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Are Ex Ante CEO Severance Pay Contracts Consistent with Efficient Contracting?

Published online by Cambridge University Press:  13 July 2016

Brian D. Cadman ,
John L. Campbell  and
Sandy Klasa
Brian D. Cadman
Affiliation:
brian.cadman@business.utah.edu, University of Utah, Eccles School of Business, Salt Lake City, UT84112
John L. Campbell
Affiliation:
johnc@uga.edu, University of Georgia, Terry College of Business, Athens, GA30606
Sandy Klasa*
Affiliation:
sklasa@eller.arizona.edu, University of Arizona, Eller College of Management, Tucson, AZ85721.
*
*Corresponding author: sklasa@eller.arizona.edu
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Abstract

Efficient contracting predicts that ex ante severance pay contracts are offered to chief executive officers (CEOs) as protection against downside risk and to encourage investment in risky projects with a positive net present value (NPV). Consistent with this prediction, we find that ex ante contracted severance pay is positively associated with proxies for a CEO’s risk of dismissal and costs the CEO would incur from dismissal. Additionally, we show that the contracted severance payment amount is positively associated with CEO risk taking and the extent to which a CEO invests in projects that have a positive NPV. Overall, our findings imply that ex ante severance pay contracts are consistent with efficient contracting.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 51 , Issue 3 , June 2016 , pp. 737 - 769
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2016 

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