2014-Issue 10—Executive compensation continues to be a hot topic for politicians, shareholders, shareholder advisory firms and the media. A major point of contention for these groups revolves around benefits provided to executives in connection with a change in control, commonly called "golden parachutes." While the total value of change in control benefits has stayed high (at roughly $30 million on average for CEOs at the top 200 companies), many companies have made significant changes to their compensation strategy in recent years to appease stakeholders.
Change in control benefits can include severance payments, accelerated vesting and payment of equity awards (such as stock options or restricted stock), fringe benefits, and gross-up payments for excise taxes imposed as a result of Internal Revenue Code Sections 280G and 4999. The Securities and Exchange Commission (SEC) requires public companies to disclose the value of these benefits in the company’s annual proxy filing. Shareholders can voice their frustration (or satisfaction) with the company’s pay practices through a say-on-pay vote.
To help companies keep their change in control benefits in line with their peers and to shed light on current pay practice trends, Alvarez & Marsal Taxand, LLC’s Compensation and Benefits Practice conducted another study of change in control arrangements among the top 200 U.S. publicly traded companies in 2013. The study was also performed in 2006, 2007, 2009 and 2011.
This article summarizes our methodology and key findings for 2013. Find the comprehensive report with the full study results, including industry-specific analysis, here.
Methodology for Change in Control Analysis
We conducted a comprehensive analysis of executive change in control arrangements of the top 200 U.S. publicly traded companies. To compare practices in different industries, we reviewed the 20 largest companies in 10 different industries. The companies were selected based on market capitalization.
The analysis focused on change in control protections provided to the chief executive officer (CEO) and other named executive officers (NEOs). The analysis was based on information in each company’s SEC filings and disclosures. In particular, we reviewed the CEOs’ and other NEOs’ employment agreements, as well as the companies’ policies, equity plans, annual bonus plans, retirement plans, deferred compensation plans and proxy disclosures. Below is a summary of some of our key findings.
The average total value of change in control benefits for the top 200 CEOs remained relatively flat at $29,853,057 in 2013 compared to $30,263,141 in 2011.
Just 30 percent of the CEOs are entitled to receive “gross-up” payments — meaning the company will pay the executive the amount of any excise tax imposed as a result of a change in control, thereby making the executive “whole” on an after-tax basis. This is a substantial decrease from 2009, when this benefit was provided to 61 percent of CEOs.
In 2013, 63 percent of companies had at least one equity plan that provided for double trigger vesting (change of control and termination of employment required to accelerate vesting of equity awards), compared with 53 percent in 2011 and only 28 percent in 2009.
There are significant differences in change in control protection between industries. To examine differences in change in control protection by industry, you can access a full copy of the study results here.
Benefit Values for CEOs
One goal of the SEC executive compensation disclosure rules is transparency. To aid in this effort, companies must quantify any parachute payments the CEO and other NEOs would receive upon a hypothetical change in control at year-end and must disclose those amounts in the annual proxy statement. From information provided in the “Potential Payments upon Termination or Change in Control” section, as well as other sections of the executive compensation disclosure, we calculated the average amount of typical parachute payments.
On average, CEOs were entitled to change in control benefits of $29,853,057 in 2013. More than two-thirds of that value comes from accelerated vesting of long-term incentives, the value of which is largely driven by fluctuations in the stock market. Since 2011, the value of long-term incentives increased by more than $2 million. However, this increase was more than offset by decreases in the value of severance and the elimination of excise tax gross-up payments. The pie chart below illustrates the 2013 average value of each type of benefit for CEOs at the top 200 U.S. publicly traded companies.
The total value of change in control benefits for CEOs has increased since 2009, but remained relatively flat from 2011 to 2013. The chart below displays the average total benefit values for CEOs in 2009, 2011 and 2013.
Excise Tax Protection
Under the “golden parachute” provisions of Code Section 280G, a payment to an executive exceeding the “safe harbor” limit results in a 20 percent excise tax on the executive and a disallowance of the tax deduction to the corporation. Companies may address this excise tax issue in one of the following ways:
Gross-up: The company pays the executive the full amount of any excise tax imposed. The gross-up payment thereby makes the executive “whole” on an after-tax basis. The gross-up includes applicable federal, state and local taxes resulting from the payment of the excise tax.
Modified gross-up: The company will gross-up the executive if the payments exceed the safe harbor limit by a certain amount (e.g., $50,000) or percentage (e.g., 10 percent). Otherwise, payments are cut back to the safe harbor limit to avoid any excise tax.
Cutback: The company cuts back parachute payments to the safe harbor limit to avoid any excise tax.
Valley provision: The company cuts back parachute payments to the safe harbor limit if it is more financially advantageous to the executive. Otherwise, the company does not adjust the payments and the executive is responsible for paying the excise tax.
None: Some companies do not address the excise tax; therefore, executives are solely responsible for the excise tax.
This pie chart illustrates the prevalence of excise tax protection provisions for CEOs in 2013.
Shareholder advisory firms continue to drive changes in excise tax protection. Providing excise tax gross-up protection in new or amended agreements could lead shareholder advisory firms to recommend voting against the company’s say-on-pay resolution and/or the re-election of members of the compensation committee. Because of this increased scrutiny, many companies have chosen to eliminate the use of excise tax gross-ups from executive agreements. Additionally, 60 percent of the companies that currently provide excise tax gross-up protection have disclosed their intention to eliminate this benefit in the future. Companies that have removed or intend to remove excise tax gross-ups are generally moving to a valley provision or to providing no excise tax protection to executives.
The decline in the prevalence of excise tax gross-up protection for CEOs from 2009 through 2013 is illustrated in the chart below.
Change in Control Triggers
Upon a change in control, most companies provide for accelerated vesting of equity awards. The two most common equity acceleration triggers are the single trigger (only a change in control must occur) and double trigger (change in control and termination of employment must occur). We continue to see a shift from a single trigger towards double trigger vesting, with 63 percent of companies in 2013 providing for double trigger vesting in at least one equity plan, up from 53 percent in 2011 and only 28 percent in 2009. Notwithstanding the current shift to double trigger vesting, most companies (85 percent) still have at least one equity plan that provides for single trigger vesting. However, because equity plans typically remain in place for 10 years, we expect the prevalence of single trigger vesting to decrease in the coming years.
Alvarez & Marsal Taxand Says:
The executive compensation landscape continues to shift. While the total value of benefits that CEOs are entitled to upon a change in control has been largely unchanged for the past two years, there have been substantial decreases in severance benefits and entitlements to excise tax gross-ups. Sustained pressure from shareholders, shareholder advisory firms and regulators has made (and will continue to make) a significant impact on the type of change in control benefits provided to executives. Boards of directors and compensation committees need to remain vigilant of changing market trends and should be prepared to respond to challenges regarding the benefits provided to executives.
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J.D. Ivy, Managing Director, contributed to this article.
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