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Executive Severance Agreements: Making Sense of an Emerging, Yet
Fragmented, Research Field
Oxford Research Encyclopedia of Business and
Management
Executive Severance Agreements: Making Sense of an
Emerging, Yet Fragmented, Research Field
Felice B. Klein, Kevin McSweeney, Cynthia E. Devers, Gerry McNamara, and
Spenser Blosser
Subject: Business Policy and Strategy, Finance, Human Resource Management, Organization
Theory, Organizational Behavior
Online Publication Date: Oct 2017 DOI: 10.1093/acrefore/9780190224851.013.30
Summary and Keywords
Scholars have devoted significant attention to understanding the determinants and
consequences of executive compensation. Yet, one form of compensation, executive
severance agreements, has flown under the radar. Severance agreements specify the
expected payments and benefits promised executives, upon voluntary or involuntary
termination. Although these agreements are popular among executives, critics continually
question their worth. Yet severance agreements potentially offer three important (but less
readily recognized) strategic benefits. First, severance agreements are viewed as a
means of mitigating the potential risks associated with job changes; thus, they can serve
as a recruitment tool to attract top executive talent. Second, because severance
agreements guarantee executives previously specified compensation in the event of
termination, they can help limit the downside risk naturally risk-averse executives face,
facilitating executive-shareholder interest alignment. Third, severance agreements can
aid in firm exit, as executives and directors are likely to be more open to termination, in
the presence of adequate protection against the downside.
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Executive Severance Agreements: Making Sense of an Emerging, Yet
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Severance agreements can contain provisions for ten possible termination events. Three
events refer to change in control (CIC), which occurs under a change in ownership. These
are (1) CIC without termination, (2) CIC with termination without cause, and (3) CIC with
termination for cause. Cause is generally defined by events such as felony, fraud,
embezzlement, neglect of duties, or violation of noncompete provisions. Additional events
include (4) voluntary retirement, (5) resignation without good reason, (6) voluntary
termination for good reason, (7) involuntary termination without cause, (8) involuntary
termination with cause, (9) death, and (10) disability. Voluntary retirement and
resignation without good reason occurs when CEOs either retire or leave under their own
volition, and voluntary termination with good reason occurs in response to changes in
employment terms (e.g., relocation of headquarters). Involuntary termination refers to
termination due to any reason not listed above and is often triggered by unsatisfactory
performance.
Although some prior work has addressed the antecedents, consequences, and moderators
of severance, the findings from this literature remain unclear, as many of the results are
mixed. Future severance scholars have the opportunity to further clarify these
relationships by addressing how severance agreements can help firms attract, align the
interests of, and facilitate the exit of executives.
Keywords: severance agreements, executive compensation, golden parachutes, employment agreements,
termination
A Severance Review
Scholars from a variety of disciplines have devoted significant attention to understanding
the determinants and consequences of executive compensation (Devers, Cannella, Reilly,
& Yoder, 2007). In fact, a number of reviews and meta-analyses have already been
published on the topic (e.g., Devers et al., 2007; Gomez-Mejia & Wiseman, 1997; Tosi,
Werner, Katz, & Gomez-Mejia, 2000). Thus, we know a lot about executive compensation,
which defined broadly includes bonuses, stock options, restricted stock, and incentives.
However, one form of executive compensation, executive severance agreements, has
flown under the radar.
Nonetheless, executive severance agreements are beginning to garner increasing
interest, both within the business press and academic communities. Unfortunately, the
fragmented nature of this inquiry provides a limited understanding of these agreements.
Specifically, although executive severance comes in many shapes and sizes, these
agreements generally specify the expected payments and benefits promised executives,
upon voluntary or involuntary termination. The frequency with which such agreements
appear has grown steadily since the 1980s (Green, 2013; McGregor, 2014). Indeed, over
80% of CEOs have some form of termination guarantee (Cowen, King, & Marcel, 2016).
More importantly, the severance payments these agreements promise are far from trivial.
