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Contract Length and Severance Pay

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  • Vladimirov, Vladimir

Abstract

Renewable fixed-term contracts are widespread in executive compensation. This paper studies why these contracts are optimal, what determines their length, and how that length affects managerial behavior. The model relates a contract's length to the period during which dismissing a manager triggers severance pay. Though longer contracts are more costly to terminate, their severance protection can discourage managers from trying to avoid replacement through window dressing or concealing soft information. Thus, the board's choice of contract length balances higher replacement costs with a higher likelihood of window dressing. The predicted determinants of contract length and severance pay are supported empirically.

Suggested Citation

  • Vladimirov, Vladimir, 2021. "Contract Length and Severance Pay," CEPR Discussion Papers 16288, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:16288
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    More about this item

    Keywords

    Contract length; Contract horizon; Severance pay; Renewable fixed-term contracts; Voluntary and forced turnover; Turnover-performance sensitivity; Asymmetric information;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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