Golden Parachute- Meaning, Examples, Pros, and Cons

Golden parachute refers to the process where a large amount of money is offered to the top executives of the company as compensation for leaving their positions. Although the practice is widespread, growing scrutiny and shifting trends are pushing for closer alignment with shareholder interests and the overall performance of the companies. This blog will offer you complete knowledge of the term Golden Parachute. You will learn what it is, how this term came into existence, and how it works, along with examples of golden parachutes in real life.

Meaning of Golden Parachute

A golden parachute provides benefits to employees, usually executives, in the event of involuntary termination triggered by a “change-in-control” This is the case when a company is acquired, merged (two companies are combined into one) or bought out. In such situations, the executives concerned receive compensation packages that are designed to ease the impact of their departure and provide financial security during the transition phases in the ownership or structure of the company.

The purpose of a golden parachute is to ensure that these executives receive significant financial benefits and incentives even if their employment is terminated as a result of the change of ownership. Golden parachutes include retiring allowance in the form of cash, stock options, bonuses, and other benefits. One recent example of the golden parachute is John Foley, CEO of Peloton, who received an amount worth about US$225 million on stepping down, according to the Bloomberg index.

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History of Golden Parachute

The term “golden parachute” was first introduced in 1961 during a situation involving Howard Hughes and former president and CEO of Trans World Airlines, Charles C. Tillinghast Jr. Shareholders, attempting to remove Hughes from control, provided Charles C. Tillinghast Jr. with an employment contract. That contract contained a clause that would compensate him if he lost his job due to Hughes taking back control of the company.

The use of golden parachutes significantly increased in the early 1980s due to a rise in mergers and acquisitions. These transactions often led to changes in management and raised concerns among executives about the potential loss of their jobs or the reduction of their compensation packages. In response to this uncertainty, companies began to include golden parachute clauses in employment contracts and executive compensation packages.

How Does the Golden Parachute Work?

As we already know, to receive golden parachute benefits, an executive must be terminated from his position because of a company takeover or merger. The whole working of the golden parachute is explained below:

A Golden Parachute agreement is created that contains the outline of the benefits that the executive will be provided with after his termination, along with other terms and conditions. This agreement serves as a safety net, offering executives financial protection and benefits.
Then the benefits of a golden parachute are specified in the contract. These benefits can be in the form of cash payments, stock options, bonuses, pension enhancements, or other perks. Apart from these, the other golden parachute benefits include retirement benefits, continued enrollment in the company’s pension plans, paid dental and medical insurance, and reimbursement for legal fees.
Afterward, the calculation of these monetary and non-monetary benefits is done. The specific formula for calculating payments is generally outlined in the executive’s agreement.
The Golden Parachute agreement is then approved by the company’s board of directors and, in some cases, by shareholders.

Public companies are also required to disclose executive compensation, including golden parachute arrangements, in their proxy statements.

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Golden Parachute and Its Controversy

Golden parachutes can be seen as a way to align the interests of executives with shareholders and prevent resistance to potential mergers or acquisitions. However, they can also be controversial. Critics argue that:

Golden Parachute can lead to excessive compensation for executives, even in cases where their performance may not justify such significant payouts.
Executives, who are already well-compensated, should not require additional financial incentives to cope with the common professional risk of job termination.
It might encourage executives to prioritize personal financial gain over the long-term success and stability of the company during times of change in control.

Shareholders also often express dissatisfaction with golden parachutes. They believe that executives are receiving substantial payouts while shareholders may be experiencing losses or reduced returns on their investments. The costs associated with golden parachute payouts may be viewed as diverting resources that could otherwise be used for investment in the business or returned to shareholders.

To align executive compensation with the company’s performance and to recover compensation in cases of financial mismanagement, some businesses have increased the use of performance-based metrics and refund policies.

Examples of Golden Parachute

Some examples of golden parachutes that were highlighted in the media include:

Following the acquisition of Twitter in 2022 by Elon Musk, he fired the company’s executive management team, including CEO Parag Agrawal. Parag received a severance package worth US$57.4 million, while other top executives also received significant payouts, leading to scrutiny of the significant golden parachutes in this acquisition.

In 2016, Meg Whitman, the CEO of Hewlett-Packard Enterprise, was in line to receive nearly US$91 million if the company underwent an acquisition under her leadership. Additionally, she was assured over US$51 million in compensation in case of termination. Ultimately, she received a US$35.6 million severance package under her golden parachute clause. This case became a point of conflict at the time because of the company’s layoffs and downsizing.

In 2016, Dell successfully merged with storage giant EMC. According to the terms of his golden parachute, EMC’s CEO received $27 million in compensation.

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Benefits of Golden Parachute

Supporters of golden parachutes contend that these arrangements offer advantages to stockholders:

1. Encouraging the Recruitment and Retention of Executives: Golden parachutes are seen as a tool to attract and retain top-tier executives, particularly in industries prone to mergers. By providing executives with financial security in the event of a takeover, companies may find it easier to recruit and maintain skilled leadership.

2. Maintaining Executive Objectivity During Takeovers: If the executives are guaranteed financial security in the event of a possible job loss, they may be discouraged from making decisions based only on feelings of personal disagreement regarding their positions. Golden parachutes help executives remain impartial and focused on the company’s best interests during the takeover process.

3. Opposing Takeover Attempts: Golden parachutes are viewed as a defense against takeover attempts. This approach is often an element of a bigger poison pill strategy, which increases the difficulty and expense of control acquisition for potential acquirers. This is believed to protect the company and its long-term interests.

4. Encouraging the Achievement of Long-Term Objectives: It is said that golden parachutes help CEOs implement long-term organizational goals by providing a safety net in times of change.

Top 10 Golden Parachutes

Regardless of your opinion, some golden parachutes are undeniably crazy. A glimpse of ten of the most striking ones is provided below:

Hank McKinnell, CEO of Pfizer, received a US$188 million severance package after his resignation, even after a 44% decline in the company’s stock value since he took over in 2001.
When the CEO of General Electric, John F. Welch Jr. retired, he was given a US$417 million severance payout, which at the time was the biggest in corporate history.
Edward E. Whitacre Jr., CEO of General Motors, received an amount of more than US$200 million.
Home Depot CEO Robert L. Nardelli received a departure package worth around US$210 million after resigning from the company.
When John Kanas stepped down as CEO of North Fork Bank, he received both a severance package and a retirement package totaling an amount equal to US$214 million.
When Lee R. Raymond retired from Exxon Mobil, he received approximately $400 million, which includes a pension, stock options, and other benefits like a US$1 million consulting contract, personal security, home security for two years, a car and driver, and business jet use for business travel.
Fred Hassan, the chief executive of Schering-Plough, received a payout of US$189 million for his company’s merger with Merck.
UnitedHealth Group CEO William D. McGuire’s rewards came in the form of stock options worth US$1.6 billion, to be exact, but he took advantage of some of them on the days when the company’s stock price fell, making money when the stocks rose once more.
When Louis Gerstner stepped down as CEO of IBM in 2002, he was paid a severance package worth US$189 million by IBM.
Thomas Ryan left his position as CEO of CVS, and he received US$185 million in severance pay from the company.

Conclusion

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What is a Golden Parachute?

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