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What is a Golden Parachute?
What’s important to know about it?
In this article, I will break down the meaning of Golden Parachute so you know all there is to know about it!
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What Is Golden Parachute
In business, the golden parachute refers to very high benefits offered by a company to its executives in the event their employment contract is terminated following a merger or acquisition.
In other words, a company will include provisions in its employment contract with its executives where they are given stock options, cash bonuses, generous severance pay, and other benefits in the event they are terminated following a change of control.
For example, a company may include very high cash bonus payouts to its top executives should their employment contract be terminated following a takeover.
Golden parachutes make the acquisition of the target company more expensive as the acquiring firm must make large payouts to the target’s executives to terminate their contracts.
The term is called a “golden parachute” as it allows the company’s top executives to softly land after losing their job.
In essence, the golden parachute is an anti-takeover measure that a company may adopt to deter other companies from acquiring it.
Keep reading as I will further break down the meaning of a golden parachute and tell you how it works.
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How Does A Golden Parachute Work
Golden parachutes represent lucrative benefits offered to company executives when their employment contract is terminated following a merger or takeover.
In other words, a company will include various provisions in its employment contract with its top executives detailing the benefits that they may obtain if they are terminated following a merger or acquisition.
There are many ways that companies can “sweeten” the executive’s termination following a takeover, such as:
- Payout of large cash bonus
- Award of important stock options
- Accelerated vesting of unvested stock options
- Compensation for legal fees
- Very good health and dental benefits
- Lucrative pension plans
The executive’s employment contract will contain contractual clauses detailing what benefits the executive may be entitled to and what events will trigger the payout of the benefits.
Typically, the trigger event can be a change of stock ownership leading to a new shareholder or group having the majority of the votes or a change in the composition of the board.
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Golden Parachute Components
Golden parachutes are awarded by public companies to key personnel and executives by companies to compensate them should they lose their job following a merger or acquisition.
The idea is to protect the company’s top executives and to make a potential merger or acquisition more costly for the acquirer.
Golden parachutes generally require that shares of a publicly traded company are sold and key executives or employees are terminated without cause or resign for good reason.
A good reason could be a relocation of the executive, a substantial decrease in their responsibilities, a significant change in their role, or other measures taken by the company.
Golden parachute packages can include cash salary for a certain period of time, lump sum cash payment, stock award vesting, restricted stocks, continued retirement benefits, the continuation of executive perks, medical benefits, departure bonuses, and other benefits.
Typically, company CEOs will get golden parachutes entitling them to two or three times the value of their base salary and bonus, along with benefits, stock options, and pension payments.
Other C-level executives such as Presidents, COOs, and CFOs will receive one or two times their base salary along with bonuses, benefits, stock options, and pensions.
Some of the most lucrative golden parachute payments have been made by Disney to Michael Ovitz where he received a severance payment of $100 million, Philip Purcell from Morgan Stanley where he got an exit package of $114 million, and Jim Kilts from Gillette where he received a golden parachute of $165 million.
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Pros And Cons of Golden Parachutes
Golden parachutes offer different advantages and disadvantages when used by companies.
The most important benefit of offering golden parachutes to key employees or top executives is that a company is looking to make a potential acquisition or merger more expensive for another company.
Golden parachutes are part of different measures taken called a “poison pill”.
Another benefit of golden parachutes is that the key employees and executives have the assurance that they will either remain employed following an acquisition or receive a lucrative payout if they are terminated.
Another benefit companies see in adopting golden parachutes is that it allows them to more easily attract and retain top executive talent, particularly in industries prone to mergers and acquisitions.
However, although golden parachutes can have benefits, you must also be aware of their drawbacks.
The most notable drawback is that companies are highly criticized when they make generous payouts to top executives in addition to the generous wages and perks they already benefited from.
When the golden parachute payouts are too large, many will question whether or not the target’s board observed its fiduciary duty of making decisions in the best interest of the company.
Also, opponents of golden parachutes argue that the cost of golden parachutes relative to the merger or acquisition cost can be insignificant.
As a result, the additional cost will not dissuade other companies from proceeding with a takeover.
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Golden Parachute Regulations
Over the years, there has been a lot of criticism about companies giving lucrative golden parachutes to their upper executives.
The opposition against golden parachutes has been so important that the US Congress adopted laws and regulations to prevent excessive payouts or severance packages that are too generous.
In 2010, Section 951 of the Dodd-Frank Wall Street Reform and Consumer Act provided that companies must obtain the votes of advisory shareholders on all instances of golden parachutes.
Then, in 2011, the Securities and Exchange Commission adopted a new clause on the “say-on-pay” vote and golden parachutes.
In other words, shareholders must vote on the compensation packages that companies are looking to offer their top executives including the CEO, CFO and at least three other most highly compensated executives.
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Golden Parachute Examples
Let’s look at a few examples of golden parachutes to better understand the concept.
Company A wants to adopt different measures to deter other companies from submitting a hostile takeover bid.
As part of these measures, it grants shareholders the right to purchase shares of the company at a significant discount if a shareholder acquires more than 10% of the company’s shares.
Also, it includes golden parachutes in its contracts with its key employees and executives where they are given a special bonus representing 200% of their annual compensation along with additional stock options in the event of a change of control.
Company A considers that buying out Company B can lead to greater value for its shareholders.
Company A calculates that it will cost $100 million to acquire a controlling interest in Company B.
Company A offers $100 million to Company B, but Company B rejects the offer.
Company A submits a hostile takeover bid for $100 million directly to Company B’s shareholders.
However, Company B had adopted a poison pill making it more costly for Company A to buy out Company B.
Company B has also given golden parachutes to all its top executives and key employees.
In total, the acquisition cost goes from $100 million to $150 million.
At that price, Company A no longer believes that the acquisition will be worth it.
Company A withdraws its hostile takeover bid.
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So there you have it folks!
What does golden parachute mean?
In a nutshell, a golden parachute is an agreement between a company and an employee outlining various benefits the employee will receive should his or her employment contract be terminated in the event of a change of control.
Typically, golden parachutes are offered to upper executives and key employees.
The most common examples of golden parachutes are generous severance payments, lucrative cash bonuses, stock options, vesting of awarded options, and other benefits.
In most recent times, golden parachutes are seen as excessive and highly criticized.
Opponents do not believe that making gratuitous payments to CEOs or paying employees to be terminated is fair and does not bring value to the shareholders.
However, those who are in favor of golden parachutes believe that it makes it easier for them to hire and retain top talent in certain industries and allows executives to remain objective about the company during a takeover process.
Now that you know what golden parachutes are and how they work, good luck with your research!
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