Golden Parachutes: Cut the Cords

CEO severance packages are out of control—much too big and used too often. Pro or con?

Pro: Outrageous Excess

Among wealthy countries, the U.S. isn’t known for its social safety net. If you’re laid off, your modest unemployment checks will come for six months—if you’re lucky enough to qualify. And with the disappearance of employer-funded pensions, retirement these days is more about clipping coupons than vacationing in Europe for most Americans.

But the safety net for the richest Americans leaving a job is quite comfortable indeed. Even though the average chief executive earns 262 times the pay of the average worker—taking in more in one workday than the worker gets in a year—CEOs are showered with luxurious rewards whenever they leave a job (see BusinessWeek.com, 2/22/06, "The Golden Parachute Club of 2006"). Whether it’s Lee Raymond’s $400 million gift as he retired from ExxonMobil (XOM) last year or John Kanas’ $185 million reward when North Folk Bancorp sold itself to Capital One Financial, it’s clear that executives need not fret as they exit the corporate stage and head for the golf course.

Not every executive’s pay package reaches triple-digit millions, but the median retirement pay for executives in the Standard & Poor’s 500-stock index is $1 million a year, says Paul Hodgson, an executive-pay expert for the Corporate Library, a corporate governance research organization. Meanwhile, half of all workers have no retirement security plan besides Social Security—a sort of old age minimum wage. Inequality in itself may not be evil, but you have to wonder if the invisible hand is whisking us back into a polarization between rich and poor akin to the era of Louis XIV.

Inequality isn’t the only problem with golden parachutes. The other issue—and one that irks shareholders more than labor advocates—is the pay-for-failure phenomenon. Violating the American ideal of meritocracy, CEOs often walk away from a job poorly done into a gilded cocoon of cash, stock options, and company-paid taxes. The most recent example is Robert Nardelli’s $210 million farewell from Home Depot (HD) after a reign remembered for a stagnating stock price and a military style of management that jarred employees.

Daniel Pedrotty, director of the investment office of the umbrella union group AFL-CIO—which manages $400 billion in assets along with the Change to Win Coalition—says that Home Depot’s decision to not offer the same "pay for pulse" package to the incoming CEO proves that "golden parachutes aren’t needed to attract talent."

So what’s the alternative to what Pedrotty calls "platinum helicopters"? It’s simple, experts say: reward performance. "That’s how you justify a hefty pay package to shareholders," says David Danovitch, a partner at Gersten Savage, a New York City law firm with small- and mid-cap clients. "It’s hard to argue with someone who’s done a good job."

Con: It’s Simply Supply and Demand

To criticize golden parachutes is to mock a free-market economy. CEOs hold out for the highest possible compensation commensurate with their credentials—don’t we all?

For positions of that level, the guarantee of a large severance package makes it less risky for an executive to jump ship and chance the tempestuous waters of hostile takeovers and management changes that regularly roil Big Business.

Even Bob Nardelli’s infamous $210 million kiss good-bye doesn’t sound so unreasonable if you look at all the facts. Nardelli came to Home Depot after running a veritable empire: GE (GE). It only made sense for Home Depot, a much smaller enterprise, to lure him with more money and the security of a stellar severance package if things didn’t work out. For Nardelli, the components that went into his severance package added up to a lot.

Let’s keep in mind that CEOs command such extraordinary compensation because they have extraordinary leadership skills.

"I’ve tried to hit a golf ball, so I understand why Tiger Woods makes $80 million a year," says Pearl Meyer, senior managing director at Steven Hall & Partners, an executive compensation consulting firm. "But most people haven’t tried to be a CEO. They see the private aircraft and parking space by the door but have no idea how difficult the job is."

The Tigers, Oprahs, and Barbra Streisands of the world command top dollar because they work hard to make the most of their special talents and possess the savvy to market themselves for maximum profitability. Ditto for CEOs.

Nonetheless, let’s remember that few chiefs get farewell hugs as big as Nardelli’s or Lee Raymond’s from ExxonMobil or John Kanas’ from North Folk Bancorp—that’s why it’s such big news when they do. And corporations are taking steps to address one of the public’s bitterest complaints about golden parachutes: "pay for poor performance."

"Lawyers are grappling with ways to clarify the small print, to specify exactly what defines a disappointing performance and how that will affect severance," says Meyer. "We’re also writing ‘claw backs’ into contracts, where executives can get their stock taken away if they violate Sarbanes-Oxley or other rules."

