Wednesday, December 07, 2011

Do we really need such research?

In another example of apparently entirely unnecessary research, Dr. Peggy Huang of Tulane University discovers that companies which agree to give their CEOs all-cash payouts, in case they step down, significantly underperform their competitors.

A cash-only contract in force during a given year is associated with annual stock returns over the subsequent three years that are 4.2% lower than the average returns of firms whose CEOs have no severance provisions.

Do we really need to know whether the returns are 4.2% lower, or 4% or 5%?

Isn't it obvious that, if I am a CEO with the parachute of a cash payout, that will tend to incentivise me to take less responsible actions than if my payout is principally in terms of shares which are blocked for say 5 years after I depart the company?

Dr Huang also says that all-cash contracts appear to be on the rise. If so, that appears to be a research finding worth having, does it not? True, but it would be more valuable if there was some accompanying analysis of WHY all-cash payouts are increasing when they are against both commonsense and research findings such as Dr Huang's.

Not to attack Dr Huang's research too much, I should point out that her research covered a sample of S&P500 CEO severance agreements between 1993 and 2007, and examined whether and how the existence and structure of severance agreements influences subsequent firm performance, CEO investment behavior, and the likelihood of CEO turnover. Her research shows that while firms with severance agreements tend to perform worse than firms without severance agreements, the structure of severance agreements also affects performance significantly.

Surprisingly, her research suggests that executives with severance contracts are more likely to be forced out of their firms - in her view because severance agreements, rather than promoting incentive alignment between CEOs and shareholders, actually exacerbate agency problems which lead to overinvestment and poor subsequent firm performance. She does not seem to examine whether companies whose value-set leads them to provide cash-only severance contracts are also companies whose value-set leads them to more rapidly dismiss CEOs (so should anyone really want to work as a CEO for a company which has such values?)

In another surprise, she finds that CEOs who are provided a cash-only severance package tend to "over-invest" in research. Over-invest? In research? Now that would be worth researching! Sphere: Related Content

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