Research Brief: For CEOs, Chapter 11 is Rarely a Horror Story

What Did The Study Look At?

Corporate bankruptcies generally do not carry the stigma of years past yet few CEOs want to have a Chapter 11 on their CV. Beyond a bruised ego, substantial salaries and stock options are often at stake, and these considerations may affect a CEO’s decisions when his or her firm is in distress. This research tallies up how much of a personal financial hit top executives experience when their corporations file for bankruptcy. It also examines whether or not the potential for personal losses affects a CEO’s decision to leave the firm, as well as the role creditor control rights play in CEO departure. 

How Was The Study Designed?

Researchers tracked employment and compensation changes for CEOs of 322 public firms filing for Chapter 11 bankruptcy in the U.S. They solved the challenge of tracking post-bankruptcy CEO employment by using Securities and Exchange Commission filings, news articles, executive directories, and social networks.

What Did The Study Find?

• Nearly two-thirds of incumbent CEOs (defined as CEOs in place or internally promoted within three years prior to the Chapter 11 filing) continue in some form of employment, and one-third continue as full-time executives. Of the incumbent CEOs maintaining full-time executive positions, half remain with the restructured firm emerging from bankruptcy, while the other half land at other public or private companies. 
• For these CEOs, total compensation (salary, bonus, equity-based pay, and severance) stays roughly the same. “It appears that these executives’ labour market reputations are not tainted by the bankruptcy filing.” 
• Those who do not find new executive employment experience a median compensation loss until retirement of about $4 million, or roughly five times their pre-bankruptcy compensation level.
• A typical CEO, whether or not he maintains full-time executive employment, suffers a loss of about $2 million in stock and option holdings in the bankrupt firm (measured from the last fiscal year prior to bankruptcy through the bankruptcy filing).
• CEOs with long tenure at the firm suffer greater income losses. “One possible interpretation is that longer tenure cause the CEO’s managerial skill set to be specialized to the business of the bankrupt firm,” the researchers note, “and thus difficult to transfer to a new employer – and so the wage loss from having to leave the firm is greater.”
• Greater creditor control rights are associated with a higher likelihood of both forced departure and failure to maintain full-time executive employment. 

What Do I Need To Know? 

The average CEO tends to suffer smaller personal losses during bankruptcy than generally thought. This might reassure those in corporate finance; some are concerned that high expected personal costs can cause CEOs to hedge against default by reducing corporate leverage and perhaps under-invest in risky corporate projects.

The fact that one-third of incumbent CEOs continue in full-time executive positions, either at the restructured company or at other private or public companies, suggests they were judged to have handled the crisis competently, perhaps becoming even more valuable as a result. “Indeed, our evidence shows that replacement CEOs who maintain full-time executive positions — several of whom are turnaround specialists —fare even better with a slight increase in compensation after bankruptcy,’ the researchers note. 

Finally, it appears that creditors do keep CEOs honest. As this study shows, creditors play an active role in CEO turnover, particularly in organizations with greater creditor control rights.

Title: How costly is corporate bankruptcy for top executives? 

Authors: B. Espen Eckbo (Tuck School of Business); Karin S. Thorburn (Norwegian School of Economics); Wei Wang (Queen's School of Business) 

Published: Working paper available for download from the Social Science Research Network 

— Alan Morantz