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You're fired. Here's your $16 million.
Multimillion-dollar severance packages for lousy executives are more than just outrageous. They also provide critical clues about a company's board, its stock and its future.
By Michael Brush
While many Americans are cashing their final unemployment checks and wondering how theyll pay next months bills, the top brass at our nations biggest companies could hardly pick a better time to be laid off.
Chief executives leaving S&P 500 companies pocketed a cool $16.5 million on average in the past two years on the way out the door. And there's little sign yet that the going rate for executive departure has come down.
That $16.5 million doesnt even count juicy perks like gold-plated pension plans, rich stock option grants, health benefits, or use of corporate jets and company secretaries. These goodies can bump up the value of the typical executive severance package by an additional 50%.
The biggest potential prize on the horizon? That would go to Robert Nardelli, who could collect more than $82 million for leaving Home Depot (HD, news, msgs).
Critical clues about a company
If youre tempted to dismiss these opulent severance packages as just another holdover from the era of corporate greed, dont. There is a valuable investing intelligence in all this, too.
Juicy severance packages often tell you a board isnt riding management hard enough. Lax oversight can mean a board doesnt care much about what should be its main task -- looking out for shareholders. If so, guess what happens to the stock?
It sinks.
When executives can negotiate an excessive severance package, it suggests the board has no control over shareholder funds, says Paul Hodgson, a researcher at the Corporate Library, a group that advocates stronger board oversight of companies so that shareholders can benefit.
Fat severance packages are such a strong signal about a boards true motives that the Corporate Library is going to include them in the corporate board "grading system" it plans to offer investors this year. Hodgson recently examined 2001 and 2002 severance packages at S&P 500 companies in a study called "Golden Parachutes and Cushion Landings."
Looming disaster for shareholders?
To be sure, no one has actually proved that rich severance packages in themselves indicate a stock will go down -- even though studies have linked weak boards to poor stock performance.
But theres no shortage of anecdotal evidence suggesting that piggish severance packages can spell disaster for shareholders.
Shares of HealthSouth (HLSH, news, msgs), for example, plummeted to 14 cents recently from $12.80 two years ago because of revelations of alleged accounting fraud. Ousted CEO Richard Scrushy -- who presided over the decline -- may be in line to get one of the richer severance packages in recent history. It could worth anywhere from $25.5 million to $31.8 million. The company says it wont pay because Scrushys employment contract is void. The company also says it will seek past bonus and incentive pay from Scrushy for any years in which financials have to be restated.
Shares of Gemstar-TV Guide International (GMSTE, news, msgs) have plummeted to $3.40 from almost $50 two years ago. But former Chief Executive Henry Yuen, who is now chairman, will get an especially sweet severance payment of $22 million -- plus options and goodies. Thats a ridiculous level of compensation for failure, for being removed from the chief executive position, says Ted White, the director of corporate governance at the California Public Employees' Retirement System (CalPERS), which manages pension funds for public employees in California. CalPERS has a position in Gemstar, which declined to comment on Yuen's severance package.
The Gemstar perk package may be ridiculous, but its fairly typical. The Corporate Librarys Hodgson says he has uncovered many of the juiciest severance packages at companies whose stocks did the worst in the past two years like Tyco (TYC, news, msgs), Lucent Technologies (LU, news, msgs), AOL Time Warner (AOL, news, msgs), Dynegy (DYN, news, msgs) and Conseco (CNCEQ, news, msgs).
Enriching management buddies
No one is arguing that severance packages aren't important. You dont want executives to feel like they need to entrench themselves because it would be a financial disaster if they left, says White. But a lot of the severance agreements kick in when executives are essentially getting fired. When most of us get fired, we get shown to the door. Why should others get fired and get enormous sums of money?
Here's how to check out severance packages at companies youre interested in. Type the ticker symbol into the Quote box on MSN Money; then click on the SEC Filings link along the lefthand side of the page. Look for a form called DEF 14a, and search this lengthy document for words like employment contract. Then dig in.
Below are some of the red flags to look for -- strong signals that a board is placing a much higher priority on enriching its management buddies than it is on rewarding shareholders like yourself.
Red flag: multiyear goodbye payments
The typical severance package grants execs two or three years' worth of salary and bonus. Thats a formula Hodgson thinks is already too generous, given the amount many execs earn and the signing bonuses they enjoy. But many boards go way beyond this. If so, consider it a red flag about a boards independence, says Hodgson.
At Clear Channel Communications (CCU, news, msgs), for example, many executives work under a seven-year rolling contract that renews every day. If they are edged out at any point, theyre guaranteed salary and bonus for the rest of the contract -- in effect, seven years pay.
That works out to about $28 million for Clear Channel CEO L. Lowry Mays, and up to about $18.65 million each for his two sons -- Chief Operations Officer Mark Mays and Chief Financial Officer Randall Mays. This is one reason Clear Channel gets low marks for governance by the Corporate Library.
Thats incredible, says Brandon Rees, research analyst with the AFL-CIO Office of Investment. Thats a new one to me. I dont see any shareholder justifications for those arrangements. It means it would be very costly to shareholders to remove them, so they are essentially held at ransom.
