Hiring and Firing a Key Executive at Yahoo

Joseph E. Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. The following post is based on a column by Mr. Bachelder which first appeared in the New York Law Journal. Andy Tsang, a senior financial analyst with the firm, assisted in the preparation of this column. Related research from the Program on Corporate Governance includes Golden Parachutes and the Wealth of Shareholders by Lucian Bebchuk, Alma Cohen, and Charles C. Y. Wang (discussed on the Forum here). This post is part of the Delaware law series; links to other posts in the series are available here.

Yahoo! Inc. paid its Chief Operating Officer (COO) just under $100 million for 14 months work (November 12, 2012–mid-January 2014). This compensation/severance arrangement is the subject of a recent opinion by the Delaware Court of Chancery and is the subject of this post.

The Amalgamated Bank Case

On February 2, 2016, the Delaware Court of Chancery granted a demand by Amalgamated Bank to inspect the books and records of Yahoo pursuant to Section 220 of the Delaware General Corporation Law (DGCL). Amalgamated Bank v. Yahoo! Inc., 132 A.3d 752 (Del. Ch. 2016). Amalgamated made this demand in connection with its investigation into the circumstances associated with the hiring and firing of the Yahoo COO, Henrique de Castro.

On June 6, 2016, Amalgamated and Yahoo filed with the Delaware Supreme Court a Stipulation and [Proposed] Order of Dismissal of the case (the “Stipulation”). [1]

Instead of inspecting the books and records of Yahoo under Section 220 of the DGCL, Amalgamated, according to the Stipulation, “has decided to make a demand on the Board requesting that it investigate and/or take action in connection with, among other things, the circumstances of de Castro’s termination.”

The February 2 Chancery Court decision (hereinafter referred to as the “Opinion”) contains a detailed discussion of the circumstances associated with the hiring and firing of de Castro. [2] To the extent discussion in this post regarding the hiring and firing of de Castro reflects language contained in the discussion in the opinion, citation is made to the pages of the reporter at which the court’s discussion appears.

Yahoo’s Business Difficulties

In 2012 Yahoo was struggling with its core businesses—which include Internet search, communications and digital content. (That struggle preceded 2012 and continues today.) Two businesses in which it had invested prior to 2012 were doing well (Yahoo! Japan Corporation (in 1996) and Alibaba Group (in 2005)). [3] In 2011, Yahoo’s revenue from its core businesses was about $5.0 billion (down by 31% from a high of $7.2 billion in 2008) and its operating income from those businesses was $800 million (down by 28% from a high of $1.1 billion in 2005).

Adding to the distractions in 2012, there was a turnover in that one year of 10 out of 11 of Yahoo’s directors. An activist shareholder, Third Point, demanded, among other things, four seats on the Board of Directors. (Third Point settled for three seats.) Other demands by Third Point included the ouster of the then-Chief Executive Officer (CEO), Scott Thompson. [4]

Yahoo terminated Thompson in May 2012. On July 17, 2012, it hired its sixth CEO (including two interim CEOs) in five years, Marissa Mayer. [5] Mayer was Vice President of Local, Maps, and Location Services at Google Inc. (now Alphabet Inc.).

Negotiation with de Castro to Become COO

Soon after Mayer started at Yahoo, she was contacted by de Castro, President of Media, Mobile, and Platforms at Google. De Castro indicated he would be interested in becoming COO, the number two position, at Yahoo. Mayer apparently concluded that de Castro’s suggestion was a good one and on September 12, 2012 she told the Compensation and Leadership Development Committee of the Board (the “Committee”) at Yahoo that she was having discussions with a person to take the number two role at Yahoo. She did not identify de Castro but explained that it would take a “significant compensation package” to attract the individual she was talking with. (This paragraph is based on language contained in the Court’s discussion at 132 A.3d at 761.)

