.57)
3,402
0.516
Yes
Yes
-0.033***
(-2.77)
-0.020***
(-7.58)
-0.125***
(-6.43)
0.016***
(7.94)
-0.087***
(-5.74)
-0.007
(-1.11)
0.003
(0.37)
-0.004***
(-3.76)
0.002
(0.18)
-0.001***
(-2.58)
0.024***
(4.18)
-0.001***
(-3.13)
0.439***
(9.39)
2,591
0.492
Yes
Yes
-0.056***
(-4.24)
-0.016***
(-5.39)
-0.134***
(-5.77)
0.012***
(5.09)
-0.069***
(-4.00)
-0.007
(-0.89)
0.020*
(1.65)
-0.004***
(-3.55)
-0.012
(-1.00)
-0.001***
(-3.78)
0.019***
(2.91)
-0.001***
(-2.75)
0.517***
(9.48)
1,872
0.475
Yes
Yes
-0.038***
(-3.00)
-0.020***
(-7.57)
-0.159***
(-8.04)
0.033***
(14.80)
-0.084***
(-5.35)
-0.000
(-0.06)
0.029***
(3.09)
-0.004***
(-3.57)
0.012
(1.14)
-0.001***
(-3.34)
0.034***
(5.79)
-0.001***
(-2.60)
0.514***
(10.26)
3,402
0.525
Yes
Yes
-0.050***
(-3.55)
-0.017***
(-5.65)
-0.169***
(-7.38)
0.022***
(8.82)
-0.101***
(-5.66)
0.001
(0.11)
0.023**
(2.08)
-0.004***
(-3.86)
0.011
(0.93)
-0.001***
(-3.08)
0.034***
(4.97)
-0.002***
(-3.16)
0.540***
(9.77)
2,591
0.501
Yes
Yes
-0.075***
(-4.75)
-0.014***
(-3.85)
-0.183***
(-6.67)
0.015***
(5.59)
-0.082***
(-4.06)
-0.001
(-0.15)
0.041***
(2.87)
-0.005***
(-3.57)
-0.009
(-0.62)
-0.001***
(-3.95)
0.029***
(3.71)
-0.002***
(-3.06)
0.628***
(9.72)
1,872
0.486
Yes
Yes
59
Table 5
CEO Severance Contract, Patent Innovation, and R&D Efficiency (IV/2SLS)
This table provides IV/2SLS regression results of patent innovation and R&D efficiency on severance contract.
Panel A studies patent quantity and patent quality as measured by future citations, Panel B analyzes patent
generality and originality captured by the distribution of citations made or received, and Panel C examines R&D
efficiency as measured by patent quantity and citations over R&D expenditures. LnPatent is the natural logarithm of
one plus total number of patents filed by the firm over the next one, three, and five years subsequent to current fiscal
end, scaled by the average number of patents filed across all firms in the same USPTO class and application years.
LnCite is the natural logarithm of one plus the number of citations received per patent over the next one, three, and
five years subsequent to current fiscal end for the firm, where the number of citations is scaled by the total number
of citations received for all patents filed in the same USPTO class and application years. Generality (Originality) is
average generality (originality) across all patents filed in next one, three, and five years for the firm, where the
generality (originality) score for each patent is scaled by the average generality (originality) of all patents filed in the
same USPTO class and application years (bias corrected using Hall (2001)). Severance is instrumented by PreCEO
Severance and %Industry Severance. The two stages are jointly estimated. The first-stage results are consistent with
Table 3 and thus omitted. Appendix II provides variable definitions. Industry and year fixed effects are included.
Robust t-statistics are shown in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels.
Panel A: Patent Quantity and Patent Quality as Measured by Future Citations
Severance
Log (MVE)
ROA
Book Leverage
Tobin's q
R&D/Assets
HI
HI2
Log (Firm Age)
G-Index
Inst. Own.
CEO Tenure
CEO-Chair
CEO Age
CEO Age>=65
Constant
Observations
R-squared
Year and Industry FE
1-yr
LnPatent
3-yr
5-yr
1-yr
LnCite
3-yr
5-yr
-0.283***
(-3.94)
0.394***
(23.03)
0.076
(0.23)
0.255**
(1.98)
-0.068***
(-4.05)
8.986***
(15.91)
1.572***
(5.52)
-1.141***
(-3.48)
0.302***
(10.66)
-0.002
(-0.29)
0.214*
(1.68)
0.004
(0.76)
0.093**
(2.42)
-0.009***
(-2.74)
-0.123
(-1.42)
-3.030***
(-11.99)
3,457
0.586
Yes
-0.518***
(-5.23)
0.486***
(20.16)
0.554
(1.15)
0.232
(1.27)
-0.077***
(-3.34)
12.030***
(15.12)
1.938***
(4.71)
-1.294***
(-2.70)
0.406***
(9.94)
0.003
(0.33)
0.188
(1.04)
0.003
(0.33)
0.141***
(2.59)
-0.011**
(-2.46)
-0.052
(-0.43)
-3.756***
(-10.91)
2,709
0.625
Yes
-0.743***
(-6.02)
0.539***
(17.14)
1.402**
(2.07)
0.260
(1.07)
-0.096***
(-3.39)
14.067***
(13.79)
2.056***
(3.94)
-1.301**
(-2.13)
0.415***
(7.73)
0.006
(0.53)
0.382*
(1.69)
0.001
(0.07)
0.156**
(2.26)
-0.012**
(-2.02)
0.038
(0.24)
-4.108***
(-9.61)
2,019
0.642
Yes
-0.095***
(-3.76)
0.035***
(5.80)
0.117
(1.00)
-0.021
(-0.47)
0.006
(0.95)
2.054***
(10.37)
0.396***
(3.96)
-0.289**
(-2.51)
0.042***
(4.20)
0.000
(0.13)
0.100**
(2.24)
-0.005***
(-2.68)
0.024*
(1.81)
0.001
(0.79)
-0.038
(-1.24)
-0.255***
(-2.88)
3,457
0.381
Yes
-0.129***
(-4.48)
0.026***
(3.64)
0.248*
(1.78)
-0.070
(-1.31)
0.010
(1.48)
2.001***
(8.66)
0.306**
(2.56)
-0.154
(-1.11)
0.043***
(3.59)
-0.002
(-0.69)
0.032
(0.61)
-0.005**
(-2.36)
0.049***
(3.11)
0.001
(0.69)
-0.033
(-0.93)
-0.080
(-0.81)
2,709
0.363
Yes
-0.188***
(-6.04)
0.025***
(3.15)
0.259
(1.52)
-0.112*
(-1.83)
0.015**
(2.03)
1.855***
(7.20)
0.411***
(3.12)
-0.241
(-1.57)
0.034**
(2.48)
-0.003
(-1.16)
-0.008
(-0.14)
-0.005**
(-2.09)
0.038**
(2.15)
0.001
(0.70)
-0.019
(-0.48)
0.042
(0.39)
2,019
0.372
Yes
60
Table 5-continued
Panel B: Patent Generality and Originality
Severance
Log (MVE)
ROA
Book Leverage
Tobin's q
R&D/Assets
HI
HI2
Log (Firm Age)
G-Index
Inst. Own.
