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Time to rethink the golden parachute?

By in Business, Economy, Finance on October 3, 2016

Companies need to reconsider the way they handle CEO terminations

Executive pay is a hot topic for shareholder and stakeholder activists, but nothing gets everybody’s blood pumping faster than a CEO who walks away from a disastrous performance with a substantial golden parachute. “Companies need to reconsider the way they handle CEO terminations to avoid arousing controversy and appearing to pay for failure,” says Martin Hopkins, Executive Committee Member at the South African Reward Association (SARA) and a partner at PWC in the People & Organisation practice.

For example, in 2011, executives at Hewlett-Packard, Bank of New York Mellon, Burger King and Yahoo were asked to step down and received a combined $60 million in severance packages. Hewlett-Packard’s Leo Apotheker alone received a whopping $13.2 million in cash and stock severance. Recently, a prominent South African company paid its CEO a golden handshake in excess of R20 million following a disastrous event on his watch.

“We must recognise that there may be sound commercial reasons why companies take the pragmatic course of essentially paying a CEO to leave, but it is not recommended from a governance point of view because it sends the wrong message to staff and shareholders, and severs the vital link between pay and performance,” Hopkins says.

Principles 161 to 163 of King III make it clear that an executive who is terminated because of poor performance should suffer financial consequences in order to support a “balanced and fair remuneration policy”. Based on its draft, King IV, due to be released by the Institute of Directors in Southern Africa on 1 November 2016, will take a similar line.

Well-defined process required to dismiss CEO for non-performance
It is important to recognise that the issue of CEO termination pay-outs is not necessarily as clear-cut as it may initially seem. One factor to consider is that South African labour law is extremely employee-friendly; dismissing a CEO for non-performance would require a proper process to be followed. It is likely to take between one and two years to dismiss a CEO, during which time the company would be disadvantaged by having no proper leadership.

“It’s a process that would necessarily involve lawyers and intense media scrutiny with all the reputational and other risks that implies,” Hopkins says. “You can see why it would make business sense to shut that particular circus down, and avoid a prolonged, public washing of dirty corporate linen.”

Legal factors to consider
Another factor is that CEOs who are dismissed would in any event be entitled to substantial pay-outs in terms of the law. A termination package would at a minimum include notice pay, and CEO notice periods are longer than those for lesser employees—six months is best practice—plus two weeks’ salary for every year worked. Share awards that have not yet vested would also be paid out on a pro-rated basis.

Frequently, the notice pay would be subsumed within a “loss-of-office” payment which, while not mandated, is generally considered reasonable. Hopkins says that around one year’s salary is considered acceptable.

“In other words, a CEO who is being dismissed or asked to leave would anyway be leaving with a substantial sum of money based on perfectly legitimate grounds. But what must be avoided is any implication that executives are not subject to the same strictures as other employees, who are penalised for poor performance. Such perceptions damage the notion that the company is run fairly, and break down the trust that is essential for sustainable profitability. It also means that successful executives who are moving on prematurely for other reasons, are by implication tarred with the same brush.

“All employees, including CEOs, need to be treated fairly but it may be time for companies to bite the bullet and go through due legal disciplinary processes leading to dismissal in the case of poor performance of senior executives,” Hopkins concludes.