A few things about golden parachutes bother me:
1. The term. The term “golden parachute” is intended to convey a certain cushy lavishness. In fact, it makes no sense. A parachute made of gold will drop like a lead balloon. With a golden parachute, you won’t get a soft landing, you’ll plummet to a bone-crushing death. A parachute made of silk, canvas or sail-cloth works much better, but you never hear anyone calling an executive termination arrangement a “silk parachute.”
2. The kitchen sink lump sum. When an executive gets a golden parachute payment, it is usually reported as one lump sum amount. Outrage ensues. What isn’t reported is that the lump sum invariably includes benefits the executive has already earned, such as deferred compensation and payouts on previously-vested compensation. I’ve even seen an executive’s 401(k) balance included in his publicly-reported golden parachute. Getting paid what you previously earned might be copper or bronze, but it’s not golden. So when we get outraged over golden parachutes, let’s be sure we’re not getting outraged over the golden part, not the fool’s gold.
3. The ex post view. Golden parachutes are, by definition, paid when an executive leaves. Executives sometimes leave for good reasons, such as selling the company for a good price, but the departures that get our attention are those that are for bad reasons, such as poor performance. So viewed ex post, golden parachutes usually look bad.
There is an assumption that it is always inappropriate to pay an executive who leaves for poor performance. This is, in fact, something that the newly-proposed Shareholder Empowerment Act of 2009 would ban.
But when viewed ex ante, sometimes these payments make sense, even for poor performers. For instance, if to lure an executive to our company we need to pay her for benefits she is forfeiting at her old company, we can either reimburse her for them now or, instead, we can offer to pay them only if we terminate her early, even if that termination is because things didn’t work out. We might win that concession from her by convincing her that if things do work out at our company, she’ll make a lot more than she would have at her old company and therefore will still be ahead. But if things don’t work out, and we end up having to pay her for the forfeited benefits, outrage will ensue. And we’ll learn our lesson from the bad PR: Pay her successor up-front, even if it costs us more.
4. Tax trumps all. I’ve seen golden parachutes attacked because they are not tax-deductible or because an executive’s benefits were grossed-up. There is nothing inherently wrong with doing things that are not tax-deductible or that require a tax gross-up. Just because the government decides something is or is not taxable doesn’t mean we should or should not do it. (Look what happened when we mindlessly piled into tax-advantaged stock options. The civilization may never recover.) So in deciding whether to enter into a golden parachute arrangement, a company should consider all the relevant factors, including the tax costs. If on balance the golden parachute still makes sense, the company should do it.
5. We’re not tenured professors. A golden parachute may be needed to protect a specific deal, as in the example above. And a golden parachute can be fair when executives, well on their way to achieving a multi-year performance target, have their company sold out from under them. In situations like that it is hard to begrudge the payment (though we often do). What is easy to begrudge is the automatic golden parachute built on the presumption that by reaching the executive suite you’ve somehow earned tenure, especially when your company treats other employees as terminable at-will. It’s as if the executive suite moved to a northern European welfare state, leaving the rest of the company to toil away in Bangladeshi sweat-shops. There are situations in which golden parachutes make good sense, but these sorts of parachutes give them all a bad name.