CEO Tenure
CEO-Chair
CEO Age
CEO Age>=65
Constant
Observations
R-squared
Year FE
Industry FE
1-yr
Patent Generality
3-yr
5-yr
1-yr
Patent Originality
3-yr
5-yr
-0.060***
(-3.16)
0.019***
(4.11)
0.287***
(3.25)
0.012
(0.36)
-0.009**
(-2.04)
1.505***
(10.11)
0.486***
(6.48)
-0.423***
(-4.90)
0.007
(0.89)
0.000
(0.03)
0.139***
(4.13)
-0.004***
(-2.86)
0.020**
(1.97)
0.001
(1.54)
-0.041*
(-1.80)
0.002
(0.03)
3,457
0.443
Yes
Yes
-0.045**
(-2.22)
0.016***
(3.36)
0.360***
(3.69)
-0.007
(-0.19)
-0.010**
(-2.20)
1.127***
(6.96)
0.451***
(5.39)
-0.409***
(-4.18)
-0.006
(-0.76)
-0.001
(-0.48)
0.058
(1.58)
-0.003**
(-2.12)
0.028**
(2.49)
0.002*
(1.81)
-0.058**
(-2.36)
0.070
(1.00)
2,709
0.464
Yes
Yes
-0.053**
(-2.32)
0.020***
(3.48)
0.287**
(2.30)
-0.036
(-0.80)
-0.010*
(-1.85)
1.113***
(5.92)
0.459***
(4.77)
-0.423***
(-3.76)
-0.012
(-1.25)
-0.001
(-0.58)
0.054
(1.31)
-0.004*
(-1.88)
0.030**
(2.34)
0.001
(1.29)
-0.072**
(-2.49)
0.067
(0.86)
2,019
0.442
Yes
Yes
-0.177***
(-4.35)
0.040***
(4.07)
-0.335*
(-1.76)
-0.010
(-0.13)
0.012
(1.26)
2.377***
(7.41)
0.679***
(4.20)
-0.516***
(-2.77)
0.056***
(3.45)
0.016***
(4.18)
0.061
(0.84)
-0.006**
(-2.08)
0.040*
(1.83)
-0.000
(-0.18)
0.004
(0.09)
-0.449***
(-3.13)
3,457
0.337
Yes
Yes
-0.286***
(-5.59)
0.048***
(3.82)
-0.397
(-1.60)
-0.045
(-0.47)
0.011
(0.90)
2.113***
(5.14)
0.534**
(2.51)
-0.387
(-1.56)
0.048**
(2.29)
0.017***
(3.39)
0.023
(0.25)
-0.010**
(-2.47)
0.061**
(2.16)
-0.000
(-0.15)
0.053
(0.84)
-0.286
(-1.61)
2,709
0.242
Yes
Yes
-0.296***
(-5.24)
0.061***
(4.26)
0.328
(1.06)
-0.007
(-0.06)
0.003
(0.22)
1.956***
(4.18)
0.415*
(1.73)
-0.274
(-0.98)
0.008
(0.31)
0.017***
(3.09)
0.056
(0.54)
-0.012***
(-2.65)
0.028
(0.89)
-0.003
(-1.14)
0.062
(0.86)
-0.074
(-0.38)
2,019
0.229
Yes
Yes
61
Table 5-continued
Panel C: R&D Efficiency
Severance
Log (Sale)
ROA
Book Leverage
Tobin's q
HI
HI2
Log (Firm Age)
G-Index
Inst. Own.
Tenure
CEO-Chair
CEO Age
CEO Age >=65
Constant
Observations
R-squared
Year FE
Industry FE
1-yr
Patent/R&D
3-yr
5-yr
1-yr
Cite/R&D
3-yr
5-yr
-0.026**
(-2.10)
-0.014***
(-5.83)
0.052
(1.26)
0.015
(0.70)
-0.003
(-1.54)
0.105**
(2.53)
-0.084*
(-1.73)
-0.007
(-1.49)
0.002**
(2.29)
0.004
(0.22)
0.000
(0.42)
0.014**
(2.56)
-0.000
(-0.06)
-0.005
(-0.43)
0.233***
(5.53)
1,823
0.227
Yes
Yes
-0.071***
(-2.93)
-0.021***
(-3.91)
0.092
(1.05)
0.003
(0.06)
-0.004
(-0.99)
0.204**
(2.26)
-0.188*
(-1.78)
-0.012
(-1.26)
0.004**
(2.11)
-0.050
(-1.21)
-0.001
(-1.42)
0.030***
(2.63)
0.000
(0.03)
-0.007
(-0.28)
0.334***
(3.80)
1,481
0.109
Yes
Yes
-0.269**
(-2.44)
-0.043*
(-1.75)
-0.156
(-0.35)
-0.047
(-0.23)
0.009
(0.49)
1.040**
(2.50)
-1.066**
(-2.19)
-0.062
(-1.33)
0.015
(1.56)
-0.090
(-0.48)
-0.006**
(-2.36)
0.111**
(2.10)
-0.001
(-0.11)
-0.011
(-0.10)
0.875**
(2.19)
1,132
0.042
Yes
Yes
-0.027
(-0.45)
-0.048***
(-4.05)
0.091
(0.46)
-0.026
(-0.26)
-0.006
(-0.63)
0.475**
(2.35)
-0.434*
(-1.85)
-0.009
(-0.41)
0.001
(0.26)
0.103
(1.09)
-0.000
(-0.10)
0.062**
(2.29)
-0.003
(-1.55)
0.044
(0.73)
1.054***
(5.15)
1,823
0.163
Yes
Yes
-0.125**
(-1.99)
-0.049***
(-3.60)
0.153
(0.68)
-0.182
(-1.58)
-0.007
(-0.69)
0.594**
(2.56)
-0.528*
(-1.94)
-0.017
(-0.69)
0.007
(1.37)
0.015
(0.14)
-0.002*
(-1.67)
0.100***
(3.36)
-0.005**
(-1.97)
0.047
(0.71)
1.154***
(5.10)
1,481
0.145
Yes
Yes
-0.221**
(-2.33)
-0.046**
(-2.20)
-0.011
(-0.03)
-0.340*
(-1.88)
0.011
(0.69)
1.040***
(2.90)
-0.985**
(-2.35)
-0.021
(-0.52)
0.015*
(1.82)
0.000
(0.00)
-0.005**
(-2.46)
0.114**
(2.52)
-0.009**
(-2.21)
0.099
(1.00)
1.328***
(3.86)
1,132
0.086
Yes
Yes
62
Table 6
CEO Severance Contract and Capital Investment (IV/2SLS)
This table provides IV/2SLS regression results of capital investment on CEO severance contract. The dependent
variables are industry-median-adjusted capital expenditures scaled by assets (Capex/Assets) and industry median
adjusted property, plant, and equipment over assets (PP&E/Assets) measured at the first, third, and fifth anniversary
of current fiscal year end, where industry is based on the same two-digit SIC code across all Compustat firms in the
same fiscal year. Severance is instrumented by PreCEO Severance and %Industry Severance. The two stages are
jointly estimated. The first-stage regression results predicting the use of a severance contract are consistent with
Table 3 and thus omitted for brevity. All variables are defined in Appendix II. Industry and year fixed effects are
included. The t-statistics based on robust standard errors are reported in parentheses. ***, **, and * denote
significance at the 1%, 5%, and 10% levels.
