Golden Parachute Awards: Review
Golden Parachute Award- Review
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Golden parachutes or severance agreements can be described as agreements that allow a company’s top executives to get a large severance pay and other benefits if their employment is terminated due to the change of ownership of the employing corporation. The event is formally referred to as a change-of-control agreement (Farlex, par. 1). Golden parachutes are offered by the board of directors of the corporation upon the approval of the shareholders. The argument that is raised in support of this is that when the executives lose their jobs, they suffer a loss of status and or power that comes as a result of the change of ownership of their employer company. Some golden parachute awards are however given even when the ownership of the corporation has not changed entirely. An example includes a case where a certain part of the corporation’s stock has been acquired (Farlex, par. 2). This research paper seeks to give a review of articles on the recent golden parachute awards in order to get information on how different companies compensate departing executives.
Justification for Golden Parachutes
There are several grounds on which golden parachutes have been justified. One of them is that they assist the corporations to be in a position to acquire and retain executives of high quality who would have refused to take the job without the agreements. Secondly, they discourage takeover bids, as they are included in the costs of the acquisition of the corporation. The third justification is that if the executives are not offered the golden parachute awards, they may try to resist any form of acquisition so that they can preserve their jobs, an action which may work negatively in the interests of the shareholders (Farlex, par. 3).
Restrictions on the agreements have been intensified from the 1980s as the practice of giving golden parachute awards became very common. This was done because it was realized that the practice was producing stock returns negatively as compared to the positive stock returns for shareholders that were produced in the initial stages (Farlex, par. 4). The Federal Deposit Insurance Corporation (FDIC) issued a rule on 6 February 1996 restricting thrifts, troubled banks and holding companies from awarding the golden parachutes payments. However, people qualified for retirement benefits and pensions are exempted from this law. The FDIC may also allow legitimate payments but can stop any payments that it considers improper or abusive. FDIC-insured institutions are protected from paying their employees’ legal expenses that are subject of related enforcement proceedings (Farlex, par. 5).
Golden Parachute Award for Home Depot’s CEO
In the article by the Washington Post’s staff writer Ylan Q. Mui entitled “Seeing Red over a Golden Parachute,” it was stated that the Chairman and Chief Executive of Home Deport, Robert Nardelli had resigned abruptly and thus was entitled to a golden parachute award. In the article, it stated that the company’s board of directors accepted his resignation. According to the existing agreement at the time when he was joining the company some seven years before, he was entitled to money amounting to US dollars two hundred and ten million (US$210 million), in either cash or stock options. That included $32 million in bonus and $2 million in severance payment (Mui par. 1-2).
Nardelli’s payout prompted an emergence of critic’s comments on the extravagant awards and bonuses given to executives. A senior research associate of Corporate Library, which is a research firm for the executive compensation, stated that the package offered to Nardelli was among the highest that he has ever seen. This makes Robert Nardelli one of the twelve highest paid executives although in one of the worst performing companies in America. Contributing to this golden parachute award issue, one of the shareholders of Home Depot, Evelyn Davis termed it as ‘unbelievable’. The article also included some comments from the then incoming chairman of the House Financial Services Committee, Barney Frank who spoke against that package stating that it was just a representation of how the executive pays had negative effects (Mui, par. 4). Mr. Frank was quoted as saying, “Mr. Nardelli’s contribution to raising Home Depot’s stock value consists of quitting and receiving hundreds of millions of dollars to do so.” He then declared that he would study the whole idea of compensating executives (Mui, par. 5).
It is reported in the article that Nardelli had joined the company with the promise of increasing the profits and sales of the company in addition to centralizing the management. However, he received more criticisms than praises. He succeeded in many areas such as doubling revenue from $45.7 billion in the year 2000 to $ 81.5 in 2005 although this was short of the $100 billion projected mark (Mui, par. 7-8). He replaced some senior executives, established a top down management and expanded the company’s wholesale business that it attracted professional contractors.
He was often criticized for his hefty salary and failure to bring any real impact on the company’s stock price, which was negatively affected by slowed expansion of stores and competition from its rival, Lowes. It is reported that the Home Depot stocks closed at $40.16 on the day of his resignation, while it had closed at $40.75 one day before he joined the company. The values had actually gone down 0.8 percent (Mui, par. 9-10). This factor led the shareholders of the company to question his hefty compensation. In the previous year, it is reported that he had received compensation worth $30 million and earning a total of $125.57 million as his annual salary, stocks and bonuses among other payments (Mui, par. 11).
