IDEAS home Printed from https://ideas.repec.org/a/eee/jbfina/v59y2015icp111-126.html
   My bibliography  Save this article

Ex ante CEO severance pay and risk-taking in the financial services sector

Author

Listed:
  • Brown, Kareen
  • Jha, Ranjini
  • Pacharn, Parunchana

Abstract

We examine 533 CEO severance contracts for financial services firms from 1997 to 2007 and find that ex ante severance pay is positively associated with risk-taking after controlling for the incentive effects provided by equity-based compensation. We report a positive causal relation between the amount of severance pay and risk-taking using popular market-based risk measures as well as the distance-to-default and the Z-score. We also find that severance pay encourages excessive risk-taking using metrics such as tail risk and asset quality. Our results are consistent with the risk-shifting argument and provide support for recent reforms on severance pay in the financial sector.

Suggested Citation

  • Brown, Kareen & Jha, Ranjini & Pacharn, Parunchana, 2015. "Ex ante CEO severance pay and risk-taking in the financial services sector," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 111-126.
    • Handle: RePEc:eee:jbfina:v:59:y:2015:i:c:p:111-126
    DOI: 10.1016/j.jbankfin.2015.04.027
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0378426615001582
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jbankfin.2015.04.027?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Gustavo Manso, 2011. "Motivating Innovation," Journal of Finance, American Finance Association, vol. 66(5), pages 1823-1860, October.
    2. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-1054, July.
    3. Marianne Bertrand & Sendhil Mullainathan, 1999. "Is There a Discretion in Wage Setting? A Test Using Takeover Legislation," RAND Journal of Economics, The RAND Corporation, vol. 30(3), pages 535-554, Autumn.
    4. repec:fip:fedhpr:y:2010:i:may:p:65-71 is not listed on IDEAS
    5. John Y. Campbell & Jens Hilscher & Jan Szilagyi, 2008. "In Search of Distress Risk," Journal of Finance, American Finance Association, vol. 63(6), pages 2899-2939, December.
    6. Viral V. Acharya & Lasse H. Pedersen & Thomas Philippon & Matthew Richardson, 2017. "Measuring Systemic Risk," The Review of Financial Studies, Society for Financial Studies, vol. 30(1), pages 2-47.
    7. Carl R. Chen & Thomas L. Steiner & Ann Marie Whyte, 1998. "Risk‐Taking Behavior And Management Ownership In Depository Institutions," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 21(1), pages 1-16, March.
    8. Fahlenbrach, Rüdiger & Stulz, René M., 2011. "Bank CEO incentives and the credit crisis," Journal of Financial Economics, Elsevier, vol. 99(1), pages 11-26, January.
    9. Yakov Amihud & Baruch Lev, 1981. "Risk Reduction as a Managerial Motive for Conglomerate Mergers," Bell Journal of Economics, The RAND Corporation, vol. 12(2), pages 605-617, Autumn.
    10. Roman Inderst & Holger M. Mueller, 2010. "CEO Replacement Under Private Information," The Review of Financial Studies, Society for Financial Studies, vol. 23(8), pages 2935-2969, August.
    11. Hamid Mehran & Alan Morrison & Joel Shapiro, 2011. "Corporate governance and banks: what have we learned from the financial crisis?," Staff Reports 502, Federal Reserve Bank of New York.
    12. Stuart L. Gillan & Jay C. Hartzell & Robert Parrino, 2009. "Explicit versus Implicit Contracts: Evidence from CEO Employment Agreements," Journal of Finance, American Finance Association, vol. 64(4), pages 1629-1655, August.
    13. DeYoung, Robert & Peng, Emma Y. & Yan, Meng, 2013. "Executive Compensation and Business Policy Choices at U.S. Commercial Banks," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 48(1), pages 165-196, February.
    14. Oliver Hart & Luigi Zingales, 2014. "Banks Are Where The Liquidity Is," NBER Working Papers 20207, National Bureau of Economic Research, Inc.
    15. Laeven, Luc & Levine, Ross, 2009. "Bank governance, regulation and risk taking," Journal of Financial Economics, Elsevier, vol. 93(2), pages 259-275, August.
