Directors & Boards: Column

Home |

Subscriptions |

Articles Archive |

Current Issue |

Back Issues |

Shopping

Advertising |

List Rental |

Editorial Calendar |

Background |

Column

Robert H. Rock,
Publisher,
Directors & Boards

Time to Revisit Your CIC Agreements

To avoid embarrassment and deal complications, the compensation committee should demand detailed estimates of total change-in-control liabilities.

By Robert H. Rock

The headline of a recent Wall Street Journal article suggested: “Want a Bonus? Acquire a Company.”

The so-called “I Must Do a Merger Bonus” rewards a CEO for deal-making, and many CEOs have been rewarded handsomely for growing their companies through acquisition. However, given the gargantuan size of some golden parachutes, perhaps a more appropriate headline would read: “Want a really big bonus? Sell your company!”

If a CEO wants to get rich fast, selling out is often the way to do it. The typical change-in-control (CIC) agreement provides a CEO with a raft of lucrative payments, which typically include three years of pay and bonus, accelerated vesting of stock options, and enhanced retirement benefits. Some agreements go further, often much further.

For example, some contracts provide for three times average annual W-2 compensation, and thus recent option exercises greatly enhance the CIC payment. Some agreements promise to gross up payments to ensure executives receive the net of any excise taxes. In terms of enhanced retirement benefits, the most liberal CIC agreements credit service to age 65, provide a benefit not discounted for age, and continue certain benefits and perquisites such as medical insurance and automobile usage. As a result, it is not uncommon for parachute payments to be in the tens of millions of dollars.

For an executive, a golden parachute is a very good severance package. For the shareholder, it provides financial security for top management, enabling them to more objectively negotiate the best deal without giving undue consideration to their own continuing employment. Without a golden parachute, an entrenched management might suppress or even sabotage a buyout proposal.

But CIC arrangements may encourage a CEO to sell out. The lure of a big payday can captivate a CEO, stimulating him to convince first himself and then his board that the time is right to sell. Once a CEO starts contemplating a sale, and calculating his personal take, the desire to get a deal done can be overwhelming. He can taste it! A CEO nearing retirement is particularly susceptible to this siren call. Rather than quietly going off into retirement, he can go out in a blaze of glory, convinced that he rightfully enriched his shareholders as well as himself.

As M&A activity picks up, the compensation committee should demand detailed estimates of total CIC liabilities in the event of a transaction. The cost of these agreements should be calculated, by individual, and disclosed to the full board. If the estimate of the total CIC liabilities is more than 3-4 percent of the value of a possible transaction, the board should question the reasonableness of the arrangements and should consider reducing CIC benefit levels. They should consider scaling back CIC benefits by eliminating gross-up payments, installing double triggers, incorporating mitigation clauses, and capping at the Section 280G limit.

To avoid embarrassment, lawsuits, and deal complications, boards must carefully analyze and in some cases redesign their CIC arrangements.

Robert H. Rock is Chairman and Publisher of Directors & Boards