The Contract Year Phenomenon in the Corner Office: An Analysis of Firm Behavior During CEO Contract Renewals

This paper investigates how executive employment contracts influence corporate financial policies during the final year of the contract term. We find that the impending expiration of fixed-term employment contracts creates incentives for CEOs to engage in strategic window-dressing activities, including managing earnings aggressively and withholding negative firm news. At the same time, acquisitions announced during the contract renegotiation year yield higher abnormal returns than during other periods, suggesting that the upcoming contract renewal can also have disciplinary effects on potential valuedestroying behaviors of CEOs. CEOs who engage in manipulation during contract renewal obtain better employment terms in their new contracts. * We thank Heitor Almeida, Lauren Cohen, Claudia Custodio, Ben Esty, Jay Hartzell, Dirk Jenter, Timothy Johnson, Amit Seru, Devin Shanthikumar, Andrei Shleifer, and seminar participants at Pennsylvania State University (Smeal), University of California, Irvine (Merage), University of Cincinnati (Lindner), University of Geneva (GFRI), University of Illinois at Urbana-Champaign (College of Business), University of Lausanne (HEC), University of Notre Dame (Mendoza), University of Washington (Foster), University of Zurich (IBF), the American Finance Association Annual Meeting, the Minnesota Corporate Finance Conference, the Red Rock Finance Conference, and the Eighth Annual Academic Conference on Corporate Governance for helpful discussions and comments.