Golden Parachutes Are Excessive

Merger and acquisition activity for 2005 was hot, touching $1 trillion. Gurus predict even more deals for 2006, particularity in the finance, technology and energy sectors. 

            The headline story in 2005 was the fat payouts to acquired company CEOs.

            Gillette’s CEO, James M. Kilts, will pocket an astounding $188 million in cash and stock options for selling his company to Procter & Gamble.  He earns another $6.5 million for agreeing to stay on board for one year as a vice-chairman after the deal.

            The payout was too much even for insiders.  The retiring Gillette vice-chairman, Joseph E. Mullaney described the package as “obscene.”  Kilts, speaking up after shareholders had approved the acquisition, was indignant, complaining that we had become “a piñata” and had earned his pay by creating billions in shareholder value.

He was not alone.  The CEO of Georgia-Pacific, A.D. Correll, will receive a $92 million severance package when the company is sold to Koch Industries.  MBNA CEO  Bruce L. Hammonds will similarly receive $102 million, Toys are Us Inc. CEO John H. Eyler will receive $63 million; David Dorman of AT&T will take home $55 million; and Michael D. Capellas of MCI will pocket $39 million.

            These are astounding numbers and are the tip of the iceberg.  Many other CEOs have negotiated similar promises.  On a sale of his company William W. McGuire of United Health will make $162 million, Robert L. Nardelli $114 million, J.J. Mulva of ConcoPhillips $92 million, Gary D. Forsee of Sprint Nextel $80 million, and   Kenneth I. Chenault of American Express $73 million.  The average parachute payment for CEOs of our largest one hundred corporations is a whopping $28 million.  

            In the 1980s we worried that CEOs were too reluctant to sell their companies, even when buyers offered above market prices for the stock.  We argued that incumbent CEOs were retaining the perks of office at the expense of their own shareholders.  Corporate boards fashioned “golden parachutes”, special severance payments if a company changed hands, to prevent executives from resisting reasonable deal offers. 

            Some boards have overcorrected and we now have the reverse incentive problem.  Now there is a serious question of whether CEOs are doing deals more for their own benefit than from their shareholders.  Indeed, a CEO who has mismanaged a company, attracting bidders who see an opportunity to correct a weakness, may benefit the most. 

            At minimum, CEOs may come to specialize in dressing up a company for a deal rather than manager the company long term. Capellas’s $39 million payout from MCI, for example, comes just three years after he collected $14 million for selling Compaq Computer to Hewlett-Packard.

            The stunning number of colossal parachute payments in 2005 has generated a reaction from shareholder advocates and attracted the attention of the Securities and Exchange Commission. 

            The nutty severance payments are a reminder that corporate governance in the United States has serious problems.  Boards of directors are struggling to get appropriate compensation incentive packages in place for their shareholders. In the end it is the boards of directors who must shoulder the responsibility for agreeing to such awards.

            The responsibility of boards of directors for the compensation package of CEOs is evaluated under the legal rubric of "fiduciary duty."  The Supreme Court of the State of Delaware, home to one-half of our major corporations, is considering, in the Disney case, whether to give more scrutiny than it has in the past to such board compensation decisions.  The Disney decision will affect golden parachute packages.

             The SEC, on the other hand, is likely to propose rules that force publicly traded companies to be more candid about the value of golden parachute agreements.  Much of the public shock at such payouts comes after they are made and not when the board agrees to do them because the corporations, under current rules, negotiate a pay package with a CEO and then disclose the value of the package's  future promises only obscurely and obliquely.  It is only when the money comes due after an acquisition that financial commentators are able to add up the bill.