CEO employment contract heterogeneity and acquirer risk-taking

Abstract

This study analyses a hand-collected, unique dataset on chief executive officer (CEO) employment contract details for S&P 500 companies over the period of 1993–2005. To control for the sample selection issue associated with firms granting a CEO contract, the study estimates the Heckman Selection model. The study finds substantial heterogeneity in contract provisions and their impact on acquirer risk-taking in mergers and acquisitions (M&As). More specifically, contract provisions that provide job and compensation security and equity incentives appear to encourage valuable risk-taking. In contrast, bureaucratic type provisions (automatic contract renewals; lack of equity incentives) motivate risky but value-decreasing deals. Further, more refined definitions of just cause for dismissal enhance valuable risk-taking, possibly by reducing contract ambiguities and the resulting disputes, whereas just causes based upon personal conduct reduce valuable risk-taking. This paper shows how heterogeneous contract provisions reflect the optimal contracting process in a competitive market for CEO talent versus managerial power over complacent boards, highlighting the importance of understanding contract complexity and heterogeneity in designing efficient contracts to enhance shareholder value and achieve strategic corporate goals.