Capex/Assets (Industry-Adjusted)
1-yr
3-yr
5-yr
Severance
Log (MVE)
ROA
Book Leverage
Tobin's q
Cash/Assets
Sales Growth
Inst. Own.
CEO Own.
Equity/TotPay
CEO Tenure
Outside CEO
CEO-Chair
CEO Age
Constant
Observations
R-squared
Year FE
Industry FE
-0.004**
(-2.04)
0.001*
(1.75)
0.029***
(3.18)
-0.014***
(-3.74)
0.003***
(5.20)
-0.024***
(-5.00)
0.005**
(2.03)
0.015***
(4.41)
0.031
(1.31)
0.000
(0.14)
-0.000**
(-2.29)
-0.001
(-0.95)
-0.001
(-0.60)
-0.000
(-0.19)
-0.016*
(-1.74)
4,180
0.136
Yes
Yes
-0.004*
(-1.84)
0.001
(1.31)
0.020*
(1.84)
-0.009**
(-2.03)
0.001**
(2.44)
-0.015***
(-2.84)
0.005
(1.61)
0.012***
(3.08)
0.014
(0.56)
-0.003
(-1.40)
-0.000*
(-1.87)
-0.000
(-0.00)
-0.000
(-0.36)
0.000
(0.33)
-0.021**
(-2.12)
3,409
0.120
Yes
Yes
-0.001
(-0.58)
0.001
(1.21)
0.015
(1.25)
0.000
(0.08)
0.001***
(2.64)
-0.019***
(-3.37)
-0.001
(-0.38)
0.008**
(2.05)
0.073***
(2.77)
-0.002
(-0.75)
-0.001**
(-2.22)
-0.000
(-0.30)
-0.000
(-0.28)
0.000
(0.04)
-0.016*
(-1.69)
2,734
0.106
Yes
Yes
PP&E/Assets (Industry-Adjusted)
1-yr
3-yr
5-yr
-0.028***
(-3.48)
-0.003
(-1.64)
0.053
(1.44)
-0.040***
(-2.70)
0.002
(0.91)
-0.133***
(-7.01)
-0.036***
(-3.39)
0.019
(1.42)
-0.247***
(-2.76)
-0.012
(-1.46)
-0.004***
(-4.87)
-0.015***
(-2.76)
-0.004
(-0.96)
0.000
(1.00)
0.006
(0.16)
4,312
0.169
Yes
Yes
-0.021**
(-2.40)
-0.000
(-0.18)
0.064
(1.45)
-0.019
(-1.11)
-0.000
(-0.00)
-0.110***
(-5.29)
-0.017
(-1.46)
0.029*
(1.95)
-0.260***
(-2.73)
-0.006
(-0.76)
-0.003***
(-3.31)
-0.008
(-1.42)
-0.006
(-1.28)
0.000
(1.10)
-0.052
(-1.31)
3,531
0.168
Yes
Yes
-0.010
(-1.00)
0.001
(0.34)
-0.010
(-0.20)
-0.007
(-0.37)
0.002
(1.02)
-0.111***
(-4.67)
-0.020
(-1.58)
0.019
(1.11)
-0.211*
(-1.93)
-0.009
(-0.96)
-0.003***
(-2.85)
-0.011*
(-1.70)
-0.002
(-0.38)
0.000
(0.92)
-0.067
(-1.61)
2,826
0.163
Yes
Yes
63
Table 7
CEO Severance Contract and Employee Base (IV/2SLS)
This table presents IV/2SLS regression results of employee base on CEO severance contract. The dependent
variables are various metrics of industry median adjusted employee base, measured at the first, third, and fifth
anniversary of current fiscal year end. These include the natural logarithm of the number of employees minus the
logarithm of the industry median number of employees (LnEmployee) and the ratio of the number of employees to
total assets (Employee/Assets) minus the industry median Employee/Assets ratio at the fiscal year end, where
industry is based on all Compustat firms with the same two-digit SIC code. Severance is instrumented by PreCEO
Severance and %Industry Severance. The two stages are jointly estimated. The first-stage regression results are
consistent with Table 3 and thus omitted for brevity. All variables are defined in Appendix II. Industry and year
fixed effects are included. The t-statistics based on robust standard errors are reported in parentheses. Coefficient
estimates on all independent variables are multiplied by 100 for the industry-adjusted Employee/Assets. ***, **, and
* denote significance at the 1%, 5%, and 10% levels.
Severance
Log (MVE)
ROA
Book Leverage
Tobin's q
Cash/Assets
G-Index
CEO Own.
Equity/TotPay
CEO Tenure
CEO-Chair
CEO Age
Constant
Observations
R-squared
Year FE
Industry FE
LnEmployee (Industry-Adjusted)
1-yr
3-yr
5-yr
0.214***
0.213**
0.001
(2.58)
(2.17)
(0.01)
0.635***
0.589***
0.521***
(31.26)
(24.68)
(18.99)
-0.230
0.336
0.210
(-0.58)
(0.66)
(0.34)
0.040
0.120
0.270
(0.26)
(0.67)
(1.24)
-0.171***
-0.146***
-0.096***
(-7.69)
(-5.77)
(-3.31)
-1.812***
-1.734***
-1.930***
(-9.11)
(-7.54)
(-6.89)
-0.003
-0.013
-0.010
(-0.35)
(-1.45)
(-0.90)
-0.900
-0.525
-1.113
(-0.94)
(-0.49)
(-0.88)
-0.344***
-0.357***
-0.229**
(-3.92)
(-3.75)
(-2.07)
-0.020***
-0.019***
-0.018**
(-3.37)
(-2.79)
(-2.12)
-0.025
-0.069
-0.088
(-0.55)
(-1.29)
(-1.38)
0.010***
0.009**
0.006
(2.82)
(2.15)
(1.18)
-3.940***
-3.497***
-1.689***
(-10.28)
(-8.13)
(-3.49)
4,273
3,483
2,752
0.467
0.425
0.387
Yes
Yes
Yes
Yes
Yes
Yes
Employee/Assets (Industry-Adjusted)
1-yr
3-yr
5-yr
0.039**
0.046**
0.052**
(2.11)
(2.10)
(2.01)
-0.047***
-0.038***
-0.024***
(-10.12)
(-7.01)
(-3.78)
0.458***
0.221*
0.097
(5.06)
(1.91)
(0.69)
-0.235***
-0.258***
-0.293***
(-6.90)
(-6.39)
(-5.88)
-0.002
-0.004
0.004
(-0.39)
(-0.74)
(0.60)
-0.400***
-0.335***
-0.400***
(-8.88)
(-6.49)
(-6.29)
0.002
0.001
0.000
(0.86)
(0.55)
(0.14)
1.270***
1.165***
1.324***
(5.87)
(4.80)
(4.57)
-0.009
-0.020
-0.078***
(-0.45)
(-0.93)
(-3.07)
0.002
0.002
0.003*
(1.27)
(1.49)
(1.82)
0.022**
0.031***
0.025*
(2.11)
(2.61)
(1.77)
-0.003***
-0.003***
-0.004***
(-3.69)
(-3.68)
(-3.67)
0.451***
0.464***
0.296***
(5.20)
(4.79)
(2.68)
4,278
3,498
2,781
0.169
0.243
0.320
Yes
Yes
Yes
Yes
Yes
Yes
64
Table 8
CEO Severance Contract and Firm Focus (IV/2SLS)
This table reports IV/2SLS regression results of firm focus, measured at the first, third, and fifth anniversary of
current fiscal year end, on CEO severance contract. Panel A analyzes firm focus based on business segments, and
Panel B examines geographic segments. The dependent variables are, respectively, Herfindahl Index of sales across
business (international geographic) segments, defined as the sum of the square of segment sales divided by the
square of total firm sales, and logarithm of the number of business (international geographic) segments. Severance is
instrumented by PreCEO Severance and %Industry Severance. The two stages are jointly estimated. The first-stage
regression results predicting the use of a severance contract are consistent with Table 3 and thus omitted for brevity.