Reader Comments

Rich

If CEOs perform well, maybe you can make a case for paying them what they're paid. Maybe. But there is no case for large severance packages when CEOs perform poorly, regardless of their level of talent or the difficulty of the job. It makes no sense to do that. The public is angry about it, and rightly so.

Warren

Is an $80,000 car four times better than a $20,000 car, and can it complete the necessary task at four times the value? I don't believe so. Saying that, is a company executive worth X-amount greater than an average employee? Hard to define, but try. Then, did the executive summarily earn the reward primarily by himself or herself or was it a joint effort that eventually resulted in this rewarding position? How many years did Nardelli put in at Home Depot? Did he build the company to its market domination? I'm fairly certain that these outrageous sums paid to executives will go the way of the unionized highly paid auto worker as I really don't believe that the industries can support them. What they should worry about is a Bolshevik revolution, and we all know how that turned out for the Romanoffs.

Gary

I must have the world's record for corporate job loss: three corporate buyouts in five years. Each time, the company execs made off with millions, and I was lucky to get a week's pay for each year worked.

Hmmm. . .

The book Good to Great talked about the best leaders being those who put their organizations above themselves. You wonder if someone is truly a great leader if he or she chooses to leave an organization in order to get a huge severance pay package after doing a so-so job. It's funny how these organizations hire these people thinking they're getting the "best," yet they give them an economic incentive to not be a great leader—motivation to leave rather than stay with the organization and make it better.

Bern

Maybe I'm missing the concept of this discussion, but isn't the whole point of a free-market economy to allow people to choose how they spend their money? And also what companies they invest in? Yet, people still complain about this issue rather than taking action.

If you don't like this concept taking place in a company you invest in, then cash out and find somewhere else to invest. If you do think it's a good idea, leave your money where it is. If everyone's free to make this choice, why can't the investors in each individual company decide if it is appropriate for their situation? And the best part about this concept is, even if you don't like the decision your board made regarding compensation, you can just cash out.

It's a corporate decision nobody outside of the equity holders should have a say in. Unless of course, we listen to the pro-side of the argument, which suggests America's blight is caused by such measures, and businesses should be responsible not for making money but rather for fixing all the problems the author cites. Oh no, wait...they shouldn't have to do that in a free market economy;

Sue

What's wrong with a few million for a failed departing executive, while the workers eat Saltines? Let 'em eat parachute silk.

It is NOT Supply and Demand

Apologists for CEO greed would like to have us believe this is merely the free market at work.

Wrong. CEO greed has nothing to do with the free market. First, only a few people ever get to be considered for those jobs. And those making the choice tend to be friends with the candidates. Second, because they sit on one another's boards, CEOs have a vested interest in protecting the interests of their closed, self-selecting brotherhood.

If it only were about a free competition where only talent mattered! But free competition it is not. CEO selection is more reminiscent of self-selection of members in a secret guild than an open, unbiased search for the best possible talent. CEOs are members of a Skull and Bones society.

And, unlike apologists would like you to believe, a CEO job is not overly difficult. True, you have to be modestly intelligent. But, studies show that CEOs are disproportionately rewarded for simple good luck. And, when luck does not favor them, their friends take care of rewarding them instead.

Bill Caplinger

It's ridiculous. It shows they have no concern for the stockholder. They sack the company for their greed. It's definitely time for the stockholders to be able to have some input, like voting.
—BMC

Guiedo in FL

When global trades equal global wages, perhaps the people will rise up in a long-overdue revolt.

Brad

The argument that current CEO compensation practices are a natural consequence of free-market economics is a shell game, deflecting critique of some serious ailments of our society. Adam Smith is probably rolling over in his grave at the prospect of watching the devolution of society into a web of trickery, deceit, and sleight of hand. Please don't misunderstand me; we have the best system in the world, but long-term U.S. cultural and economic prospects hinge upon a balance between reward for risk and reward for right. There must be internal markers guiding leaders at all levels to ultimately do the right thing.

Jackson

The only way I will ever go back into Home Depot is if I can get proof that a portion of Nardelli's severance is returned to stockholders. Or charity. Which means they can count on me never returning. As far as I am concerned, even though what he was paid was legal, everyone involved should have known that this was wrong. Just because something is legal does not always make it right. Did you ever hear that from your mom or dad, Bob? And by that standard, I would say Nardelli is a thief who was surrounded by inept board members who should be fired, without severance. What Nardelli stole was not only money. He lost the trust and confidence of a nation. I fear that if this country ever goes to war beyond Iraq, we will have one hell of a struggle to generate any unity whatsoever, because there is so much cynicism generated by our lack of faith and trust in these so-called leaders.

