Golden Parachute

Golden Parachute Executive Compensation Severance Package Takeover Change in Ownership Corporate Governance Employment Contracts Mergers and Acquisitions
A provision in an executive's employment contract that promises substantial severance packages if the individual is terminated or chooses to leave following a change in company ownership or a takeover.
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What is a Golden Parachute?

A golden parachute is a clause found in an employment contract. It typically includes substantial financial benefits and other perks guaranteed to senior executives if they are terminated or decide to depart due to a takeover or change in company ownership. This arrangement is commonly put in place to provide security and encourage executives to remain with the company through potentially turbulent times.

Golden parachutes may include:

  • Lump-sum or continuation of salary for a specified period
  • Stock options and bonuses
  • Health and other fringe benefits
  • Retirement benefits

These provisions are distinct from regular severance packages because they are specifically designed to be triggered by a change of control at the company level.

Examples of Golden Parachutes

  1. Executive Severance Plan: An executive is terminated seven months after a new company takes over. Per the golden parachute clause in their contract, they receive two years’ worth of salary, immediate vesting of stock options, and extended health insurance benefits.

  2. Stock Cash-out Bonus: A tech company’s CEO has a golden parachute stipulating that if the company is acquired, they receive all outstanding stock options at a 25% premium in addition to a cash lump-sum payout equal to one year’s base salary.

  3. Merger Triggered Benefits: The CFO of a company receives a golden parachute clause in their contract stating that in case of a merger, they are entitled to bonuses equivalent to two years’ base salary, retirement benefits enhancement, and immediate vesting of all long-term incentive plans.

Frequently Asked Questions (FAQs)

1. Why are golden parachutes controversial? Golden parachutes can be controversial due to the substantial financial packages they promise to executives, which may not align with the company’s financial health or shareholder interest.

2. Are golden parachutes common in all industries? While they are most common in large corporations across a variety of industries, particularly in sectors prone to mergers and acquisitions, they may not be as prevalent in smaller companies or industries with less executive turnover.

3. Do golden parachutes affect company acquisition decisions? Yes, the presence of golden parachutes can influence both the executives’ decision to support a takeover and the acquiring company’s cost considerations.

4. How is the value of a golden parachute determined? The value is usually predetermined in the executive’s contract and may be based on salary, length of service, and stock options, among other factors.

5. Are golden parachutes taxable? Yes, they are typically subject to federal, state, and sometimes local income taxes.

  • Severance Package: Compensation provided to an employee upon termination, which may include salary continuation, benefits, and stock options, but is not specifically tied to a change of control.

  • Change of Control: A scenario in which a company undergoes a significant change in ownership, such as through mergers, acquisitions, or takeovers.

  • Stock Option: An incentive that gives an employee the right to buy shares of the company stock at a later date, often at a set price.

  • Merger: A process by which two companies combine to form a new entity, potentially triggering golden parachute clauses.

  • Takeover: When one company acquires control of another, often leading to the invocation of golden parachute clauses for its executives.

Online References

Suggested Books for Further Studies

  • “Executive Compensation Best Practices” by Frederick D. Lipman and Steven E. Hall
  • “Pay Without Performance: The Unfulfilled Promise of Executive Compensation” by Lucian Bebchuk and Jesse Fried
  • “Understanding Executive Compensation and Governance: A Practical Guide” by Irving S. Becker and Maria D. Perugini

Accounting Basics: “Golden Parachute” Fundamentals Quiz

### What is a golden parachute? - [x] A clause in an executive's contract that provides benefits if they are terminated after a change in ownership. - [ ] A financial plan for early retirement. - [ ] A strategy to reduce company expenses. - [ ] A tax-saving scheme for high-income individuals. > **Explanation:** A golden parachute is a provision in an executive's employment contract that gives them substantial financial and non-financial benefits if the executive is terminated or leaves due to a change in company ownership. ### Why are golden parachutes included in executive contracts? - [ ] To reduce the company's tax obligations. - [ ] To ensure executives save for retirement. - [x] To provide security and encourage executives to stay during company transitions. - [ ] To comply with labor laws. > **Explanation:** Golden parachutes are included to provide security to executives and to encourage them to remain with the company through times of instability, such as mergers or takeovers. ### In which scenario is a golden parachute likely to be triggered? - [x] When there is a change in company ownership. - [ ] When the company files for bankruptcy. - [ ] When an executive retires voluntarily. - [ ] When the company issues dividends. > **Explanation:** Golden parachutes are specifically designed to be triggered by events involving changes in company ownership, such as a takeover or merger. ### Who typically receives a golden parachute? - [ ] All company employees. - [ ] Only junior staff. - [x] Senior executives. - [ ] Shareholders. > **Explanation:** Golden parachutes are generally designed for senior executives who occupy strategic positions within a company. ### What is a common criticism of golden parachutes? - [ ] They do not offer sufficient financial benefits. - [x] They can be excessively generous and misaligned with shareholder interests. - [ ] They are mandatory in all industries. - [ ] They often result in tax evasion. > **Explanation:** Golden parachutes can be seen as excessively generous, often resulting in criticism that they are misaligned with the company's and shareholder's financial interests. ### How does a change of control clause relate to golden parachutes? - [ ] It only applies to changes in internal policies. - [ ] It specifically triggers the activation of the golden parachute benefits. - [x] It only includes the sale of company assets. - [ ] It is unrelated to executive compensation. > **Explanation:** A change of control clause typically specifies conditions that, when met, trigger golden parachute benefits for executives. ### What tax implications do golden parachutes have? - [ ] They are exempt from all taxes. - [x] They are generally subject to federal, state, and sometimes local income taxes. - [ ] They reduce the company's overall tax burden. - [ ] They defer tax payments for executives. > **Explanation:** Golden parachutes are usually considered as taxable income, subject to various levels of taxation depending on jurisdiction. ### When do executives usually negotiate golden parachutes? - [ ] After being hired for a managerial position. - [x] During the negotiation phase prior to accepting an executive role. - [ ] After a company announces a merger. - [ ] After they are terminated. > **Explanation:** Golden parachutes are typically negotiated during the hiring process as part of an executive's employment contract. ### How can golden parachutes impact mergers and acquisitions? - [ ] They always make mergers cheaper. - [ ] They ensure immediate cost savings. - [x] They may increase the overall transaction cost due to executive compensation. - [ ] They have no impact at all. > **Explanation:** Golden parachutes can elevate transaction costs during mergers and acquisitions as they require significant compensation payouts to executives. ### What type of benefits might a golden parachute include apart from cash compensation? - [ ] Free travel only. - [x] Stock options, bonuses, health, and retirement benefits. - [ ] Only office supplies. - [ ] Licensing agreements. > **Explanation:** Apart from cash compensation, golden parachutes may include stock options, bonuses, and extended health and retirement benefits.

Thank you for exploring the comprehensive details and challenging quizzes on the concept of golden parachutes. Keep enhancing your expertise and stay ahead in the world of finance!

Tuesday, August 6, 2024
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