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Force-Fields, Risk-Taking, and Termination Pay: Severance's Barrier to Internal Governance

CEO Compensation used to induce risk-taking is a complicated issue which requires the interpretation of numerous endogenous factors including severance pay, change-in-control pay, and vega and delta of the CEO’s portfolio. New and exciting hypotheses in the literature indicate that prior interpretation of the risk-inducing effects of severance may no longer be the norm. This paper investigates the new hypotheses and forwards a new hypothesis: that risk-reduction by CEOs is a result of rational reduction of cash-levels leading to reduced likelihood of termination and allowing the CEO to make investments which may be self-serving and increasing in overall firm risk — optimizing their personal compensation. Such manipulation of cash-levels in order to reduce governance efficacy of the Board of Directors is proposed as the ‘force-field’ hypothesis. I find evidence to suggest that severance induces CEOs to implement the ‘force-field’ hypothesis and allows them to optimize their compensation in a way that may ultimately be value-destructive to shareholders due to increased agency costs and poor investment decisions.