Staying marketable with Golden Parachutes.

Increased takeover activity has forced companies to review Golden Parachutes for their top management. 

VLSI Technology takes care of its employees in case of a takeover bid.

The Board of directors at VLSI Technology Inc. have adopted an employee retention plan using Golden Parachutes for its 27 top executives, to protect the employees against a possible takeover by Royal Philips Electronics. Royal Philips could use the takeover bid to attract the senior management of VLSI Technology. This would lead to a ‘shift” in loyalty among VLSI executives, which would be detrimental to the interests of the company. Hence golden parachutes, which involved large sums of money, were offered to the employees in order to retain them.

The terms of the ‘Parachute’ included:

• Lump sum payments that was twice the executive’s annual base salary.

• Continued medical benefits.

• Personal computer for all the 27 employees.

Golden Parachutes envisage a provision in the employment contracts of top management providing for compensation for loss of jobs following a change of control. This anti-takeover strategy is usually adopted as a precautionary measure by the companies against mergers and takeovers.

Forms of a Golden Parachute:

These tools usually come in a variety of forms, which include:

• Continuation of the salary

• Bonus and/or certain benefits and perquisites

• Retirement benefits

• Accelerated vesting of stock incentives

To decide on the form of the Golden Parachute, the compensation committee of the company should:

Firstly, seek inputs from both legal and compensation consultants. They must then base their decisions on the information obtained on the competitive practices in concerned industries. The committee should also understand how severance agreements operate, circumstances under which they could be triggered, and the approximate costs under alternative scenarios.

“ The renewed attention to golden parachutes isn’t surprising, given today’s active merger climate” says Paula Todd, a senior consultant on executive compensation.

When and why is this strategy used?

When…

Protection is provided to the employees in the wake of two events.

• Controlling stake of the company changes hands

• Individual employees get terminated from their jobs due to a change in the control of management.

This “double trigger” initiates the company to go in for the anti-takeover strategy.

Why…

• To maintain the competitiveness of the organisation’s executive compensation.

• To help a company attract and retain a qualified management team who will act in the best
  financial interests of shareholders, even under the threat of a takeover.

Elaborating on why the Golden Parachute strategy is used in the event of a possible takeover.

1) Takeovers or consolidations may bring about the need to recruit or retain executives due to a change   in the organisation’s structure.

2) Consolidations may lead to redundancies in many executive positions. Hence to remove these redundancies, a good attractive compensation package must be offered to the executives.

• To provide an equity type bonus, which enables senior executives to share in payoffs to shareholders beyond increase in value of stock and options owned by them.

• To protect executives of a company against significant negative personal as well as financial consequences that result from a change in control. This strategy helps to keep executives focused on shareholders interests, rather than on their own interests. This in turn helps to curb the senior manager’s natural inclination to  “drag their feet” when they are presented with the prospect of the business changing hands.

Evaluating the Tax aspect of golden parachutes

Companies have many alternatives to provide the payments and deal with the taxes thus generated.

The two most popular tax approaches for golden parachutes are:

• The cutback approach

In this case, the company pays the employee up to a certain threshold limit. Here, the company can deduct the full amount of the parachute payment and the employee is not subject to any excise taxes. The additional compensation that the employee receives in this case is less.

• The gross-up approach

In this case, the company absorbs the non-deductible portion of the payment above the threshold limit.

In addition, the company increases the payment to the employee to compensate for excise taxes.

Conclusion

Golden parachutes can be an expensive option for some companies, but benefits that companies obtain far outweighs the costs. Hence they are considered a very favourable tool.

Related reading  

“Gentlemen, Don your Parachutes: VLSI technology takes care of its own in case of a takeover.” By Jeff Dorsch

“Increased takeover activity has companies reviewing Golden Parachute Provisions for their top management group” New York business week Dec 7, 1999