Golden Parachute | Meaning, Working and Rules

What is Golden Parachute?

Golden Parachute is defined as a financial association or compensation package that is usually presented to pinnacle executives, particularly CEOs and other excessive-rating executives, mainly on the occurrence of a merger and acquisition. The term “Golden Parachute” is derived from the idea of giving some monetary assurance to higher-level employees in case their position gets terminated in the company. Various monetary benefit is offered to employees which can include stock options, severance pay, grants, etc.

How does the Golden Parachute work?

The primary purpose of golden parachutes is to encourage top executives to agree to mergers or acquisitions that may not be in the best interests of shareholders but may benefit executives personally. Typical components of a Golden Parachute package include:

1. Severance Pay: Executives receive substantial severance pay, often calculated as a multiple of their base salary and bonus. This payment provides financial security if they lose their job due to a merger or acquisition.

2. Stock Options and Grants: Executives can receive accelerated vesting of stock options and grants, allowing them to cash in on their equity holdings before a change in control occurs.

3. Continuation of benefits: Benefits like health insurance, retirement plan contributions, and other benefits may continue for a certain period after the merger so that the executives do not face a sudden loss of these benefits.

4. Consulting contracts: Some golden parachute contracts include consulting contracts that guarantee higher payouts or benefits for executives who agree to stay for a certain period to help with the transition.

5. Non-competition agreements: Senior executives may also receive non-competition agreements that prevent them from joining competing companies for a certain period after they leave the company.

Example of Golden Parachute

Suppose Company XYZ is a publicly traded company whose CEO is John. Under John’s leadership, the company performed well, but received competition from larger rival ABC Corporation. XYZ Company’s board of directors is evaluating the offer, and if the offer is successful, John’s role may change or be terminated. Due to this situation, XYZ Corporation and John have a parachute competition agreement. It may include:

1. Severance pay: If John is terminated as a result, he will receive a significant severance package that often includes a variety of salaries and income. For example, he will receive three times his annual salary plus a bonus.

2. Accelerated Stock Options: Any stock options or stock options that John holds in Company XYZ will be accelerated, meaning they will become vested and exercisable immediately upon receipt. This allows him to know the value of the company’s shares based on the purchase price.

3. Ongoing Benefits: John will continue to receive health insurance, retirement benefits, and other benefits for a specified period (usually several years after receiving them), ensuring that he does not lose those benefits immediately.

4. Consent Agreement: John may agree to act as a consultant for ABC Company for a period after the acquisition; will receive pay or additional benefits during this period.

5. Non-Competition Clause: The contract may include a non-compete clause that prohibits John from working for a competing company for a certain period.

Golden Parachute Rules

Golden parachutes are based on rules and regulations to prevent leaders from using their power and paying more than leaders. Important rules and considerations include:

1. Tax Consequences: If the amount paid under the cremation arrangement exceeds certain limits, tax duty will be charged by the Internal Revenue Code (IRC). This excise tax is designed to prevent excessive compensation.

2. Authorisation Approval: In most cases, business owners must agree to install a gold ceiling, especially in large cases. Business owners can raise concerns about executive pay at shareholder meetings.

3. Disclosure Requirements: Public companies must disclose details of golden parachute agreements in their licenses so that shareholders understand the details of these arrangements.

Difference between Golden Handcuffs and Golden Parachutes

Basis	Golden Handcuffs	Golden Parachutes
Purpose	Golden handcuffs are used to retain key executives and employees in a company for some time. It is designed to prevent employees from leaving the organisation.	Golden parachutes aim to provide financial security to managers during mergers or acquisitions where there is a risk of unemployment due to change.
Contents	Golden handcuffs often include long-term incentives such as restricted stock units (RSUs) or stock options that vest over time. These incentives are only valid if employees have been with the company for a certain period.	Gold parachutes include separation, equity capital, regular benefits, and other financial incentives to reduce the impact of mergers or senior management buyouts.