Whats more, if L. Lowry Mays leaves and neither of his sons is appointed chief executive, the severance terms for the sons immediately double to 14 years' salary and bonus, plus 2 million options and other benefits.
What board of directors would ever approve something that inane and give them 14 years of pay just because they sprang from his loins? asks Graef "Bud" Crystal, an executive compensation columnist for Bloomberg who also wrote the book, "In Search of Excess: The Overcompensation of American Executives." I wouldnt want to buy the stock if that is how they are going to treat the shareholders. It is shameless, a kind of dynasty thing.
Clear Channel declined to comment on the severance packages for managers.
Believe it or not, some poor executives only get one year of salary and bonus if they're booted. This distinction earns their companies high grades from Hodgson. Right now, they include: Cigna (CI, news, msgs), Newell Rubbermaid (NWL, news, msgs), Moodys (MCO, news, msgs), and Nucor (NUE, news, msgs). Companies paying less than a years salary and bonus are Family Dollar Stores (FDO, news, msgs), Intuit (INTU, news, msgs) and Micron Technology (MU, news, msgs).
Red flag: pension plan injections
While aging boomers inject Botox to smooth out wrinkles, corporate bosses have discovered another way to recapture their youth. They simply get the board to set back the pension clock when coming aboard.
Delta Air Lines (DAL, news, msgs) CEO Leo Mullin, for example, was immediately granted 22 years of pension credit when he signed on. More recently, the company set up special retirement trusts to protect the pensions of execs in case the company files for bankruptcy protection. What is egregious about this is that the workers plan is getting increasingly underfunded while their plan is getting guaranteed, says AFL-CIOs Rees. Delta declined to comment.
At Coca-Cola (KO, news, msgs), Steven Heyer, president and chief operating officer, and General Counsel Deval Patrick got 10 years of pension injection. (Coca-Cola declined to comment.) And at Sears (S, news, msgs), General Manager Kathryn Bufano and other top execs earn two years of pension credit for every year they work.
Sears is unapologetic, responding that it needs to offer these pension terms to attract qualified managers. In some cases, new managers forfeit pensions when they join Sears, so Sears has to make up the difference, the company says.
Says Reese: We believe that extraordinary pension benefits like these undermine the goal of linking executive pay to company performance . . . The money would have been better spent giving them performance-based compensation.
Red flag: lots of extra accessories
From corporate jets and secretaries to office space, country club memberships and financial planning help, there seem to be few limits to the services some execs enjoy in retirement at the expense of shareholders.
The things that trigger us the most are the arrangements providing office space for life, transportation, consulting contracts and the whole list of goodies they can get, says White at CalPERS. It is obvious the person was able to get the upper hand and get all the goodies in negotiations, but it is hard to argue why this is good for shareholders.
Some companies take these accessories to a whole new level. An unusual provision by Home Depot, for example, would forgive a $10 million retention loan to CEO Nardelli were he to leave. Its hard to imagine why a loan designed to retain a chief executive should be forgiven if he leaves, says Hodgson.
Youve got to wonder whether the board of directors is thinking about the best interests of the shareholders if the chief is allowed to leave for underperformance and you essentially reward him for that underperformance, agrees AFL-CIOs Rees.
Another add-on to watch for: the tax gross-ups. These give execs additional money to cover the taxes on their severance benefits. Shareholders at Home Depot, for example, will have to foot the bill for any additional taxes Nardelli has to pay on that $10 million retention loan he gets to keep if he isnt retained.
Another example: Former Advanced Micro Devices (AMD, news, msgs) chief executive WJ Sanders III, now chairman, gets a tax gross-up on the cost of health benefits for himself and his family. AMD says Sanders severance package is reasonable because the cash and bonus portion is comparatively small -- at $6 million.
Also watch for the automatic vesting of options that werent scheduled to be vested for several years had an exec stayed on. Does this make any sense, if the options were originally granted as an incentive? No, say shareholder advocates. But youll find this provision in many severance contracts, like those at Clear Channel. Home Depot takes the concept a step further. It would continue to grant Nardelli 450,000 new options a year in retirement, for three years.
Thats a pretty rich burden to put on shareholders at a time when there are new doubts about whether options improve stock performance, anyway. Studies by professors from Indiana University and Texas A&M found no link between a company's performance and the amount of stock or options owned by its corporate executives.
Reformers go to work
Shareholder advocates -- like pension fund managers for labor unions -- are finding some success in limiting excessive severance packages.
The International Brotherhood of Teamsters, for example, got Bank of America (BAC, news, msgs) to ask shareholders to vote on whether they wanted the power to sign off on excessive executive severance packages. They said yes. Then the company agreed it would ask shareholders to approve any severance packages that grant more than two times salary and bonus. Really getting into the spirit of things, Bank of America went a step further and made other reforms, like extending the vesting and holding period for executive options -- thus presumably increasing their value as an incentive.
Similar lobbying by the AFL-CIO got Coca-Cola and General Electric (GE, news, msgs) to cut back on some retirement perks, says Rees. But his group is still waiting to see how Tyco will respond to a shareholder vote asking for the power to approve excessive severance packages.
Its hit and miss, says Rees. Now that shareholders are voicing their desire to approve severance packages, companies are starting to respond a little. But many are still reluctant to act on limiting executive severance benefits.
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