What is a Golden Parachute?

A golden parachute is a terminology that is common with HR and compensation professionals. It is a type of compensation agreement that ensures that top company executives get huge payments if they are laid off from their positions following a merger or acquisition of the company. Typically, these agreements are subject to disclosure and in many cases, shareholder approval.

As the name suggests, the idea of the golden parachute is to provide these top executives with a safe and soft landing, cushioning the effects of their job loss. In some companies, the golden parachute payment can be given to executive leaders who leave for reasons other than mergers and acquisitions. Such payments are similar but markedly different than golden handcuffs.

Origins of the Golden Parachute

The term “golden parachute” was first used in 1961. Charles C. Tillinghast Jr., who had previously served as president and CEO of Trans World Airlines, was supposedly the first to get a golden parachute when the business was attempting to gain control from Howard Hughes. Thanks to his golden parachute, if Hughes restored control of the company and dismissed Tillinghast, his employment contract had a provision that would pay him a large sum of money.

Although this was a one-time occurrence in the 1960s, it gained popularity as a method of paying white-collar workers, particularly in the late 1970s. During the 1980s, there was an increase in the number of golden parachutes and aggressive takeovers in American corporations. According to Harvard Business Review, by 1986, more than 35% of the 250 biggest US corporations had adopted the golden parachute model, allowing them to give out huge cash bonuses and other incentives to their CEOs in the event of a change in company ownership.

How Does a Golden Parachute Work?

Golden parachute clauses are usually related to the departure of senior executives as a consequence of a merger or acquisition. Severance compensation might be a flat amount, a bonus, stock options, or the realization of previously awarded remuneration. The employment contract of most companies has explicit wording that specifies when the golden parachute provision will be activated.

Who Gets Golden Parachutes?

Golden parachutes are typically reserved for only some top executives. However, in some companies, some C-level executives (chief executive officer, chief operating officer, chief financial officer, chief legal officer, and more) and even lower-level roles that are strategically important to the Company can also have the golden parachute clause in their employment contracts.

The Purpose of a Golden Parachute

Since its inception in the 1970s and 1980s, the primary purpose of the golden parachute has been to protect chief executive officers and other high-ranking executives against probable removal from their positions in the event of mergers/acquisitions/takeovers.

Golden parachutes often encourage these top executives to accept an employment offer because of the security it offers them in a market where alternative CEO opportunities are scarce. This means that golden parachutes may be employed as recruiting and retention incentives. Top executives may be attracted to join a business by the prospect of substantial future compensation, which will keep them with the company until that big payment comes.

Also, a golden parachute may aid in aligning CEO interests with those of shareholders. Due to the protection that golden parachutes offer and the cost of covering likely-to-be-lost future profits, it would be in the chief executives’ best interests to oppose a merger or acquisition that would momentarily increase share value. The top management would have little motive to meddle in the market in pursuit of corporate control, which may include takeover offers. In fact, for some CEOs, the sale of their firm may represent a watershed moment in their careers. In addition to monetary gain, they would profit from any favorable press that would accompany the sale of the company if they received golden parachutes.

Furthermore, Golden Parachutes can dissuade an undesired or hostile acquisition of the firm since the raider is now liable for paying out substantial amounts to the CEO and other top personnel. In this setting, golden parachutes might function as both a poison pill and a deterrent against takeover efforts. Companies may set up golden parachutes in response to takeover proposals.

Examples of a Golden Parachute

Elon’s Twitter Acquisition

Elon Musk paid $44 billion for Twitter in 2022. Then Musk sacked the whole senior team, including the CEO, Parag Agrawal, who allegedly earned $57.4 million, according to The Guardian. Over 120 million dollars in golden parachute bonuses were paid out in return for Twitter’s purchase, along with other prominent executives.

Microsoft’s Acquisition of Activision Blizzard

With Microsoft’s anticipated acquisition of Activision Blizzard, Activision Blizzard CEO Bobby Kotick has found himself in the limelight. In the event that his firing from employment is unwarranted, Kotick is entitled to $15 million in compensation. Kotick also holds 6.5 million Activision Blizzard shares, either personally or indirectly. The current value of these shares is $619 million if Microsoft paid $95 per share to buy the firm.

The Staples and Office Depot Merger that Didn’t Happen

Staples and Office Depot were exploring a merger until a federal court blocked it in May 2016. Had they merged, the CEO of Office Depot, Roland Smith, would have collected $39 million under the terms of his golden parachute.

Had the merger happened, Smith would have left the Company with a $7 million severance, roughly twice his salary and annual bonus, and $32 million in restricted stock and shares tied to Office Depot’s performance.

Dell’s Merger of EMC

When Dell merged with storage giant EMC in 2016, EMC’s CEO received $27 million in compensation, according to the Hartford Business Journal. This package comprised $7 million in cash and another $20 million in EMC stock.

Pros of Golden Parachutes

Offering golden parachutes to top executives during corporate planning may provide some advantages. First, it is difficult for any organization to operate well when senior-level executives have opposing interests. Some takeovers may be beneficial to the company’s future. But if top executives are concerned about their employment, they may undermine any merger or takeover attempts. Golden parachutes also encourage employees to worry less about their compensation and actively participate in the merger’s processes if they so desire.

White-collar professionals are more likely to depart in good spirits when the conditions of their severance payment are disclosed. Because the parties are following a preset agreement, there is no remorse between them. Additionally, it protects a company from damage from essential employees who lose their jobs as a result of a merger.

Contract clauses like golden parachutes lower the likelihood of hostile takeovers. Getting rid of such an expensive package may not be acceptable if the purchasing business intends to remove the key workers who are currently operating the company.

Cons of Golden Parachutes

While golden parachutes are beneficial, they also come with some major drawbacks. Due to the amount of the payment, other workers who are eligible for a conventional severance payment do feel deprived, ignored, and less fortunate. Employee dissatisfaction can impede an organization’s ability to function correctly.

Top-level executives are often fired due to poor performance or unethical behavior. However, the golden parachute provides an incentive for these executives to make mistakes and depart their positions with huge payouts, which is unfortunate.

According to some critics, management’s responsibility is to operate in a manner that helps the organization. And as such, if a merger benefits both organizations while resulting in the layoff of a white-collar boss, the corporation is not required to give them anything more than their already high salaries and perks.

Controversies Regarding Golden Parachutes

The use of golden parachutes has its controversies. One popular argument in support of golden parachutes is that they make it easier to recruit and retain top leaders; this is especially true in merger-prone sectors. Furthermore, proponents of these expensive compensation packages argue that CEOs are better able to maintain objectivity during a merger or takeover and that the exorbitant costs of golden parachute contracts deter takeovers.

However, opponents of golden parachutes claim that CEOs are already well compensated and should not be awarded extra money just because they are fired. Opponents go even further, arguing that CEOs already have a fiduciary obligation to work in the best interests of the firm and should not need any extra financial incentive to retain neutrality and do what’s best for the business.

An Example of a Bad Golden Parachute

Certain golden parachutes are so large that they may substantially harm a company’s financial situation. For example, Marissa Mayer reportedly received $187 million in compensation after selling Yahoo’s main business to Verizon in 2016. This payment affected the business financially.

Conclusion

A golden parachute contract is a form of agreement between firms and their leadership teams. This agreement offers financial assistance to the executive team as a safety net in the event of termination. By offering a guaranteed cash stream in the event of a poor result, these agreements may incentivize CEOs to take additional risks. Giving such payments has numerous benefits, but it also runs the danger of leading to excessive spending on executive perks, which might harm the company’s bottom line.