    16. repec:bla:jfinan:v:58:y:2003:i:2:p:519-548 is not listed on IDEAS
    17. Saunders, Anthony & Strock, Elizabeth & Travlos, Nickolaos G, 1990. "Ownership Structure, Deregulation, and Bank Risk Taking," Journal of Finance, American Finance Association, vol. 45(2), pages 643-654, June.
    18. John, Teresa A & John, Kose, 1993. "Top-Management Compensation and Capital Structure," Journal of Finance, American Finance Association, vol. 48(3), pages 949-974, July.
    19. Guay, Wayne R., 1999. "The sensitivity of CEO wealth to equity risk: an analysis of the magnitude and determinants," Journal of Financial Economics, Elsevier, vol. 53(1), pages 43-71, July.
    20. John, Kose & Saunders, Anthony & Senbet, Lemma W, 2000. "A Theory of Bank Regulation and Management Compensation," The Review of Financial Studies, Society for Financial Studies, vol. 13(1), pages 95-125.
    21. Mitchell A. Petersen, 2009. "Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches," The Review of Financial Studies, Society for Financial Studies, vol. 22(1), pages 435-480, January.
    22. Edward I. Altman, 1968. "Financial Ratios, Discriminant Analysis And The Prediction Of Corporate Bankruptcy," Journal of Finance, American Finance Association, vol. 23(4), pages 589-609, September.
    23. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    24. Edward I. Altman, 1968. "The Prediction Of Corporate Bankruptcy: A Discriminant Analysis," Journal of Finance, American Finance Association, vol. 23(1), pages 193-194, March.
    25. Weisbach, Michael S., 1988. "Outside directors and CEO turnover," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 431-460, January.
    26. Andres Almazan & Javier Suarez, 2003. "Entrenchment and Severance Pay in Optimal Governance Structures," Journal of Finance, American Finance Association, vol. 58(2), pages 519-547, April.
    27. Rajgopal, Shivaram & Shevlin, Terry, 2002. "Empirical evidence on the relation between stock option compensation and risk taking," Journal of Accounting and Economics, Elsevier, vol. 33(2), pages 145-171, June.
    28. Fich, Eliezer M. & Tran, Anh L. & Walkling, Ralph A., 2013. "On the Importance of Golden Parachutes," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 48(6), pages 1717-1753, December.
    29. John Core & Wayne Guay, 2002. "Estimating the Value of Employee Stock Option Portfolios and Their Sensitivities to Price and Volatility," Journal of Accounting Research, Wiley Blackwell, vol. 40(3), pages 613-630, June.
    30. P. Raghavendra Rau & Jin Xu, 2013. "How Do Ex Ante Severance Pay Contracts Fit into Optimal Executive Incentive Schemes?," Journal of Accounting Research, Wiley Blackwell, vol. 51(3), pages 631-671, June.
    31. Van Wesep, Edward D. & Wang, Sean, 2014. "The prevention of excess managerial risk taking," Journal of Corporate Finance, Elsevier, vol. 29(C), pages 579-593.
    32. Lambert, Ra & Larcker, Df & Verrecchia, Re, 1991. "Portfolio Considerations In Valuing Executive-Compensation," Journal of Accounting Research, Wiley Blackwell, vol. 29(1), pages 129-149.
    33. Houston, Joel F. & James, Christopher, 1995. "CEO compensation and bank risk Is compensation in banking structured to promote risk taking?," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 405-431, November.
    34. Dechow, Patricia M. & Sloan, Richard G., 1991. "Executive incentives and the horizon problem : An empirical investigation," Journal of Accounting and Economics, Elsevier, vol. 14(1), pages 51-89, March.
    35. Yermack, David, 2006. "Golden handshakes: Separation pay for retired and dismissed CEOs," Journal of Accounting and Economics, Elsevier, vol. 41(3), pages 237-256, September.
    36. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, vol. 80(5), pages 1183-1200, December.
    37. Kose John & Yiming Qian, 2003. "Incentive features in CEO compensation in the banking industry," Economic Policy Review, Federal Reserve Bank of New York, vol. 9(Apr), pages 109-121.