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Executive Severance Agreements: Making Sense of an Emerging, Yet
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The average guaranteed severance payout for CEOs of S&P 500 firms is $29.7 million for
termination following a change in control (firm takeover) and $16.4 million for
involuntary dismissal (most often resulting from poor performance).1
While severance agreements are popular among executives, the press is rife with serious
questions about their worth. The most vocal critics impugn severance agreements as
rewards for failure, as they often allow outgoing executives to depart with large payouts
in hand, when they or their firms have performed poorly (Bebchuk & Fried, 2004; Dash,
2007). For example, in 2010 shareholders and activists were outraged that HewlettPackard CEO Mark Hurd would receive a $40 million severance payment for his board
pressured resignation, following several ethical violations (Waters, 2010). Further, after
Pfizer CEO Hank McKinnel resigned in 2006, and received a severance payout of $188
million, shareholders sponsored a plane to fly over the annual meeting with the banner,
“Give it Back, Hank!” (Baratz, 2013).
Despite this outrage, severance agreements potentially offer important, but less readily
recognized, strategic benefits. As we explain, these prospective benefits fall into three
broad categories: (1) attracting executive talent, (2) aligning managerial interests, and
(3) facilitating firm exit.
Attracting Executive Talent
Some proponents argue severance agreements can serve as a recruitment tool to attract
top executive talent (Cowen et al., 2016). For example, a fair amount of ambiguity often
exists regarding the fit between executives and new job demands (Allgood & Farrell,
2003; Zhang, 2008). Thus, for executives considering job offers, the threat of dismissal
and the subsequent adverse financial, human, and social capital consequences can
generate (often high) perceptions of employment and compensation risk (LarrazaKintana, Wiseman, Gomez-Mejia, & Welbourne, 2007; Semadeni, Cannella, Fraser, & Lee,
2008; Wiesenfeld, Wurthmann, & Hambrick, 2008). The greater the perceived
employment and compensation risk, the more likely highly qualified candidates will
decline offers. Severance agreements are viewed as a means of mitigating those potential
risks, by reducing at least a portion of the downside potential associated with job
changes.
Aligning Managerial Interests
Advocates propose that severance agreements can also have positive effects, post-hire.
Specifically, as noted above, because they guarantee executives previously specified
compensation in the event of termination, severance agreements can help limit the
downside risk naturally risk-averse executives face (Almazan & Suarez, 2003; Singh &
Harianto, 1989A). Scholars argue that downside protection discourages risk aversion.
Thus, consistent with agency theory logic, severance agreements should facilitate
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Executive Severance Agreements: Making Sense of an Emerging, Yet
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executive-shareholder interest alignment. For example, involuntary termination
agreements may allow executives to reveal negative information that they may be more
inclined to conceal or invest in risky yet potentially valuable firm projects (van Dalsem,
2010). In addition, change-in-control agreements may render CEOs less resistant to
takeovers that may benefit shareholders (Singh & Harianto, 1989A). In sum, some argue
that severance agreements have the potential to align executives’ interests with those of
shareholders (Rau & Xu, 2013).
Facilitating Firm Exit
Finally, severance agreements are also argued to facilitate both voluntary and involuntary
executive exit (Almazan & Suarez, 2003; Goldman & Huang, 2015). Specifically, some
have argued that in situations where voluntary or involuntary termination is desired,
executives and directors are more open to termination, in the presence of severance
agreements that provide adequate downside protection (Inderst & Mueller, 2010; van
Dalsem, 2009, 2010). Thus, board members may be willing to dismiss an executive with a
severance package, as it can ameliorate the cost of dismissal. Relatedly, the existence of a
severance package lessens the possibility of long, drawn-out negotiations during a
dismissal effort. Overall, heavy criticism notwithstanding, severance agreements appear
to have the potential for beneficial pre- and post-hire effects for executives, firms, and
investors.
Scholars began focusing attention on severance in the 1980s. However, in light of
concerns about inflated top executive compensation, and the financial crisis of 2007,
academic interest has recently surged. This outpouring of attention has produced
thought-provoking work on a variety of subtopics and from a diversity of perspectives.
Nevertheless, as is the case with most emerging research areas, although this literature
continues to rapidly grow, it is quite broad and fragmented. Thus, no unifying theoretical
or conceptual thread exists to synthesize important contributions across subtopics and
perspectives. As a result, scholars and practitioners are left to make sense of its
disjointed nature, which inhibits advancement of this nascent but important line of
research. Thus, a deeper understanding of severance holds high relevance for
management theory and practice.