All variables are defined in Appendix II. Industry and year fixed effects are included. The t-statistics based on robust
standard errors are reported in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels.
Panel A: Business Segment
Herfindahl Index-Business Segment
1-yr
3-yr
5-yr
Severance
Log (MVE)
ROA
Book Leverage
Tobin's q
Sales Growth
Stock Ret [-1]
G-Index
Inst. Own.
CEO Own.
Equity/TotPay
CEO Tenure
CEO-Chair
CEO Age
CEO Age >=65
Constant
Observations
R-squared
Year FE
Industry FE
-0.085***
(-4.48)
-0.058***
(-12.60)
-0.091
(-0.97)
0.008
(0.23)
0.040***
(8.88)
0.065**
(2.44)
-0.007
(-0.55)
-0.015***
(-8.09)
0.041
(1.12)
-0.596**
(-2.40)
0.042**
(2.28)
0.003**
(2.03)
-0.012
(-1.19)
-0.002*
(-1.84)
-0.034
(-1.32)
1.406***
(18.09)
3,109
0.294
Yes
Yes
-0.096***
(-4.45)
-0.058***
(-11.47)
-0.161
(-1.54)
0.081*
(1.95)
0.037***
(7.82)
0.030
(1.05)
-0.010
(-0.71)
-0.015***
(-7.33)
0.073*
(1.83)
-0.556**
(-2.10)
0.036*
(1.80)
0.004**
(2.25)
-0.009
(-0.81)
-0.001
(-1.15)
-0.047*
(-1.67)
1.361***
(16.19)
2,493
0.298
Yes
Yes
-0.083***
(-3.54)
-0.053***
(-9.31)
0.126
(1.06)
0.141***
(2.99)
0.029***
(5.51)
0.010
(0.31)
-0.012
(-0.79)
-0.015***
(-6.80)
0.114**
(2.55)
-0.369
(-1.29)
0.040*
(1.78)
0.003
(1.42)
-0.006
(-0.49)
-0.002
(-1.59)
-0.041
(-1.35)
1.335***
(14.90)
1,877
0.332
Yes
Yes
Log (No of Business Segments)
1-yr
3-yr
5-yr
0.139***
(3.01)
0.149***
(13.30)
0.189
(0.84)
-0.060
(-0.69)
-0.104***
(-9.52)
-0.137**
(-2.12)
0.020
(0.65)
0.037***
(8.35)
-0.171*
(-1.95)
0.606
(1.01)
-0.117***
(-2.60)
-0.007**
(-1.97)
0.038
(1.52)
0.004*
(1.85)
0.091
(1.47)
-0.868***
(-4.61)
3,110
0.281
Yes
Yes
0.136***
(2.61)
0.152***
(12.32)
0.309
(1.22)
-0.231**
(-2.29)
-0.097***
(-8.41)
-0.103
(-1.50)
0.020
(0.59)
0.034***
(6.91)
-0.264***
(-2.74)
-0.062
(-0.10)
-0.121**
(-2.49)
-0.008**
(-2.03)
0.037
(1.36)
0.001
(0.40)
0.152**
(2.24)
-0.630***
(-3.09)
2,495
0.276
Yes
Yes
0.142**
(2.48)
0.136***
(9.66)
-0.203
(-0.70)
-0.304***
(-2.62)
-0.071***
(-5.49)
0.001
(0.02)
0.011
(0.30)
0.031***
(5.73)
-0.432***
(-3.94)
-0.633
(-0.90)
-0.088
(-1.59)
-0.008
(-1.63)
0.035
(1.12)
0.002
(0.85)
0.129*
(1.73)
-0.564**
(-2.56)
1,879
0.283
Yes
Yes
65
Table 8 – continued
Panel B: Geographic Segment
Herfindahl Index-Geographic Segment
1-yr
3-yr
5-yr
Severance
Log (MVE)
ROA
Book Leverage
Tobin's q
Sales Growth
Stock Ret [-1]
G-Index
Inst. Own.
CEO Own.
Equity/TotPay
CEO Tenure
CEO-Chair
CEO Age
CEO Age >=65
Constant
Observations
R-squared
Year FE
Industry FE
0.078***
(5.11)
-0.028***
(-7.67)
0.216***
(2.95)
0.070**
(2.48)
-0.018***
(-4.94)
0.069***
(3.31)
-0.021**
(-2.06)
0.004**
(2.55)
-0.074**
(-2.57)
-0.017
(-0.09)
-0.059***
(-4.00)
0.001
(0.66)
-0.003
(-0.43)
-0.001
(-1.18)
-0.006
(-0.31)
0.975***
(16.04)
3,264
0.448
Yes
Yes
0.092***
(5.29)
-0.026***
(-6.28)
0.183**
(2.22)
0.040
(1.24)
-0.019***
(-4.92)
0.088***
(3.90)
-0.024**
(-2.24)
0.005***
(2.86)
-0.072**
(-2.28)
-0.057
(-0.29)
-0.067***
(-4.22)
0.000
(0.04)
-0.012
(-1.37)
-0.000
(-0.00)
-0.022
(-1.01)
0.919***
(13.79)
2,626
0.445
Yes
Yes
0.109***
(5.47)
-0.025***
(-5.37)
0.087
(0.90)
0.029
(0.76)
-0.018***
(-4.19)
0.087***
(3.46)
-0.039***
(-3.31)
0.006***
(3.18)
-0.076**
(-2.09)
-0.096
(-0.43)
-0.068***
(-3.73)
0.001
(0.65)
-0.015
(-1.41)
0.000
(0.29)
-0.030
(-1.21)
0.870***
(11.80)
1,996
0.433
Yes
Yes
Log (No of Geographic Segments)
1-yr
3-yr
5-yr
-0.192***
(-5.06)
0.049***
(5.36)
-0.268
(-1.48)
-0.155**
(-2.20)
0.031***
(3.52)
-0.154***
(-2.97)
0.059**
(2.37)
-0.013***
(-3.53)
0.092
(1.29)
-0.421
(-0.93)
0.137***
(3.70)
-0.002
(-0.52)
0.022
(1.07)
0.002
(0.95)
0.121**
(2.47)
0.593***
(3.92)
3,280
0.308
Yes
Yes
-0.230***
(-5.09)
0.052***
(4.96)
-0.366*
(-1.71)
-0.055
(-0.65)
0.035***
(3.55)
-0.196***
(-3.35)
0.065**
(2.31)
-0.015***
(-3.73)
0.089
(1.08)
-0.269
(-0.52)
0.192***
(4.67)
-0.000
(-0.01)
0.031
(1.33)
0.002
(0.83)
0.088
(1.56)
0.527***
(3.06)
2,639
0.315
Yes
Yes
-0.217***
(-4.21)
0.062***
(5.15)
-0.129
(-0.52)
0.046
(0.47)
0.040***
(3.54)
-0.233***
(-3.57)
0.079**
(2.54)
-0.019***
(-4.16)
0.141
(1.49)
-0.363
(-0.63)
0.204***
(4.29)
-0.002
(-0.54)
0.011
(0.42)
0.001
(0.54)
0.061
(0.97)
0.443**
(2.33)
2,009
0.346
Yes
Yes
66
Table 9
CEO Severance Contract and Financial Leverage (IV/2SLS)
This table presents IV/2SLS regression results of financial leverage, measured at the first, third, and fifth
anniversary of current fiscal year end, on CEO severance contract. The dependent variable is industry median
adjusted book (market) leverage defined as book value of debt divided by book (market) value of total assets, where
industry is based on the same two-digit SIC code across all Compustat firms in the same fiscal year. Severance is
instrumented by PreCEO Severance and %Industry Severance. The two stages are jointly estimated. The first-stage
regression results predicting the use of a severance contract are consistent with Table 3 and thus omitted for brevity.
