“Marissa Mayer will make over $44 million if Verizon fires her”- quoted the Business Insider few months back. CEO Marissa Mayer became the subject of widespread speculation for reasons other than her performance at Yahoo! Ever since Verizon agreed to buy the internet giant, industry has been abuzz with the exorbitant Golden Parachute that Marissa would be flying with in case the former decides to terminate her.

source: Yahoo Schedule 14A

The latest being the buzz around Exxon Mobil’s Rex Tillerson, who is likely to receive a Golden Parachute of $180 million from the company in the event of his confirmation as President elect, Donald Trump’s Secretary Of State.

Merger is a major event in the corporate landscape and brings about great deal of changes in all the companies involved. While some changes are foreseen, others remain ambiguous. However, what is intriguing is the fact that the change flows across each level in the corporate structure and the helm is no exception. Many a times, high-ranking managers and executives lose their job in the process of merger. But what is interesting enough to note is the fact that it’s not an absolute loss for them. Usually, companies undergoing merger compensate the top level executives with astronomical amounts and this is known as Golden Parachute.

• What is Golden Parachute?
• History of Golden Parachute
• Golden Parachute vs Golden Handshake vs Golden Handcuff
• Benefits of Golden Parachutes
• Top 10 Golden Parachutes
• Golden Parachute – Criticisms & Controversies
• Regulations For Golden Parachutes
• Tax perspective – Golden Parachute
• Conclusion

What is Golden Parachute?

Technically, Golden Parachute is defined as a contract between the Company and its top level management which entails that the executives will be offered considerable benefits in case the latter is terminated as a result of the restructuring activity. These benefits usually include cash bonus, stock options, retirement package, medical benefits, and of course a handsome severance pay. It is also used as a tool for Anti-takeover mechanism or Poison pill to dissuade any potential merger. The quantum of benefits or compensation promised to the crème-de-la-crème of the company might lead many acquirers to change their takeover decision.

History of Golden Parachute

The history of Golden Parachute dates back to 1961, when Charles C. Tillinghast Jr.of Trans World Airlines became its first recipient. It is said that amidst the tug of war to push off Howard Hughes, Tillinghast Jr was offered a generous Golden Parachute in case Hughes gained control of the company and fired Tillinghast. However, the tide of events was different and Charles C. Tillinghast Jr. continued in the company for fifteen more year. Amusingly, he also never collected the parachute.

The name “Golden Parachute” is used to denote the soft and safe landing of the terminated executive with monetary benefits way above the usual severance packages.

While this was an isolated incident in the 60s, it soon became a preferred way of compensating white-collar employees, particularly in the late 70s. Hostile takeovers became the order of the day in the 1980s and the US corporate landscape saw a surge in the Golden Parachutes. As per Harvard Business Review, by 1986 around 35% of the largest 250 US corporations had implemented a clause stating that their executives will be provided with cash payments along with a range of other benefits in case there is change of hands.

Source: Harvard Business Review

The graph shows that there was a significant rise in the Golden Parachute contracts in the decade between 1980 and 1990. The cumulative number of contracts jacked up from 75 to 300. Earlier only small companies fell prey to hostile takeovers. However, with the popularity of junk bond market, financing became comparatively easier and even large multinationals and Fortune 500 companies became easy targets of hostile takeovers. During this period, several companies included the clause of Golden parachute in their employment contracts in an attempt to retain highly qualified employees. This was considered a major element of security by high-level executives before they took up jobs in merger-prone industries. Needless to say it was a defensive mechanism also for hostile takeovers as it increased the cost of takeovers considerably.

Source:Mondaq.com

Advisory firm, Institutional Shareholder Service (ISS) has revealed a trend that the quantum of golden parachute as a percentage of the target’s equity value increases as deal size become smaller.  The graph shows the size of reported golden parachute payments as a percentage of the target’s equity value for the 25 largest deals announced between May 2013 and April 2014 and also includes the 65 companies that enhanced compensation for executives.

Golden Parachute vs Golden Handshake vs Golden Handcuff

Many a times, there are few terms being interchangeably used with Golden Parachute. One of them is Golden Handshake. Golden Handshake is nothing but an upgraded form of Golden Parachute. The severance package in Golden handshake is a bit more generous than the latter. Another minor variation is that Golden Handshakes are offered to high-ranking executives who are terminated through dismissal, corporate restructuring, or even during their scheduled retirement. The severance package for Golden Handshake includes cash, equity and certain stock options. There can be other elements included in it as well, which solely depends on the discretion of the company.

Another term used in the similar sense is Golden Handcuffs. While Golden Parachutes and Golden Handshakes may make the high-level CEOs more inclined towards exit to receive the hefty package waiting for them, Golden Handcuffs act in the opposite way. They act as a disincentive for executives for leaving the company and joining the competitors. It is said that under the clause for Golden Handcuffs, executives have to give back the bonuses and rewards received if they leave before a stipulated period.

Benefits of Golden Parachutes

There are two perspectives of evaluating the nuances of Golden Parachute. One is from a company’s perspective and the other is from a shareholders’ perspective.

• First of all, no company can function if there is a conflict of interest at the key management level. While certain takeovers are hostile, some of them can even be beneficial for the company’s future and growth. If the key personnel become insecure about their job, they may try to cause hindrances in the merger or takeover process. On the other hand, with Golden Parachute, employees can be secured about their compensation and offer complete co-operation the merger procedures.
• Once the terms of Severance package is laid out, the exit of white collar executives becomes more cordial. Things go in accordance with a pre-determined agreement and there is no bad blood. This also protects a company from being maligned by its key personnel in the event of termination due to merger.
• The possibilities of hostile takeovers are reduced with the clause of Golden Parachutes being included in the contract. The acquiring company might not find it appealing to shed such an expensive package if it plans to ouster the key employees already in control.

