Background. During the next few months, compensation for executives will surely make headlines again as publicly traded companies begin filing proxies with the Securities and Exchange Commission. Executive pay continues as a hot-button issue, but a new report suggests that compensation committees are becoming increasingly wary of golden parachute severance agreements.
A Blip or a Trend? A recent article published by WorkForce.com notes that while the average golden parachute has jumped 32 percent in value during the past two years, pressure from shareholders, as well as new SEC disclosure rules, is driving a trend toward performance-based executive compensation, according to the tax advisory affiliate of global professional services firm Alvarez & Marsal.
According to the study, the biggest factor behind increasing payouts today isn’t cash, but rather long-term incentives, typically based upon share performance. Long-term incentives comprised nearly 60 percent of the value of golden parachute agreements in 2011, according to the report. Consequently, a balanced view might note that this result actually is a desirable outcome, since rising share value certainly benefits all shareholders.
“Gross-Ups” in Decline. About half of the 200 companies covered in the report currently provide some form of excise tax gross-up (where the company reimburses the executive for some or all of the tax cost of receiving benefits) to key executives. However, change appears to be in the wind. For example, 80 percent of top information technology companies that provide excise tax gross-ups have publicly announced their intention to phase them out, according to the report. The logic for these costly gross-ups has always been a bit shaky, and this trend almost certainly has been driven by more detailed disclosure.
Aligning with Shareholder Interests? Golden parachute agreements are intended to align key executives’ personal incentives with those of shareholders and to keep them focused on achieving a deal favorable to shareholders, even it means that the employment of those executives will be terminated as a result. However, according to Dirk Jenter, associate finance professor at Stanford University’s Graduate School of Business, that may not be the case. His research indicates that companies are far more likely to be sold when the CEO nears retirement age. More specifically, the probability of a firm being acquired jumped by 50 percent when a chief executive reached 65 or 66 years old. Younger CEOs were much less likely to agree to a sale. This leads him to suggest that these agreements don’t work the way they are supposed to.
Conclusion. None of this is really new, but closer scrutiny of change-of-control/severance agreements should be expected. With more detailed disclosure rules resulting from the Dodd-Frank Act coming on line soon and more shareholder resistance expected to be reflected in “say on pay” votes, golden parachutes may lose some luster (but are not likely to disappear).
Robert L. Musick, Jr. Richard Deutsch
(804) 249-6027 (804) 249-6026
bmusick@titanhr.com rdeutsch@titanhr.com