On September 23, 2012, the Committee met again and Mayer provided a term sheet summarizing the proposed compensation package. She still did not identify the candidate. One day later, September 24, 2012, the Committee “met for a total of thirty minutes.” The candidate was identified as de Castro and a proposed offer letter to him was presented to the Committee (the “Original Offer Letter”). The Committee approved the Original Offer Letter and gave Mayer authority to continue negotiating with de Castro. Mayer was to coordinate with the Chairman of the Committee on non-material changes in the Original Offer Letter and the Committee reserved authority to approve any “material changes.” (This paragraph is based on language contained in the Court’s discussion at 132 A.3d at 762.)

Complexities of Offer to de Castro

The offer was finalized by letter dated October 15, 2012 (the “Final Offer Letter”). In addition to cash compensation, the compensation package included three forms of equity award: a Make-Whole Restricted Stock Unit (RSU) award, an Incentive RSU award, and a Performance Stock Option award. The latter two awards were intended to represent four years’ worth of equity grants, according to the Final Offer Letter.

The following chart sets forth information regarding each of the three awards based on the terms of the Final Offer Letter.

Certain Terms of de Castro’s Three Equity Awards

Target Value Vesting Schedule Accelerated Vesting Upon a Termination Without Cause
Make-Whole RSUs $20 million 1/48 per month over 4 years Unvested portion fully vests
Incentive RSUs $18 million 1/4 on the first anniversary of grant and thereafter 1/48 per month over the next 3 years. Twelve-month tail
Performance Stock Option $18 million 1/4 on each of 7/26/2013 (about 8 months from grant), 1/26/2014, 1/26/2015 and 1/26/2016, in each case, subject to meeting performance criteria. Twelve-month tail

The Court notes the complexity in understanding how these values might vary over time. These variances depended on when and under what circumstances de Castro’s employment was terminated. In fact, the Court devotes detailed tables and considerable discussion to these differences and states repeatedly that no explanations were given to the committee in this regard. (See, for example, 132 A.3d at 766.)

Apparently, in the course of the negotiation with de Castro, significant changes were made in vesting provisions affecting equity awards that the Committee never approved. For example, the Original Offer Letter (which the Committee did see) provided that upon a termination without Cause there would be accelerated vesting of portions of the Incentive RSU award and the Performance Stock Option award. These portions (called “tails”) were the portions of each award scheduled to vest within six months following the date on which a termination without Cause occurs. (That is, the portions that would have vested if the executive had remained employed during the six-month period.) [6] The Final Offer Letter extended the “tail” from six months to twelve months. Apparently, the Committee never approved this. (132 A.3d at 768.) The result of increasing the “tail” from six to 12 months was an increase of $4.81 million (to $25.64 million) in the amount of accelerated vesting for those two awards upon de Castro’s termination in January 2014.

The accelerated vesting for the third equity award, the Make-Whole RSU award, was changed in the Final Offer Letter from partial to full vesting. According to the Opinion, the Committee was not advised of this change. (132 A.3d at 768.) The result of this change was an increase of $7.79 million (to $31.18 million) in the amount of the accelerated vesting in the Make-Whole RSU award upon de Castro’s termination in January 2014. Taken together, the changes noted in the three awards provided de Castro with an additional $12.6 million without prior knowledge or approval of the Committee.

Thus, according to the Opinion, the Committee was not appropriately informed on a number of material changes in the Original Offer Letter made by the Final Offer Letter. (132 A.3d at 771.)

De Castro started employment at Yahoo on November 12, 2012. According to the Opinion, he apparently did not perform satisfactorily (132 A.3d at 773) and his employment was terminated January 16, 2014. With the written consent of the Committee, the termination was treated as a termination without Cause (132 A.3d at 772). [7] On this basis, de Castro became entitled to receive a severance payout of $58 million. Following is a breakdown of amounts provided to de Castro for the 14-month period of his employment ending with his termination on January 16, 2014. These amounts are derived from Yahoo’s proxy statements.