For example, one emerging issue highlights this relevance. Specifically, recent research
shows that female CEOs receive larger severance agreements than male CEOs, perhaps
as a means of reducing their higher termination risk and post-termination employability
concerns (Klein, Chaigneau, & Devers, 2015). However, whether female executives
demand more severance or directors assume they require it is unclear. In addition, we
know little about whether and how severance impacts other demographic minorities, or
those that differ in terms of cultural (e.g., collectivistic), or cognitive (e.g., core-selfevaluation, promotion or prevention orientation, etc.) dimensions. Given the increasing
pressures to increase diversity in TMTs, the CEO office, and on corporate boards, our
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Executive Severance Agreements: Making Sense of an Emerging, Yet
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knowledge gap is notable since it is important to understand the concerns of these
diverse leaders and how firms can enhance their ability to recruit them.
Taking into consideration the increasing emphasis on effective corporate governance,
including as explained above attracting minority members to top management roles, it is
important for management scholars to develop a more comprehensive understanding of
this common, yet as compared to executive compensation, much less visible aspect of
executives’ employment contracts. Accordingly, the body of severance research was
reviewed by searching EBSCOhost, ProQuest, JSTOR, Web of Science, and Google
Scholar using a broad base of severance-related keywords (e.g., “agreement,” “contract,”
“pay,” or “payment” combined with each of the following: “severance,” “separation,”
“change-in-control,” “termination,” “golden parachutes,” and “golden handshakes”), in
the domains of economics, accounting, law, finance, sociology, and management. In
addition, we searched through the references of all of the articles we found for additional
papers that were relevant and also searched through any articles that cited the most
relevant papers. We then classified existing theory and evidence into an organizing
framework presented in Figure 1.
Click to view larger
Figure 1. Framework of Executive Severance
Agreements: Antecedents, Consequences, and
Moderators.
As we describe below, this
review allows us to better
clarify the concept of
severance, organize and
integrate prior findings,
identify emerging research
opportunities, and develop
a foundation for
facilitating new research
directions, as they relate
to management theory and
practice.
Review
Although severance is often conceptualized as a guarantee for change in control or
involuntary termination, such agreements can contain provisions for several termination
events. Adding further complexity, although some severance scholars focus on original
(pre-hire) severance agreements (e.g., Rusticus, 2006), others examine severance
agreements at different times during a CEO’s tenure, as the value of these agreements
tends to move with changes to CEO compensation (e.g., Gillan, Hartzell, & Parrino, 2009).
Yet another strand of work focuses on separation pay (at-termination payouts), which
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Executive Severance Agreements: Making Sense of an Emerging, Yet
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often differs significantly from original severance guarantees (Goldman & Huang, 2015;
Yermack, 2006).
In addition, some research explores the antecedents of severance agreements (e.g.,
Agrawal & Knoeber, 1998; Rau & Xu, 2013), while other work focuses on their
consequences (e.g., Buchholtz & Ribben, 1994; Fich, Tran, & Walking, 2013). Perhaps
more importantly, however, although many studies examine the utility of severance from
the firm perspective (e.g., Bodolica & Spraggon, 2009), others view its utility from the
perspective of executives (e.g., Klein et al., 2015), leaving results difficult to reconcile.
Thus, it remains unclear whether severance agreements actually exhibit their proposed
effects on executive attraction, interest alignment, and firm exit.
This entry’s review begins by differentiating among the individual termination events
often included in executive severance agreements. After these important clarifications,
the article draws on a framework that classifies research into antecedents, consequences,
and moderators, to summarize what is currently known about severance agreements and
articulate what important gaps remain in the severance literature. The article then gives
a brief overview of a multidisciplinary research agenda that lays the foundation for
advancing the severance literature: by better linking theory and evidence on severance to
the three strategic benefits discussed earlier. This entry also discusses innovative
research methods capable of addressing these gaps.
