Less Is More
When it comes to CEO severance more companies are rethinking first principles.
October 29 2007 by Chief Executive
There are few subjects as toxic as CEO severance, especially when it comes to so-called “pay for failure” as when a CEO is politely shown the door when performance has been lackluster. Every so often another outrage du jour inflames critics who fulminate about CEO compensation that is said to be out of control. The most celebrated cases were Michael Ovitz’ disastrous 14 month tenure as CEO of Disney where he walked away with a total payout of $140 million. When Hank McKinnell was forced out at Pfizer after five years and a continuous slide in the share price he walked away with $180 million. Then there is everyone’s favorite, Bob Nardelli’s departure from Home Depot after six years. His severance payment came to an eye-popping $210 million. Carly Fiorina who was pushed out after five years received only $42 million. Yahoo’s Terry Semel actually departed without any severance but he earned $400 million during his three years with the company.
Some these payments were the lump sums of total pensions, long-term compensation and stock or restricted stock awards accumulated over the length of the CEO’s tenure. And some, properly understood were actually part of the hiring costs incurred in attracting top talent. Everyone forgets that Nardelli, for example, was hired in 2000 at the very top of the pay-for-talent market where the GE options he had coming had to be compensated for.
It’s worth noting that many tech companies do not make severance arrangements at all. Cisco, Google, Intel, and Microsoft do not have exit packages for their senior executives. Many critics of CEO pay like it that way. However, this is not the norm. According to research by Equilar, a compensation research firm, the median potential CEO severance for companies in the Fortune 200 is about $21 million. (Here severance compensation is defined as payments arising as a result of termination without cause. They are calculated as the aggregate of lump-sum cash, value of accelerated equity, continued benefits including retirement and deferred compensation plans and any tax gross up payments.)
Other findings include:
- Among Fortune 250 firms, 17.5 percent of CEOs have no severance or change-in-control coverage. 57.7 percent of CEOs have both severance and change-in-control coverage and 24.8 percent of CEOs have one or the other.
- Tax gross-up payments are far more prevalent in CEO change-in-control packages, appearing 48.3 percent of the time; as opposed to 4.7 percent of the time for severance packages.
- For CEOs with a change-in-control agreement in place, 80.4 percent of lump-sum cash payments require a double trigger. Among CEOs with a change-in-control agreement or incentive plans that allow for the acceleration of equity, 60.3 percent receive payments with only a single trigger.
In a recent blog Equilar CEO David Chun called attention to an interesting countertrend: Companies that are ratcheting severance packages downwards. In the vanguard is Cardinal Health, the
In the employment contract for Cardinal CEO R. Kerry Clark, a former vice chairman of Procter & Gamble, the multiple of base salary and bonus that the company would pay to
As far as Chun can tell no other company has been as creative in using a declining multiple in its severance arrangement which addresses a major concern of shareholders. However, he does point to Madison, NJ based Wyeth for having revisited its severance plans in a major way. In the company’s 1998 plan payouts included multiples of cash, bonus and long term incentives and other rewards. In 2006, it redefined this downward to include only cash and bonues drawing down a possible payout from $65 million for CEO Robert essner to a mere $22 million. Not chump change, but hey, a $40 million drop is not trivial.
In addition, AT&T also made an effort in this direction by redefining change in control. Earlier under Ed Whitacre as boss the change in control provision was triggered if 35 percent of the shares were controlled by another entity. This year the board figured maybe this wasn’t really a change in control so it redefined the trigger to be 50 percent. Small steps to be sure, but a beginning. Chun says that it’s too early to tell whether these cases are anomalies or the beginnings of a countertrend. For exmple, many boards have adopted policies which require the company to seek shareholder approval for future severance payments that exceed 2.99 times an executive’s base salary and bonus. Such policies are now in force at Alcoa, AT&T, GM, HP, Marathon Oil, McKesson, Prudential Financial, Safeway, Sprint Nextel (2.00 times), Verizon Communications, and Wachovia.
But Chun does see boards and management taking a closer look at exit packages that need to be brought in line with shareholder sensibilities. To paraphrase Martha Stewart, that is a good thing.