Why Are There Golden Parachutes?

Throughout the financial crisis, I've been emailing with an old friend of mine who works in the financial industry. I imagine that I'll be quoting him in the future, but he needs to be kept pseudonymous. So I'll call him by the name of a very smart Minister of Finance, in the original Irish -- Ó Coileáin. Here he explains why bad CEOs so often get enormous bonuses as they leave the company. Basically, boards are paying bad CEOs to go away, because they're so entrenched that there's no other way to make them leave. Often enough, it's worth it.

Firing executives is impressively difficult -- boards represent investor interests only imperfectly, CEO's are far better at the political side than any collection of investors and almost any board, so getting rid of the head of almost any company is crazy hard. Now, I've yet to be firmly convinced as an investor that there's more than a tiny number of CEO's/management teams that can actually add value to a company. On the other hand, I've been astounded how much value it is possible for a bad or misguided management team to destroy and how many new and different ways a CEO can throw your money down the toilet. I can think right now of more than a few management teams my firm would happily pay millions of dollars to replace if we could get them to leave without putting up a fight. You aren't giving away the company's money (or at least you're not trying to), you're making an investment, and often one that pays excellently very quickly. Carly Fiorina left HP and the then-$50b company returned 50% in the next year, which is totally worth $21m.

So if you're trying to stop the golden parachutes, the key step seems to be making it easier to fire CEOs. I don't know exactly how you do that, but I'd be very interested in hearing ideas.

Comments

[Brodysattva]

So it's like offering amnesty from war-crimes prosecution to dictators in exchange for stepping down ...

[Neil the Ethical Werewolf]

Hadn't thought of that analogy, Brody, but it's a good one.

[marc sobel]

http://shakespearessister.blogspot.com/2008/09/temerity-size-of-texas.html

has the best suggestion and it follows Republican principles of Social Darwinism

[Shock Mouse]

I think House Dems would totally pay $5 billion right now for Cheney and Bush to step down.

[Sir Charles]

Neil,

What you need are independent directors rather than a board handpicked and dominated by the CEO.

A statutory provision to require a majority of directors be independent would be a big step.

Check out these suggestions on corporate governance by the Council of Institutional Investors.

http://www.cii.org/UserFiles/file/council%20policies/CII%20Corp%20Gov%20Policies%204-11-08%20Final.pdf

[karl]

Move your headquarters to a "right-to-work" state.

[Sir Charles]

karl,

That's funny.

[oddjob]

This is a racket, and this CEO racket has been going on for a couple of decades now. (It was years ago I first heard this explained on PBS somewhere.) I don't have a good idea about how to stop it, but it seems to me the entire manner in which CEO's of big companies are hired is rife with nasty shit like this.

[Corvus9]

That is both depressing and yet somehow reassuring. It's nice to know that it's not just a huge money giveaway, on the other hand it's really sad to think that you can't get rid of the fat cats without a huge money giveaway.

[jncam]

Neil, what need is regulation to make it easier to fire CEOs. Regulation should prevent this type of nonsense.

[BruceMcF]

Specifically, no executive receiving compensation in excess of ten times median income can receive a contract of more than two years.

That plus a requirement for independent directors would be two big regulatory steps in the right direction.

[Blitzgal]

Karl, that was my thought. Is it still hard to fire CEOs in states with "at will" employment policies? I personally know people who ended up shafted and couldn't do anything about it for this reason, but of course they were pink collar workers.

[Neil the Ethical Werewolf]

The question, jncam, is - what kind of regulatory structure do we need? Bruce's suggestion seems interesting, though I'd make the number bigger than ten.

Is it possible for the law to distinguish clearly between executives and non-executives? Because I wouldn't want to prevent some high-level programmer or scientist who was running a department or something from getting job security.

Karl and Blitzgal - I thought that states with 'at will' employment policies just permitted a certain kind of contract. That doesn't prevent people from designing other kinds of contracts, if they so choose. (Could be wrong about this -- as the kids say, IANAL.) If I understand Ó Coileáin correctly, the problem is somewhere in the intersection of how CEO contracts are written, and their ability to use their internal political powers to entrench themselves.

[Sir Charles]

At will employment simply means that one can be fired for any reason, good, bad or indifferent. The only exception would be a union collective bargaining agreement or personal contract requiring just cause for the discharge, or a successful claim that the discharge violated a federal or state law prohibiting the firing for reasons of impermissible discrimination.

The main thing you need operationally to get rid of a CEO though is an independent board of directors. This can be mandated through legislation. It won't be perfect, but it would help. And with that, maybe a provision in the law that holds the directors as fiduciaries accountable for imprudent expenditures on golden parachutes.

[Neil the Ethical Werewolf]

Sir Charles, when states have 'at will' employment, you can still write a contract in that state that doesn't permit firing for any reason whatsoever, right?

I was thinking above that it doesn't force all employment to be 'at will' employment.

[Sir Charles]

Yes -- you can have a contract that provides for just cause or some other standard for discharge. An "at will" employment state (and almost every jurisdiction falls under this category in the U.S.) doesn't set any standard for the termination of employees or impose any obligations on employers in this realm.

[Scott K]

From what I understand:

-The board of directors are supposed to be elected by the stockholders in a corporation.

-Current law allows the "management" to assume that a stockholder that does not bother to vote to be a vote in favor of their position.

-In today's market, many stockholders are simply investors who do not really care about the company's operation as long as they make money, and if this does not happen, they do not become more actively involved in said operation-- they just sell their shares.

It seems like a simple solution would be to change the laws to mandate that the final verdict on stockholder votes be based on the actual votes cast, rather than the total number of shares. That seems like a easier sell, politically, since it can be viewed as a way to make the company accountable to its owners. It would also cause the board of directors to answer directly to the shareholders rather than fight against the status quo. Independence is a rather difficult measure to enforce, I think, in today's incestuous world of executives.

[jean]

Why are these people hired OVER AND OVER?