Golden Parachute

What is a Golden Parachute?

A golden parachute, in mergers and acquisitions (M&A), refers to a large financial compensation or substantial benefits guaranteed to company executives upon termination following a merger or takeover. Benefits include severance pay, cash bonuses, and stock options.

History of Golden Parachute

The term “golden parachute” was first used in 1961. Charles C. Tillinghast Jr., former president and CEO of Trans World Airlines, was credited as the first golden parachute recipient when the company was trying to get control away from Howard Hughes.

In case Hughes regained control of the company and fired Tillinghast, the company gave Tillinghast a clause in his contract that would provide him with a substantial amount of money if he were to lose his job.

Example of a Golden Parachute

The employment contract of Colin, the CEO of Company A, includes a golden parachute clause that guarantees him $100 million in severance pay, stock options, a retirement package, and medical benefits if he is terminated.

Company A gets taken over by another company and the management team at Company A is replaced. Colin, who is now forced to leave the company, will be able to reap the benefit of having the golden parachute clause in his employment contract.

Advantages of Golden Parachutes

By providing golden parachute clauses to high-level company executives, companies are able to:

• Hire and retain top talent: Golden parachutes are used in attracting top talent. Executives want security – especially if the company is in an industry prone to M&A or if the company experiences a high executive turnover rate. Offering golden parachutes widens the pool of applicants and attracts high-level employees.
• Reduce/Remove conflict of interest during a merger: Often, during a merger, executives are nervous about their job security and can be tempted to delay or sabotage the merger through defenses such as a poison pill, crown jewels defense, or Pac-man defense. A golden parachute guarantees compensation in the event of job loss. This encourages executives to work for the best interests of the firm rather than being preoccupied with their own financial security.
• Reduce hostile takeovers: Competitors looking to acquire a company with golden parachutes for its top executives may think twice about engaging in a hostile takeover since they would then be responsible for paying out the extravagant termination packages in the event of taking control of the company and replacing the existing management team.

Controversies Regarding Golden Parachutes

Golden parachutes given to company executives create controversies because they create the following circumstances:

• Require the company to pay a lot of money: Golden parachute compensation may substantially reduce the company’s bottom line profitability.
• Moral hazard problem: Knowing that their termination would give them substantial benefits, executives with golden parachutes may feel little to no incentive to do a good job. Executives with a golden parachute may not act in the best interest of shareholders.
• May not deter hostile takeovers: Although golden parachutes may reduce hostile takeovers, they typically make up only a small percentage of the overall cost of a merger. Therefore, golden parachutes may not significantly inhibit hostile takeovers. That would mean that they offer relatively little benefit as compared to their very high cost.

Top 10 Golden Parachutes

Here is a list of the top 10 biggest golden parachutes in 2016:

More Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:

• M&A Considerations and Implications
• Employee Stock Ownership Plan (ESOP)
• Restrictive Covenant
• Vested Benefit
• See all valuation resources
• See all equities resources