Termination Events
Even though change-in-control (CIC) and involuntary termination (IT) are the most
widespread, controversial, and studied forms of severance, our broad review of proxy
statements revealed that severance agreements can, and often do, cover many additional
forms of termination (termination events). Thus, severance agreements include provisions
that specify the promised payment for all or some of the following ten possible
termination events. Three events refer to change in control (CIC), which occurs under a
change in ownership. These are (1) CIC without termination, (2) CIC with termination
without cause, and (3) CIC with termination for cause. Cause is generally defined by
events such as felony, fraud, embezzlement, neglect of duties, or violation of noncompete
provisions (Schwab & Thomas, 2006). Additional events include (4) voluntary retirement,
(5) resignation without good reason, (6) voluntary termination for good reason, (7)
involuntary turnover without cause, (8) involuntary turnover with cause, (9) death, and
(10) disability. Voluntary retirement and resignation without good reason occurs when
CEOs either retire or leave under their own volition, and voluntary termination with good
reason occurs in response to changes in employment terms (e.g., relocation of
headquarters) (Bodolica & Spraggon, 2009). Involuntary turnover refers to termination
due to any reason not listed above and is often triggered by unsatisfactory performance.
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Executive Severance Agreements: Making Sense of an Emerging, Yet
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These termination events differ in a number of important ways. More specifically, as
summarized in Table 1, are some ideas on how these events could differ: whether they are
related to performance, whether they are under the CEO’s control, whether they are
under the board’s control, and their likelihood of occurrence as perceived by the CEO.
Yet, no study we are aware of has explored all of the different termination events or
developed theory based on the differences between the types of severance events.
Accordingly, future research should address how the relationship between certain CEO
and firm characteristics and severance may depend on these differences.
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Executive Severance Agreements: Making Sense of an Emerging, Yet Fragmented, Research Field
Table 1. Comparison of Events in CEO Severance Agreements
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Executive Severance Agreements: Making Sense of an Emerging, Yet Fragmented, Research Field
Event
CIC
without
CIC
with
termina
tion
termina
tion
CIC for
cause
Volunta
ry
Resigna
tion
retirem
ent
Volunta
ry
Involun
tary
Involun
tary
termina
tion
termina
tion
termina
tion
without
cause
with
cause
Disabili
ty
Death
Definitio
Occurs
Occurs
Occurs
Termina
Occurs
Occurs
Termina
Termina
Termina
Termina
n
followin
g an
followin
g an
followin
g an
tion of
contract
when a
CEO
when a
CEO
tion due
to any
tion due
to
tion of
contract
tion of
contract
acquisiti
on
acquisiti
on
acquisiti
on,
due to
retireme
decides
to leave.
decides
to leave
other
reason,
events
such as
due to
disabilit
due to
death.
resultin
g in
resultin
g in
which
was due
nt.
due to
the
often
due to
felony,
fraud,
y.
change
in CEO
terminat
ion of
to cause
events,
compan
y
unsatisf
actory
embezzl
ement,
without
terminat
ion.
the
CEO.
i.e.
felony,
fraud,
embezzl
ement,
neglect
of
duties,
violation
of noncompete
changin
g the
terms of
the
agreeme
nt.
perform
ance.
neglect
of
duties,
violation
of noncompete
provisio
ns.
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Executive Severance Agreements: Making Sense of an Emerging, Yet Fragmented, Research Field
provisio
ns.
Perform
ance-
Yes
Yes
Yes
No
No
No
Yes
Yes
No
No
No
No
Yes
Yes
Yes
Yes
No
Yes
No
No
Under
Sometim
Sometim
Sometim
No
No
No
Yes
Yes
No
No
the
board’s
es
es
es
Possible
Possible
Unlikely
Possible
Possible
Possible
Possible
Unlikely
Unlikely
Unlikely
related
Under
the
CEO’s
control
control
Percepti
on of
likelihoo
d of
occurrin
g
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Executive Severance Agreements: Making Sense of an Emerging, Yet
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Table 2 presents the average guaranteed value of severance for each of the different
termination events for Fortune 500 and S&P 500 CEOs. These data were collected by
obtaining each firm’s proxy statement, filed in 2010 or 2011 depending on the date of
their Annual Shareholder Meeting, from the SEC website. Then a search was conducted
for guaranteed severance pay information for each CEO and the total dollar value of
guaranteed severance pay was coded for each of the possible ten termination events
reported. Some firms listed this data in a table; for these firms, the total value was simply
coded. When this information was not directly provided, these values were calculated
using text descriptions and compensation summary tables.