This case highlights some of the disadvantages that are associated with severance agreements awards where so much money is used to award top executives in corporations who should have left their positions because of their failures.
An article in the AFLO-CIO , (America’s union movement) website reported that in 2006, some chief executives were awarded golden parachute awards in form of generous packages though they had performed poorly and as a result cost corporations and investors to lose much money. Those that had been mentioned include Home Depot’s former CEO Robert Nardelli and Pfizer’s Henry McKinnel, both of whom received more than $200 million each (AFL-CIO, par. 1). It is also stated that the huge exit packages are primarily due to employment agreements between the executives and the companies. The agreements are said to be legally binding contracts with the terms under which the CEOs would be employed. The disadvantage that is cited is that there is a guarantee of the executives receiving the compensations in spite of the poor performance of the stocks (AFL-CIO, par. 2).
The employment agreement also states what the executives would be given if their jobs are terminated under different conditions. They may be given the golden handshakes if they retire or their employment terminated or they may receive golden parachute awards if the ownership of their companies is taken over by different entities. It is indicated in the article that the proponents of such severance agreements claim that such compensation can maximize the wealth of the shareholders without the executives worrying that they would lose their jobs due to the change in the control of the company. However handshakes and golden parachute awards are guaranteed by a very huge amount of money. Sometimes when the amount is too excessive, it may allow the executives to propose for a merger though it may be against the share holders’ interests. It is also recorded that golden parachutes may lead to lower firm valuation as stated by Professor Lucian Bebchuk of Harvard (AFL-CIO, par. 3).
In many cases, exit packages are often two or three times the salary and bonus. The total payment is boosted by the increasing vesting option awards, pension benefits and stock awards that are contained in the agreements. In some cases, the termination terms may not be included in the initial terms of agreement but in the individual plan. Also if the payment for golden payment is above 2.99 times, the average annual salary and bonus of the executive for the five preceding years, then that amount above the average salary are not deductible by the company and therefore the latter must pay the taxes for the extra amount (AFL-CIO, par. 4). The companies are also required to pay excise taxes equivalent to twenty percent of the amount over the average salary plus bonus for the five preceding years and the cost goes to the shareholders.
In the case of KB Home Company, the Chief executive was paid $175 million as his salary as the company had accepted his retirement letter and he had not been sacked although he had been involved in stock options’ backdating (AFL-CIO, par. 6).
Yahoo plans for Golden Parachutes Awards
In a news blog entitled “Yahoo outlines golden parachutes for employees” dating February 19th 2009, appearing on the CNET website, it is reported that Yahoo has already laid out the golden parachute plans for its workers employed on full time contracts, filing them with the Securities and Exchange Commission. This is in preparation of a possible takeover by the Microsoft Incorporation. Yahoo has a plan of offering its executives and its full time employees between four months to two years of severance pay, depending on their job title or rank in the company (Kawamoto, par.1).
The golden parachute is in place to become effective if any employee was to lose his or her job without any cause within two years after the new owner had taken over. Yahoo’s Chief Executive and Co-Founder, Jerry Yang, will also benefit from such an award. The packages are meant to enable the company retain its employees as well as a work environment that is stable and also to give the workers economic benefits if at all they would lose their jobs. The golden parachute award would also include dental and health coverage for the length of time that is covered by severance awards. This would mean that if Microsoft prevails in the takeover even in a hostile situation, or through a friendly merger, the employees would be retained (Kawamoto, par.2-8). This can be praised as a very wise decision that is meant to benefit the employees of Yahoo in case Microsoft takes over the control of the company and the latter decides to lay off some of the workers.
Toronto- Dominion Bank CEO Forgoes His Golden Parachute Award
An article entitled “TD’s Clark to forgo golden parachute” appearing in the Financial Post of February 28, 2009, it was reported that the Chief executive of Toronto-Dominion Bank based in Toronto, which is also Canada’s second largest lender had decided to forgo his golden parachute award (Callan, par.1). He was meant to claim a severance pay of ten million US dollars when leaving the office but waived it and also froze his pension in the deal that saw his employment term being extended up to the year 2013. This has taken place as complaints by the shareholders continue to be raised about the huge bonuses for the executive, especially in this period of market down turn. There is an anticipation that Toronto Dominion Bank would come under great pressure to allow the shareholders voice their concerns on compensation during its annual general meeting. It is reported that the shareholders of three major Banks; Canadian Imperial Bank of Commerce, National Bank of Commerce and Royal Bank of Canada, have revolted in recent times wanting to have a voice in the issue of payment and compensation (Callan, par.4-5).