JOHN

I agree with Brad that not only CEO compensation packages are shell games but also: What about stock options for these thieves? As a stock owner, I would like to receive stock at below-market prices so I can be rich, too.

Joe

Any people making more than $100,000 dollars a year with medical benefits--let alone someone making $210 million--should be ashamed of themselves if any full-time worker in their corporation doesn't make a living wage. With the technology we have today, the only reason we have the poor is because of the greedy rich.

Bill

Couple these executives with our local school superintendents and double-dipping state employees, and it's clear that compensation for performance has really lost it meaning. Our local school superintendent hasn't had a budget pass in three years and still gets a raise to $180,000 a year. A recent state employee collects about $70,000 per year pension and gets hired as a consultant for the same job he retired from for yet more money while he lives in Montana--the "job" is in New Jersey. It is wrong, and it's not the system at fault. It's just that we need to speak up more as both stockholders and voters. Spend our money to reputable companies, and vote some new blood into the political arena. Come on, Massachusetts. Must you keep sending all the Kennedys to Washington?

ps

There is now a good old-fashioned oligarchy in the U.S. as existed at the end of the 19th century. I do not have issues with CEOs making eight-figure incomes if the firm is bringing in 10- to 11-figure profits. I do have an issue with rewarding failure. Prince's exit from Citi was relatively cheap compared to the excess aloha money given to Purcell, O'Neal, and Grasso and the leech like Welch continuing to milk GE. If the boards do not control these excesses, look for the government to step in, which will be worse. The funny think is, in this shareholder society, individuals do have the power to make their feelings known. They just don't, which is very unfortunate.

John

Let's examine this "pay for performance" theory for a moment. Let's further restrict it to stock performance since it is one of the major benchmarks of company performance--always has been and always will be. Assume during a given year a company's share price rises, say, 15%. Not a bad return. When the firm's annual report comes out during the first quarter of the following year, you can bet that in next week's pay check that return will be highlighted to the nth degree. Let's also face the fact that CEOs work under separate employment contracts loaded with a rich menu of rewards. But what if this hypothetical return resulted because the overall economic environment took off that year and investors purchased its shares for no other reason than the firm operated in the "hot" market sector. Anyone remember when the stock prices of dot-com equities went to Pluto just because they were part of the hot sector of their time? Does the CEO deserve a huge bonus, because the stock happened to eclipse a certain benchmark through market dynamics and not because of anything he or she did? Likewise, when the opposite occurs--a stock gets ripped because of negative news, i.e., the current bond mess Merrill and Citi are experiencing right now--does a CEO deserve a golden parachute? Take Citi for example. It's stock has plunged more than 40% this year. The Citi shareholder has been screwed by Chuck and company, yet he will walk away with millions in cash, stock options, and other benefits. I am a capitalist at heart, but this has nothing to do with free markets. Furthermore, the often-heard spin put out by corporate communications departments, that companies have to provide such compensation packages in order to "attract and retain" top level talent, is one of the biggest lies ever bestowed on the investing public. As a former broker of a major wall street firm, I firmly believe that an increase in a firm's stock price over a year's time has less to do with the CEO and more to do with the current economic environment. Yet the CEO is rewarded because the stock price met or exceeded an established benchmark. This example is akin to praising the President with strong economic performance when it is well known the federal reserve pulls the strings by either expanding or restricting the money supply via raising or lowering key interest rates. In the end, CEOs will continue to be paid huge sums of money, insulated by their friendly board of directors, and walk off with millions when they fail. Sounds like a free-market economy to me.

Greg

Agree and disagree. When these CEOs are hired, no one can certify whether they will be star performers or not. The core of free enterprise is to risk something. After offering such hefty payment packages to lure CEOs into extremely demanding jobs and pressure, if things don't work out, you just can't decide to change the rules of play; the only thing left is to try and not make the same mistake again, probably by changing the basis of the offer. You have to remember that not every talent will excel in every place or position; you have to have the right talent. Not every frog is Prince Charming.