All variables are defined in Appendix II. Industry and year fixed effects are included. The t-statistics based on robust
standard errors are reported in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels.
Book Leverage (Industry-Adjusted)
1-yr
3-yr
5-yr
Severance
Log (MVE)
ROA
Tobin's q
PP&E/Assets
Capex/Assets
RD/Sales
SG&A/Sales
Stock Ret [-1]
Log (Vol [-1])
HI
HI2
Inst. Own.
Board Independence
Log (Board Size)
CEO Own.
Equity/TotPay
Tenure
Constant
Observations
R-squared
Year FE
Industry FE
-0.023**
(-1.98)
-0.003
(-1.25)
-0.241***
(-5.18)
-0.004
(-1.52)
0.007
(0.39)
-0.190**
(-2.20)
-0.302***
(-5.33)
0.067***
(2.93)
-0.018***
(-2.88)
0.011
(1.29)
0.130***
(3.29)
-0.192***
(-4.54)
0.051***
(2.63)
0.052***
(3.10)
0.024*
(1.95)
-0.492***
(-4.56)
-0.010
(-0.98)
-0.001***
(-2.66)
0.003
(0.06)
3,541
0.143
Yes
Yes
-0.032**
(-2.34)
-0.001
(-0.48)
-0.221***
(-3.78)
0.002
(0.76)
0.001
(0.06)
-0.038
(-0.39)
-0.263***
(-4.01)
0.028
(1.07)
-0.013*
(-1.75)
0.010
(0.97)
0.172***
(3.79)
-0.237***
(-4.82)
0.065***
(2.97)
0.056***
(3.05)
0.026*
(1.86)
-0.464***
(-3.88)
-0.006
(-0.60)
-0.001***
(-3.14)
-0.010
(-0.16)
2,906
0.137
Yes
Yes
-0.045***
(-2.96)
-0.000
(-0.01)
-0.152**
(-2.23)
-0.002
(-0.51)
0.037
(1.59)
-0.125
(-1.18)
-0.227***
(-2.91)
0.027
(0.91)
-0.008
(-0.99)
0.013
(1.16)
0.295***
(5.50)
-0.371***
(-6.09)
0.062**
(2.55)
0.036*
(1.73)
0.015
(0.95)
-0.438***
(-3.14)
-0.011
(-0.91)
-0.001***
(-3.49)
0.047
(0.66)
2,249
0.144
Yes
Yes
Market Leverage (Industry-Adjusted)
1-yr
3-yr
5-yr
-0.018**
(-1.98)
-0.003
(-1.28)
-0.268***
(-7.56)
-0.017***
(-8.64)
-0.032**
(-2.24)
-0.137**
(-2.09)
-0.162***
(-3.75)
0.016
(0.90)
-0.034***
(-7.08)
0.035***
(5.54)
0.042
(1.37)
-0.070**
(-2.11)
0.056***
(3.73)
0.032**
(2.47)
0.026***
(2.77)
-0.373***
(-4.41)
-0.005
(-0.63)
-0.000
(-1.38)
0.109**
(2.49)
3,465
0.231
Yes
Yes
-0.021**
(-1.97)
0.000
(0.07)
-0.296***
(-6.56)
-0.012***
(-5.42)
-0.037**
(-2.31)
0.015
(0.20)
-0.151***
(-3.00)
-0.005
(-0.24)
-0.021***
(-3.83)
0.018**
(2.34)
0.067*
(1.87)
-0.100**
(-2.54)
0.067***
(4.01)
0.024*
(1.66)
0.020*
(1.84)
-0.341***
(-3.53)
-0.006
(-0.78)
-0.001**
(-2.38)
0.065
(1.30)
2,829
0.186
Yes
Yes
-0.021*
(-1.75)
-0.001
(-0.53)
-0.218***
(-4.24)
-0.010***
(-4.06)
-0.007
(-0.38)
-0.050
(-0.62)
-0.138**
(-2.36)
-0.011
(-0.50)
-0.010*
(-1.67)
0.023***
(2.68)
0.134***
(3.27)
-0.182***
(-3.93)
0.041**
(2.24)
0.016
(0.98)
0.022*
(1.85)
-0.385***
(-3.49)
-0.009
(-0.97)
-0.001**
(-2.33)
0.125**
(2.30)
2,177
0.161
Yes
Yes
67
Table 10
CEO Severance Contract and Firm Risk (IV/2SLS)
This table provides IV/2SLS regressions of industry median adjusted total stock return volatility, systematic risk and
idiosyncratic risk over next one, three, and five years following current fiscal year end on CEO severance contract.
Total risk is the standard deviation of daily stock returns minus the industry median total risk. Systematic risk is the
estimated market beta (coefficient on the risk premium of the market portfolio), and idiosyncratic risk the standard
deviation of the error terms estimated from the Fama-French three factor model using daily stock returns, minus
industry median systematic and idiosyncratic risk respectively. Industry is based on the two-digit SIC code across all
Compustat firms during the fiscal year. Severance is instrumented by PreCEO Severance and %Industry Severance.
The two stages are jointly estimated. The first-stage regressions predicting the use of a severance contract are
consistent with Table 3 and thus omitted for brevity. All variables are defined in Appendix II. Industry and year
fixed effects are included. Robust t-statistics are reported in parentheses. ***, **, and * denote significance at the
1%, 5%, and 10% levels.
1-yr
Severance
Total Risk (Ind.-Adj.)
3-yr
5-yr
-0.0021***
(-3.08)
Log (MVE)
-0.0004**
(-2.40)
ROA
-0.0151***
(-5.05)
Leverage
-0.0007
(-0.67)
Tobin's q
-0.0003
(-1.61)
Cash/Assets
0.0019
(1.24)
Capex/Assets
0.0274***
(6.35)
R&D/Assets
-0.0044
(-0.88)
Stock Ret [-3]
0.0006***
(3.61)
Vol [-3]
0.4620***
(19.36)
G-Index
-0.0003***
(-4.42)
Inst. Own.
