News from Cass Business School

CEOs set for big severance pay-offs sell their firms cheaper

Golden parachutes cost investors $249 million in lost takeover premiums

Top executives in line to receive over-generous severance packages are more likely to sell their firms cheaper when weighing up a takeover bid, a new study has found. CEOs with larger so-called golden parachutes settled for a five per cent smaller acquisition premium - typically selling their firms $249 million below value.

The study, co-authored by Dr Anh Tran at Cass, looked at more than 850 acquisitions announced in the US between 1999 and 2007. It examined the relative importance of golden parachutes to CEOs when all other parts of their merger pay package, including potential loss of earnings, were taken into account. The findings showed that a 10 per cent increase in the importance of the parachute relative to the merger pay package was linked to a five per cent fall in acquisition premium - amounting to a typical shortfall of $249 million.

Dr Tran said the results indicate that larger parachutes encourage some executives to compromise the interests of shareholders. "Our results show that as CEOs become more insulated from personal losses due to relatively larger parachutes, shareholders obtain less favourable acquisition terms. This suggests that overly important parachutes encourage some self-serving CEOs to sacrifice premium for personal gain," he said.

Dr Tran added: "When a firm becomes a takeover target, CEOs are faced with a moral hazard. They have direct influence over actions that could provide personal benefit at the possible expense of shareholders. Because of this, it is the relative importance of parachutes to CEOs, not their mere presence, which is important.

"If a golden parachute protects CEOs from a severe loss of personal wealth during a takeover, they behave differently than if they were fully exposed to the loss. A trivial parachute relative to a large loss in future earnings is unlikely to motivate an executive to consent to a takeover of their firm. However, an overly generous parachute relative to their full pay package could induce a rush to sell, regardless of the acquisition price being offered.

"Our research shows that as the importance of golden parachutes to CEOs increases, shareholders suffer a drop in acquisition premiums. This suggests that larger parachutes induce some CEOs to sacrifice the interests of shareholders in pursuit of their own personal gain."

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