Page 254 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

240 The Complete Guide to Executive Compensation

since it would result in a higher percentage of most recent pay. Conversely, no stock option
exercises, low or no bonus payments, significant deferral of pay, and rapidly increasing
earnings at the end of the five-year period would hurt the executive in a five-year formula.
Some companies promise to gross up the payment to executives to ensure they receive
the annual net of any excise taxes. In doing so, the company may also include other items in
the contract. The most common is immediate vesting of all unvested stock options and stock
awards. It may further require immediate payout. Typically, the vesting action is tied to a
single-trigger definition. Payout more likely is tied to a double-trigger event. Additionally,
some double-trigger contracts provide enhanced retirement benefits, the most liberal being
crediting service to age 65 and providing a benefit not discounted for age. Reimbursement
of all legal fees might also be added in addition to the continuation of some benefits (e.g.,
medical and life insurance) and perquisites (e.g., automobiles, financial counseling, as well as
outplacement counseling) for a limited period of time. Some may give a cash bonus of suffi-
cient size to cover the exercise cost of all outstanding stock options. Parachutes that are
significantly more liberal than the IRC-defined “golden parachutes” are often called platinum
parachutes. Although COC contracts may be exempt from the reporting and disclosure
requirements of ERISA (as a top-hat plan), companies need to review carefully to ensure
compliance.
The value of a golden parachute to an executive is clear: it is a good severance package.
The value to shareholders is that since executives are protected financially, they should not be
worried about losing their jobs and, thereby, be free to negotiate the best possible arrangement
for shareholders.
The extent to which the above is applicable is often a function of organization level. The
CEO and perhaps the next level of senior executives may have the most lucrative contracts.
The contracts of executives one level below are slightly less lucrative, and so on down
the line. If the same contract does not cover all executives equally, then it could gradually
de-liberalize for lower-level executives, smoothly transitioning pay into that provided for
non-executives.
At the time of a takeover, some companies have extended to all employees the type of
severance benefits usually reserved for executives. The all-employee protection plan is often
called a tin parachute. An example would be a plan that would double the normal severance
benefit. Thus, a company that normally provided two weeks per year of service would now
provide four weeks per year of service for any employee who lost his or her job within a
prescribed period of time (e.g., one year) after the takeover had been completed. To avoid
ERISA treatment as a pension plan, such payments must be completed within 24 months.
In designing or reviewing parachutes, it is useful to compare the payouts as well as com-
paring them to a standard termination schedule. Table 6-6 shows five possible standard termi-
nation formulas: a tin parachute of four weeks per year of service; and golden parachute
multiples of 2.99, silver parachutes of 1.99, and bronze parachutes of 0.99 of the previous
five years’ W-2 average. Increases during this five-year period of 5 percent, 10 percent, and
20 percent are shown. The higher the rate of increases, the lower the payment as a percentage
of current pay. The five-year average W-2 salary and bonus typically is lower than current-year
income; however, long-term incentive payments (including gains on exercised nonqualified
stock options) will increase the base period average.
Since parachutes are not length-of-service sensitive, they pay extremely well for short
service; however, the traditional severance formulas may pay better for longer service. This
analysis would suggest the policy pay under the more liberal of the two formulas.