“Golden parachutes” get a lot of press, and they always sound like elite packages for high-level executives. Very few people get them, and very few people know how they work.
Companies usually reserve them for executives at the top of the organization chart, and these contracts establish an agreed-upon compensation package that the employee would immediately receive upon termination. The benefits package usually includes a list of specific terms that explain what the terminated employee will receive.
How a Golden Parachute Works
When someone is offered an executive position at a firm, the contract will often include a golden parachute clause. This clause states the amount of severance pay, stock options, and cash bonuses that he or she would get.
The contract includes clear language about the conditions under which a golden parachute applies. The terms can be weighed so heavily in the employee’s favor that it almost seems like termination could come as good news. Some clauses cover an employee if they are terminated due to a merger. Golden parachutes have benefited companies and individuals, but they’ve also created some controversy.
Advantages of Golden Parachutes
By providing golden parachute clauses, companies are able to:
- Have an easier time finding executives. Golden parachutes are a main selling point in attracting new high-level employees. Executives typically want to have some security, especially if they are looking to work in a company that is at high risk of being bought out by another firm, or if the company has a reputation for turnover at the top levels. Offering golden parachutes helps businesses draw from a larger pool of applicants.
- Reward risk takers. Golden parachutes can help alleviate the stress that executives feel about their job. Many of them are nervous that making mistakes or going the wrong way on key decisions can lead to losing their job, so they are reluctant to take risks or go against the status quo. Corporations need leaders who are willing to take risks, and golden parachutes can be a tool to help them be effective leaders and make bold decisions.
- Remove the conflict of interest that an executive would have during a merger. During a merger, executives can be tempted to delay or even sabotage the efforts because they are afraid of losing their own job. With a golden parachute clause guaranteeing their compensation, they may be more objective about evaluating a merger.
- Reduce the probability of a hostile takeover. When golden parachutes are in place, other companies find hostile takeovers less appealing because they’d be responsible for expensive termination packages.
- Facilitate more amicable severances. When employees are fired, they often want to retaliate against their employer. They may threaten to sue, disclose sensitive material, or take even more drastic action. Under a golden parachute agreement, they will usually be more than happy to part ways without either party feeling any tension.
Controversies of Golden Parachutes
Golden parachutes also create controversies because they:
- Cost the company money. Golden parachutes of course require companies to pay substantial amounts of money, even when terminating an employee for good cause. Termination is a risk at any position. Critics feel that if an employee doesn’t do a good job, they shouldn’t be paid millions of dollars when they need to be replaced.
- Deter motivation. If executives believe that they are going to become rich through their severance packages, they may have little incentive to do a good job. An executive who doesn’t have to worry about performance and evaluations will probably have a poorer work ethic. Well-crafted golden parachute clauses can limit the provisions under which the company is required to pay out.
- Create resentment with other employees. Typically, only upper-level executives receive golden parachute agreements. These employees are already well compensated and can probably build up a substantial emergency fund with relative ease. Employees who make less money don’t necessarily get any help if they are terminated, so feelings of animosity and resentment can brew, especially under the threat of a merger.
- Expose the fact that executives may not be objective in the event of a takeover. During a merger or any other agreement that may affect a company’s future, an executive has a sworn duty to look after the company’s best interests. Critics argue that they shouldn’t need a golden parachute to remain objective during this process.
- May not necessarily discourage hostile takeovers. Golden parachutes make up a small percentage of the cost of a merger. In the scheme of things, they’re not a major inhibiting factor when it comes to preventing hostile takeovers.
Classic Examples of Golden Parachutes
There are a number of famous cases involving the use of golden parachutes. Many of these cases have fueled outrage on the part of investors, the general public, and in some cases, law enforcement. Some of the most noteworthy cases include:
Tony Hayward of British Petroleum
Tony Hayward was the CEO of British Petroleum (BP) during one of the most infamous oil spills in history. He was subsequently fired for poor leadership, but he left with a severance package of over $1 million (the same amount he’d make in a year) and a pension close to $12 million. This agreement created headlines such as “$12M Payoff for Captain Clueless.”
Kenneth Lay was the CEO of Enron before the company became a household name following allegations of fraud, perjury, and questionable accounting practices. Lay had golden parachute clauses that entitled him to over $25 million. However, unlike his associates, he stayed with the company to the end. He was indicted and stood to serve 45 years in prison. He died of a heart attack before his appeals were exhausted. Many other Enron executives were incarcerated but stand to leave prison with millions of dollars due to the golden parachutes they had in place. Meanwhile, employees, investors, and clients of Enron were left penniless in their wake.
Lehman Brothers was a firm that went bankrupt in 2008. They paid millions of dollars to their fired executives at the same time they were begging for a bailout from the Federal government. They were just one company that was responsible for mandating a $700 billion bailout while providing lucrative golden parachutes for their former leaders.
Carly Fiorina of Hewlett Packard
Carly Fiorina was the CEO and chairman of Hewlett Packard. She was dismissed for performance related issues in 2005, but received $45 million including a $21 million severance package. Ironically, she went on to become the economic advisor for John McCain, who was adamant about putting an end to the use of golden parachutes at the expense of investors and taxpayers.
On one hand, golden parachutes help companies attract the best executive talent. On the other hand, those executives may not be as motivated to do their job because they stand to make as much or more through their various severance packages than by working. Furthermore, golden parachutes may discourage mergers, which are usually beneficial to investors. But since golden parachutes help executives remain objective, they may also facilitate mergers at the same time.
Golden parachutes exist to make things better for managers. They provide enough benefits for investors to consider, but in the end, they are more likely to be a liability. The existence of golden parachutes is evidence that there is a strong management bias. In other words, executives are often more concerned with leveraging their own wealth and success than they are in promoting the success of the corporation or the wealth of its shareholders.
How do you feel about the payouts that executives get when they leave?