Does Ex Ante Severance Pay Affect the Timeliness of Bad News Disclosure? The Role of Managerial Exit Costs

Abstract

Extant literature documents a positive association between ex ante severance pay and timeliness of bad news disclosure, suggesting that the provision of severance pay is consistent with efficient contracting. Relying on an empirically unexplored theory, we investigate whether and how managerial exit costs (i.e., financial and nonfinancial losses triggered by employment termination) affect the effectiveness of severance pay in curbing bad news withholding. We find that managerial exit costs attenuate the positive association between severance pay and timely disclosure of bad news. Moreover, we document that severance pay does not prompt managers to reveal bad news when their exit costs are sufficiently high (i.e., in the top quartile). This result suggests that exit costs erode the efficacy of ex ante severance pay in curtailing bad news withholding. Overall, our findings support the notion that a “one-size-fits-all” approach to structuring severance agreements undermines the potential of severance pay to benefit investors.

Arranging Golden Goodbyes for Executive Exits: A Review and Agenda for Severance Pay

“…Chen et al (2015), who found that this effect is particularly pronounced for severance agreements of greater value or duration, affirm this conclusion. Studies have also identified other relevant contextual factors that can amplify the positive relationship between severance agreements and risk-taking, such as executives having a high-variable pay structure (Ling, 2012) or more promising career prospects outside of the firm (Akamah, Brockbank, & Shu, 2022).…”