Wharton Article Focuses on the Benefits, Pitfalls of Different Severance Arrangements
July 20, 2012
Over the past two years, severance arrangements have clearly been in the spotlight, and a recent article in Wharton’s online business journal, Knowledge@Wharton reviews several recent packages, noting that "most firms are thinking through what they are doing and most are getting it right,” but questioning the impact of certain outsize arrangements on performance and morale for employees below the executive level. The article cites “exorbitant” severance packages like the $100 million stock grant made to Google’s departing CEO Eric Schmidt in 2011 as an example of an outsize payment. However, the article presents several reasons why companies structure CEO pay packages to include separation payments, including their usefulness in mitigating risk for an executive preparing to join a company whose future is less than certain and the fact that severance arrangements help ensure executives do not stay with a company longer than is beneficial for shareholders. In addition, citing a recent Governance Metrics International study, the article notes that the majority of top golden parachutes since 2000 actually comprised large equity grants, pensions and deferred compensation from previous years to which executives were already entitled.
As for the risks of utilizing separation payments, the article suggests that outsized packages for CEOs may anger employees and shareholders alike. "The extent that ex-CEOS are treated like an elite group that is apart from the rest of the firm really is a red flag for many employees, and it can really affect their sense of loyalty to the firm,” observes Wharton legal studies and business ethics professor Thomas Donaldson. However, the article also notes that perhaps contrarily to public opinion, shareholders are less likely to react negatively to a big severance package being paid to a leader who is fired or managed out after poor performance, considering the departure beneficial to the company; payouts made to CEOs who leave voluntarily are more likely to cause a dip in stock price, “suggesting that shareholders feel the board is making poor decisions and not working for their interests.”