0.0012
(1.05)
CEO Own.
0.0178***
(2.66)
Equity/TotPay
0.0013**
(2.10)
Tenure
-0.0000**
(-2.22)
CEO-Chair
0.0004
(1.29)
CEO Age
-0.0000
(-0.54)
CEO Age >=65
-0.0003
(-0.40)
Constant
-0.0080***
(-2.71)
Observations
4,176
R-squared
0.409
Industry FE
Yes
Year FE
Yes
-0.0023***
(-3.03)
-0.0003**
(-2.03)
-0.0187***
(-5.35)
0.0004
(0.37)
-0.0003
(-1.41)
0.0006
(0.35)
0.0335***
(7.12)
-0.0014
(-0.24)
0.0007***
(3.58)
0.4281***
(15.28)
-0.0003***
(-4.80)
0.0023*
(1.79)
0.0193***
(2.65)
0.0017**
(2.52)
-0.0001***
(-2.88)
0.0006*
(1.74)
-0.0000
(-0.09)
-0.0014
(-1.57)
-0.0111***
(-3.86)
3,812
0.409
Yes
Yes
-0.0020**
(-2.47)
-0.0004**
(-2.00)
-0.0181***
(-4.88)
0.0020
(1.57)
-0.0001
(-0.79)
-0.0011
(-0.61)
0.0375***
(7.62)
0.0027
(0.46)
0.0007***
(3.57)
0.3726***
(11.88)
-0.0003***
(-4.55)
0.0020
(1.52)
0.0179**
(2.37)
0.0012*
(1.82)
-0.0001***
(-2.69)
0.0007*
(1.89)
-0.0000
(-0.21)
-0.0005
(-0.59)
-0.0087***
(-3.00)
3,206
0.415
Yes
Yes
Systematic Risk (Ind.-Adj.)
1-yr
3-yr
5-yr
-0.0595**
-0.0392*
-0.0144
(-2.34)
(-1.65)
(-0.58)
-0.0351*** -0.0303*** -0.0294***
(-6.27)
(-5.88)
(-5.55)
-0.5472*** -0.5757*** -0.4692***
(-4.93)
(-5.33)
(-4.18)
-0.0676*
-0.0903**
-0.0823**
(-1.69)
(-2.43)
(-2.10)
0.0037
0.0109*
0.0056
(0.60)
(1.96)
(1.01)
0.1027*
0.0710
0.1131**
(1.79)
(1.35)
(2.05)
0.2360
0.2391
0.4310***
(1.48)
(1.64)
(2.89)
-0.1460
-0.3246*
-0.2067
(-0.79)
(-1.87)
(-1.14)
0.0085
0.0101*
0.0172***
(1.33)
(1.79)
(3.08)
9.9651*** 11.3220*** 11.1939***
(11.26)
(13.07)
(11.77)
-0.0033
-0.0018
-0.0041*
(-1.48)
(-0.90)
(-1.96)
0.0984**
0.1619*** 0.1522***
(2.27)
(4.09)
(3.77)
0.4754*
0.4854**
0.2750
(1.92)
(2.15)
(1.20)
0.0288
0.0067
-0.0055
(1.23)
(0.33)
(-0.27)
-0.0009
-0.0003
0.0001
(-1.36)
(-0.54)
(0.15)
-0.0123
-0.0076
-0.0028
(-1.03)
(-0.70)
(-0.24)
0.0044*** 0.0044*** 0.0042***
(4.30)
(4.65)
(4.33)
-0.0235
-0.0363
-0.0345
(-0.79)
(-1.34)
(-1.25)
-0.0018
-0.0535
-0.0086
(-0.02)
(-0.60)
(-0.10)
4,176
3,812
3,206
0.203
0.257
0.281
Yes
Yes
Yes
Yes
Yes
Yes
Idiosyncratic Risk (Ind.-Adj.)
1-yr
3-yr
5-yr
-0.0016**
(-2.38)
-0.0004**
(-2.53)
-0.0137***
(-4.76)
0.0001
(0.06)
-0.0003**
(-2.13)
0.0021
(1.39)
0.0274***
(6.61)
-0.0089*
(-1.85)
0.0004**
(2.46)
0.3798***
(16.54)
-0.0003***
(-4.62)
0.0006
(0.57)
0.0143**
(2.23)
0.0014**
(2.28)
-0.0000**
(-2.36)
0.0005
(1.61)
-0.0000*
(-1.69)
0.0001
(0.16)
-0.0049*
(-1.72)
4,176
0.413
Yes
Yes
-0.0017**
-0.0014*
(-2.36)
(-1.82)
-0.0004**
-0.0004**
(-2.21)
(-2.29)
-0.0180*** -0.0173***
(-5.34)
(-4.84)
0.0012
0.0027**
(1.04)
(2.18)
-0.0002
-0.0001
(-1.38)
(-0.63)
0.0004
-0.0018
(0.26)
(-1.02)
0.0334*** 0.0355***
(7.36)
(7.50)
-0.0076
-0.0064
(-1.40)
(-1.11)
0.0005***
0.0004**
(2.83)
(2.41)
0.3649*** 0.3386***
(13.50)
(11.21)
-0.0003*** -0.0003***
(-4.91)
(-4.57)
0.0016
0.0015
(1.26)
(1.15)
0.0167**
0.0158**
(2.37)
(2.17)
0.0016**
0.0014**
(2.56)
(2.20)
-0.0001*** -0.0000**
(-2.89)
(-2.49)
0.0007**
0.0008**
(2.02)
(2.07)
-0.0000
-0.0000
(-1.25)
(-1.11)
-0.0008
-0.0004
(-0.90)
(-0.43)
-0.0091*** -0.0081***
(-3.30)
(-2.90)
3,812
3,206
0.410
0.421
Yes
Yes
Yes
Yes
68
Table 11
CEO Severance Contract, Firm Value, and Performance (IV/2SLS)
This table provides IV/2SLS regression results of future firm value, operating, and stock return performance on
CEO severance contract. Panel A examines Tobin's q, Panel B studies operating performance, and Panel C focuses
on stock return performance. The dependent variable is, respectively, industry median adjusted q measured at the
fiscal end of one, three, and five years following current fiscal year, industry median adjusted operating income
before depreciation over assets (OPINC) measured at the first, third, and fifth fiscal end subsequent to current fiscal
year, and buy-and-hold abnormal returns subtracted by the value (equally)-weighted average return on a matched
size and market-to-book portfolio (BHAR) over three, four, and five years following current fiscal end. Industry is
based on the same two-digit SIC code across all Compustat firms in the same fiscal year. Severance is instrumented
by PreCEO Severance and %Industry Severance. The two stages are jointly estimated. The first-stage regressions
predicting the use of a severance contract are consistent with Table 3 and thus omitted for brevity. All variables are
defined in Appendix II. Industry and year fixed effects are included. The t-statistics based on robust standard errors
are reported in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels.
Panel A: Tobin's q (Industry-Adjusted)
1-yr
3-yr
5-yr
(1)
(2)
(3)
Severance
Log (MVE)
Book Leverage
Cash/Assets
Sales Growth
G-Index
Inst. Own.
CEO Own.
