This paper explores how motivating an incumbent CEO to undertake actions that improve the effectiveness of his management interacts with the firm's policy on CEO replacement. Such policy depends on the presence and the size of severance pay in the CEO's compensation package and on the CEO's influence on the board of directors regarding his own replacement (i.e., entrenchment). We explain when and why the combination of some degree of entrenchment and a sizeable severance package is desirable. The analysis offers predictions about the correlation between entrenchment, severance pay, and incentive compensation.

We examine optimal capital requirements in a quantitative general equilibrium model with banks exposed to nondiversifiable borrower default risk. Contrary to standard models of bank default risk, our framework captures the limited upside, but significant downside risk of loan portfolio returns. This helps to reproduce the frequency and severity of twin defaults : simultaneously high firm and bank defaults. Hence, the optimal bank capital requirement, which trades off a lower frequency of twin defaults against restricting credit provision, is higher than under default risk models which underestimate the impact of borrower default on bank solvency.