Saturday, January 13, 2007

A peek inside executive severance agreements

The outrage over Bob Nardelli's and Hank McKinnell's multi-hundred million dollar severance agreements still hangs like a cloud over US business. But lost in the outrage is exactly how these severance agreements came to be, and why they look the way they look.

The most misleading impression these articles give is that the board of directors decided to reward the outgoing CEO for his years of service, and thus packed his briefcase with stock options, deferred compensation and cash as a way of saying thanks. (Here's one of the only articles I saw that explained the issue clearly.)

Nonsense. They'd prefer in these situations to pay nothing, even to claw back some of the existing millions they'd paid out.

But the severance agreement is signed when the CEO is hired, not when she's fired. In many cases, when the CEO is lured from another company (say, GE), the employment contract--which covers severance--includes "make-goods" for compensation the CEO is leaving behind (like unvested options, pensions, etc.).

When the CEO is fired, the company needs to pay up on these make-goods or other partially-earned awards. It's in the contract--not optional.

And remember, when the employment contract is negotiated, the prospective CEO has a lot of leverage. She'll hire an attorney and a consultant to make sure she's taken care of in case she's terminated for any reason. And it's true that the CEOs have been far better than their boards at negotiating for their own benefit, should the worst happen.

Therefore, the seeds for the negative PR avalanche around severance packages were sown years before, when the CEOs were initially hired.

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