Bankruptcy and CEO compensation

What is the impact of corporate bankruptcy on a CEO’s personal career and wealth? Are they personally tainted by the bankruptcy event? These and related issues are the subject of a new research paper, How Costly is Corporate Bankruptcy for the CEO? by Tuck School of Business professors B. Espen Eckbo and Karin S. Thorburn, and Wei Wang from the Smith School of Business at Queen’s University in Canada.

The study examines three main issues: What happens to CEOs’ careers when their firms file for bankruptcy? Do top executives experience large personal income losses? Do founder status and creditor control rights influence the probability of CEO departure and the income loss? The findings are based on data collected from 322 large public companies that filed for bankruptcy between 1996 and 2007.

The authors find that one-third of the incumbent CEOs (defined as CEOs in place three years prior to the bankruptcy filing) are able to maintain full-time executive employment, either at a new company or at the restructured company emerging from the bankruptcy. For the CEOs maintaining full-time executive employment, the median change in total compensation (that includes salary, bonus, equity-based pay, and severance pay) is statistically indistinguishable from zero. It appears that the market reputation of these CEOs is not tainted by the bankruptcy filing.

For the remaining two-thirds of CEOs who assume non-executive directorships on corporate boards, become consultants, or simply retire, bankruptcy filing is costly. They experience a median compensation loss of about $7 million. While some retirements are voluntary, and the study does not include data on personal wealth management in retirement, these results suggest that CEOs who leave the executive labour market incur a substantial personal cost of bankruptcy.

In addition, incumbent CEOs who remain with the firm until the year of bankruptcy filing typically suffer a substantial loss of equity holdings in the bankrupt firm. The loss is about $2 million in stock and option holdings when measured from the last fiscal year prior to bankruptcy through filing, and about $11 million when measured from three years prior to filing.

Summing up, the study says that evidence shows that one out of three CEOs maintains executive employment through bankruptcy and tends to suffer smaller personal losses than is traditionally believed. While executives with large ownership stakes and those heading profitable firms are more likely to continue at the top of the company, it adds.