Executive Severance Agreements: Making Sense of an Emerging, Yet Fragmented, Research Field

Abstract

Scholars have devoted significant attention to understanding the determinants and consequences of executive compensation. Yet, one form of compensation, executive severance agreements, has flown under the radar. Severance agreements specify the expected payments and benefits promised executives, upon voluntary or involuntary termination. Although these agreements are popular among executives, critics continually question their worth. Yet severance agreements potentially offer three important (but less readily recognized) strategic benefits. First, severance agreements are viewed as a means of mitigating the potential risks associated with job changes; thus, they can serve as a recruitment tool to attract top executive talent. Second, because severance agreements guarantee executives previously specified compensation in the event of termination, they can help limit the downside risk naturally risk-averse executives face, facilitating executive-shareholder interest alignment. Third, severance agreements can aid in firm exit, as executives and directors are likely to be more open to termination, in the presence of adequate protection against the downside. Severance agreements can contain provisions for ten possible termination events. Three events refer to change in control (CIC), which occurs under a change in ownership. These are (1) CIC without termination, (2) CIC with termination without cause, and (3) CIC with termination for cause. Cause is generally defined by events such as felony, fraud, embezzlement, neglect of duties, or violation of noncompete provisions. Additional events include (4) voluntary retirement, (5) resignation without good reason, (6) voluntary termination for good reason, (7) involuntary termination without cause, (8) involuntary termination with cause, (9) death, and (10) disability. Voluntary retirement and resignation without good reason occurs when CEOs either retire or leave under their own volition, and voluntary termination with good reason occurs in response to changes in employment terms (e.g., relocation of headquarters). Involuntary termination refers to termination due to any reason not listed above and is often triggered by unsatisfactory performance. Although some prior work has addressed the antecedents, consequences, and moderators of severance, the findings from this literature remain unclear, as many of the results are mixed. Future severance scholars have the opportunity to further clarify these relationships by addressing how severance agreements can help firms attract, align the interests of, and facilitate the exit of executives.

CEO Gender-Based Termination Concerns: Evidence From Initial Severance Agreements

“…This has important implications for corporate governance and recruiting. In particular, although prior literature has argued that severance agreements can function as a recruitment tool (Cowen et al, 2016; Rau & Xu, 2013), empirical work has yet to provide support for this argument (Klein et al, 2017). Consistent with gender and UE research, female leaders’ heightened termination concerns likely lead some women to “opt out” from assuming executive roles.…”

“…However, although boards may perceive severance as a recruitment tool, they may also view it as a tool for aligning CEOs’ interests with those of shareholders postappointment (Almazan & Suarez, 2003; Cadman et al, 2016). This raises an interesting question of if and/or how boards’ interest alignment concerns may influence incumbent CEOs’ severance values throughout their tenures and, further, whether gender-related severance gaps persist over time (Klein et al, 2017). Although this question is beyond the scope of this study, examining the factors that may affect CEOs’ postappointment severance values and gender-related severance gaps offers interesting avenues for scholars to pursue.…”

“…Our results suggest that guaranteed severance pay can be effective in this regard by insuring CEOs against termination losses. Although prior severance research has acknowledged the benefit of using severance agreements as a recruitment tool (Cowen et al, 2016), very little empirical work has shown support for this argument (Klein, McSweeney, Devers, McNamara, & Blosser, 2017). Thus, our findings extend the severance literature (Cowen et al, 2016; Rau & Xu, 2013) and suggest that severance agreements can be viewed as an especially effective recruitment tool for female CEO candidates.…”

Arranging Golden Goodbyes for Executive Exits: A Review and Agenda for Severance Pay

“…Executives exit their roles for a wide array of reasons, such as declining health, poor performance, retirement, or to take other jobs (Gentry, Harrison, Quigley, & Boivie, 2021; Klein, McSweeney, Devers, McNamara, & Blosser, 2017; Ridge, Hill, & Aime, 2014). These departing executives often take with them large payments, negotiated ex-ante, that are commonly referred to as severance pay.…”

“…We do so by outlining key differences between severance pay and other types of executive compensation, as well as highlighting the importance of considering distinctions between severance pay linked to various executive exit scenarios. While studies have begun to advance our view of severance at a broad level (for a related review of severance payments triggered due to various forms of departures, see Klein et al, 2017), prior research has often lacked precision in discussions involving severance, a critical oversight since the exact terms of severance pay are contingent upon the mode of an executive's departure. This lack of precision is likely a factor in why the evolving research in this area has thus far often produced mixed or complicated conclusions.…”