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Golden Parachutes

Although widely criticized as a "reward for failure", golden parachutes are potentially useful. They get competent employees to accept the CEO job, they facilitate an efficient market in corporate control, and they prompt inadequate CEOs to leave on their own volition.

As Merrill Lynch and Citigroup bosses leave their struggling banks with millions of dollars in their pockets, golden parachutes are once again broadly condemned. The outrage is justified on a meritocratic basis: why should these CEOs earn so much money if they fail?

But why would golden parachutes exist at all if they were so inefficient and detrimental?

For a start, being dismissed and widely viewed as a failure constitutes a huge blow to a former CEO's reputation. A blow he or she might never recover from. As CEO turnover increases, risk averse but extremely competent high flyers may need some reassurance they will not have lost everything should they be fired after accepting the top job. With career concerns, the golden parachute is their insurance policy. Similarly, if CEOs are to innovate and take risks, they should not be punished for failure, as this paper argues.

In addition, we already know that one purpose of golden parachutes is to restrain managerial opposition to hostile but value-creating takeover bids on their company. One could counter that better corporate governance and stronger shareholder activism should render this unnecessary.

However, quite often the CEO or employees under his management are the only ones informed enough to take a decision. They should therefore be properly incentivized. This is where severance payments are especially useful. For instance, they give the CEO an incentive to exit should he realize that he is not fit for the job. Without any such payment, he would presumably stay at the head of the company and gamble with its future.

Similarly, bearing bad news is generally not a good career move. Wall Street CEOs who have reasons to believe that some segments of financial markets are abnormally underpriced in a crisis will therefore be secretive, refuse to immediately acknowledge and announce losses, lest they be fired. Unless they are given golden parachutes, this attitude dangerously delays the day of reckoning.

In conclusion, golden parachutes facilitate fundamental corporate change by limiting managerial entrenchment, and by in some circumstances leaving the decision to change management to the most informed party, i.e., the CEO. Unlike some CEOs, they should not be dismissed so easily.

In this respect, as in many others, the answer lies in giving shareholders more say. After all, they are the ones paying for CEO compensation. If golden parachutes are in their (and the company’s) interests, they should be able to grant them. On the contrary, if golden parachutes are an element of rent extraction by CEOs, empowered shareholders will suppress them.

Pierre Chaigneau

Editeurs: Pierre Pâris, Bruno Lannes, Pierre Chaigneau

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