Compensation for Business Leaders

Golden Parachutes

Another form of deferred compensation is a "golden parachute," which provides pay and benefits to an executive after termination of employment that is due to a change of control resulting from a merger or acquisition. Golden parachutes are also used as a defensive measure to avoid a hostile takeover due to the increased costs associated with a golden parachute.

A golden parachute is an excess payment in a severance agreement. If the total payment equals or exceeds 3 times the five-year average of covered compensation reported in a W-2, the individual’s “base amount”, the excess “parachute” payment is outside a “safe harbor” and subject to Section 280G which denies a deduction to the employer of the excess amount. If 280G is triggered, the executive is subject to Section 4999, a nondeductible 20% excise tax. Payments may be “grossed up” to cover the 20% excise tax but the gross up is also considered to be a parachute payment. If the executive has unvested options that vest due to a change of control, a portion of the options value is included in determining the 3 times benefits payable. Some Compensation Committees retain discretion to adjust severance payments amounts to avoid 280G and 4999 being triggered.

Disclosure of golden parachute compensation arrangements and vote requirements relating to covered proxy statements, schedules, and forms filed with the SEC took effect on or after April 25, 2011.

Golden parachutes extend pay and benefits for a limited time period, usually 1-3 years. There are two reasons for doing this:

1. Ensures top management stay focused on and carry out their responsibilities in the interest of the organization in the event of a merger or hostile takeover.
2. They are attractive to organizations, as these payments can be treated as business expenses (unless they are deemed excessive).

Change of Control

Typically, when a company is acquired, there is a subsequent change in management that can leave many key executives without a job. With a change of control, it used to be that top management only received a severance package after being ousted in a takeover. The package was designed to safeguard them from mergers and acquisitions that could potentially threaten their post-transaction employment.

Now, change of control arrangements are structured to be either single-trigger, requiring only a change-in-control to take place, or double trigger, which requires a change of control and a resulting termination. Single trigger change of control provisions are heavily criticized for providing top management the benefit of a payment for the change of control without termination of employment. Double-trigger change of control agreements are more prevalent than single-trigger and favored by shareholders. They require both a change of control, as well as a resulting qualified termination of employment. Double-trigger change of control arrangements lend protection to top management following a change of control. For a specified period of time, the executive will receive payment if not terminated for cause, or if the executive leaves for a qualified reason such as a compensation decrease, title change, required relocation, etc. Also, as this structure necessitates a resulting termination of employment, the six-month payment delay required under 409A takes effect, unless the termination is involuntary or the executive is terminated with good reason, which negates the need for the change of control payment to be 409A compliant.

Termination

CEO severance payments in excess of $150 million are newsworthy headlines. More and more frequently, we hear of these substantial payouts for the top executive officer of major U.S. corporations.

The common termination clauses in severance agreements include:

• Involuntary Termination without Cause. Termination by the employer without cause is a "separation from service." Severance payments will be triggered.
• Termination with Good Reason. Treated the same as a termination by the employer without cause, the result of material changes to the role and responsibilities of the employee's current job.
• Involuntary Termination for Cause. The executive does not receive severance payments in the event of a termination for cause. The compensation and benefits that are received customarily are limited to those already earned and vested under applicable plans and other arrangements of the employer.
• Voluntary Termination other than Death or Disability. Ordinarily, a voluntary termination without good reason does not give rise to severance benefits in reviewing an employment agreement.
• Termination due to Death, Disability or Retirement. Payments upon termination of employment for disability or death are subject to any other form of "separation from service" (i.e., lump-sum versus installments). However, this type of termination may occasionally trigger vesting of some benefits, or short- and long-term incentive plans.