Every year, we read stories of corporate Board of Directors firing a senior executive for unsatisfactory performance and then paying the executive millions of dollars upon his or her departure. Usually, the story talks about a Chief Executive Officer but sometimes it is another executive. Excessive payments to departing executives are often called “Golden parachutes,” and there are many examples.
Several years ago, for example, the Walt Disney company hired Michael Ovitz and then terminated him 14 months later. Ovitz reportedly received a severance package of $140 million. Recently, Wells Fargo admitted that thousands of their employees opened new accounts in customer’s names without consent to generate bigger fees and commissions. The scandal has damaged the bank and led to many investigations and potential fines. The person in charge of the retail division where the scandal occurred, announced her retirement and reportedly received about $125 million upon her departure.
There are various reasons why executives are highly compensated when they depart a company, even when their performance was poor. Much of what happens is the result of a system that is stacked in favor of the executives and against shareholders and companies.
When a senior executive agrees to take a position, that employee almost always negotiates and signs an employment agreement with the new employer. This is expected and protects the employee from leaving an existing job and then being terminated for no good reason at the whim of a Board. The problem is not the existence of an employment contract.
In the employment contract, there is a clause which says the executive may be fired “for cause,” in which case nothing more is owed to him or her. Generally, the definition of “cause” is limited to being found guilty of felony acts, committing fraud, or stealing from the company. The definition of “cause” almost never includes poor performance. It is very difficult to prove “cause” exists in most situations, as the term is defined in typical employment contracts.
How did “cause” become so narrowly defined and almost unenforceable? It is unclear, but I have a theory, based on my observations over the past forty years.
Generally, a Board retains an employment consultant to help negotiate the contract or provide an opinion that the contract is fair and competitive in the industry. The same consultant will often seek to sell human resource related consulting services to CEO’s in the future. If a consultant recommends approval of a CEO’s favorable employment contract, the consultant is more likely to be favorably considered when that CEO approves hiring an HR consultant.
After one Board agrees to a narrow definition of “cause,” it quickly becomes cited by other executives and their attorneys as the standard. Often, the employee’s attorneys draft the employment agreement and include the narrow definition.
When an executive is terminated for poor performance but not “for cause,” under the definition of his or her employment contract, he or she is typically entitled to all the compensation and benefits that he or she would have received if they had not been terminated. This usually includes salary not yet paid, bonuses not yet earned, stock options not yet vested, and various other entitlements. If a terminated executive has three years left on a contract, the company often has to pay three years of full compensation as if the executive had been a stellar executive.
To address the problem caused by unsuccessful executives being given golden parachutes, some things need to change. The definition of “cause” needs to be more broadly defined. Successive years underperforming a peer group of companies should be cause for termination. If a dispute occurs regarding the performance measures, it could be submitted it to an arbitration panel for resolution.
Other items to be considered cause for dismissal could include successive poor results on confidential employee surveys, failure to meet budget targets in successive years, failure to follow written directives from the Board, etc.
However, when a company is acquired by another company and the executive’s position is eliminated, that should not be termination for cause. A company will want its executives to cooperate with a potential acquirer and not obstruct a deal otherwise desired by the Board even if the executives lose their jobs as a result of the acquisition. Full compensation should be paid in the event of a change in ownership which results in the loss of a job.
Companies which provide audit services to another company are generally not permitted to provide other consulting services to avoid influencing the impartiality of the audit. Similarly, companies which provide employment contract services could be forbidden from providing other consulting services to the company involved.
Finally, when an employee is terminated without cause, he or she should not be paid full bonuses for all the remaining years of their contract. Clearly, the bonuses would not be earned.
Scott MacDonald was CEO of several companies. His book, Saving Investa, How an ex-factory worker helped save one of Australia’s iconic companies, includes 25 critical lessons learned.
Scott MacDonald has been CEO, President, or Managing Director of several companies. His book, Saving Investa; How an ex-factory worker helped save one of Australia’s iconic companies, has won numerous awards.