Table 2. Severance for 2010 Fortune 500 and S&P 500 CEOs
Variables
Percent of CEOs with the
provision
Estimated contractual
value
CIC without termination
15.9%
$2,245,975
CIC with termination
84.6%
$22,949,321
CIC with termination for
cause
0.4%
$60,470
Voluntary retirement
26.1%
$3,913,201
Resignation without
good reason
5.5%
$510,228
Voluntary termination
with good reason
35.3%
$5,785,123
Involuntary termination
without cause
66.2%
$11,297,095
Involuntary termination
with cause
12.8%
$701,882
Disability
58.0%
$11,180,571
Death
63.3%
$12,835,923
As seen in Table 2, CEO severance agreements containing CIC with termination without
cause and involuntary termination without cause were common, with 84.6% and 66.2% of
the CEOs having such agreements, respectively. The other termination events for which a
majority of CEOs had a severance agreement are disability and death, 58.3% and 63.3%,
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Executive Severance Agreements: Making Sense of an Emerging, Yet
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respectively. CEOs were less likely to have agreements containing provisions for the other
six events. For example, only 15.9% had CIC without termination, 0.4% had CIC with
termination for cause, 26.1% had voluntary retirement, 5.5% had resignation without
good reason, 35.3% of CEOs had voluntary termination with good reason provisions, and
12.8% had involuntary termination with cause. The guaranteed payments for these
different severance provisions also varied significantly. For instance, the four events that
were the most common are also the largest: CEOs were guaranteed $11.3 million on
average for involuntary termination without cause, $22.9 million on average for CIC with
termination without cause, $11.2 million for disability, and $12.8 million for death. The
values CEOs were guaranteed for the other six events were much smaller: $2.2 million for
CIC without termination, $60.4 thousand for CIC for cause, $3.9 million for retirement,
$510.2 thousand for resignation without good reason, $5.8 million for voluntary
termination with good reason, and $701.9 thousand for involuntary termination with
cause.
Adding to the complexity of the construct are the number of terms that refer to some
form of severance in various literatures and the inconsistencies regarding how they are
defined. First, some researchers have used the term “severance agreements” to refer
only to the voluntary and involuntary termination provisions (e.g., Bodolica & Spraggon,
2009; Cowen et al., 2016; Peters & Wagner, 2014), whereas others have used it to include
all termination and CIC provisions (e.g., Almazan & Suarez, 2003; Dalton, Daily, & Kesner,
1993; Rau & Xu, 2013). We focus on the latter definition and include all provisions in an
executive’s employment contract related to the termination of his or her contract.
Second, some severance provisions are commonly referred to under different terms. For
example, CIC agreements are often called “golden parachutes,” whereas involuntary
termination agreements are called “golden handshakes.” Further, agreements on the
payments that executives receive as they are being terminated are sometimes call
“separation pay agreements,” while “discretionary severance pay” is the difference
between the severance agreement and the severance payout (Goldman & Huang, 2015).
It is important to note that although severance agreements list the minimum terms for
this payout, executives often receive larger awards (in a variety of forms) at termination
than what is specified in the agreement (Goldman & Huang, 2015; Yermack, 2006), likely
to facilitate expedient transitions. Last, the term “sunset provisions” refers to the vesting,
forfeiture, and expiration provisions for equity grants for executives who leave the firm
(Dahiya & Yermack, 2008).
As noted above, although change-in-control (CIC) and involuntary termination (IT) are the
most common and studied severance forms, many others exist. However, we know little
about these other types of severance. As a result, we encourage research that begins to
shed light on the roles these other forms of severance may play in executive attraction,
interest alignment, and exit.
