Golden parachutes: as their importance to CEOs increases, shareholders lose out in takeovers

According to a new study of par Cass Business School [1] (London) et LeBow College of Business [2](Philadelphia), CEOs eager to receive so-called ’golden parachutes’ have been found to settle for lower acquisition premiums, costing shareholders millions of pounds. The study have found that these greedy CEOs are typically selling their firms $249million (£158m) below value

The study, carried out by Dr Anh Tran from Cass Business School, which is part of City University London, and Professors Eliezer Fich and Ralph Walkling from the LeBow College of Business at Drexel University in Philadelphia [3], looked at more than 850 acquisitions announced in the US between 1999 and 2007.

The authors examined the relative importance of golden parachutes to CEOs when all other parts of their merger pay package, including potential loss of earnings, were taken into account. The findings showed that a 10 per cent increase in the importance of the parachute relative to the merger pay package was linked to a five per cent fall in acquisition premium - amounting to a shortfall of $249million in deal value for the average takeover.

Dr Tran said the results indicate that larger parachutes encourage some executives to compromise the interests of shareholders. "Our results show that as CEOs become more insulated from personal losses due to relatively larger parachutes, shareholders obtain less favourable acquisition terms. This suggests that overly important parachutes encourage some self-serving CEOs to sacrifice premium for personal gain," he said.

Golden parachutes have come under recent attack in the UK after business secretary, Vince Cable, condemned directors who “forget their wider duties when a fat cheque is waved before them”. He promised to review the way pay incentives for top managers are drawn up. In the US, the Obama administration has also imposed limits on parachute payments to rein in executive compensation at companies bailed out by the government.

Dr Tran added: "When a firm becomes a takeover target, CEOs are faced with a moral hazard. They have direct influence over actions that could provide personal benefit at the possible expense of shareholders. Because of this, it is the relative importance of parachutes to CEOs, not their mere presence, which is important".

"If a golden parachute protects CEOs from a severe loss of personal wealth during a takeover, they behave differently than if they were fully exposed to the loss. A trivial parachute relative to a large loss in future earnings is unlikely to motivate an executive to consent to a takeover of their firm. However, an overly generous parachute relative to their full pay package could induce a rush to sell, regardless of the acquisition price being offered."