It was also reported that the pension that Mr. Clark was meant to receive will now be paid in stock being converted into 4.7 million of shares that cannot however divest until after two years following his retirement. This, according to the bank is to harmonize the shareholders interests with those of Mr. Clark. The contract has been extended to thirteen years to allow him to reach his goals of expanding the bank’s services into the USA. There was a concern however that a major US bank may want him and that he had to be retained in the Toronto-Dominion Bank so that it can develop a succession plan. (Callan, par. 7-10).
CEOs arranged for the compensation for fired executives
The Huffington Post contains an article about the Lehman Brothers Holdings which is now in bankruptcy where the Chief Executive officers arranged for money amounting to millions of dollars for its fired executives at the time when it was still pleading for the a Federal lifeline. This has revealed why the government declined to save the company from collapsing while the former was injecting billions of dollars into others similar companies (Davis, par.1).
The scandal forced the former CEO of the bank, Richard S. Fuld Jr. to appear before the House Oversight and Government Reform Committee. He took full responsibility for the actions he undertook and confirmed that he paid out approximately $350 million before 2007 though he knew the company was heading for an economic collapse. It was revealed that he was planning to offer golden parachutes amounting to $18.2 million to two executives as special payments though they had left their jobs involuntarily and an additional $5 million to one who was leaving voluntarily (Davis, par. 4-6). This is an indication that different company managements has in many cases manipulating the golden parachute system to suit themselves or their friends without caring for the shareholders’ plight.
KB Homes Former CEO Gets Huge Golden Parachute Award
The article dated December 20, 2006 and entitled “KB Homes Rewards Former CEO Bruce Karatz for Backdating Options” reports that despite him being involved in backdating the stock option grants, he was to receive a golden parachute award (Silverman, par. 1). The internal investigation done had revealed that Karatz plus another executive had altered option grant dates so that they could increase their compensation value. However, unless the Board of directors blocked his “retirement” package, he was to receive a hefty payout. The Los Angeles Times had calculated that his golden parachute package was amounting to one hundred and seventy five million US dollars. Commenting on this matter, Patrick McGurn said that “By heavily rewarding an executive that improperly lined his own pockets, KB Homes shows disdain for its shareholders and encourages further malfeasance. We urge institutional investors to join us in speaking out against this outrageous golden parachute” (Silverman, par 3).
Gold parachutes awards to continue
In the article appearing on CNN website entitled “Golden Parachutes here to stay,” it is reported that the advocates of the seven hundred billion US dollars bailout in Congress had proposed a limitation on the golden parachutes for senior executes. This was the first time in the US history when the Congress had acted to cut down the excessive compensations for the CEOs. However those who had hoped that the golden packages would be scrapped off had a reason to get disappointed (Isidore, par 1-4). Some lawmakers stated that they would not support the bailout motion if the golden parachute continued to be offered. This was in the consideration that the CEOs of the Wall Street were to receive the golden parachute awards despite its poor performance “The golden parachutes have been exchanged for camouflage parachutes,” said DeFazio during debate. “The execs on Wall Street will still get millions. Look at the loopholes there (Isidore, par 5-6.”
A treasury official stated that golden parachutes could still be paid in future as long as they had been triggered by the change of the ownership of the companies and not by corporate failure or involuntary termination. The co-founder of Corporate Library, Nell Minow stated that stricter limits should be placed on golden parachutes as this would be a good step towards the major changes on the golden parachutes awards (Isidore, par 5-6). The government of the United States should place restrictions on the golden parachutes to restrict the companies from incurring so many expenses that are passed over to the shareholders.
From the review done on these articles, it is clear that t golden parachute awards were established with proper motives; to enable chief executives or any other senior executive employees to work effectively without worrying about losing their jobs in case the company’s ownership is taken over by another company. In addition, the awards attempt to prevent the CEO’s from fighting takeovers that would result in their job loss, but actually are beneficial for their employer. However, the golden parachute system is flawed in that it is susceptible to weaknesses such as paying out CEOs who have underperformed leaving their employers in a worse financial shape than when they joined the company. It has been noted in some cases, for example Home Depot, when the CEO exited, the share price was 0.8% lower than when he joined the company and, he had not met his revenue targets. Despite his poor performance, he still received a large payout. Golden parachute awards tend to reward outgoing senior executives whether or not they performed to the benefit of the company, and it is the shareholders who pay for this. It is thus recommended that while these awards have good motives, they should be further amended to peg payouts on executive’s performance.
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