Tag: Management contracts


CEO Contractual Protection and Managerial Short-Termism

The following post comes to us from Xia Chen and Qiang Cheng, both of the School of Accountancy at Singapore Management University; Alvis Lo of the Department of Accounting at Boston College; and Xin Wang of the Accounting Area at the University of Hong Kong.

In our paper, CEO Contractual Protection and Managerial Short-Termism, which was recently made publicly available on SSRN, we investigate whether CEO contractual protection, can address managerial short-termism by reducing managers’ incentives to engage in myopic behavior. Managers generally have incentives to boost short-term performance to increase their welfare, potentially at the expense of long-term firm value. However, CEOs with contractual protection are protected from short-term performance swings and downside risk, and consequently are likely to have weaker incentives to engage in myopic behavior.

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CEO Job Security and Risk-Taking

The following post comes to us from Peter Cziraki of the Department of Economics at the University of Toronto and Moqi Xu of the Department of Finance at the London School of Economics.

In our paper, CEO Job Security and Risk-Taking, which was recently made publicly available on SSRN, we use the length of employment contracts to estimate CEO turnover probability and its effects on risk-taking. Protection against dismissal should encourage CEOs to pursue riskier projects. Indeed, we show that firms with lower CEO turnover probability exhibit higher return volatility, especially idiosyncratic risk. An increase in turnover probability of one standard deviation is associated with a volatility decline of 17 basis points. This reduction in risk is driven largely by a decrease in investment and is not associated with changes in compensation incentives or leverage.

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CEO Employment Agreements in a “Say on Pay” World

The following post comes to us from Michael S. Katzke, a founding partner of Katzke & Morgenbesser LLP, and is based on a Katzke & Morgenbesser publication by Mr. Katzke and Henry I. Morgenbesser.

Although much has been written and discussed in the past few years about the impact of “Say on Pay” and Dodd-Frank on CEO compensation practices (including the narrowing or elimination of employment agreement provisions such as excise tax and other tax gross-ups and automatic “evergreen” renewal terms which have not been viewed as shareholder friendly), there has been less discussion as to whether employment agreements remain a viable option in a Say on Pay world. In spite of the complicated relationship between a CEO hire and the company, some companies, as a policy matter, do not put the terms of such relationship in writing. Complexities that are often spelled out in a written agreement include duties and responsibilities of the CEO, compensation (including formulaic increases during the term), the duration of the term of employment, termination provisions, severance payments under certain termination scenarios, and post-employment restrictive covenants. As discussed below, in our view, written employment agreements continue to be viable and recommended, particularly in the case of CEOs hired from outside the company.

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CEO Contract Design: How Do Strong Principals Do It?

The following post comes to us from Henrik Cronqvist, Associate Professor of Finance at Claremont McKenna College and Rüdiger Fahlenbrach, Associate Professor of Finance at the Ecole Polytechnique Federale de Lausanne (EPFL) and affiliated with the Swiss Finance Institute.

In our paper, CEO Contract Design: How Do Strong Principals Do It?, forthcoming in the Journal of Financial Economics, we contribute a new perspective on executive compensation research by studying changes to CEO employment contracts implemented by some of the most sophisticated and financially savvy principals in U.S. capital markets: private equity sponsors. If the changes in a firm’s governance structure following a leveraged buyout (LBO) allow for arm’s-length bargaining between private equity (PE) sponsors, as ‘‘strong principals,’’ and the CEOs of the portfolio companies as their agents, we may observe changes to contract features of importance to the private equity sponsors.

Our objective in this paper is to answer three questions. First, do the strong principals redesign CEO contracts? If they do, which contract features do they change? We examine a comprehensive set of features of CEO contracts in addition to cash pay, such as perquisites, equity incentives, vesting conditions, and severance pay. Second, how do the CEO contracts designed by PE sponsors square with contracting theories? Finally, do the CEO contracts we study avoid some of the most criticized compensation practices in U.S. public firms? Regulators and shareholder interest groups should be interested in whether their proposals differ markedly from contracts where a shareholder with significant ownership and financial expertise bargains with a CEO.

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CEO Employment Contracts and Non-compete Covenants

Randall S. Thomas is a John Beasley II Professor of Law and Business at Vanderbilt Law School.

In our recent working paper, When Do CEOs Have Covenants Not to Compete in Their Employment Contracts?, we undertake the first comprehensive study of contractual restrictions on CEOs’ post-employment competitive activities. The large random sample of nearly 1,000 CEO employment contracts for 500 companies was selected from the S&P 1500 from the 1990s through 2010. We find that about 70% of CEO contracts have post-employment competitive restrictions. We also find more covenants not to compete (CNCs or noncompetes) in longer-term employment contracts and at profitable firms. In addition, our study uses a nuanced state-by-state CNC strength of enforcement index to test the variance of CEO noncompetes across jurisdictions.

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Contractual Versus Actual Severance Pay Following CEO Turnover

The following post comes to us from Eitan Goldman of the Department of Finance at Indiana University and Peggy Huang of the Department of Finance at Tulane University.