Top 10 Golden Parachutes

Source: Bloomberg

Golden Parachute – Criticisms & Controversies

Something seemingly so attractive cannot be sans controversies and criticisms, isn’t it? Golden Parachutes have been the favourite punching bag for many critics. The groups particularly miffed with it are the shareholders and other employees of the company. Few reasons why Golden Parachutes are usually opposed to are:

• The quantum of the package is mammoth, which leads other employees entitled to receive a generic severance package to feel as deprived, neglected and less-privileged. This kind of dissatisfaction amongst existing employees form a hindrance to smooth functioning of a company.
• Many a times, the top-level executives underperform or do something unethical, due to which they may end up losing their jobs. Many companies offering the Golden Parachute are silent on these aspects, and the clause ends up being an incentive to erring managers who are terminated. Needless to say, shareholders and employees will not feel good about it. Eg: Tony Hayward, the Chief Executive officer for British Petroleum, was terminated due to the perceived lack of leadership during the infamous oil spill that tarnished his tenure. However, he is reported to have walked away with severance package of more than a million dollars and an eight-digit pension amount.
• Critics feel that it is the responsibility of the management to act in the best interest of the company. If a white-collar executive loses his job because of a friendly merger, there is no need for the company to compensate them in addition to their already fat package.
• Another logic against the Golden Parachute is that if the acquirer has deep pockets, the compensation cost may be a trivial amount for him. Hence, the idea of using Golden Parachute as anti-takeover mechanism is rendered futile.

Shareholders in particular are not too fond of Golden Parachutes because many of them are of the opinion that it is unnecessary wastage of shareholder’s money. They feel many CEOs who are promised hefty severance package will only be enamoured by it and not work for the long-term goals of the company. Whether or not their fears are genuine is difficult to be concluded, though.

 In a research paper titled-“Golden Parachutes and the Wealth of Shareholders” by Lucian A. Bebchuk, Alma Cohen and Charles C. Y. Wang, it is stated that over the long-term, golden parachutes maybe harmful for shareholder value. Those companies which implement the golden parachute clause obtain lower risk-adjusted stock returns as compared to their counterparts, in spite of the fact that the latter are more likely to be acquired. The researchers explained that Golden parachutes make acquisition like a cake-walk for CEOs and they aren’t afraid of being acquired. Therefore, they are not motivated enough for enhancing shareholder value.

Regulations For Golden Parachutes

The ongoing oppositions have gained considerable momentum over the couple of years. So much so that, the Congress has released tax rules in a move to discourage rampant golden parachutes involving “too generous” severance packages. Additionally, in 2010, section 951 of the Dodd-Frank Wall Street Reform and Consumer Act has also made it compulsory to obtain votes of advisory shareholder on all instances of golden parachutes, henceforth.

In 2011, the SEC unveiled new clause on the Say on Pay vote and Golden Parachute. The Say-on-Pay vote requests investors to vote on the compensation of the top executives of the company – the CEO, the Chief Financial Officer (CFO), and at least 3 other most highly compensated executives.

About the Golden Parachute, the SEC mandated that –“Companies are required to comply with the golden parachute shareholder advisory vote and disclosure requirements in proxy statements to approve a merger or acquisition and similar forms initially filed on or after April 25, 2011.”

According to a consultancy, Pearl Meyer, the data between 2011 and 2014 reveals that merely around 5% of Golden Parachute votes garnered less than majority support. Even though in most of the cases, shareholders were not opposed to the actual merger. Concerned shareholders are now taking a stand against the Golden Parachutes they do not deem appropriate.

Tax perspective – Golden Parachute

The internal revenue code has three components pertaining to the golden parachutes. As per Section 4999 of the IRS, a 20% excise tax is imposed, additional to the normal income tax, on “excess parachute payments,” while section 280G deems the payments under Golden Parachute non-deductible to the company. These provisions are passed by the Congress as a part of the Deficit Reduction Act of 1984. Lastly, section 162(a) of the internal revenue code denies tax deductibility of any compensation over and above $1 million unless the same is linked to the performance of the executive. This way the under-performing high-ranking executives when compensated with a hefty package, will come under the purview of this section.

Conclusion

Golden parachutes is indeed an intriguing concept and opinions continue to be divided on it. However, it has emerged as one of the most indispensable part of CEO compensation package.  While the clause seems important to lure and retain immensely talented executives in the company, underlying ambiguity causes many to take undue advantage of the situation. Even though many provisions have been adopted to curb the blatant misuse of the Golden Parachute, unfortunately, they have not been realised to their full potential. Golden Parachute is quite ubiquitous and corporations have been using various strategies to circumvent the provisions under section 4999 and section 280G of the Internal Revenue Code.

The clause must mention in particular that the package is intended only in the event of hostile takeover. Noticing the blatant misuse, many companies have tweaked the conditions pertaining to the Golden Parachutes. While many have reduced the size of the package, many have included ethics clause to exclude any errant CEOs from drawing the Golden Parachutes.

The post Golden Parachute | Definition| Examples | Payments | Tax appeared first on Free Investment Banking Tutorials | WallStreetMojo.