The Advisors' Blog

– Oguz (Oz) Tolon, ISS’ U.S. Compensation Research

The issue of golden parachute payments and advisory votes on such exit packages has come to the fore in recent weeks following the decision by Xstrata plc to decouple its Glencore merger vote from that of attendant payments to executives, and as new research from Harvard University Law School Professor Lucian Bebchuk and others questions the efficacy of such payments on long-term shareholder value. This article explores say-on-golden-parachute votes in 2012, examining the components of certain payments deemed problematic by shareholders based on failed votes.

Looking Back at 2012
Through Oct. 4, ISS tracked 94 say-on-golden-parachute proposals in 2012, of which 34 were Russell 3,000 (R3K) companies, two were S&P 500 constituents, and 58 were other firms, including large caps Aon plc and Sunoco. Of these, ISS is tracking just three that failed to garner majority support.

The first say-on-golden-parachute proposal to fail in 2012 was at Advance America, Cash Advance Centers, a Spartanburg, South Carolina, payday loan company, where ISS recommended shareholders oppose exit payments due to what it deemed “problematic” modifications to change-in-control agreements with the company’s executives. Specifically, in connection with the merger agreement, on Feb. 15 the company amended agreements previously entered into with its president and CEO J. Patrick O’Shaughnessy and chief financial officer James A. Ovenden, to provide modified single-triggered retention payments to these executives in lieu of their prior double-triggered severance payments. In addition, the company also made special equity grants and adjustments to the executives’ base salaries, without a disclosed rationale and subsequent to the announcement of the merger agreement, which raised significant concerns.

Concerns about the proposed payments resonated with shareholders, who opposed the resolution with 52.1 percent of the votes cast against. Notably and by comparison, the merger proposal received near unanimous support (99.6 percent), suggesting that many investors clearly viewed the say-on-golden-parachute resolution as discrete from the underlying change-in-control transaction.

In another example, Ariba shareholders voting at an Aug. 29 special meeting failed to back the advisory golden parachute proposal, though strongly endorsed the related merger agreement whereby German technology giant SAP would buy the cloud networking company for $45.00 per share in cash. Among shareholder voting, 99.9 percent supported the merger deal with SAP, while just 49.5 percent supported the related exit payments. As in other cases, a number of problematic provisions were added prior to the merger vote, including the possibility of paying Ariba’s CEO’s cash severance without a qualifying termination of employment and deeming performance share metrics achieved at the 200 percent level solely because the company entered into a merger agreement.

A third failed say-on-golden-parachute vote this year also occurred on Aug. 29 at Interline Brands, a marketer and distributor of broad-line maintenance, repair and operations products, where shareholders’ opposition marked the highest level recorded, at nearly 62 percent, since implementation of the golden parachute vote in the spring of 2011. At Interline, the CEO’s double triggered cash severance had been recently modified to single trigger, and the outstanding performance-based equity was being paid out at maximum attainment level without regard to the achievement of underlying goals.

A significant difference evidenced this year between support levels on the merger transaction and the related say-on-golden-parachute proposal suggests some investors are choosing to abstain on exit pay ballot items despite rendering a vote in favor of the transaction, while others may simply vote against parachute proposals as a matter of course, irrespective of voting decisions on the underlying mergers.

Specifically, during the period studied, the average support on parachute proposals across ISS’ coverage universe was approximately 81 percent, while the underlying merger transactions averaged above 95 percent of votes cast. Given average shareholder support across the R3K on management say-on-pay proposals during the 2012 proxy season stood above 90 percent, the relatively lower level of support on parachute proposals warrants scrutiny.

Parachute Payments in Practice
Of the 94 companies studied, CEO cash severance was double-triggered at 57 companies ( 60.6 percent). By comparison, the cash severance for NEOs other than the CEO was double-triggered at 60 companies, representing 64 percent. At 10 companies examined, there were no existing, legacy agreements in place, and executives were not entitled to traditional severance payments. For CEOs, a total of 20 companies maintained single- or modified single-trigger legacy arrangements, while seven had entered into new agreements with their CEOs containing what ISS deemed to be problematic features during the most recent year under review.

Meanwhile, 11 companies did not maintain or pay any severance to NEOs other than the CEO in transactions that came to a shareholder vote in 2012; however, 18 maintained single- and modified single-triggers in legacy arrangements and five of those had adopted them in 2012. Within this universe, 39.4 percent of companies maintained or newly enacted (cash) severance triggers of concern to investors.

In terms of triggers for the acceleration of unvested, outstanding equity awards held by NEOs, the prevalent practice appears to be the single-trigger, i.e., automatic vesting acceleration; however, the most prevalent arrangement is that boards maintain discretion to determine the outcome in cases of change-in-control merger transactions, and it appears that boards exercise this discretion to provide automatic accelerated vesting of equity awards a majority of the time, since that was the outcome at 80 out of 94 companies studied (85 percent).
Excise tax provisions in existing agreements were observed at 34 out of the 94 companies. However, just 16 actually paid excise taxes to NEOs, as the rest did not trigger 280G tax liabilities.

In addition to potential severance, retention payments to NEOs were seen at 21 out of the 94 companies. While single-triggered in most cases, these payments were generally reasonable in magnitude, and accompanied double-triggered severance payments. Retention bonuses replaced severance payments in at least two instances.

As noted above, the most prevalent practice of some concern to investors is the single-trigger acceleration of unvested equity awards held by NEOs, seen at 80 out of the total 94 companies. Companies which in practice disclosed two or more problematic features in their golden parachute proposals made up of 41.5 percent of the entire universe, while companies with at most one problematic feature represent a majority at 58.5 percent.

Shifting Investor Focus: Single-Trigger Equity Acceleration
Notably, ISS tracked a few cases this year where investors displayed opposition to golden parachute payments despite double-triggered cash severance payments and no excise tax gross-ups. At Delphi Financial Group, for example, the say-on-golden-parachute resolution passed with just 56 percent support even though no executive was entitled to a cash severance payment. They were, however, entitled to $34.8 million on a combined basis, $33.5 million of which was comprised of single-trigger equity acceleration and related excise tax gross-ups.

At Benihana, meanwhile, the golden parachute proposal squeaked through with 50.3 percent of votes cast, despite a double-triggered cash severance arrangement with the CEO. However, $5.6 million of the total potential golden parachute payments to all NEOs (in the amount of $9.3 million) was generated from single-triggered acceleration of unvested, outstanding equity awards held by Benihana NEOs.

While some argue that single-trigger equity acceleration provides executives an incentive to pursue transactions with potentially a higher premium to shareholders, there has been growing concern that such golden parachutes are not necessarily beneficial, and some investors, as evidenced by voting in 2012, appear to view these payments as windfalls without the loss employment.