There is a lot of angst, and sometimes justifiable anger, against the large severance packages made to departing CEOs. Previously, these severance deals of CEOs only came to light after their exit. However, since 2006, the Securities and Exchange Commission requires data on CEO compensation in the US to be transparent. Data is still hard to collate, but the average exit package (often referred to as “golden parachute” in popular press) for CEOs of S&P 500 companies appears to be two to three times of their annual compensation.
A Google search of the 10 largest golden parachutes reveals that $100 million just about gets you on the list, which tops at a whopping $417 million paid to Jack Welch of General Electric. Yes, $417 million, and he left in a cloud because of the way he had abused company perquisites for personal use. No wonder, shareholder activists as well as many observers are outraged at these separation packages, especially when they are awarded to CEOs who have either served a short tenure or failed.
Even severance packages of successful CEOs are hard for the public to swallow. For example, Danny Vasella of Novartis was to be paid 72 million Swiss Francs over six years, provided he did not go to work for the competition. This ignited an initiative banning such golden parachutes, which was put to Swiss voters as a public referendum. The Swiss, despite their pragmatism and business friendly attitude, still voted 68% in favour of the ban. It was favoured by a majority in all the 26 Swiss cantons.
I understand the public furore over this, and until recently, had little sympathy for such CEO exit packages. However, at the risk of eliciting rebuke and derision, let me argue why I have had a change of heart on this issue. While one may legitimately question the amount awarded, there are sound reasons for the existence of golden parachutes for CEOs.
Risky proposition
Most golden parachutes are negotiated by incoming CEOs who have been hired from outside the organisation. One must realise that when hiring a new CEO, the pool is existing successful CEOs unless it is an internal promotion.
An external candidate views the potential CEO opening as a risky proposition. Here you are a successful CEO, comfortable in the organisation you are leading, having negotiated the rules of engagement with important stakeholders. Now you are presented an option where you do not know the company, its problems, the depth of management, or the board of directors and their quirks.
Yes, the interviewing process yields some information, but as has been famously quipped: an interview is a conversation between two liars. The candidates present themselves as great and the company itself as perfect.
To accept the risk of leaving a known devil for an unknown one, it is not surprising that the incoming CEO negotiates a golden parachute. This is especially true if the previous CEO was fired, as it signals to the incoming CEO that this board has a penchant for letting CEOs go. Furthermore, in the euphoria of having found their “man”, the board and the recruitment committee are happy to agree to a golden parachute because it has no immediate cost to the company. In any case, at this stage of the process, the possibility of the incoming CEO’s exit is furthest from their mind.
Sinners and saints
Boards of directors get most of the blame for excessive CEO pay. In my experience, many boards are easily manipulated by the CEO if the CEO has occupied that position for a few years. Yet, there is at least one rational reason for a CEO golden parachute from the shareholders’ perspective. It makes the CEO less likely to stand in the way of the company being potentially acquired.
As we know from the literature on acquisitions, being acquired is value accretive for the shareholders as the acquirer pays a premium for this privilege. The last thing you want as a shareholder in the target company is the CEO worrying about their own future, and therefore, putting a spanner in the works.
Finally, CEOs have a lot of sensitive information on the company. Regardless of how well run and ethical the organisation may have been, there are always skeletons in the closet. As I have frequently observed, let us not forget that within the space of a day, we are all both sinners and saints. No one is perfect and it does not help to deify organisations or individuals. The silence of the outgoing CEO is valuable and more likely if the separation is on friendly terms.
To comprehend the costs of an unamicable CEO exit, one only needs to observe the $13 billion market cap decline for Tata Group listed companies in the seven weeks since Cyrus Mistry was unceremoniously removed as Chairman of Tata Sons. I do not wish to be misunderstood. Please note that monetary terms of his exit were not an issue for Mistry.
I am simply using the incident to draw the more general conclusion that it is in the best interests of the shareholders for CEO exits to be as non-controversial and amicable as possible. The potential erosion of billions of dollars in shareholder wealth puts into perspective CEO golden parachutes that run into millions of dollars.
Nirmalya Kumar is a visiting professor of marketing and London Business School and distinguished Fellow at INSEAD Emerging Markets Institute.
