In the midst of all of the chatter about the
economic fiasco bailout package, the term “golden parachute” has been bandied about quite a bit. Most folks know it has something to do with executive compensation – but what the heck is it?
A golden parachute is an agreement between a company and an employee that allows for compensation and benefits at the employee’s termination, usually when control of the company changes. Since most companies aren’t eager to extend benefits to employees like you and I on termination, the term really applies to executives – they’re the ones with leverage to make these kinds of demands.
Companies agree to these packages as a way of attracting and retaining candidates for executive positions. Executives like them because they rarely include a requirement that the executive perform well in order to be compensated (see AIG, Bear Stearns, etc.).
The term was traditionally used as a specific clause which would provide a pay-out in the case that the company was acquired – the idea was that the “parachute” would cushion the fall. The first time the term was used in corporate history referred to the takeover of TWA airlines. In 1961, as creditors tried to push out Howard Hughes, Charles C. Tillinghast Jr. was guaranteed a significant pay out in the event that Hughes remained in control of TWA. The concern was that Hughes would fire Tillinghast out of revenge; Tillinghast stayed at TWA for 15 more years.
Since the days of Tillinghast, the trigger events for golden parachute payments have changed. In most cases, the shift of control need not be hostile (friendly takeovers and mergers may cause a trigger) and indeed, the numbers of shares changing hands need not be a majority. Even though the trigger events are becoming more lax, the payouts are getting bigger.
One of the most famous golden parachute compensation packages in recent years belonged to Senator McCain’s economic advisor, Carly Fiorina. Under Fiorina’s watch as CEO of Hewlett-Packard, corporate shares plummeted more than 50% and the company suffered huge job losses. Fiorina was fired in 2005. She received $21 million in severance pay after her firing and an additional $21 million in stock options and pension benefits, bringing her total payout to $42 million. As a result of the payout, company shareholders filed suit against both Hewlett Packard and Fiorina personally, hoping to salvage some of the funds paid out to Fiorina.
Other notable golden parachute payouts?
Angelo Mozilo of Countrywide was entitled to a $37.5 million severance package when Countrywide was acquired by Bank of America. He didn’t take the severance after bowing to public pressure but did cash in stock options, walking away with an estimated $129 million. Mozilo was (in)famous for complaining about opposition to his compensation in an email that read:
Boards have been placed under enormous pressure by the left-wing anti-business press and the envious leaders of unions and other so-called “C.E.O. Comp Watchers.”
Richard Fuld of Lehman Brothers received about $22 million as a severance package when Lehman was sold. He also redeemed nearly half a billion – $490 million – worth of stock. The New York Times has placed his compensation for ruining the company at $17,000/hour.
Kerry Killinger of WaMu received $44 million in September when he left office. Alan Fishman took over for him and worked less than three weeks before the economic collapse. He is expected to walk away with between $16 and $20 million for less than a month’s worth of work.
Similarly, at Wachovia, Ken Thompson received $5 million in severance when he was voted out this year; he had pocketed nearly $30 million in stock and options during the prior two years. His replacement, who was on the job for about 3 months prior to the bids by Wells Fargo and Citibank, stands to leave with up to $12 million.
And who lost out on the golden parachutes? Bowing to public pressure and government scrutiny, the Federal Housing Finance Agency refused to reward CEOs that killed their companies. Daniel Mudd of Fannie Mae was denied his golden parachute by the FHFA. Similarly, Richard Syron of Freddie Mac, was also denied a significant severance.
What are the tax consequences for these plans? Congress has actually imposed serious tax consequences in an effort to limit the use of the plans (psst, Congress, it’s not working). Excise taxes of an additional 20% or so are added to income tax in the case of plans that are considered excessive. Excessive plans are those with packages which exceed “normal” compensation by a factor of three. So, of course, instead of limiting exit compensation to three times normal compensation, executives generally bargain with the tax bite in mind… if you want to net $20 million, you request $25 million.
But (and you knew there was a but) payments to or from some qualified plans, such as pension, profit-sharing and stock bonus plan plans, are exempt from tax penalties. Additionally, if you take a peek at the compensation packages for most of these CEOs, you’ll see that a lot of the payout came in the form of stocks and options paid out in the year prior to ousting. This is not surprising; it’s an additional way of limiting the company’s exposure to tax under the golden parachute rules, which imposes restrictions on the timing of payments.
Congress has also deemed golden parachute payments not deductible to the employer, unlike regular wages – the result of which is that the shareholders, not the executive, gets hit. Excise taxes paid by the executive are not deductible to the recipient, but then that’s not really a problem since most federal income taxes are not deductible to taxpayers anyway.
The rules and exemptions under the plans are extensive. I can barely wade through them myself after an entire semester of the tax benefits of employee compensation… But that’s why these companies have armies of tax professionals on their side, hoping to limit their tax consequences and make their executives happy. So far, what appears to have happened is that executives are getting a whole lot of payments for nothing… Tax laws have not served as a deterrent to excessive payments as Congress might have hoped. Perhaps outside of the bailout package, some additional restrictions are in order? I sure hope so.