Compensation and Severance Paid to de Castro*

Compensation: Amount
Salary $710,000
Cash Bonuses $1,100,000
Portions of Equity Awards Vesting During Employment:
— Make-Whole RSUs $7,920,000
— Incentive RSU’s $9,620,000
— Performance Stock Option $19,070,000
Total Compensation During Employment $38,420,000
Cash Severance $1,140,000
Portions of Equity Awards as to which Vesting Accelerated:
— Make-Whole RSUs $31,180,000
— Incentive RSU’s $9,620,000
— Performance Stock Option $16,020,000
Total Severance $57,960,000
Grand Total $96,380,000

Source: The Author and Andy Tsang, based on Yahoo’s proxy statements.

* The values shown for salary, cash bonuses and cash severance are the dollar values of the amounts actually paid. The values shown for the portions of Make-Whole RSUs and Incentive RSUs vesting during employment are based on the stock price on the vesting date. The value shown for the portion of Performance Stock Option vesting during employment (no portion of the option was exercised during employment) is based on the intrinsic value on the termination date, meaning the spread between exercise price and the stock price on the termination date. (Intrinsic value is a reasonable approach since de Castro was given only 90 days following his termination to exercise the option.) The values shown for the portions of the Make-Whole RSUs and Incentive RSUs as to which vesting accelerated are based on the stock price on the termination date. The value shown for the portion of the Performance Stock Option as to which vesting accelerated is based on the intrinsic value on the termination date.

Ninety-seven percent ($93.43 million) of the grand total of $96.38 million is made up of equity award amounts. Substantially all of these amounts resulted from values attributable to Yahoo’s investments in Alibaba and Yahoo! Japan. As already noted, the acquisitions were made and most of the value was created before de Castro was hired.

As of December 31, 2013 (less than one month prior to de Castro’s termination without Cause in January 2014):

  • Yahoo had a 24% stake in Alibaba that can reasonably be estimated to have had a value at that time of at least $40 billion. [8]
  • Yahoo had a 35% stake in Yahoo! Japan, with a value at that time of approximately $11 billion.

Taken together, the two investments had a combined value for Yahoo of at least $51 billion. This, of course, does not take into account the tax consequences to Yahoo if it sold its interest in Alibaba and/or Yahoo! Japan. (To put this into perspective, Yahoo’s own market cap at that time was $41 billion.)

It was a mistake to have so much of de Castro’s compensation and severance derived from the investments of Yahoo in Alibaba and Yahoo! Japan. Not only did he have nothing to do with the original acquisitions but, presumably, he had limited duties and authorities, if any, in the management or strategic planning regarding these companies.

Lessons to be Learned

  1. The Committee should not have left so much of the negotiation of de Castro’s arrangement to Mayer. Mayer and de Castro had been colleagues at Google until just weeks before the negotiation began. The negotiation probably should have been handled directly by one or more directors.
  2. The Committee should have been more fully informed as to a very complex package. It should have had a better understanding of how the package worked under different circumstances including different terminations of employment. This would include an understanding of the values that could be realized under different terminations and how those values compared to severances provided to similarly situated executives in comparable companies.
  3. A compensation committee should be careful not only in the amount but in the design of the incentive awards it makes to a new executive.
    1. To what extent should new incentive awards be based on values created by the employer prior to the date the new executive starts employment?
    2. If a new award includes such values, what conditions should be attached to the executive’s earn-out of these values? Should that earn-out be based on a target growth in those values? If the executive’s employment is terminated for poor performance in the first 14 months, the executive’s severance certainly should not reflect such previously attained values to the substantial degree it did in the case of de Castro.
    3. Shouldn’t the earn-out of performance-based incentive awards—in the form of equity or otherwise—be tied primarily to the performance of the business, or businesses, for which the executive has responsibility and authority? As noted, there is no evidence that de Castro had significant responsibilities as to the management of Alibaba or Yahoo! Japan.

