The Advisors' Blog

– Peter Hursh, Managing Director, ECG Advisors, LLC

With CEO turnover at or near an all-time high for reasons of substantial underperformance, lots of directors are looking at the departing CEO’s employment agreement and thinking to themselves: “Gee, I wish we had…”

Here are ten key terms they wish they had written into the CEO’s employment agreement, the first time around:

1. A definition of “cause” that includes “substantial underperformance,” as measured by continuing failure (say, for two consecutive fiscal years) to achieve minimum financial goals and, in particular, failure to meet easily achievable non-financial goals. Termination of employment for “cause” would mean, of course, no severance pay – – or perhaps in the case of “cause” which is substantial underperformance, very limited severance pay.

2. A “clawback” feature that requires the CEO to repay bonuses earned, and stock option spreads cashed in, when the company’s financials have to be restated. Often, “substantial underperformance” does not mean restated financials, so the directors are relieved that the absence of a clawback feature didn’t hurt their company.

3. Provision for the CEO to resign automatically from his or her seat on the Board upon termination of employment for any reason. Who wants a disgruntled former CEO to have the right to stay on the board?

4. Severance pay, for termination of employment by the Company without “cause,” of no more than one year’s “pay” (defined as current salary plus the average of the last two years’ bonuses). The theory here is that severance pay is intended to be “bridge pay” between job 1 and job 2, and that most executives who are actively seeking re-employment should be able to find their next job within a year.

5. Severance pay in installments instead of a lump sum. Installments, with the right to discontinue them if the CEO breaches his or her post-employment duties to maintain trade secrets, not to compete, and not to solicit former employees, are the only way – – short of litigation – – to have any leverage on the executive’s post-employment conduct. Look out for the tricky rules under tax code section 409A on deferred compensation, which may apply to installment payments.

6. Severance pay that is offset, after the first several months, by earned income from the next employer. The offset keeps the severance pay from being a windfall – – collecting pay from the old and new employers at the same time. If the CEO finds a new job a week after being fired, there may be some overlap, but the board can rationalize that as compensation for the incidental expenses incurred during the transition.

7. No post-termination executive benefits or perquisites (especially automobile allowances, club memberships, subsidized travel and tax gross-ups) during the severance pay period. They were difficult enough to rationalize as “business-justified” while the executive was with us; now that he or she is gone, especially for failing to perform, why are we still providing them?

8. A definition of “retirement” that feels like a real retirement from the company – – say, at least age 60 with at least 20 or more years of service – – as opposed to leaving with only a few years of service and getting another job. Then, we won’t provide an ex-CEO who isn’t really retiring with, for example, lifetime healthcare benefit coverage.

9. Mitigation of damages – – i.e., offsets – – for benefit coverage provided by a successor employer, even if the executive declines the new coverages. If the individual could have elected to pay the premiums for the new employer’s medical, dental and vision care plans, then he or she should be treated as having done so – – instead of simply opting for the former employer’s free coverage. Thus, any successor employer’s health plan is the so-called “primary plan,” paying benefits first, with our plan paying benefits second.

10. Provision for the company to decide how to resolve legal disputes, and in what venues – – as opposed to the old “boilerplate” contract language that called for mandatory arbitration. In many cases these days, arbitration is as costly as court litigation. And at least the company can appeal a court’s decision; the company has no right to appeal from the arbitrator’s decision.