Surveys - Employment Agreements and Severance
2015.Apr.02 CEO Severance Protections Promote Long-term View (academic study). The paper titled CEO Contractual Protection and Managerial Short-Termism begins with the following information about its scope and findings:
- [This paper] investigate[s] 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.
- . . . Overall, our findings suggest that CEO contractual protection, in the form of employment agreements and standalone severance pay agreements, can reduce managers’ incentives to engage in myopic behavior. While the popular press often associates employment agreements and ex postseverance pay with managerial power and entrenchment, our evidence suggests that ex ante, such contractual protection can expand managers’ horizons and address the agency problem of managerial short-termism.
See further discussion in this Harvard Governance Blog.
2013.May.2 How Private Equity Investors affect CEO Contracts (academic study).
Two economics professors are about to publish the attached study about how CEO employment agreements change when their employers convert from public to private ownership. They focused on 20 companies that sold to the largest private equity firms, e.g. Blackstone, Carlyle, and Kohlberg. The general finding - that most CEO employment agreements underwent a major redesign – is not surprising. More interesting are the findings about particular changes that resulted, notably:
- A 25% increase in salary (for new hires) and bonus opportunities (for all).
- Performance-based bonuses calculated by reference to cash-flow based measures (EBITDA), with a shift “away from qualitative, non-financial, and earnings-based measures.”
- Internal rates of return (IRR) generally selected to measure for longer term performance.
- Exit events that commonly trigger vesting of about 50% of unvested equity awards, provided certain IRR or other return hurdles are satisfied.
- Severance pay multiples do not change, but most redesigned agreements provide for the forfeiture of unvested stock options, restricted stock, and other equity awards (with rights of first refusal that allow employers to repurchase vested equity).
- Perquisites that generally remain the same (e.g., tax gross-ups and company-provided aircraft).Regarding the sampled companies, the authors explained that large PE firms are generally in the best position to make value-maximizing decisions. The study is titled “CEO Contract Design: How Do Strong Principals Do It?” (forthcoming in Journal of Financial Economics).