    38. Joel F. Houston & Kevin J. Stiroh, 2006. "Three decades of financial sector risk," Staff Reports 248, Federal Reserve Bank of New York.
    39. Chen, Carl R. & Steiner, Thomas L. & Whyte, Ann Marie, 2006. "Does stock option-based executive compensation induce risk-taking? An analysis of the banking industry," Journal of Banking & Finance, Elsevier, vol. 30(3), pages 915-945, March.
    40. Renee B. Adams & Hamid Mehran, 2003. "Is corporate governance different for bank holding companies?," Economic Policy Review, Federal Reserve Bank of New York, vol. 9(Apr), pages 123-142.
    41. repec:bla:jfinan:v:59:y:2004:i:1:p:207-225 is not listed on IDEAS
    42. Rangarajan K. Sundaram & David L. Yermack, 2007. "Pay Me Later: Inside Debt and Its Role in Managerial Compensation," Journal of Finance, American Finance Association, vol. 62(4), pages 1551-1588, August.
    43. Van Dalsem, Shane, 2010. "Determinants of CEO severance contracts and their components and the effects of severance contracts on executive turnover," Journal of Economics and Business, Elsevier, vol. 62(4), pages 257-272, July.
    44. Hayes, Rachel M. & Lemmon, Michael & Qiu, Mingming, 2012. "Stock options and managerial incentives for risk taking: Evidence from FAS 123R," Journal of Financial Economics, Elsevier, vol. 105(1), pages 174-190.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Illiashenko, Pavlo & Laidroo, Laivi, 2020. "National culture and bank risk-taking: Contradictory case of individualism," Research in International Business and Finance, Elsevier, vol. 51(C).
    2. Kolasinski, Adam C. & Yang, Nan, 2018. "Managerial myopia and the mortgage meltdown," Journal of Financial Economics, Elsevier, vol. 128(3), pages 466-485.
    3. Christian Haddad & Lars Hornuf, 2021. "The Impact of Fintech Startups on Financial Institutions' Performance and Default Risk," CESifo Working Paper Series 9050, CESifo.
    4. Jennifer Kunz & Mathias Heitz, 2021. "Banks’ risk culture and management control systems: A systematic literature review," Journal of Management Control: Zeitschrift für Planung und Unternehmenssteuerung, Springer, vol. 32(4), pages 439-493, December.
    5. Ivo Schedlinsky & Friedrich Sommer & Arnt Wöhrmann, 2016. "Risk-taking in tournaments: an experimental analysis," Journal of Business Economics, Springer, vol. 86(8), pages 837-866, November.
    6. Hasan, Mostafa Monzur & Cheung, Adrian (Wai Kong) & Taylor, Grantley, 2020. "Financial statement comparability and bank risk-taking," Journal of Contemporary Accounting and Economics, Elsevier, vol. 16(3).
    7. Adachi-Sato, Meg & Vithessonthi, Chaiporn, 2019. "Corporate debt maturity and future firm performance volatility," International Review of Economics & Finance, Elsevier, vol. 60(C), pages 216-237.
    8. Patricia Boyallian & Pablo Ruiz-Verdú, 2018. "Leverage, CEO Risk-Taking Incentives, and Bank Failure during the 2007–10 Financial Crisis [Endogenous matching and the empirical determinants of contract form]," Review of Finance, European Finance Association, vol. 22(5), pages 1763-1805.
    9. Gerhard Philip Maree Grebe & Johan Marx, 2023. "The Perceived Relationship between Risk Culture and Operational Risk Management Practices of Ghanaian Banks," JRFM, MDPI, vol. 16(9), pages 1-22, September.
    10. Ilona Sobien, 2022. "Znaczenie wymogow kapitalowych w sektorze bankowym (The Importance of Capital Requirements in the Banking Sector)," Research Reports, University of Warsaw, Faculty of Management, vol. 1(36), pages 15-28.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Chesney, Marc & Stromberg, Jacob & Wagner, Alexander F. & Wolff, Vincent, 2020. "Managerial incentives to take asset risk," Journal of Corporate Finance, Elsevier, vol. 65(C).
    2. Bai, Gang & Elyasiani, Elyas, 2013. "Bank stability and managerial compensation," Journal of Banking & Finance, Elsevier, vol. 37(3), pages 799-813.
    3. Lin Guo & Abu Jalal & Shahriar Khaksari, 2015. "Bank executive compensation structure, risk taking and the financial crisis," Review of Quantitative Finance and Accounting, Springer, vol. 45(3), pages 609-639, October.
