CEO employment contracts, managerial myopia and corporate acquisition decisions

This thesis empirically studies the determinants of CEO employment contracts and the impacts of such agreements on managerial investment decisions. As of 2005, approximately half of S&P 500 CEOs had employment contracts. A typical contract protects the CEO by decreasing the probability he will be replaced due to poor performance. In this study, I examine whether the presence of a contract ex ante impacts CEO investment decisions. Two competing hypotheses are developed. The incentive effect hypothesis predicts that employment contracts may alleviate managerial concern regarding short-term profits and encourage CEOs to make investments that maximize shareholder value in the long run. Alternatively, the entrenchment effect hypothesis states that contracts may entrench poor-performing CEOs by insulating them from the discipline of the corporate control market and internal governance mechanisms, thereby leading CEOs to pursue private benefits at shareholder expense. An examination of the impact of CEO contracts on acquisition decisions provides support for the incentive effect hypothesis. Specifically, acquirers with CEO contracts pay lower premiums for their targets and experience higher long-run post-acquisition abnormal returns than acquirers without such contracts. Moreover, CEOs with contracts tend to engage in riskier deals. Further, the investigation of the determinants of the use of CEO contracts demonstrates that the probability of a CEO contract is positively related to the magnitude of managerial myopia and the expected costs to shareholders of managerial myopia, consistent with the incentive effect hypothesis. These findings are robust to a variety of model specifications, different event windows and control variables, industry effect and Heckman (1979) self-selection adjustment. This study stands in contrast to the emerging literature claiming that CEO employment contracts represent rent extraction by powerful managers at shareholder expense.