Equity/TotPay
Tenure
CEO-Chair
CEO Age
CEO Age >=65
Constant
Observations
R-squared
Industry FE
Year FE
-0.295***
(-3.74)
0.139***
(9.07)
-1.050***
(-8.40)
2.229***
(14.37)
0.296***
(3.17)
-0.005
(-0.73)
0.119
(0.93)
3.333***
(4.16)
0.110
(1.58)
-0.003
(-1.53)
-0.144***
(-4.01)
-0.002
(-0.75)
0.226**
(2.51)
-0.983***
(-2.99)
4,028
0.265
Yes
Yes
-0.384***
(-4.53)
0.071***
(4.45)
-1.145***
(-8.39)
1.579***
(9.77)
0.244**
(2.56)
-0.012*
(-1.80)
0.143
(1.08)
1.978**
(2.35)
0.042
(0.62)
-0.004**
(-1.99)
-0.082**
(-2.20)
-0.002
(-0.56)
0.352***
(3.81)
-0.461
(-1.38)
3,262
0.235
Yes
Yes
-0.433***
(-4.97)
0.007
(0.41)
-1.061***
(-7.28)
1.280***
(7.33)
0.279***
(2.92)
-0.015**
(-2.10)
0.270**
(1.99)
1.484*
(1.66)
0.051
(0.74)
-0.003
(-1.59)
-0.033
(-0.84)
-0.005
(-1.41)
0.475***
(4.97)
0.207
(0.62)
2,588
0.222
Yes
Yes
Panel B: OPINC (Industry-Adjusted)
1-yr
3-yr
5-yr
(4)
(5)
(6)
-0.022***
(-3.21)
0.014***
(10.30)
-0.057***
(-5.30)
0.102***
(7.66)
0.007
(0.88)
0.002***
(3.47)
-0.001
(-0.08)
-0.192***
(-2.75)
-0.008
(-1.27)
-0.000
(-0.55)
0.006*
(1.93)
-0.001**
(-2.31)
0.009
(1.11)
-0.068**
(-2.41)
4,013
0.440
Yes
Yes
-0.025***
(-3.23)
0.012***
(7.89)
-0.063***
(-4.97)
0.104***
(6.94)
-0.001
(-0.09)
0.002***
(3.46)
0.000
(0.04)
-0.242***
(-3.09)
-0.007
(-1.07)
-0.000
(-0.47)
0.009***
(2.65)
-0.001**
(-2.09)
0.021**
(2.50)
-0.075**
(-2.41)
3,267
0.444
Yes
Yes
-0.024***
(-2.79)
0.012***
(7.32)
-0.046***
(-3.13)
0.115***
(6.57)
-0.002
(-0.20)
0.002***
(3.02)
0.006
(0.46)
-0.180**
(-2.01)
-0.007
(-0.96)
-0.000
(-0.41)
0.015***
(3.69)
-0.001***
(-2.99)
0.029***
(3.06)
-0.063*
(-1.86)
2,604
0.451
Yes
Yes
69
Table 11 - continued
Panel C: Buy and Hold Abnormal Returns Matched on Size and Market-to-Book Portfolio (BHAR)
Severance
Log (MVE)
ROA
Book Leverage
Tobin's q
Cash/Assets
Sales Growth
Vol [-1]
Stock Ret [-1]
Equity/TotPay
CEO Tenure
CEO-Chair
CEO Age
CEO Age >=65
Constant
Observations
R-squared
Year FE
Industry FE
BHAR Matched on Value-Weighted Portfolio
3-yr
4-yr
5-yr
(7)
(8)
(9)
BHAR Matched on Equally-Weighted Portfolio
3-yr
4-yr
5-yr
(10)
(11)
(12)
-0.083*
(-1.75)
-0.059***
(-5.33)
0.981***
(4.44)
-0.012
(-0.13)
-0.043***
(-3.62)
0.317***
(2.92)
0.035
(0.56)
8.190***
(5.78)
-0.086***
(-2.99)
-0.026
(-0.56)
0.005
(1.43)
-0.063**
(-2.53)
0.003
(1.59)
0.057
(0.93)
0.241
(1.18)
4,274
0.064
Yes
Yes
-0.091**
(-2.00)
-0.073***
(-6.62)
0.849***
(3.89)
-0.006
(-0.07)
-0.031***
(-2.66)
0.391***
(3.58)
0.017
(0.28)
7.278***
(5.25)
-0.067**
(-2.33)
-0.042
(-0.93)
0.005
(1.63)
-0.047*
(-1.88)
0.002
(0.97)
0.077
(1.26)
0.309
(1.52)
4,274
0.048
Yes
Yes
-0.119**
(-2.09)
-0.075***
(-5.62)
1.136***
(4.26)
0.005
(0.05)
-0.058***
(-4.02)
0.462***
(3.54)
0.199***
(2.62)
7.309***
(4.29)
-0.113***
(-3.23)
-0.087
(-1.57)
0.004
(1.00)
-0.084***
(-2.79)
0.003
(1.20)
0.126*
(1.70)
0.526**
(2.13)
4,249
0.071
Yes
Yes
-0.215***
(-3.15)
-0.095***
(-5.96)
1.230***
(3.86)
-0.006
(-0.04)
-0.093***
(-5.40)
0.739***
(4.74)
0.293***
(3.21)
6.925***
(3.40)
-0.129***
(-3.10)
-0.067
(-1.01)
0.003
(0.63)
-0.114***
(-3.15)
0.002
(0.79)
0.290***
(3.27)
0.878***
(2.98)
4,225
0.080
Yes
Yes
-0.137**
(-2.46)
-0.094***
(-6.94)
1.075***
(4.02)
0.009
(0.09)
-0.040***
(-2.76)
0.579***
(4.33)
0.162**
(2.14)
6.042***
(3.56)
-0.100***
(-2.87)
-0.130**
(-2.35)
0.004
(1.14)
-0.066**
(-2.17)
0.001
(0.39)
0.177**
(2.35)
0.664***
(2.67)
4,249
0.051
Yes
Yes
-0.224***
(-3.43)
-0.121***
(-7.65)
1.270***
(4.05)
0.013
(0.11)
-0.071***
(-4.16)
0.856***
(5.46)
0.263***
(2.98)
5.087**
(2.56)
-0.098**
(-2.40)
-0.118*
(-1.82)
0.003
(0.62)
-0.088**
(-2.47)
-0.000
(-0.08)
0.341***
(3.86)
1.071***
(3.67)
4,225
0.059
Yes
Yes
70
Table 12
CEO Severance Contract and Compensation Structure
This table presents OLS and IV/2SLS regressions of CEO compensation structure on severance contract. The
dependent variables are CEO cash pay divided by total pay (Cash/TotPay), equity pay including restricted stock
grants and stock options grants (Black-Scholes) divided by total pay (Equity/TotPay), and the Black-Scholes value
of options granted divided by total pay for current year. In IV/2SLS regressions, Severance is instrumented by
PreCEO Severance and %Industry Severance. The two stages are jointly estimated. The first-stage regression results
predicting the use of a severance contract are consistent with Table 3 and thus omitted. All variables are defined in
Appendix II. Industry and year fixed effects are included. The t-statistics based on robust standard errors are
reported in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels.
