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CEO Severance Packages Lower Performance, Says Finance Professor

[A new twist on the story in #msg-44867998.]

http://online.wsj.com/article/SB10001424052970204397704577074301463590914.html

›DECEMBER 5, 2011
By Leslie Kwoh

Companies might want to think twice before offering their CEOs severance packages.

Break-up contracts can take a toll on a company's stock performance, lowering returns by as much as 4% in the three years after the agreements are introduced, according to a study by Peggy Huang, an assistant professor of finance at Tulane University's Freeman School of Business. The study showed similar findings at the five-year mark.

Ms. Huang analyzed more than 2,000 CEO severance agreements from S&P 500 companies between 1993 and 2007. Firms that introduced such contracts underperformed in the markets by 1.6% on average in the ensuing three-year period, when compared with firms that did not, the study found.

The disparity was even greater for companies that offered cash-only contracts (as opposed to a mix of cash and stock options). These firms underperformed by 4% on average in the stock market, when compared to companies that had either severance contracts with a stock component or no severance contracts at all.

CEOs with a break-up contract already in place, especially a cash-only contract, were likely to invest more heavily in research and development, aggressively betting on risks that might end in failure, Ms. Huang says. "With a severance contract, a company is basically saying that even if a CEO fails, there will be no penalty," she says.

Still, severance agreements seem to have grown in popularity, with the share of S&P 500 firms offering such contracts more than doubling during the study period, to 56%. That could be because CEO turnover has increased and more top executives are demanding a safety net, Ms. Huang says.

Companies that insist on offering severance pacts can cushion some of the financial impact by incorporating more stock options, she suggests, thus aligning the CEO's personal wealth with the firm's performance.‹