To isolate the effects of contracts on investment, the author ran several models that controlled for a variety of factors, including CEO age and career path and such industry variables as the quality of corporate governance, volatility of sales, firm survival rates, investment opportunity, company size, and risk measures. The author performed several regression analyses across different contract lengths, looking for correlations with capital expenditure and R&D spending.
The author found that investments decreased over the course of a fixed-term contract; CEOs spent 20 percent more on capital projects, for example, in the first year of a five-year deal than in the last year. The horizon effect in the last two years of the contract is stark in the other direction: Investment is lower by 8 percent in the penultimate year compared with the year before that and falls another 9 percent in the final year.
At-will CEOs also showed a decline in investment activity over time; overall, however, the analysis showed they invested much less than their peers, implying that to some degree they always feel like short-timers. By contrast, CEOs with a longer expected horizon invested more than their peers, a finding that held true when the comparison was made both with at-will CEOs and with CEOs whose fixed-term contracts were almost up. The author ran several models to gauge the impact of these investment approaches on profitability. Although the models revealed no earnings improvement under the stewardship of CEOs in the waning days of a fixed-term contract, they showed that profitability for CEOs with at-will deals was lower as their time neared an end, which was presumably a reflection of the increasing tenuousness of their employment situation.
If boards want to keep their investment programs on track as periods of possible transition approach, they should carefully consider how they structure their CEO’s contract, the author concludes.
The type and duration of CEO contracts have a big effect on decisions involving investments in research and development and capital projects. Overall, CEOs with long fixed-term contracts invest the most, and mostly at the beginning of their tenures. To keep investment programs on a more stable basis, boards should consider renegotiating contracts before they enter their final phase.