Have CEO Severance Packages Gotten Out of Hand?

  @ibtimes on October 06 2011 12:56 PM
Apotheker
Leo Apotheker attends a session at the World Economic Forum (WEF) in Davos in this January 28, 2010 file photo. REUTERS

 

Like most employees, when CEOs of large companies don't meet the expectations of their employers, they can be fired. Yet unlike the average worker, the high-profile CEO often leaves the company with a hefty severance package, sometimes worth tens and even hundreds of millions of dollars.

 

 

One example is recently ousted Hewlett-Packard CEO Leo Apotheker, who served less than a year in his role. Despite his short stint with HP, he was entitled to nearly $14 million in severance pay.

 

 

Apotheker was entitled to a cash payment of $7.2 million, which he will receive over 18 months. In addition, the former CEO will receive a bonus of $2.4 million under the Pay-for-Results Plan that the company enacted in 2005. During the chief's tenure, the stock price tumbled more than 40 percent -- so it is unclear on what results, if any, Apotheker needed to hit in order to receive the bonus.

 

 

Furthermore, Apotheker will receive about $3.6 million in accelerated stock vesting, along with several hundred thousand dollars in relocation costs and other miscellaneous expenses. HP has declined to comment on the payout.  

 

 

Most heads of large corporations would receive large payouts if they are fired. According to data compiled by corporate governance firm research firm GovernmentMetrics International (GMI), 470 CEOs of S&P 500 companies are able to receive a severance package in the case of termination. If termination is due to a change of control in the company, the median pay exit package would equal about $33 million, while the median would be nearly $21 million if the termination was a firing without cause.

 

 

The big severances are not just for companies experiencing success. More than a quarter of the companies in the S&P 500 reported declining income and/or net losses in their last full fiscal year, GMI notes. However, it would cost approximately $2.6 billion to fire all of these CEOs.

 

 

The large exit package is nothing new, and some CEOs have received far more than Apotheker after leaving their respective companies. Merrill Lynch fired CEO Stanley O'Neal in 2007 after the company reported over $2 billion in losses for that fiscal year's third-quarter. Bloomberg reported that O'Neal received a $161.5 million parachute in stock awards and retirement benefits.

 

 

Home Depot CEO Robert Nardelli was given about $210 million in severance pay after he was let go in 2006. During his five-year role as head of the company, the stock price declined 8 percent.  

 

 

In fact, Apotheker's severance package did not even match that of his two predecessors at HP, Mark Hurd and Carly Fiorina. Both walked away from the company with severance packages near $40 million, although Hurd waived the right to most of that money when he became co-president of Oracle.  Yet both Fiorina and Hurd served as CEO for a far longer period of time than Apotheker.

 

 

THE NUANCES OF THE SEVERANCE PACKAGE

 

 

Numerous factors play a role in determining the severance package of a CEO or other top executive, Steve Rabitz, an attorney with Stroock & Stroock & Lavan who specializes in executive compensation, told International Business Times. This includes the executive's experience, the industry, the finances of the company and whether the company is prone to a merger or acquisition.

 

 

What a severance package contains also varies widely. Rabitz noted that most severance packages contain equities, such as stock and options awards, that can't be exercised until a certain date or until the stock reaches a certain price.

 

 

The whole process is to ensure that compensation is aligned with shareholder interest, Rabitz said, but noted that shareholders sometimes get angry over packages they believe are over the top, especially if the company is struggling.

 

 

The equities portion of the CEO severance package usually contain between 75 and 90 percent for large public companies, Paul Hodgson of GMI told IBTimes.

 

 

With recession pushing stock prices lower, the stock portion of severance packages have taken a hit. However, Hodgson said the size of the cash portion of severances has been reduced in recent years due to shareholder anger. Until a few years ago, CEOs would receive three times their salary and bonus. However, due to shareholder anger, some companies capped that at two times salary and bonus.

 

 

ARE THE LARGE SEVERANCE PACKAGES NECESSARY?

 

 

While a few executives would not want to become CEO without a hefty severance guarantee, James Reda, the founder and managing director of corporate governance firm James Reda & Associates, suspects that most executives would take the positions even if the packages were significantly smaller.

 

 

But they all ask for it, Reda told IBTimes. It's pretty much general practice.

 

 

But Rabitz noted there are cases where it is important to offer a large severance. For example, if an executive were to become CEO of a company vulnerable to takeover, he or she may demand a hefty severance as insurance against job loss.

 

 

Reda pointed out that a large severance package can help ensure continuity at a company, since canning the leader can be a double-loss for the bottom line. For starters, the company has to pay the outgoing CEO the large severance package. Then, the company is often desperate to tap another strong leader, thus giving the new CEO more bargaining power over his or her pay package.

 

 

If the company knows that they have to pay 25 to 30 million (to fire the CEO), they may be less likely to pull the trigger, Reda said.

 

 

INCREASED TRANSPARENCY

 

 

The federal government has implemented policies over the last several years to enhance scrutiny over executive compensation. In 2006, the Security and Exchange Commission required that public companies include Compensation Discussion and Analysis, in yearly filings. The disclosures should focus on the most important factors underlying each company's compensation policies and decisions.

 

 

Enacted last year, the Dodd-Frank Wall Street Reform and Consumer Protection Act contains a say-on-pay provision allowing shareholders to cast a non-binding vote on executive pay. However, both Reda and Rabitz said the vote asks whether shareholders approve of pay practices as a whole, and portions of compensation.

 

 

While there will be disagreements amongst the public about whether executives are paid fairly, Rabitz said the most important thing is that it is open for people to see.     

 

 

There have been a lot of visceral responses that have been totally understandable, he said, referring to the public anger over large severances. However, it's all about the process. How the company got to the number and why?

 

 

Write to Samuel Weigley at s.weigley@ibtimes.com

 

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