A favorite tool to prevent hostile takeovers during the merger-mad 1980s is making a comeback–golden parachutes.
However, this time around they are being used to retain top executive talent in a tight labor market.
“More and more [executives] are expecting them,” Paula H. Todd, a principal with Towers Perrin in Stamford, Connecticut, says of the alluring severance agreements.
During the late ’80s, companies bent on protecting themselves from a takeover could install abundant golden parachutes as “poison pills” to make the cost of acquiring the companies prohibitive.
Now, they’re put in to attract people “who won’t take jobs because there’s inadequate change-of-control protection,” the consultant says.
Todd adds that the increasingly used pro-employee features in golden parachutes include payments to account for taxes charged to highly compensated departing executives and favorable coverage triggers.
Take the tax benefits, called “gross-ups.” A number of companies offering parachutes are agreeing to include payments to cover the 20 percent excise tax on what the Internal Revenue Service deems to be excess payments: More than three times an executive’s average five- year earnings, according to a Towers Perrin report on golden parachutes.
In fact, the institution of this tax reined in the widespread use of golden parachutes during the late-1980s merger boom.
In terms of favorable coverage triggers, the “walkaway” agreement, in particular, reflects the discretionary tempering of the current job market.
Normally, golden parachutes are triggered by two events. One is a change of control of the company via a merger, acquisition, or even– depending upon how the employment contract is written–a spin-off or a “spin-in.”
The second is a lessening in job status that can range from a pay cut to a demotion to a firing.
Under a walkaway provision, only the first trigger applies. In a typical agreement, if no job hardship occurs within 12 months after a change of control, a covered executive can walk away from the company with two or three times annual pay plus benefits, Todd said at a Towers Perrin press briefing in New York City on compensation issues in the 2001 proxy season.
In the current competitive market for executives, that’s a powerful incentive for attracting talent. And, according to Todd, it’s an excellent short-term retention tool. “Most employees can stomach anything for 12 months, if they know that two or three-times pay [is] coming afterward,” she says.
The growing interest in walkaway and other change-of-control agreements reflects the changing priorities among executives, who these days are more focused on job quality than job security. Frequently, Todd points out, executives are saying: “I’m signing up for a deal with this company, and [if the ownership changes,] I don’t want to be forced to work for these unknown people.”
Towers Perrin consultants, however, offered two pieces of cautionary advice to employers constructing walkaway agreements. One is to sharply define what constitutes a change in control for the purposes of the provision, says Andy Restaino, a consultant in the firm’s New York City office.
For instance, a company may include a “spin-in” (a previously spun-off company brought back into the fold) in the definition of a change in control. That could spawn a situation in which one employee with a lucrative walkaway agreement continues to work side-by-side with one who doesn’t. That could cause friction among groups of employees, Todd says.
Todd also cautions employers in the midst of a merger deal to narrow the field of executives who are offered walkaways. “Our advice is that the walkaway is most appropriate for people who [are] going to be redundant anyway,” she says.
“If it turns out the person is great, it may be cheaper to buy [the person] out of the walkaway” and retain them, rather than seeking a new executive in the currently costly labor market, Todd adds.
Of course, given the recent wave of layoffs, the cost of talent is coming down.
For example, back in late 1999 and early 2000, the consultant was trying to figure out on behalf of an airline in search of a new chief executive officer what it would cost to buy out the contracts of each of 10 top executives in the industry.
“The cheapest one was $10 million, and some [would cost] $30 million to $40 million,” says Todd, who refused to name the airline.
The current pool of executives is “handcuffed” by unvested stock and other non-cash compensation, the consultant says. She adds, “You won’t have a discussion with [those] folks unless you keep them whole.”