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date: 09 December 2022

Executive Severance Agreements: Making Sense of an Emerging, Yet Fragmented, Research Fieldlocked

Executive Severance Agreements: Making Sense of an Emerging, Yet Fragmented, Research Fieldlocked

  • Felice B. Klein, Felice B. KleinSchool of Human Resources and Labor Relations, Michigan State University
  • Kevin McSweeney, Kevin McSweeneyMays Business School, Texas A&M University
  • Cynthia E. Devers, Cynthia E. DeversUniversity of Texas A&M
  • Gerry McNamaraGerry McNamaraBroad College of Business, Michigan State University
  •  and Spenser BlosserSpenser BlosserHuman Resources Manager, Precision Castparts

Summary

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.

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.

Subjects

  • Business Policy and Strategy
  • Finance
  • Human Resource Management
  • Organization Theory
  • Organizational Behavior

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