Constance E. Bagley, a professor at Harvard Business School, studies how control of corporations changes hands. BusinessWeek Associate Editor Emily Thornton recently talked to her about the evolution of the big payments CEOs get when their employers change hands. Here are edited excerpts from their conversation:
When did companies first start to put agreements in place to pay CEOs in the event of a merger, and why?
You had any number of employment agreements that provided, in the event you were terminated without cause or quit for good reason, that you were able to collect a certain amount of severance.
But one of the earliest cases [of a payout related to a change in control] was in 1979, when Reliance Electric was involved in takeover negotiations with Exxon (). The people at Reliance credited the agreements for making it possible for them to do what they needed to do even though it meant accepting the bid and losing their jobs.
But it was the Bendix affair in 1982 that really got people's attention. The head of Bendix, William Agee, launched a bid for Martin Marietta (). Martin Marietta launched a "Pac Man defense" and made a hostile bid for Bendix. Then Bendix ended up being acquired by Allied Corp.
In the course of this, Agee bailed and took an expensive parachute with him. It was, at that point, the most expensive golden parachute ever: $4 million. Congress felt the person who started a hostile takeover for Martin Marietta made a lot of money, [and] investment bankers and lawyers made a lot of money, but they questioned if value was created.
That's when Congress first passed legislation that says if you receive compensation of more than 2.99 times your annual pay, then it should be subject to a special excise tax.
Did these provisions immediately become a popular practice?
In 1982, a BusinessWeek article alluded to the fact that executives were evenly split over whether or not these were acceptable provisions.
While 45% disapproved of them, 44% approved. And 11% were unsure. By 1987, 35% of the U.S.'s 1,000 largest companies had change-in-control plans. And as of 2001, 81% of the companies had plans. A number of companies put these agreements in place right before deals happened. Then people said: "Wait a minute. Is this just a coincidence?"
As with poison pills, directors were advised by their lawyers that it would be easier to justify these provisions if they put them in place before they had a gun to their heads. So companies started to put them in as a general matter. And today, when they become more vulnerable, they strengthen the arrangements.
Since shareholders are becoming hostile again, CEOs are saying that, if there is a change of control, they want to be covered.
What was the rationale for these provisions in the beginning?
Originally, the provisions were conceptualized as aligning the interests of management with the interests of shareholders. Shareholders said: "We know that there are instances when a hostile bidder may come in and offer a premium over market that shareholders want to accept. But we're concerned that management may be resisting it because they will lose their jobs." That was one argument for these arrangements.
The second point of view was that, regardless of whether or not they should accept the bid, shareholders don't want management distracted by where the next paycheck will come from.
How do the change-in-control provisions in place today compare with those in the past?
These agreements are clearly more common. What's interesting is that now you have "single triggers" in which a change of control alone is enough to [cause a payout -- without the CEO leaving the company].
The range of situations they're being applied to has also expanded. In the early days, it tended to be a hostile deal that would trigger the provision. What has happened now, such as with Gillette's CEO, James Kilts, is that people are starting to say that whether the deal is hostile or friendly shouldn't matter. That's why in some cases you not only get your parachute agreement but also continue to be employed by the newly merged company.
And triggers have also been reduced in some cases. Merck () is an example where if only 20% of the shares change hands, it's enough to trigger payments.
If these provisions are so common, should boards be concerned about them?
It's becoming one of those things, like de-staggered boards and the like, that institutional shareholders are pointing to as potential corporate-governance weaknesses. Directors ought to be looking at these provisions more closely than before.
Institutional investors have been scrutinizing [these agreements] more closely, particularly when the payments are more than 3% of the deal. They're concerned when there's a conflict of interest because the person negotiating stands to benefit from the deal.
For example, if a buyer is willing to pay $5 billion for a company, but it has to pay $100 million to the CEO, will it offer just $4.9 billion to shareholders? They're worried about that type of situation -- and for good reason.
One company, Occidental Petroleum () responded to a 59% shareholder vote in 2005 demanding prior shareholder approval of golden-parachute payments by adopting a new policy that on its face required shareholder approval. However, buried in the last line of the policy, the board reserved the right to abandon the policy at any time without prior notice.
Aren't these agreements also increasingly being applied to board members as well?
I'm troubled by the practice, frankly. There's enough scarcity of qualified board members these days that if a company gets taken over, it's no problem for them to find another position. So I think [these agreements] smack of impropriety. I think the idea -- that we're so worried you won't be able exercise your fiduciary duty on behalf of the corporation that we must make sure that you're secure because you might lose your board fees -- is disturbing.
It also puts board members in a position where they stand to favor an acquisition potentially, because it may net them an additional amount of money. They should be doing what's in the best interest of the corporation as a whole. And there may be an instance where the best interest of the corporation is not selling, even if the shareholders initially aren't happy about that.