Golden Parachutes Encourage CEOs to Abandon Shareholder Interests During Takeovers, New Study Finds

Golden parachutes – the typically lucrative payments made to CEOs when their company is acquired or their employment is terminated – encourage CEOs to put personal gain before shareholder interests, say scholars in Philadelphia and London.  Their research shows that CEOs who have these generous severance deals are more likely to settle for lower acquisition premiums – typically selling their firms for $249 million (£158m) less, on average.

The study was conducted by Ralph Walkling, a finance professor and executive director of the Center for Corporate Governance in the LeBow College of Business at Drexel University; Eliezer Fich, an associate professor of finance at Drexel LeBow and a Center fellow;  and Anh Tran of the Cass Business School, which is part of City University London; he recently earned his Ph.D. at Drexel LeBow.

Their study examined more than 850 acquisitions announced in the United States between 1999 and 2007, examining the relative importance of golden parachutes to CEOs when all other parts of their merger pay package, including potential loss of earnings, were taken into account. The findings showed that a 10 percent increase in the importance of the parachute relative to the merger pay package was linked to a 5 percent fall in acquisition premium -- amounting to a shortfall averaging $249 million in deal value.

Golden parachutes have come under recent attack in the United Kingdom after Business Secretary Vince Cable condemned directors who “forget their wider duties when a fat check is waved before them.”  He promised to review the way pay incentives for top managers are drawn up.  In the United States, the Obama administration has imposed limits on parachute payments to rein in executive compensation at companies bailed out by the government.

“Golden parachutes began appearing 20 or more years ago as a way for companies to attract and retain talented executives,” said Drexel LeBow’s Walkling. “But their effect too often is to encourage CEOs to act against the interests of their own companies and its shareholders. An improper balance in an executive’s pay package can generate a rush to sell on one hand or improper resistance to acquisition attempts on the other, regardless of the price offered.”

“If a golden parachute protects CEOs from a severe loss of personal wealth during a takeover, they behave differently than if they were fully exposed to the loss,” Tran added.  “A trivial parachute relative to a large loss in future earnings is unlikely to motivate an executive to consent to a takeover of their firm.  But an overly generous parachute relative to their full pay package could induce them to sell at a bargain price.”

The research is entitled On the Importance of Golden Parachutes.