Inflating Golden Parachutes

Plus, SEC decries special charges; and more.

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Pulling the ripcord on golden parachutes can be an expensive decision for some executives whose weighty contracts trigger hefty excise taxes. But a recent survey by New York­ based human-resources consultancy William M. Mercer Inc. finds that, as competition for top talent intensifies, more companies are offering to cover this tax liability should an executive be ousted in a corporate takeover.

A golden parachute’s postmerger severance package is often huge. It’s no surprise, then, that the Internal Revenue Service wants a piece of the windfall. During the 1980s mergers-and-acquisitions craze, the IRS imposed a 20 percent excise tax on what it considers “excess parachute payments”–or more than three times an executive’s average annual compensation five years prior to the takeover.

As a result, many companies now offer “gross- ups,” added payments that cover excise taxes levied on an executive whose golden parachute opens in the wake of a merger or change in control. Although gross-ups are not tax deductible at the corporate level, many companies believe they are needed to attract– and retain–valuable executives.

By including gross-ups in golden parachutes, companies give executives the fi-nancial comfort that allows them to better concentrate on the business aspects of a mer-ger or acquisition, according to Mercer principal How- ard Golden. With gross-ups, executives know they’ve negotiated a severance package that will make them “whole,” he says.

Gross-ups were added to executive compensation packages two years ago at KeyCorp, a $76 billion bank holding company based in Cleveland. According to spokesman William Murschel, the benefit is extended to senior officers and other high-ranking executives. “Tax gross-up policies are becoming prevalent to protect the accumulated benefits of senior executives who have acquired substantial pension and vested stock options and may be nearing retirement age,” Murschel explains.

To be sure, Mercer’s study of 350 large publicly traded companies found that 64 percent of those with golden parachutes now offer gross-up payments, up from 46 percent in 1994. Among the group: Ingersoll-Rand, Hershey Foods, Avery-Dennison, and General Signal. And Golden expects this benefit trend to continue. “Without the benefit,” he asserts, “top-level recruitment and retention strategies would be jeopardized.”

———————————————– ——————————— Introducing the Super Drip
A new wrinkle in dividend reinvestment programs (DRIPs) is gaining popularity with companies looking for a nontraditional way to raise capital. Called Super DRIPs by some, the plans offer companies a method for raising money by bypassing investment bankers and going to shareholders directly.

Super DRIPs address one of the major drawbacks of standard DRIPs, which were originally intended to allow investors to directly reinvest their dividends in more shares. Regular DRIPs lock companies into selling a set number of shares at prescribed intervals– even if the terms are not favorable to the company. With Super DRIPs, “the issuer is always in complete control of how much new equity capital it issues on a monthly or quarterly basis,” says Richard K. Ainsberg, managing director of Bear, Stearns & Co., one of the firms that designs Super DRIPs.

Super DRIPs can also incorporate price supports to avoid issuing shares through the DRIP on the cheap. “We can decide on a monthly basis to turn the spigot on or off,” says Cindy McHugh, senior vice president of investor relations at Equity Residential Properties Trust, a Chicago-based real estate investment trust that recently adopted a Super DRIP. She also likes the idea of raising capital without a road show. “The response is strong, without too much hoopla,” she says.

Thus far, such companies as Entergy Corp., Countrywide Credit Industries, and Michaels Stores have adopted the Super DRIP. And according to Marc Feuer, senior managing director at Bear, Stearns, more could soon join the parade. “The only reason more companies aren’t using this method is that the traditional [investment] bankers don’t tell them about it,” he claims. “They don’t want to lose the business.” — Joseph McCafferty

———————————————– ——————————— The SEC Decries Special Charges
Excite Inc. recently paid $96 million to Netscape in a two-year Internet-access deal, but then wrote off two-thirds of the new “asset” in the same quarter in an effort to reduce the deal’s drag on earnings. Excite is not alone in attempting such tactics. In fact, companies as diverse as Cendant Corp. (see CFO, October 1998) and AOL are making earnings restatements as common as foreign currency devaluations.

As a result of such practices, it’s become harder and harder to view a company’s earnings through the murk of “special charges.”

But not for long, if Securities and Exchange Commission chairman Arthur Levitt has his way. This fall, Levitt called on both the SEC staff and private groups to stem the abuse of these techniques and shore up the quality of reported earnings through broad-reaching new initiatives.

“In the zeal to satisfy consensus earnings estimates and project a smooth earnings path, wishful thinking may be winning the day over faithful representation,” said Levitt in his opening address for the New York University Center for Law and Business on September 28. “As a result, I fear that we are witnessing an erosion in the quality of earnings, and therefore the quality of financial reporting.” Prominent accountants, analysts, observers– and perhaps even corporate executives–applauded Levitt for the broad effort, which many saw as an unprecedented challenge to the financial community by an SEC chairman.

“There is a symbiotic addiction in predicting and meeting quarterly earnings that’s developed between corporate management teams and their analysts,” says Robert Herz, a partner with PricewaterhouseCoopers LLC and chairman of the American Institute of Certified Public Accountants’s SEC regulations committee. “[The chairman’s] initiative will address issues that the SEC staff believes cut at the basic operation of our capital markets.”

One practice the new rules will address is “big-bath” restructuring charges, which became commonplace in the 1980s. In big-bath accounting, estimates of future restructuring expenses are taken in one charge and stowed as reserves.

The SEC’s other initiatives also ad-dress creative ac-quisition accounting, with its large write-offs of acquired research and development; “cookie jar” re-serves, in which previous charge-offs are revised to boost earnings; misapplications of “materiality” standards; and premature revenue recognition. The SEC is currently crafting proposed staff accounting bulletins due for release by the end of the year.

The New York Stock Exchange and the National Association of Securities Dealers also will organize a panel to examine and im-prove audit- committee performance. John Whitehead, a former deputy Secretary of State and retired senior partner of Goldman, Sachs & Co., and Ira Millstein, an attorney and noted corporate- governance expert, will co-chair the panel. The initiative also taps the AICPA to review various auditing standards and practices introduced over the past several years.

In addition, Levitt directed the Financial Accounting Standards Board to reprioritize projects to address critical issues– such as the ex-pected revision to business combination accounting and liability accounting–sooner than anticipated. FASB chairman Edmund Jenkins, who has been an outspoken defender of the board’s independence, responded coolly, noting, “I am encouraged that Chairman Levitt is looking for a private-sector solution to this problem rather than injecting government into the process.”

He did not indicate, however, if FASB would alter its agenda immediately.

Finally, Levitt admonished the entire corporate-finance community before wrapping up his address, saying, “For corporate managers, remember: The integrity of the numbers in the financial reporting system is directly related to the long-term interests of a corporation. While the temptations are great and the pressures strong, illusion in the numbers are only that– ephemeral and, ultimately, self- destructive. To Wall Street I say, ‘Look beyond the latest quarter. Punish those who rely on deception, rather than the practice of openness and transparency.'”– Ian Springsteel

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