Golden Parachute

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Golden Parachute

An agreement that provides key executives with generous severance pay and other benefits in the event that their employment is terminated as a result of a change of ownership at their employer corporation; known more formally as a change-of-control agreement.

Golden parachutes are provided by a firm's board of directors and, depending on the laws of the state in which the company is incorporated, may require shareholder approval. These agreements compensate executives in the event that they lose their job or quit because they have suffered a reduction in power or status following a change of ownership of their employer corporation. Some golden parachutes are triggered even if the control of the corporation does not change completely; such parachutes open after a certain percentage of the corporation's stock is acquired.

Golden parachutes have been justified on three grounds. First, they may enable corporations that are prime takeover targets to hire and retain high-quality executives who would otherwise be reluctant to work for them. Second, since the parachutes add to the cost of acquiring a corporation, they may discourage takeover bids. Finally, if a takeover bid does occur, executives with a golden parachute are more likely to respond in a manner that will benefit the shareholders. Without a golden parachute, executives might resist a takeover that would be in the interests of the shareholders, in order to save their own job.

As golden parachutes have grown increasingly lucrative, they have come under criticism from shareholders who argue that they are a waste of corporate assets. These shareholders point out that managers already have a fiduciary duty to act in the best interests of their shareholders and should not require golden parachutes as an incentive. Especially suspect are large parachutes that are awarded once a takeover bid has been announced. Critics charge that these last-minute parachutes are little more than going-away presents for the executives and may encourage them to work for the takeover at the expense of the shareholders.

As the practice of offering golden parachutes became more and more common in the 1980s, efforts to place restrictions on the agreements increased. Many of these efforts stemmed from the realization that the practice, which had once showed a positive stock return for shareholders, was now producing negative stock returns.

On February 6, 1996, the Federal Deposit Insurance Corporation (FDIC) issued a final rule that restricted troubled banks, thrifts, and holding companies from making golden parachute payments. Exceptions to the rule are allowed for individuals who have qualified for Pension and retirement plans. Other exceptions permit the FDIC to enforce the spirit of the law by allowing legitimate payments but stopping payments that might be considered abusive or improper. The rule also prevents FDIC-insured institutions from paying the legal expenses of employees who are the subject of related enforcement proceedings. The rule went into effect on April 1, 1996.

Further readings

Mogavero, Damian J., and Michael F. Toyne. 1995. "The Impact of Golden Parachutes on Fortune 500 Stock Returns: A Reexamination of the Evidence." Quarterly Journal of Business and Economics 34: 4.

"New Powers: FDIC Cuts Down Golden Parachutes." 1995. The Banking Attorney. 5: 12.

West's Encyclopedia of American Law, edition 2. Copyright 2008 The Gale Group, Inc. All rights reserved.
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