An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Ewa Sletten
Northwestern University

Thomas Lys
Northwestern University

Abstract: We find that 50% of CEOs initial employment agreements contain an explicit severance provision with a mean value of $5.38 million, with the specified payouts higher when the sponsoring firm is riskier, the CEO is hired from outside, the predecessor was fired, the CEO is older, and the employment contract contained a confidentiality clause. Thus our evidence is consistent with those contracts providing CEOs with insurance for the search and reputation costs associated with termination. However, the severance offered to CEOs also complements the effect of executive stock options in inducing CEO risk-taking. Risk-taking as measured by stock return volatility is positively associated with the amount of ex ante severance in a CEO’s compensation package interacted with the risk-incentives from executive stock options (ESO).

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