HP’s former-CEO, Carly, was kicked to the curb by the board today. You know she was a horrible leader when the valuation of her former company increases $4.5 BILLION (almost 7% today) on the news. Yet, she’s leaving with a very nice $21M severence package after only a little over five, horrible years on the job.
I fail to understand this logic. How is this acceptable in the business world?
I’ll leave the full answer to the experts, but the simple answers are ‘because they negotiate them’ and ‘because it’s more cost effective then completing the contract’.
And BTW good riddance to bad rubbish.
The cynical answer is that corporate officers of one company tend to be on the boards of other companies. So, the boards they sit on sets policy based on how they’d each like to be treated by their corporation. Other officers from other companies that sit on their corporation’s board make decisions the same way.
Also, the career suits that set policy at these corporations tend to actually believe that the top executives actually deserve silly compensation (like 10 thousand times what some of the lower eschelon might make) because their every working minute adds so much more value to the company than whole years of lesser peoples’ effort does.
So salaries, options, severance packages and all that tend to inflate over time, leading to some truly stupifying numbers.
[Some days, I’m not this cynical. I know that a good CEO can be worth a lot to a company. But I just can’t believe his worth is a million percent more than any of his employees.]
Someone who is CEO material is a rare commodity. Someone who is good CEO material is even more rare. And firing the CEO is the quickest way to show investors that the board is mad as hell and not going to take it anymore.
So the CEO negotiates a severance package.
Right, but I think the OP is asking why CEOs have so much leverage to negotiate, whereas normal employees don’t.
Personally, I think the circle of people in these positions is small within any given industry, so the board is afraid that if they stiff somebody, they may soon find themselves in a position where that person can exact revenge. There can also be outright conflicts of interest that would never be tolerated among regular employees. It also helps that it’s somebody else’s money. The good old free market at work.
Well, I’m not sure that she was that horrible or a CEO. She turned HP from a money-losing venture into a profit making one in her five year tenure. A lot of people disagreed with her execution in the end but even the people that fired her, “thanked her for turning the profitability of the company around,” according to NPR.
I have no knowledge of the HP situation, but big $$ severances can result when:
A) It’s part of the original contract hiring the exec. Acme, Inc. wants to hire a hotshot prospect away from a competitor, but she won’t make the jump (and give up her secure job at Beta Corp.) unless she knows she has the severance as a cushion if it doesn’t work out at Acme.
B) The exec has a 5 year contract with a large salary, stock options, etc, and Acme wants to can her with 3 years remaining. The two then negotiate the severance, because it’s cheaper for Acme than paying her for the next 3 years. The exec agrees, because it frees her from any further obligation to the company, and may make it easier to find another job somewhere else.
c) The exec knows where the bodies are buried, and Acme wants to avoid a
public dispute.
d) Acme wants the exec out, but doesn’t want her working for any direct competitors, because she knows too much about Acme’s long term strategies, or other confidential information.
But the OP raises a good point - isn’t the astronomical salary in and of itself enough of a cushion if “things” don’t work out?
Not necessarily. Situations A & B in my reponse are just possible alternatives or motivations. There may not be a long term contract with 3 years of big salary remaining.
If I’ve worked for Beta for 15 years, and am a star VP with a big salary and prospects for more in the future, Acme isn’t going to get me to give up that security and switch to Acme, even as CEO, if I can be out the door a year later with no severance, even if they double my salary for that one year.
Without severance packages in play, a rich company could use high salaries to attract talent away from a competitor, only to dump him/her immediately. The old company of course won’t rehire him/her because of the now-public disloyalty, resulting in a net loss of one VIP.
Thus, the hiring company has effectively assassinated one of their competitor’s valuable assets.
If you’re in demand, you can demand anything.
A good CEO is in demand. So much so that he can command an enormous salary by everyman standards. So much so that he can demand other perks, including a nice package if things don’t work out.
There’s a somewhat less sinister answer to this question, as well.
