Are CEOs a Victim of Corporate Bankruptcy?
It is not always easy to sympathise with CEOs, particularly when it comes to compensation, however a US study sought to shed light on the personal financial impact of corporate bankruptcy on CEOs and how it affects their career earnings. The study examined CEOs of US companies that filed for bankruptcy and found that for CEOs who left the executive labor market following their tenure with a bankrupt company, there was a significant financial loss incurred over the remainder of their career. For those maintaining executive employment, no adverse personal financial effects were found.
Key Topics: CEO compensation; Bankruptcy costs; Executive turnover
Title of Reviewed Article: How costly is corporate bankruptcy for the CEO?
Researchers: B. Espen Eckbo (Dartmouth College), Karin S. Thorburn (Norwegian School of Economics), and Wei Wang (Queens University).
Publication: Journal of Financial Economics, 2016, Vol. 121 No. 1, pp. 210-229.
Setting the Scene
When a company files for bankruptcy there is the potential for it to have significant personal financial costs for the company’s CEO. Such costs can range from a reduction in the value of their equity holdings to being forced into a career change. Such potential costs are of importance to various stakeholders, as they may affect the behaviour of CEOs who might look to hedge against their own potential losses at the expense of shareholders (e.g. Strebulaev & Yang, 2013). This idea of personal CEO loss from corporate bankruptcy is also a concept used in the design labour contracts, with various contract provisions often made in relation to bankruptcy (e.g. Chemmanur, Cheng, & Zhang, 2013).
In this study, the researchers examine the effect of corporate bankruptcy on CEO’s career and compensation.
How the research was conducted
This study took a sample of 322 bankrupt publicly traded US companies, with 497 Chapter 11 filings, between 1996 and 2007. Data for 642 unique CEOs was examined. Data was collected on companies and CEOs primarily from the Bankruptcy Research Database at the University of California at Los Angeles (UCLA), as well as from various other sources such as ExecuComp and Securities and Exchange Commission (SEC) filings. Companies in the sample were relatively large, having average sales of $2.5bl in the year prior to filing for bankruptcy. Companies were from a wide variety of industries.
The researchers tracked CEO employment through bankruptcy, starting three years prior to bankruptcy being confirmed, and where a CEO who leaves their position, up to three years following bankruptcy. They estimated the determinants of CEO turnover, in addition to determinants of continued executive employment. The researchers then estimate the determinants of the CEO compensation changes. The present value (PV) of compensation changes was estimated, based on old versus new compensation, up to age 65 in order to determine the effect of bankruptcy on CEOs. For the purpose of this study, CEO compensation was defined as the total value of salary, bonus, long-term incentive plans, and any other compensation awarded.
The analysis took into account various CEO characteristics, such as age, if they were the company founder, their company equity holding, and whether the CEO was also the chairman of the board. Company characteristics were also considered, such as the industry, value of sales, the company’s cash position, as well as various profitability measures.
Key Research Findings
18% of all CEO departures were found to be forced, due to performance related issues or pressure from shareholders, creditors, or the board.
The probability of voluntary departure was found to increase with age and decrease when the CEO was also the Chairman and had greater share ownership.
From a company characteristics perspective, poor industry-adjusted Return On Assets increased the probability of voluntary departure, with CEOs more likely to leave when there was relatively weak operating performance. While the larger the company’s size, the greater the probability of a forced departure.
Of the CEOs reviewed, approximately one-third remained in executive employment following filing bankruptcy, while the other two-thirds left the executive labor market. Of those leaving the executive labor market, 37% became nonexecutive directors, consultants or self-employed, while 42% were classified as not having new employment, some of which retired.
For those remaining in the executive labor market, there was no significant personal financial loss found, and thus their executive labor market capital was not adversely affected by bankruptcy filing. However, for those leaving the executive labor market a significant financial loss was found, with a median present value estimated loss of $7m until age 65.
The results highlight the importance of CEOs remaining in the executive labor market in whether there is significant personal loss to the CEO or not as a result of corporate bankruptcy. For those remaining in the executive labor market, compensation is largely unaffected, however, for those leaving it the personal cost is significant.
Unsurprisingly, the circumstances of the CEO departure also appears to play a part in whether they remain in the executive labor market, with those being forced out less likely than those leaving voluntarily to remain in the executive labor market. The finding that voluntary turnover decreases with the CEO share ownership, chairmanship, and the company’s performance suggests that relatively powerful CEOs are less likely to leave voluntarily, possibly because they may feel they have more to loss by doing so.
Organizational and Reward Implications
The results of this research should make interesting reading for CEOs and other stakeholders in company bankruptcy. While the majority of CEOs left voluntarily under the bankruptcy conditions examined, a substantial proportion did not find further work in the executive labor market. Assuming that many of these will have sought further executive positions, it indicates the difficulty in finding further executive positions following a corporate bankruptcy, given the limited availability of executive positions and also the possible reputational damage associated by corporate bankruptcy.
From an organisational perspective, companies should be mindful that increasing the power of CEOs through such factors as increased equity holdings and chairmanships, is likely to make them more committed to the company, which in most situations may be preferable but in bankruptcy situations, which they may have had a pivotal role in creating, it will reduce the likelihood that they will leave their post voluntarily.
Few studies have examined the personal financial impact of corporate bankruptcy on CEOs, and this study provides valuable insight into the implications both during and after a bankruptcy for CEOs. Further similar research should help to establish the breath of factors related to determining the personal financial outcomes for CEOs under corporate bankruptcy situations.
Source Article: Eckbo, B. E., Thorburn, K. S., & Wang, W. (2016). How costly is corporate bankruptcy for the CEO? Journal of Financial Economics, 121(1), 210-229.
Published by: Elsevier B.V.
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Chemmanur, T. J., Cheng, Y., & Zhang, T. (2013). Human capital, capital structure, and employee pay. Journal of Financial Economics 110(2), 478–502.
Strebulaev, I. A., & Yang, B. (2013). The mystery of zero-leverage firms. Journal of Financial Economics 109(1), 1–23.
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