An Earlier Lesson Not Learned by Yahoo: Disney/Ovitz

The Amalgamated case brings to mind The Walt Disney Company case, litigated in Delaware many years ago. [9] In both cases, the executive involved was the number two executive (in the Disney case it was Michael Ovitz) and, in both cases, the executive was terminated after approximately 14 months of employment. As discussed above, de Castro is reported to have received approximately $96 million in compensation and severance for 14 months of employment. Ovitz reportedly received approximately $130 million for 15 months of employment at Disney. In both cases the Board committee responsible for the hiring appears to have spent relatively little time considering the offer and left to the CEO the working out of the final offer. In both cases the result proved a costly one.


[1] Stipulation and [Proposed] Order of Dismissal filed June 6, 2016 with the Clerk of the Supreme Court in Yahoo! Inc. v. Amalgamated Bank, No. 83, 2016 (Del. 2016).
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[2] At the beginning of its Opinion, under the heading “FACTUAL BACKGROUND,” the Chancery Court makes the following statement: “A trial on a paper record took place on September 29, 2015. The following facts were proven by a preponderance of the evidence.” (132 A.3d at 761.)
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[3] In early 2012 Yahoo had a 42% stake in Alibaba. Today, Yahoo’s stake in Alibaba is approximately 15%.
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[4] It is noteworthy that approximately four years before, in 2008, Yahoo was also the target of another shareholder activist, Carl Icahn, who was criticizing its then co-founder CEO Jerry Yang and Chairman of the Board Roy Bostock for not selling Yahoo to Microsoft. (Reportedly, Microsoft’s initial bid for Yahoo was $44.6 billion and its final, revised bid was $47.5 billion.) Yahoo eventually settled with Icahn, giving him and his designees three seats on its Board. In April 2016 Yahoo settled a proxy contest with another shareholder activist, Starboard Value. Yahoo appointed four Starboard Value designees to the Board.
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[5] The post discusses only the compensation and severance provided to Henrique de Castro—the subject of the Amalgamated case. It does not discuss the compensation of the Yahoo CEO, Marissa Mayer. Based on Yahoo’s proxy statements, the total compensation paid to Mayer for the period beginning July 17, 2012 (her employment start date) and ending December 31, 2015, was approximately $140 million. (This amount represents the sum of (i) salary paid, (ii) actual bonus payouts, (iii) value realized on vesting of stock awards (based on the stock price on the vesting date), (iv) value realized on exercise of options (based on the intrinsic value at exercise) and (v) value of vested options not yet exercised as of December 31, 2015 (based on the intrinsic value on that date).) This does not include any severance to which Mayer might be entitled in the event of a termination of employment.
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[6] Besides vesting, the Incentive Restricted Stock Unit award and the Performance Stock Option award were subject to cutback by a “Specified Percentage” based on the length of de Castro’s employment. This separate cutback was removed in the Final Offer Letter with the approval of the Committee. (132 A.3d at 768.)
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[7] According to the Opinion, “The Committee did not actually meet in person or by phone. …There is no evidence that the Committee evaluated the alternative of a for-cause termination or was provided with a calculation of the severance benefits that de Castro would receive.” (132 A.3d at 772.)
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[8] Alibaba was privately owned on December 31, 2013. It went public September 19, 2014. The IPO price was $68 per share, indicating a total market value of approximately $168 billion. The closing price on that date was $93.89, indicating a total market value of $231 billion. The statement in the text that Yahoo’s 24% stake was worth over $40 billion on December 31, 2013 is based on the lower of these two market value figures on September 19, 2014. (As also noted in the text, neither the Alibaba nor the Yahoo! Japan valuation reflects any tax consequences to Yahoo if it sold its interest in Alibaba and/or Yahoo! Japan.)
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[9] For discussion of the several decisions by the Delaware courts in the Disney litigation, see Lawrence Lederman, Disney Examined: A Case Study in Corporate Governance and CEO Succession, 52 N.Y.L. Sch. L. Rev. 557 (2008).
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