Severance
Log (MVE)
ROA
Book Leverage
Tobin's q
Capex/Assets
R&D/Assets
Stock Ret [-1]
CEO Tenure
CEO-Chair
Founder
CEO Age
Constant
Observations
R-squared
Year FE
Industry FE
Cash/TotPay
OLS
Equity/TotPay
Option/TotPay
Cash/TotPay
IV/2SLS
Equity/TotPay
Option/TotPay
-0.027***
(-4.81)
-0.031***
(-11.77)
0.131**
(2.32)
-0.039**
(-2.01)
-0.001
(-0.17)
-0.153**
(-1.99)
-0.396***
(-4.13)
-0.014*
(-1.78)
0.002***
(3.66)
-0.011
(-1.57)
0.046***
(4.39)
-0.000
(-0.09)
1.307***
(35.55)
7,604
0.523
Yes
Yes
0.017***
(2.84)
0.022***
(7.51)
-0.241***
(-3.97)
0.029
(1.34)
0.012***
(3.70)
0.229***
(2.69)
0.460***
(4.42)
0.009
(1.03)
-0.003***
(-5.04)
0.003
(0.35)
-0.011
(-0.94)
-0.001
(-1.59)
-0.152***
(-3.38)
7,604
0.406
Yes
Yes
0.010*
(1.65)
0.015***
(5.13)
-0.281***
(-4.67)
-0.023
(-1.07)
0.016***
(4.58)
0.372***
(4.40)
0.601***
(5.73)
0.004
(0.48)
-0.003***
(-5.21)
0.004
(0.59)
0.020*
(1.76)
-0.000
(-0.40)
-0.151***
(-3.47)
7,604
0.363
Yes
Yes
-0.037***
(-2.98)
-0.025***
(-8.43)
0.075
(1.30)
-0.009
(-0.41)
-0.005*
(-1.66)
-0.209**
(-2.33)
-0.448***
(-4.46)
-0.003
(-0.32)
0.002*
(1.81)
0.000
(0.01)
0.058***
(4.78)
-0.001
(-1.05)
1.275***
(25.55)
4,958
0.630
Yes
Yes
0.030**
(2.20)
0.020***
(6.26)
-0.171***
(-2.68)
-0.005
(-0.20)
0.014***
(4.21)
0.325***
(3.27)
0.509***
(4.57)
-0.001
(-0.12)
-0.002**
(-2.04)
-0.009
(-1.13)
-0.051***
(-3.75)
-0.001*
(-1.78)
-0.142**
(-2.57)
4,958
0.506
Yes
Yes
0.032**
(2.39)
0.014***
(4.61)
-0.202***
(-3.26)
-0.043*
(-1.79)
0.019***
(5.67)
0.455***
(4.70)
0.675***
(6.24)
-0.010
(-1.15)
-0.001
(-0.84)
-0.010
(-1.29)
-0.013
(-0.96)
-0.001
(-1.16)
-0.137**
(-2.55)
4,958
0.449
Yes
Yes
71
Table 13
CEO Severance Contract and Operating Performance: Subsample Analysis (IV/2SLS)
This table presents IV/2SLS regressions of one- and three-year industry median adjusted operating performance (OPINC) on severance contract, conditional on
corporate governance, product market competition, firm risk and CEO risk aversion. We separate the data into subsamples below and above the median value of
each conditional variable. Regressions are specified as in Table 11 models 4 & 5 including all controls, year and industry fixed effects. Severance is instrumented
by PreCEO Severance and %Industry Severance. The two stages are jointly estimated. The first-stage estimating the use of a severance contract is omitted.
Leverage [-3, -1] is the average industry median adjusted book leverage over previous three years. Market competition is Herfindahl index of sales across all
Compustat firms with the same two-digit SIC code. Regulated industries are energy, telephone/telecom, utilities, financial, and mines, hotels and entertainment
(Fama-French 4, 7, 8, 11 and 12 industry). R&D/Assets [-3, -1] is the average industry-median-adjusted R&D/Assets over past three years. Sales Growtht-1 is Ln
(Salest-1 /Salest-2). Appendix II provides variable defninitions. Industry and year fixed effects are included. Robust t-statistics are reported in parentheses below
coefficient estimates on Severance. Coefficient estimates on controls are omitted for brevity. ***, **, and * denote significance at the 1%, 5%, and 10% levels.
Panel A: Conditional on Corporate Governance
G-Index
Institutional Ownership
<10
>=10
<66.85%
>=66.85%
Dependent Variable = 1-yr OPINC (Industry-Adjusted):
Severance
-0.004
-0.032***
-0.059***
0.001
(-0.29)
(-3.92)
(-5.18)
(0.08)
Obs.
1,781
2,232
1,619
2,394
R-squared
0.458
0.458
0.525
0.380
Dependent Variable = 3-yr OPINC (Industry-Adjusted):
Severance
-0.006
-0.032***
-0.058***
0.002
(-0.40)
(-3.46)
(-4.48)
(0.20)
Obs.
1,436
1,831
1,450
1,817
R-squared
0.460
0.467
0.541
0.370
CEO Ownership
<0.14%
>=0.14%
Leverage [-3, -1]
<0.93%
>=0.93%
CEO-Chair
=0
=1
-0.034***
(-3.68)
2,424
0.516
-0.003
(-0.34)
1,589
0.296
-0.029***
(-3.20)
1,923
0.430
-0.011
(-1.16)
2,090
0.491
-0.003
(-0.23)
1,255
0.377
-0.030***
(-3.59)
2,758
0.478
-0.041***
(-3.78)
2,003
0.528
-0.000
(-0.03)
1,264
0.296
-0.032***
(-2.95)
1,579
0.430
-0.023**
(-2.03)
1,688
0.493
0.002
(0.15)
987
0.354
-0.037***
(-3.82)
2,280
0.487
Panel B: Conditional on Market Competition, Firm Risk, and Growth Opportunities
Market Competition
Regulated Industry
<0.18 HI
>=0.18 LO
Regulated
Non-Reg.
Dependent Variable = 1-yr OPINC (Industry-Adjusted):
Severance
0.014
-0.042***
0.020**
-0.051***
(1.58)
(-4.28)
(2.35)
(-5.44)
Obs.
1,957
2,056
1,158
2,855
R-squared
0.608
0.335
0.152
0.421
Dependent Variable = 3-yr OPINC (Industry-Adjusted):
Severance
0.009
-0.043***
0.018*
-0.058***
(0.84)
(-3.85)
(1.75)
(-5.34)
Obs.
1,626
1,641
924
2,343
R-squared
0.621
0.332
0.170
0.422
Vol. [-1]
<1.76%
>=1.76%
R&D/Assets [-3,-1]
<0
>=0
Sales Growtht-1
<7.80%
>=7.80%
-0.026***
(-2.89)
2,020
0.549
-0.012
(-1.23)
1,993
0.353
-0.039**
(-2.10)
953
0.591
-0.011
(-1.60)
3,060
0.290
-0.028***
(-3.04)
2,114
0.414
-0.014
(-1.37)
1,899
0.484
-0.029***
(-3.03)
1,785
0.556
-0.016
(-1.20)
1,482
0.334
-0.061***
(-2.84)
743
0.608
-0.014*
(-1.73)
2,524
0.288
-0.033***
(-2.93)
1,683
0.435
-0.016
(-1.42)
1,584
0.470
72