CEO Severance Pay and Corporate Tax Planning

Abstract

We examine the association between CEO severance pay (i.e., payment a CEO would receive if s/he is involuntarily terminated) and corporate tax planning activities. We find that CEO severance pay is positively associated with corporate tax planning, consistent with CEO severance pay providing contractual protection against managers' career concerns and thereby inducing otherwise risk-averse managers to engage in incremental levels of tax planning. This result holds under an instrumental variable approach and propensity score matching, and survives alternative measures of CEO severance pay and corporate tax planning. Finally, we find that severance pay provides stronger tax planning incentives in situations where managers are expected to face greater career concerns—when they are less experienced, when they face stronger shareholder monitoring, and when they manage firms with higher idiosyncratic volatility. Overall, our results suggest that CEO severance pay represents a form of efficient contracting with otherwise risk-averse managers.