It’s not unusual for a smaller company to hire a high-powered “rainmaker” (someone whose principal talent - and job - is to bring in business) as CEO or some other highfalutin’ title. At some point, the rainmaker’s job is substantially done – they’ve brought in enough business, or landed that great account, etc. Now you have an extremely well-paid CEO sitting around who isn’t really that good at running the company. The correct response is to get rid of that person. And that person’s correct response is to negotiate the best package possible.
Another cynical theory is that the directors decide the CEO’s salary and parachute, and he decides what to pay them. It’s a cozy little circle.
Nuts: I meant to include–in a courtroom, a CEO can drag out all sorts of unattractive things about a company that the regular slobs on the assembly line have no clue about. A golden parachute is essentially paying them extra to leave quietly.
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Cynical ignorance aside, the answer (as given by several people above) is simply that “golden parachutes” are given because it’s an economic reality. When you get to the rarified CxO heights of the big, much-watched public companies, Chief Officers are often “sacrificed” by Boards to placate investors. The average tenure of a CEO is far, far less than your average employee. Therefore, someone who is being courted as a CEO is going to make demands in regards to what happens if they are fired without cause (as is happening with HP’s CEO). A good CEO is potentially worth billions to a large company, so it’s economically a good move to pay a healthy salary and benefits to the right candidate.
It is also important to consider that all Dirctors and Officers of a company, including the Board who hires/approves Officers, have a fidiciary responsibility to the owners (shareholders). In an age of heavy scrutiny and rampant shareholder lawsuits, you can be damn sure that Board members are mighty careful about who they choose for key positions, and what sort of package they are given.
In addition to what Cerowyn said (which is the correct answer – can we keep GQ a little less bilious, fellas?), CEO’s who are brought in to turn a company around know they’re going to make a lot of enemies in the entrenched bureaucracy very quickly. A golden parachute gives the reformer some confidence that he won’t be subject to a grudge firing because he pissed off the wrong Director’s son-in-law; because the cost to fire him is high, it won’t happen unless there are powerful reasons motivating it.
Golden parachutes are also useful as insurance against hostile takeovers. Typically after a takeover, the new owners want to install their own directors and management. If there are golden parachutes around, it’s going to cost a ton to do that, making the company less attractive as a takeover target. (Although this is really just a side-benefit of golden parachutes – there are cheaper, less risky ways to make your company an unattractive takeover target if that’s your primary goal.)
–Cliffy
Actually, it’s by no means clear that the so-called “cynical” or “bilious” assessment of “golden parachutes” is necessarily wrong. It is seriously disputed whether executive compensation in general, and “golden handshakes” or “parachutes” in particular, really constitutes an efficient market response (as Cerowyn and Cliffy claim) as opposed to a form of “managerial rent extraction”, i.e., using managerial power to rip off the company.
Perhaps it’s both. A recent article called Golden Handshakes: Rewards for CEOs Who Leave [pdf] studies this issue. The author summarizes:
So, there may well be economically sound reasons for lavish severance packages, but they may also result from un-competitive manipulations of the sort AskNott and DougC are talking about.
A good CEO makes decisions at a large company that have a financial impact that completely dwarfs their salaries.
A good CEO is very hard to find, the hours are unbelievable, most decisions carry large risk and these are people who are usually older in their careers when it can be very difficult to move to another company.
Obviously, there are exceptions to this. However, I think most people who are cynical about CEOs don’t realize how hard the job is. Especially since these sorts of people don’t do it exclusively for the compensation…they do it to win and compete.
I agree that a good CEO is very valuable, and that market forces should decide what a CEO gets paid. Apparently, the stockholders are OK with these high salaries and other benefits.
However, it’s not all market forces at work. In the 1980s, corporate takeovers were scaring the public, so our government made some changes to the law to make takeovers more difficult. The old market forces that would tend to keep CEO salaries in check have been supressed. Before the mid-80s, a T Boone Pickens would take over a poorly run company, fire the management, and figure out how to make it make money. Today, this is more difficult, so boards and executives are a little less accountable to their shareholders.