Steve Ellis

Parachutes should have triggers in them to protect both sides. However, in the case of a CEO who bombs out and is a failure, the company that hired him should have some covenants in the agreement--downsizing the terms of the parachute so the CEO will walk out with less. Companies might already have this in there, but I would bet they don't because they were probably so excited to get the CEO hired that they agreed to the back-end terms and didn't protect themselves. That's their fault, and the board should hold them responsible. The free lunches should end now. Also, any CEO with a big ego and an "I can do no wrong" attitude shouldn't be hired in the first place. That's trouble from Day 1. A CEO has to be a leader, make tough decisions, be direct, be accessible, be part of the mix. These ivory tower CEOs are usually a disaster. They get off on expensive lunches and dinners, corporate jets, vacations, too much golf, and sometimes even chasing women.

EF

We forget that the reason these packages can be doled out and the boards can be stuffed with members who will authorize anything for the CEO is that the government and the citizens have given the corporation the ability to exist. If these large companies were forced to be partnerships with individual liability and risk, it would be far different. Because the government has given--via our laws--a special break to corporations, the citizens should be outraged. Unfortunately, the average voter is blissfully unaware and more concerned about pseudo-issues brought up to divert his attention.

JH

No worries, anyone. All these exorbitant pay-outs to the so-called business elite are simply insider deals whose costs are passed along to everyone else. Greed is good. Plutocracy is good. If you don't believe me, ask the money changers. Start with Henry Paulson, a real U.S. patriot.

mack

The plain old simple truth is that they get no matter how they perform. It is a preponderance of idiocy for us to regulate blue collar wages while the very people responsible for these companies (and therefore the economy) run off profit/checkbook, then lay off workers in order to collect a bonus that equals up to half what the workers earned, and then pat themselves on the back.

Bob

Let's face it, you work at a company for one person only, the CEO. The stockholders, the other people at your company do not matter. Because the CEO gets his gravy when the company does well (i.e., he makes or saves them money). There have been a few companies that have had to actually borrow money to pay their CEO, because they hit that one day stock price. So remember who you are working for, and that takes the sting out of it. People get mad, hurt, or angry when something happens like a layoff, or downsizing. This is because many of us still work under the delusion that the company actually cares. Why do you think that employees are now called human capital?

Morocha

The sad part of all is that most of these executives do not do anything, and therein lies the problem as far as I am concerned. If you go into any company, the most unavailable person is the CEO--playing golf, meeting with the president, meeting with potential investors, etc. And yes, a lot of these meetings do require some aptitude and can be a huge deal in terms of the growth and the development of the company, but are these efforts worth millions of dollars? When companies submit their yearend results, they factor in the amount of money the different departments have made, and that in turn fuels the total revenue and profitability of the company, but CEOs--how much do they contribute monetary wise? There is no column on the balance sheet that says "revenues from the CEO," so why is it that they get paid so much money? Shouldn't the person who generates the most revenue be the one who gets the most pay? I don't have a problem with high executive pay; it's just that I don't see what it is that executives do that warrants such pay.

Jeff

Robert Nardelli is a jerk. After running Home Depot into the ground and not accepting a pay cut from $40 million to $20 million (how greedy can he be?), he gets to walk away with $200 million. I sold my Home Depot stock, and avoid the store like the plague. And as long as he is at the helm of Chrysler (looks like he is really doing a great job there with their latest loss), I will never buy a Chrysler product. What happened to guys like Lee Iacocca?

TomasC

Although I've never been in the shoes of a CEO, I am sure that their job must be extremely difficult (fundamental decisions which strategies to pursue, which not to pursue, a busy schedule seven days each week...etc.). Therefore, I think they should be compensated well above average, but isn't compensation 262 times higher than a salary of a regular employee too much?

The more you get, the more you want. I think that compensation packages often represent an irresistible temptation for CEOs to drive the stock price of their company up no matter what. And that is a mistake, for which we can possibly find an answer soon.

LuvMS

Having been in this position myself and lucky enough to get the big check when we were taken over by one of those glorious US investment banks, you get to understand the depth of the malaise in the system, and the only motivation is greed. They had to get a CEO, or the value of the company was compromised as were their bonuses. Why, having left another position to work for these clowns, I should be lambasted for accepting what was offered to me is a understandable, but, this is a systematic crisis of governance at all levels of the investment industry, I know who makes money for the company, it’s not the CEO or Board, it's the people who do the real work, we are just window dressing playing the game of pass the "golden goose.”

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