Golden Parachute

What is a golden parachute?

A golden parachute is a type of severance compensation paid out to company executives after termination of employment. These agreements promise specific payment if their job is negatively impacted by a merger or hostile takeover, otherwise known as a “change in control.”

This practice is common for recruiting and retaining executive leadership. A company incorporates a golden parachute into an executive’s employment contract, guaranteeing certain payments upon termination. Golden parachute agreements are common in merger-prone industries such as technology, retail, healthcare, and financial services.

In some cases, these agreements can raise the overall acquisition cost and are viewed as a tool to combat a hostile takeover. Many companies utilize compensation management software to define golden parachute agreements.

The original context behind a golden parachute is an agreement in which an employee receives compensation due to a change in control. More recent uses of this term have extended to include excessive severance packages for high-profile executives. 

History of golden parachutes

The first known instance of a golden parachute was attributed to Charles Tillinghast, Jr., former chairman of Trans World Airlines (TWA). When Tillinghast began the role in 1961, the airline sought to regain company control from investor and major stockholder Howard Hughes. 

It was unclear how long Tillinghast would keep his job due to the company's unstable legal challenges. This led to a clause in his contract that stated he would receive a cash payment upon sudden termination. 

Tillinghast never received a golden parachute payment after leaving TWA in 1976. By the next decade, golden parachutes became the norm.

Fueled by the 1980s junk bond market, firms had more than enough financing to acquire companies big and small. This era of rampant mergers and acquisitions meant that even some of the largest Fortune 500 companies weren’t safe from a hostile takeover. By 1986, over 33% of the 250 largest companies in the U.S. had adopted golden parachute clauses in their management contracts.

Regulations and laws on golden parachutes 

While golden parachute clauses are legal, many question the ethical implications of providing large payouts to executives regardless of their performance. Over the last 40 years, the U.S. government has introduced several pieces of legislation and regulations.

• Deficit Reduction Act (1984): DEFRA was a broader piece of legislation to rewrite the U.S. tax code. In the law, golden parachute payments had restrictions placed on them to deny tax benefits to “excess” payments equal to or more than three times an executive’s base compensation. This legitimized payments up to that threshold. Payments up to 2.99 times base pay became common. 
• Dodd-Frank Wall Street Reform and Consumer Protection Act (2010): This legislation made sweeping changes to prevent another financial crisis following the housing market crash of 2008. The Dodd-Frank Act also set new rules about golden parachute arrangements and how companies report them to the SEC and shareholders. 
• Tax Cuts and Jobs Act (2017): The IRS extended golden parachute rules to include executives of tax-exempt organizations. 

Types of golden parachute payments and compensation

The compensation executives can receive via a golden parachute agreement can vary. The following is a list of these types of payments. Golden parachutes can be a combination of several.

• Cash payments: The most common, this is a fixed dollar amount or percentage of a base salary.
• Stock grants and options: For large companies, stocks are another widespread type of compensation bundled into a golden parachute arrangement.
• Continued enrollment in company pension plans: For companies that still offer pensions, there are instances of executives receiving lifelong pension benefits.
• Vesting of all retirement benefits: Retirement benefits vest immediately upon termination of employment.
• Paid health and dental insurance: Continuation of health and dental insurance can be temporary or permanent, but this isn’t typical for the average executive.
• Compensation for legal fees: In some cases, executives leave and are subject to investigations by the SEC, IRS, and other government agencies.
• Non-monetary perks: There have been instances of some high-ranking executives continuing to receive certain perks long after their employment. For example, former United Airlines CEO Jeff Smisek enjoyed lifetime flight benefits and parking privileges at the company’s hub airports in Houston and Chicago.

Golden parachute best practices

Here are a few best practices and considerations to keep in mind when exploring golden parachute compensation for employees and high-level executives.

• Periodic re-evaluation: The circumstances surrounding any company can change. There’s always room for constant evaluation, so companies should aim to revisit these agreements every two to four years.
• Clawback provisions: A clawback provision is a clause in a contract that allows a company to recoup funds from employees. A company could use these to protect against poor performance or when the executive engages in ethically questionable behavior that results in their termination. Historically, these are inconsistently applied in terms of golden parachute compensation.
• Double vs. single trigger events: Companies must rigorously define what events need to happen for a golden parachute to deploy. It’s less favorable for a company to use a single trigger since this increases the odds of executives receiving a payout in more scenarios. Instead, companies should use a double trigger where multiple events must occur. One such example is if one company gets acquired by another, and then an executive loses their job or has a significant rollback in the scope of responsibilities.
• Defining the protection period: There are examples of when an executive resigns from employment well after the time of acquisition. However, it’s necessary for companies to clearly define this period of time, typically one to two years after.
• Independent compensation expert consultation: Before a company explores potential payment and benefits,  it should attempt to source an independent consultant with expertise in golden parachutes. This can further establish best practices and formulate stronger language that is good for the company and its executives.

Golden parachute vs. golden handshake vs. golden handcuff

Many use the terms golden parachute and golden handshake interchangeably. They are both severance payment agreements or clauses in an employee’s contract.

The golden handshake historically doesn't apply to companies experiencing a change in control and can go into effect in cases of voluntary resignation. Golden handshakes also go further and provide retirement benefits. It’s worth noting that golden handshakes typically include a non-compete clause, so the recipient doesn’t create a competing business or product.

Another term related to the golden parachute is a golden handcuff. A golden handcuff is similar in that it is a type of employee compensation paid out at the end of their tenure. These are meant to discourage an executive from taking employment elsewhere and prevent employee turnover.

A golden parachute differs in that the company pays out this type of compensation when an executive experiences an involuntary loss of employment.