Anticipating Harassment: #MeToo and the Changing Norms of Executive Contracts

Rachel Arnow-Richman is Rosenthal Chair of Labor and Employment Law at the University of Florida Levin College of Law; James Hicks is an Academic Fellow at the University of California Berkeley School of Law; and Steven Davidoff Solomon is Professor of Law at the University of California Berkeley School of Law. This post is based on their recent paper.

Two years ago, the #MeToo movement exposed the problem of sex-based misconduct by powerful employees, particularly CEOs. It also revealed, in some companies, an organizational culture seemingly permissive of such wrongdoing. In many instances, the misconduct went on for extended periods, involved numerous victims, and was an open secret among corporate officers and directors. Companies typically responded slowly and imposed few consequences on alleged perpetrators, preferring to cover up the problem with confidential settlements and cushioned exits rather than hold the accused accountable. This phenomenon, which we refer to as the ”MeToo accountability problem,” provokes serious questions. Why did companies tolerate such behavior? Why did they choose to protect rather than penalize CEOs? Most importantly, has the MeToo movement changed this culture?

In Anticipating Harassment: #MeToo and the Changing Norms of Executive Contracts, we examine these questions through an empirical study of CEO employment agreements. Unlike ordinary employees, CEOs are protected by written contracts that not only reject the default rule of employment at-will, but contain bespoke provisions that limit the companies’ ability to terminate CEOs without paying significant severance pay. These provisions typically contain a handful of narrowly drafted grounds on which a company can fire a CEO “for cause” (thereby avoiding financial liability), which rarely contemplate sex-based misconduct. Furthermore, existing law generally interprets these provisions in favor of CEOs, making it financially risky for companies to remove CEOs for behavior that—while wrongful—may turn out to fall short of the contractual or legal standard.

Why would companies negotiate such generous job security protections—in effect contracting away their ability to respond nimbly to allegations of sex-based misconduct? Corporate governance scholars, seeking to explain high executive compensation packages, have long argued that boards of directors and corporate executives do not deal at arm’s length. However, such theories have not been applied to other features of executive agreements, including termination provisions. We build on this literature, arguing that the same dynamics can result in “pro-CEO” definitions of cause that limit board discretion to police CEO misbehavior. However, the MeToo movement presented a shock to the dynamics and culture of corporate governance. We hypothesize that in the wake of MeToo, public companies faced new potential liability and reputational costs, and would begin to insist on terms that give them greater discretion to discipline and terminate executives.

To test our theory, we collect and hand-code a novel dataset of employment agreements relating to S&P 1500 CEOs between 2015 and 2020. We code the termination provisions along a wide range of different grounds, including those that pertain to misconduct. Our results confirm that definitions of cause in CEO employment agreements have traditionally enumerated narrow and exclusive grounds for an uncompensated termination—terms that, in most cases, do not embrace sex-based misconduct. However, in the wake of the MeToo movement, we find that companies are increasingly including (what we refer to as) ”MeToo termination rights” in CEO contracts. In particular, we find a significantly higher incidence of termination provisions that include sexual harassment, discrimination, and violations of company policies as grounds for cause. Such language embraces sex-based misconduct explicitly and expansively, and strengthens the ability of companies to respond to this behavior.

We consider the implications of our findings from three perspectives: corporate governance, contract design, and gender equity. Societal expectations about the seriousness of sex-based misconduct and the need for corporate accountability have clearly shifted, and our study shows that terms of employment are following. In this way, our results demonstrate that bargaining dynamics in the corporate context are responsive to external change. They also emphasize how contract and governance intersect to affect organizational behavior. The drafting choices we identify reveal how companies communicate, monitor, and ultimately enforce corporate values and expectations through contract design. Finally, our results suggest that companies are anticipating the risk of sex-based misconduct and positioning themselves to respond. This change holds promise for safer more equitable workplaces where high-level and rank-and-file employees are held to the same standards of conduct.

Of course, the changes we identify are on paper—only time will tell if changes to contract language result in changes to actual behavior. Nor is sex-based misconduct by CEOs the only concern. But the prior space for harassment and related misconduct—permitted by CEOs’ contractual protections—has become more limited, pushing acceptable boundaries of behavior and the norms of executive contracts closer together. We conclude that these changes represent a modest victory for the MeToo movement.

The complete paper is available for download here.

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