Ex-Ante Severance Pay Contracts and Optimal Executive Incentive Schemes

The Harvard Law School Forum on Corporate Governance and Financial Regulation 2013-02-11


Editor’s Note: The following post comes to us from P. Raghavendra Rau, Professor of Finance at the University of Cambridge, and Jin Xu of the Finance Area at Purdue University.

In recent years, large severance payouts to executives who have been fired from poorly performing firms have attracted a great deal of attention in the popular press. There is a considerable degree of popular outrage on what seem to be egregious ex post payments that are unrelated to the executive’s performance during his tenure at the firm. However, though severance agreements are potentially important elements of executives’ compensation contracts, there is little empirical evidence on the incidence and terms of ex ante severance agreements negotiated by executives, let alone on how these contracts fit into executives’ overall incentive compensation schemes.

In our paper, How Do Ex-Ante Severance Pay Contracts Fit into Optimal Executive Incentive Schemes?, forthcoming in the Journal of Accounting Research, we analyze a unique hand-collected sample of 3,688 severance contracts in place at 808 firms in 2004. Based on the full list of S&P1500 firms, this sample is the most comprehensive of any work in this area, including firms of all sizes, ages, and industries, and executives of a wide range of ranks including the Chief Executive Officer (CEO), Chief Financial Officer (CFO), Chief Operating Officer (COO), and other executives. Around 68% of the firms list explicit severance contract terms with their executives. Most contracts list up to three sets of benefits: explicit cash payments as multiples of salary and bonus (most common benefit); medical and life insurance benefits, and benefits covering the payment of legal fees, outplacement, and other perks.

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R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation,

Date tagged:

02/11/2013, 10:08

Date published:

02/11/2013, 09:16