UA Professor Finds CEOs Rewarded For Layoffs (Jeff Hankins Commentary)

A University of Arkansas finance professor has released results of a study that shows how chief executive officers are rewarded for layoff decisions.
Craig Rennie, an assistant professor of finance in the Sam M. Walton College of Business, studied 229 firms that laid off employees at least once between 1993 and 1999. What he found was the governing boards of those companies rewarded their CEOs for making the tough decision to let employees go.
For the year after a layoff occurred, CEOs of those firms received 22.8 percent more in total pay (cash plus bonus and stock-based compensation that includes restricted stock grants, stock option grants and long-term incentive pay) than did the CEOs of firms that did not have layoffs.
“We focused on layoffs because they are common operating decisions that affect shareholder wealth and thus CEO pay,” said Rennie. “Based on a comparison of CEO cash and stock-based pay for several years following layoffs, we believe CEOs receive pay increases as rewards for past decisions and motivation for value-enhancing decisions in the future.”
The findings, which will be published in The Financial Review, are an interesting look at how boards of directors try to achieve the dual objectives of rewarding managers for past performance and motivating them to deliver value-enhancing decisions in the future.
Rennie, working with Jeffrey Brookman and Saeyoung Chang, business professors at the University of Nevada at Las Vegas, confirmed that stock-based compensation aligns managerial and shareholder interests. In other words, the governing boards structure CEO compensation to ensure that managers’ goals for performance are the same as shareholders’.
Cash compensation dipped an average 6.5 percent for CEOs of layoff firms the year before the layoffs occurred. But CEOs of layoff firms received 19.6 percent more stock-based compensation than CEOs of non-layoff firms the year of the layoffs. One year after the layoffs, CEOs of firms that laid off employees received 42.6 percent more stock-based compensation than CEOs of non-layoff firms. That percentage rose to only 44.9 two years after the layoffs. But beyond that two-year period, it jumped to 77.4 percent.
What does it all mean?
“Our results were consistent with the view that layoffs create shareholder value,” Rennie said. “Layoffs are followed by an increase in operating income and a decrease in expenses.” Not surprisingly, investors like increases in income and decreases in expenses, the study found, generating abnormal stock returns immediately after the announcements.
While it’s good to know there may be some reward for making the hard decision to let workers go, we hope it doesn’t encourage CEOs to go out and lay off folks. Such decisions can be costly in other ways.

(Jeff Hankins is the publisher of Arkansas Business in Little Rock.
He can be reached via e-mail at [email protected]. For more comment and feedback, visit his blog at www.arkansasbusiness.com/jeff.)