A golden parachute is an employment contract between a corporation and one of its top executives that provides the executive with a large sum in compensation in the event that he or she is dismissed as a result of a change in ownership of the corporation. Like most executive level severance agreements, a golden parachute is intended to provide the manager with a source of income while he or she searches for a new job. The benefits often include a generous salary and bonus payment, in addition to vested status in retirement and stock plans. Many corporations believe that offering such contracts enables them to attract and retain top executive talent, because golden parachutes allay the executives' fears about losing their jobs if the corporation should become the target of a takeover. In addition, some corporations feel that adding a golden parachute provision to the corporate bylaws acts as a deterrent to unwanted takeover attempts, since these executive payments make it very expensive for a new owner to change the corporation's management team.
The term "golden parachute" came into existence in the 1980s, when hostile takeovers became commonplace in American business. The first formal guidelines for this type of severance agreement were established by the U.S. Congress as part of the Deficit Reduction Act of 1984. Golden parachute provisions are also covered in Sections 280G and 4999 of the Internal Revenue Code. The formal guidelines state that two circumstances must be present for a golden parachute clause to be activated: there must be a change in ownership or effective control (defined as the acquisition of 20 percent of the voting stock by a single entity within one year) of the corporation or a substantial portion of its assets; and the executive must be terminated without cause, forced to relocate, or faced with a significant reduction in responsibilities as a result of the change in ownership. The tax code allows an executive to claim a "reasonable" amount of severance pay as compensation, but applies an excise tax to additional amounts it determines to be "excess" parachute payments—usually anything above three times the executive's base salary and bonus.
A 1994 survey published in HR Focus revealed that a majority of companies provide some sort of "change-in-control" protection, or golden parachutes, for their top three tiers of executives. The top tier in most companies includes chief executive officers, chief financial officers, chief operating officers, and the heads of large divisions. The second tier consists of executives reporting directly to the top tier, while the third tier is made up of middle managers reporting to the second tier. In some companies, golden parachutes cover more than 100 executives earning from $100,000 to more than $300,000 per year. According to the survey, top-level executives commonly receive their golden parachutes through special change-in-control plans, clauses in their retirement plans, clauses in their individual employment contracts, or regular severance plans.
While golden parachute agreements certainly offer advantages to top executives, some analysts have questioned whether they actually benefit a corporation's shareholders. One criticism of golden parachute agreements is that they might occasionally act as a reward for poor performance by a top executive. In general, the potential for a takeover has a policing effect on a corporation's management; some experts argue that, by making takeovers more expensive and difficult, golden parachutes may protect incompetent managers and allow them to stray from policies that would maximize shareholder value. To avoid these problems, compensation experts stress that employment contracts must be worded carefully so that the board of directors retains the right to fire an executive for poor performance without activating his or her golden parachute.
As Stephen Shmanske and Nabeela Khan pointed out in Atlantic Economic Journal, golden parachutes can also increase shareholder value by aligning the incentives of managers with those of shareholders in the event of a hostile takeover attempt. The fact that a top executive is protected from personal financial loss serves to reduce his or her incentive to mislead shareholders. In this way, managers would be less likely to adopt expensive takeover defenses to protect their own employment in cases where a takeover would actually benefit shareholders. Shmanske and Khan admitted, however, that golden parachutes make takeovers more expensive and thus may prevent some takeovers from occurring that would have increased shareholder value. The key is to carefully limit the amount of the golden parachute payment in order to balance its positive and negative aspects as a compensation tool.
[ Laurle Colller Hillstrom ]
"In Event of Change, Executives Still Have Golden Parachutes." HR Focus, September 1994, 11.
Johnson, Riva T. "Severance Packages Protect Bank Executives." Texas Banking, July 1994, 12.
Rindler, Michael E. "Use and Abuse of Golden Parachutes." Trustee, February 1994, 18.
Shmanske, Stephen, and Nabeela Khan. "Golden Parachutes, Information, and Shareholder Value." Atlantic Economic Journal, March 1995, 57.
Stahl, David. "Beating Back the Sharks." Savings and Community Banker, June 1994, 15.