In our paper, Contractual Versus Actual Severance Pay Following CEO Turnover, which was recently made publicly available on SSRN, we analyze the bargaining game between the CEO and the board of directors at the time of CEO departure. We find that about 40% of S&P500 CEOs who leave their firm receive separation payments that are in excess of what the firm is legally required to give them based on their existing contract. Furthermore, we find that the average discretionary separation pay is around $8 million – close to 242% of a CEO’s annual compensation. The analysis in the paper aims to uncover the reasons behind this discretionary pay and the source of CEO power exactly at the point in time when the CEO is least likely to have any ability to bargain.

Specifically, we investigate whether CEOs who receive discretionary pay are those who have control over the board of directors or whether discretionary pay represents a tool used by the board of directors in order to help and facilitate an amicable and efficient departure of the incumbent CEO. We hypothesize that in cases when the CEO departure is voluntary, discretionary separation pay represents a governance problem. By contrast, we hypothesize that when the CEO is forced to depart, discretionary separation pay is used to help the company move on from the failed ex CEO to a better one, specifically by reducing the likelihood of a prolonged battle with the departing CEO.

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Relative Performance Evaluation and Related Peer Groups

The following post comes to us from Guojin Gong of the Accounting Department at Pennsylvania State University, and Laura Li and Jae Shin, both of the Accounting Department at the University of Illinois at Urbana-Champaign.

In the paper, Relative Performance Evaluation and Related Peer Groups in Executive Compensation Contracts, forthcoming in The Accounting Review, we examine the explicit use of relative performance evaluation (RPE) and related peer groups based on S&P 1500 firms’ first proxy disclosures under the SEC’s 2006 executive compensation disclosure rules. Prior empirical research offers mixed evidence on the use of RPE in executive compensation contracts based on an implicit approach. The implicit approach infers RPE use by regressing executive pay on industry performance across a population of firms, and thus relies on simplified assumptions concerning RPE contract details. We demonstrate that a lack of knowledge of both RPE peer group composition and the link between RPE-based performance targets and future peer performance cloud inferences drawn from implicit tests. These findings highlight the limitations of the implicit approach and underscore the importance of incorporating explicit RPE contract details in testing for RPE use.

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Private Equity in the 21st Century

The following post comes to us from David Robinson, Professor of Finance at Duke University, and Berk Sensoy of the Department of Finance at Ohio State University.

In the paper, Private Equity in the 21st Century: Cash Flows, Performance, and Contract Terms from 1984-2010, which was recently made publicly available on SSRN, we use a large, proprietary database of private equity cash flows and management contract terms over the period 1984-2010, comprising close to 40% of the U.S. Venture Economics universe, to provide new evidence on the determinants of private equity performance, cash flow behavior, and contract terms. The data are the first available for academic research to include cash flow information for a large sample of private equity funds extending beyond 2003, to include information on general partner capital commitments, and to combine cash flow information with the terms of the management contracts.

Our analysis is centered around two interrelated themes. First, we investigate the impact of broader market conditions on private equity markets. While it is well known that public and private equity markets are correlated through time, with shared periods of boom and bust, the implications of this correlation for private equity investors and managers are not well understood.

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HP Severance Case Raises Governance Concerns

Joseph Bachelder is founder and senior partner of the Bachelder Law Firm. This post is based on an article by Mr. Bachelder that first appeared in the New York Law Journal. An earlier column by Mr. Bachelder regarding severance at Hewlett-Packard is available here.

On Aug. 6, 2010, Mark Hurd stepped down as chairman, president and chief executive officer of Hewlett-Packard Company. His resignation was at HP’s request. He was provided, among other things, a severance payment of approximately $12 million. Today’s column considers whether the severance payment, given the circumstances involved in Mr. Hurd’s departure, can be reconciled with the HP Severance Plan for Executive Officers pursuant to which it was paid. Specifically, the question is whether the separation qualified as one “not for cause,” a condition to payment under that plan.

A severance of another HP CEO, Carly Fiorina, involving entirely different circumstances, was the subject of this column on March 24, 2005.

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Comparing CEO Employment Contract Provisions

The following post comes to us from Jennifer Hill, Professor of Corporate Law at the University of Sydney; Ronald Masulis, Professor of Finance at Vanderbilt University and at the University of New South Wales; and Randall Thomas, Professor of Law and Business at Vanderbilt University.

In our paper, Comparing CEO Employment Contract Provisions: Differences between Australia and the U.S., forthcoming in the Vanderbilt Law Review, we compare and contrast CEO employment contracts across two very different common law countries.

In the wake of the global financial crisis, executive compensation is front page news, with soaring rhetoric about excessive pay to ungrateful bank employees and personal attacks on CEOs and other executives. Frequently missing from the discussion, however, are basic facts surrounding the terms and conditions of the executives’ relationships with their firms. While several recent studies in the United States have begun to fill in some of the details surrounding American executive employment contracts, or the lack thereof, none have fully captured the U.S. experience, particularly from a legal perspective. Likewise, none of these studies even touch on Australian CEOs’ contractual employment relationships.

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