(dated October 31, 2005)

Talking Points - Executive Severance

George Paulin is President of Frederic W. Cook & Co.
 

There is a necessary distinction between severance for involuntary terminations unrelated to change in control transactions and those related to such transaction, because different objectives should apply.

Unrelated to a Change in Control

  • Objective should be fairness, to both the executive and the company.

    • With logical factors considered (e.g., circumstances, length of service, historical contributions, etc.).

  • Avoid having a contract or formal policy, if possible.

    • Makes it difficult to reflect what is fair on a case-by-case basis.

    • Likely to limit company’s ability to terminate for cause, and expand executive’s ability to leave for good reason.

  • Severance provisions fall into 3 simple categories (see Attachment); those that are:

    • Generally acceptable to provide.

    • Acceptable to provide when fair.

    • Rarely justified.

Related to a Change in Control

  • Objective should be neutrality:

    • Where the executive is no better off or worse off than if the transaction had not occurred.

  • A formal policy is preferable; assuming the possibility of a change in control is real.

    • Executives have peace of mind.

    • Company would spend the money anyway if a transaction occurred.

    • Better to make decisions while not under pressure of doing a deal.

  • Policies that include the following provisions often result in the executive being better off, and make it difficult to retain the executive after the transaction:

    • Single-trigger equity acceleration at the transaction closing, rather than double-trigger acceleration upon a covered termination after the transaction.

    • Broad definition of what constitutes termination for good reason.

    • Voluntary "walking windows," where the executive can leave voluntarily with severance if he or she is personally dissatisfied with the acquirer.

  • Gross-ups for penalty excise taxes under Section 280G of the tax code are generally necessary to achieve neutrality.

    • This is because the tax-code calculation for determining the excise tax is seriously flawed.

    • Executives with high cash compensation or big gains from option exercises in the "base period" do not pay, and others do.

Non-Change in Control

Executive Severance Provisions

 

Generally Acceptable

 

Acceptable, if Fair

 

Rarely Justified

 

 

 

 

 

·                    Continued “normal” annual pay and benefits for a reasonable period

 

·                    Reasonable time to exercise outstanding vested options (e.g., 90 days is common in most option agreements

 

·                    Pro rata vesting of restricted stock and long-term incentive plans (LTIP)

 

·                    Acceleration of unvested options

 

·                    Additional age and service for severance period counted toward pension

 

·                    Continued participation in LTIP

 

·                    Extended time to exercise options (note new IRC Section 409A limitations)

 

·                    Severance paid to retain

 

·                    Severance payouts included in pension/SERP calculations

 

·                    Accelerated vesting of front-loaded equity grants (i.e., future year’s grants made early)

 

·                    Maximum bonuses in severance formulas