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December 08, 1999
Increased Takeover Activity has Companies Changing Golden Parachute
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nd Points to New and Potentially More Cost-Effective Ways To Structure Protection to Meet Both Company and Executive Needs

A recent Towers Perrin CompScan survey of change-in-control (CIC) arrangements among major U.S. companies reveals that plan design continues to evolve to meet changing needs. Of over 100 companies with CIC arrangements participating in the survey, virtually all provide CIC protection to their CEO and top officers, with the median number of executives covered at 10. This coverage drops below the top management ranks, with half of the survey companies extending CIC protection to one or more corporate managers below the senior level, and only 14% covering any non-management employees.

CIC provisions, more commonly known as golden parachutes, originated in the 1980s, largely in response to hostile takeover activity. They usually come in a variety of forms, including continuation of salary, bonus and/or certain benefits and perquisites, as well as, in some cases, accelerating vesting of stock incentives and/or certain retirement benefits.

The survey indicates that nearly half of the companies plan to review and possibly modify their CIC arrangements within the next two years - a jump from the quarter planning such a review in a 1997 survey on the same topic. "The renewed attention to golden parachutes isn't surprising, given today's active merger climate," stated Paula Todd, a Towers Perrin principal and senior consultant on executive compensation. "CIC protection should help a company attract and retain a qualified management team who will act in the best financial interests of shareholders, even under the threat of a takeover. It should protect executives against significant, negative financial consequences resulting from a change in control, while avoiding potential windfalls from the change.

"Most shareholders support well-designed CIC protection as a means of keeping executives focused on shareholders' interests, rather than their own interests, when the company is in play. Such arrangements help curb senior managers' natural inclination to either "jump ship" or "drag their feet" when presented with the prospect of the business changing hands. This can have a positive effect on the business's overall takeover value."

Among the key trends noted in this year's survey is a continued rise in the use of tax gross-ups. Almost two-thirds (65%) of responding companies would gross up CIC payments to cover tax penalties one or more executives would face if their CIC payments exceeded the Internal Revenue Code's limit of three-times final average pay. And only 18% would restrict benefits to the statutory amount to avoid a so-called excess payment, a marked drop from the nearly 33% capping CIC payments in 1994.

While use of tax gross-ups has been growing, more companies are seeking to do so more cost-effectively through a so-called "conditional gross-up." This approach, reported by about 7% of survey respondents, involves capping CIC payments if they exceed the statutory limit by a small amount, but providing the full tax gross-up on higher amounts. "Conditional gross-ups," noted Todd, "ensure that recipients receive most or all of the intended benefit, while avoiding cases in which the additional value of the payment is too small to justify the high cost of the gross-up."

For most companies, CIC protection is provided in the wake of two related events - the company must change hands and the individual's employment must terminate. While this "double trigger" remains the norm for most companies, the survey found that some companies are allowing executives to receive severance upon resignation without having to prove that they suffered any hardship in job status - as long as they stay for a designated transition period, typically 12 months.

"These so-called 'walkaway' or delayed resignation provisions are becoming more prevalent," stated Todd, who noted that nearly a quarter of the companies surveyed reported such provisions. Todd cautioned that companies providing walkaway clauses should consider restricting them to the handful of senior officers most likely to be needed during the transition period, but not beyond.

"While walkaways may facilitate a smooth transition by retaining executives who might otherwise jump ship immediately, they can also give rise to inappropriate windfalls for executives who suffer no adverse impact from the change in ownership," stated Todd. "In a sense, a walkaway clause could be viewed as reversing the very feature - the double trigger - that made CIC agreements more palatable to shareholders and boards of directors over the past several years."

The survey also found that companies are starting to limit the number of people who are eligible for maximum coverage. Eligibility for a three times pay benefit is almost universal for the CEO and a small group of very senior executives. But smaller multiples apply to executives lower in the organization if they are covered at all. "This phenomenon may be a response to the more robust labor market for managerial talent or the trend toward friendlier mergers," stated Todd.

To receive a copy of the 1999 CompScan Survey, titled Golden Parachutes Today, please contact Towers Perrin at 1-800-525-6741.

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