Antecedents
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Executive Severance Agreements: Making Sense of an Emerging, Yet
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Some scholars exploring the antecedents of severance agreements have sought to
determine what influences both their award and size (Cowen et al., 2016). However, the
findings are complex. For example, researchers have found that smaller firms (which are
more likely to face takeovers) and high risk and poorly performing firms, are more likely
to award severance agreements than their counterparts (Agrawal & Knoeber, 1998; Rau
& Xu, 2013; van Dalsem, 2010). However, other evidence has shown that larger firms
provide greater guaranteed payouts to executives than do smaller firms (Rusticus, 2006).
Further, externally appointed executives are both more likely to have a severance
agreement and receive larger guaranteed payouts, relative to internal appointees (Gillan
et al., 2009; Rusticus, 2006).
In addition, Davis and Greve (1997) found that firms’ adoption of CIC agreements
diffused similarly across firms in close proximity. However, Fiss, Kennedy, and Davis
(2012) showed that shareholder and acquirer lawsuits and public visibility reduced the
extensiveness of agreements. Further, although some suggest that managerial power
affects severance awards (Bebchuk & Fried, 2004), unfortunately, the evidence here is
mixed (Singh & Harianto, 1989A; Wade, O’Reilly, & Chandratat, 1990). On an intriguing
note, although approximately 80% of CEOs have some form of a severance agreement,
20% of firms have resisted adopting this practice (Cowen et al., 2016). Nevertheless, little
is known about why some firms choose a strategy of resistance.
Additionally, it is clear from past research that some executive jobs are more challenging
than others (Hambrick, Finkelstein, & Mooney, 2005). More specifically, this research has
argued that while some executives “lead companies that have well-fortified (sometimes
even monopoly) positions, and are supported by highly capable colleagues,” “other
executives have none of these comforts” (Hambrick et al., 2005, p. 472). Accordingly,
these authors proposed the construct of executive job demands, which they defined as the
degree to which an executive’s job is difficult or challenging. It is plausible that in order
for firms to attract executives to take roles with significant job demands, they need to
offer greater insurance in the form of severance. Future studies should explore whether
executives with higher job demands receive greater severance and, further, how job
demands interact with gender and other demographic characteristics to affect
guaranteed severance pay.
Last, the majority of severance research relies on archival data, which limits our
understanding of the cognitive and behavioral processes that underlie severance
initiation. This article proposes that alternative methods (e.g., experimental, policy
capturing, survey-based research, interviews, etc.) can help advance this work. However,
such examinations are virtually absent in the severance literature. Therefore, although
prior research has yielded many insights, this entry contends that the management field
has not yet effectively integrated these findings. Thus, important questions regarding
antecedents remain.
Consequences
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Executive Severance Agreements: Making Sense of an Emerging, Yet
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As noted, advocates argue that severance agreements have important effects on
attraction, interest alignment, and firm exit. However, whether severance agreements
achieve these consequences is unclear, as the results are mixed. For example, Lambert
and Larcker (1985) showed that CIC adoption positively influenced investor reactions,
whereas Mogavero and Toyne (1995) found a negative effect. Born, Trahan, and Faria
(1993) showed that CIC agreements had no effect on tender offer success; however,
Bebchuk, Cohen, and Wang (2014) found that such agreements were associated with
higher than expected acquisition premiums. Additionally, Chen, Cheng, Lo, and Wang
(2012) demonstrated that involuntary termination agreements appeared to encourage
CEOs to take a long-term view and refrain from reducing R&D expenditures; while Huang
(2011) showed that involuntary CEO termination agreements motivated overinvestment
in short-term risky projects that ultimately increased share price volatility. Moreover,
research on discretionary involuntary termination payments found that shareholders
react negatively to voluntary discretionary payments, yet react positively to involuntary
discretionary payments (Goldman & Huang, 2015; Yermack, 2006).
In addition, although Klein et al. (2015) found that incoming female CEOs receive larger
guaranteed severance pay than incoming male CEOs, given that the value of CEOs’
severance agreements are typically linked to their annual compensation, it is unclear
whether this severance gap persists over time. More specifically, the annual
compensation of male CEOs tends to rise faster than female CEOs, especially with
positive firm performance (Munoz-Bullon, 2010; Albanesi, Olivetti, & Prados, 2015). Thus,
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