    4. Anantharaman, Divya & Lee, Yong Gyu, 2014. "Managerial risk taking incentives and corporate pension policy," Journal of Financial Economics, Elsevier, vol. 111(2), pages 328-351.
    5. Patricia Boyallian & Pablo Ruiz-Verdú, 2018. "Leverage, CEO Risk-Taking Incentives, and Bank Failure during the 2007–10 Financial Crisis [Endogenous matching and the empirical determinants of contract form]," Review of Finance, European Finance Association, vol. 22(5), pages 1763-1805.
    6. Dong, Gang Nathan, 2014. "Excessive financial services CEO pay and financial crisis: Evidence from calibration estimation," Journal of Empirical Finance, Elsevier, vol. 27(C), pages 75-96.
    7. repec:cte:wbrepe:wb1501 is not listed on IDEAS
    8. Jeong-Bon Kim & Li Li & Mary L. Z. Ma & Frank M. Song, 2013. "CEO Option Compensation, Risk-Taking Incentives, and Systemic Risk in the Banking Industry," Working Papers 182013, Hong Kong Institute for Monetary Research.
    9. Joshua D. Anderson & John E. Core, 2018. "Managerial Incentives to Increase Risk Provided by Debt, Stock, and Options," Management Science, INFORMS, vol. 64(9), pages 4408-4432, September.
    10. Gande, Amar & Kalpathy, Swaminathan, 2017. "CEO compensation and risk-taking at financial firms: Evidence from U.S. federal loan assistance," Journal of Corporate Finance, Elsevier, vol. 47(C), pages 131-150.
    11. Chaigneau, Pierre, 2013. "Risk-shifting and the regulation of bank CEOs’ compensation," Journal of Financial Stability, Elsevier, vol. 9(4), pages 778-789.
    12. Chen, Zhongdong & Ebrahim, Alireza, 2018. "Turnover threat and CEO risk-taking behavior in the banking industry," Journal of Banking & Finance, Elsevier, vol. 96(C), pages 87-105.
    13. Bharati, Rakesh & Jia, Jingyi, 2018. "Do bank CEOs really increase risk in vega? Evidence from a dynamic panel GMM specification," Journal of Economics and Business, Elsevier, vol. 99(C), pages 39-53.
    14. Srivastav, Abhishek & Armitage, Seth & Hagendorff, Jens & King, Tim, 2018. "Better safe than sorry? CEO inside debt and risk-taking in bank acquisitions," Journal of Financial Stability, Elsevier, vol. 36(C), pages 208-224.
    15. Vittoria Cerasi & Tommaso Oliviero, 2014. "Managerial compensation, regulation and risk in banks: theory and evidence from the financial crisis," Working Papers 279, University of Milano-Bicocca, Department of Economics, revised Jul 2014.
    16. Carola Frydman & Dirk Jenter, 2010. "CEO Compensation," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 75-102, December.
    17. Mohamed Belkhir & Abdelaziz Chazi, 2010. "Compensation Vega, Deregulation, and Risk‐Taking: Lessons from the US Banking Industry," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 37(9‐10), pages 1218-1247, November.
    18. Hagendorff, Jens & Vallascas, Francesco, 2011. "CEO pay incentives and risk-taking: Evidence from bank acquisitions," Journal of Corporate Finance, Elsevier, vol. 17(4), pages 1078-1095, September.
    19. Cassell, Cory A. & Huang, Shawn X. & Manuel Sanchez, Juan & Stuart, Michael D., 2012. "Seeking safety: The relation between CEO inside debt holdings and the riskiness of firm investment and financial policies," Journal of Financial Economics, Elsevier, vol. 103(3), pages 588-610.
    20. Ingolf Dittmann & Ko-Chia Yu & Dan Zhang, 2017. "How Important Are Risk-Taking Incentives in Executive Compensation?," Review of Finance, European Finance Association, vol. 21(5), pages 1805-1846.
    21. Mónica López-Puertas Lamy, 2012. "How does Ownership Structure Influence Bank Risk? Analyzing the Role of Managerial Incentives," Working Papers 1208, Departament Empresa, Universitat Autònoma de Barcelona, revised Nov 2012.

    More about this item

    Keywords

    Managerial compensation; Severance pay; Excessive risk-taking;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jbfina:v:59:y:2015:i:c:p:111-126. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jbf .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.