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How Do Ex Ante Severance Pay Contracts Fit into Optimal Executive Incentive Schemes?


  • Accepted by Philip Berger. We would like to thank an anonymous referee, Dave Denis, Diane Denis, Alex Edmans, Mara Faccio, Stu Gillan, Marc Goergen, Eitan Goldman, Jay Hartzell, Hayne Leland, John McConnell, Christine Parlour, Joshua Rauh, Vivek Sharma, Richard Stanton, Peter Swan, Hongfei Tang, David Yermack, and seminar participants at the University of California at Berkeley, the 2010 Conference on Managerial Compensation at Cardiff University, the Third Singapore International Conference on Finance, the Midwest Finance Association, 2009, the Financial Management Association, 2010, and the American Finance Association, 2012 for helpful comments. We would also like to thank Micah Allred, Clarke Bjarnason, Rahsan Bozkurt, Francis Instein, Amanda Thompson, and Jing Wang for able research assistance.


We analyze a sample of over 3,600 ex ante explicit severance pay agreements in place at 808 firms and show that firms set ex ante explicit severance pay agreements as one component in managing the optimal level of equity incentives. Younger executives are more likely to receive explicit contracts and better terms. Firms with high distress risk, high takeover probability, and high return volatility are significantly more likely to enter into new or revised severance contracts. Finally, ex post payouts to managers are largely determined by the ex ante contract terms.