Examining the Largest Golden Parachutes

After Jack Welch retired from General Electric it wasn’t until a divorce settlement forced the disclosure of his retirement benefits package that anyone took any notice. At that time, the scandal surrounding Mr. Welch was that his perquisites were valued at $2.5 million a year, and included luxuries such as the use of an $80,000-per-month Manhattan apartment owned by the company, court-side seats to the New York Knicks and U.S. Open, seating at Wimbledon, box seats at Red Sox and Yankees baseball games, country club fees, security services and restaurant bills. No one at the time of his departure had valued Mr. Welch’s full retirement package either, which – at almost $420 million – dwarfs the perks package that Mr. Welch ultimately relinquished.

Since then, multi-million dollar severance and other separation packages, commonly referred to as “walk-away” packages, have become so commonplace for CEOs that when HP fired Leo Apotheker with a $12 million guaranteed cash payment it barely registered. Accelerated equity awards along with substantial pensions and other deferred compensation all but guarantee significant payouts at many of America’s largest corporations in every termination situation except for a termination “for cause.” This report goes back to 2000 to examine the largest golden parachutes and other termination packages of the past decade, many of which have never been quantified before.

Key findings:

• 21 CEOs received walk-away packages in excess of $100 million since 2000
• Four CEOs were in the financial sector and four more were in the health care sector
• Walk-away packages include, where relevant:
  • Actual and potential stock option profits
  • Full-value stock awards
  • Salary and bonus continuation
  • Benefit and perquisite continuation
  • Executive pension benefits
  • Other deferred compensation
• The 21 CEOs walked away with a total of almost $4 billion in compensation
• Four-fifths of the group’s total compensation was comprised of equity, pensions and other deferred pay
• Tenure for the CEOs ranged from nine months for Viacom’s Thomas Freston to 29 years for North Fork Bank’s John Kanas
• Three CEOs received payouts without ever leaving

Principles and Practice

The principle of the golden parachute is a sound principle. The principle of incentivizing an executive into retirement is another sound principle. Golden parachutes are designed to protect executives, primarily CEOs, from financial harm when they make M&A decisions that may be in the best interest of shareholders but that might lead to their losing their jobs. Incentivizing executives into retirement, by having stock compensation continue to vest during retirement, is also in the best interest of shareholders because it ensures that the decisions made by the executives are in the long-term interest of the company despite the proximity of their retirement age.

Since these principles are sound, what went wrong?

In our view, what went wrong was that the principles were applied too widely. They were applied not just to cash compensation, but equity compensation, perquisites, benefits, pensions, and virtually all other forms of pay. In principle, to protect someone from financial harm if they lose their job due to a merger, that executive needs a single year’s salary and bonus. A CEO should not need three or even two years’ salary and bonus, plus immediate vesting of all equity and pensions, plus benefit and perquisite continuation, as was paid to most of the CEOs in this report. A CEO who is retiring should not need a severance package as well as a retirement package, such as was paid out to John Kanas by North Fork. A CEO who is retiring should not need a pension as well as the continued vesting of stock options and restricted stock, as was paid out to Lee Raymond by Exxon Mobil.

Too many golden parachutes and too many retirement packages are of a size that clearly seems only in the interest of the departing executive. In the case of some of the packages in this report, they have been paid to an executive who has not even departed. In the cases discussed in this report, it would seem that compensation committees have lost sight of the original principles, resulting in little or no value for shareholders despite excessive compensation.

Methodology

Rather than simply reproducing disclosed severance package figures – values over which companies exercise great discretion – to arrive at the full value of “walk-away” payments, we calculated and included all forms of compensation paid out to the CEOs in their final year of employment. These include:

• final year salary and bonuses, as well as perks and benefits
• any full-value stock that vested during the year, as well as any stock option profits resulting from the exercise of options
• actual cash and perquisite severance amounts, including any enhancement to pensions
• the value of any full-value stock that that did not lapse as a result of the termination
• the notional profit on the exercise of any stock options that did not lapse as a result of the termination
• the total accumulated benefits of any qualified or non-qualified executive retirement plans
• all other deferred compensation
• any disclosed excise tax gross-up payments

Thus our figures represent the total walk-away package earned by the executive in their final year of employment; they do not include all compensation earned by these CEOs during their tenure as CEO.

CEO Exit Packages Over $100 Million

We found 21 CEOs whose final payouts each totaled more than $100 million in the past decade plus. The list includes four companies in the health care sector and four more from the financial sector. These 21 CEOs walked away with almost $4 billion in combined compensation. In total, $1.7 billion in equity profits was realized by these CEOs, primarily on the exercise of time-vesting stock options and restricted stock. At $1.5 billion, pension payments and non-qualified deferred compensation is just behind equity profits in the ranking of pay components responsible for the total payout. In fact, equity profits, pensions, and deferred compensation represent 80 percent of the $4 billion earned by these 21 CEOs. Parting cash severance, salary, bonuses and other perquisites comprise the remaining 20 percent.

The average tenure of the CEOs in this study is about 13 years. Ed Whitacre was head of AT&T for only two years before receiving a payout of $230 million, though he had served as the CEO of SBC Communications for 15 years prior to a merger with AT&T. Wallace Malone received $125 million after only two years as head of Wachovia, after serving as CEO of SouthTrust for 23 years, and Viacom’s Thomas Freston was CEO for just nine months before receiving more than $100 million in walk-away compensation.

While some of these CEOs moved on to less high profile positions, many found gainful employment shortly after receiving these exit packages. For instance, Fred Hassan became a partner at Warburg Pincus about a year after receiving almost $190 million from Merck & Co. Similarly, Thomas Freston became a principal with firefly3, a consulting and investment firm, immediately after receiving his severance at Viacom. Meg Whitman served as a part-time Strategic Advisor to Kleiner, Perkins, Caulfield & Byers, venture capital firm, after leaving eBay and now serves as the CEO of Hewlett-Packard. In circumstances that undermine the principle of the golden parachute even further, the CEOs in the report’s “Paid and Stayed” sidebar never even left the companies they served as CEO when receiving payouts comparable to an exit package.

Conclusion

Large equity grants and pensions are the primary vehicles behind these extraordinary severance payments. Also responsible was deferred compensation which allows CEOs to put aside large compensation awards that often earn about 6 percent interest over and above the market rate. But even if these awards were based solely on cash payouts, they would seem excessive for the purpose for which they were designed – to make executives financially sound during merger and acquisition events and/or to align their interests with shareholders well into retirement. The focus of concern over these awards should be the boards that approve the employment agreements guaranteeing them.

The board of directors is entrusted with the responsibility of making sure CEOs are not being incentivized to take short-sighted risks, are not encouraged to arrange a merger simply because their walk-away package means that they could earn more through selling the company than trying to make it a success, and that they not be allowed to depart with millions in shareholder capital when mergers fail. Overgenerous severance amounts are the end result of policy permitted by the board, and the compensation committee in particular.

Directors who approve such awards for an incoming CEO or allow them to continue in place for existing CEOs may be held accountable when CEOs receive tens of millions after a short or unproductive tenure. They may also be held accountable if CEOs are paid twice for their successes. No one would argue that Jack Welch had not made a large amount of money for shareholders, but few would argue that he had not already been paid for it (and that such an excessive retirement package was, therefore, unnecessary). With increased disclosure standards on compensation and opportunities for shareholders to express themselves through Say on Pay and director withhold votes, we expect that there will be significant reputational penalties paid by the directors negotiating such awards.