Monday, December 05, 2011

Another Major Downside to Large CEO Severance Packages

According to the Wall Street Journal, Tulane Professor of Finance Peggy Huang has conducted a terrific new study regarding CEO severance packages.  As you know, many journalists, investors, and analysts have expressed dismay at some of the large severance packages provided to dismissed CEOs in recent years.  Huang set out to examine the impact of such packages in more detail.   She explored whether such packages may have led to excessive risk-taking (since the cost of failure was substantially reduced by the generous severance).  More specifically, she examined whether companies whose CEOs had such packages underperformed the stock market during the CEO's tenure. 

Her findings suggest that Boards of Directors should proceed with caution when offering such packages, particularly cash-heavy packages.  Huang examined roughly 2,000 CEO severance agreements from S&P 500 companies between 1993 and 2007.  She discovered that these firms underperformed the market by 1.6% on average over a three-year period, when compared with firms that did not have CEO severance packages.  If the CEO had a cash-only severance package, the firms underperformed the market by 4% on average.  Looking at the CEO's actions in more detail, she found some evidence suggesting enhanced risk-taking by the CEOs with severance packages. 

Professor Huang offered a comment to the Wall Street Journal about her findings:  "With a severance contract, a company is basically saying that even if a CEO fails, there will be no penalty."


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