The Advisors' Blog

I’ve blogged a couple of times about the resurgence this year of shareholder proposals that suggest a cap on executive severance amounts (we also discussed this at our recent “Executive Compensation Conference”). In response, some companies have limited the cash component of severance – although that doesn’t go as far as the proponents want.

A new 7-page FW Cook memo provides a detailed status update on these proposals – and points out possible unintended consequences of policies that limit severance benefits. Here’s the intro:

Amid the significant increase in shareholder proposals at Russell 3000 companies over the past year, the most prevalent executive compensation-related proposal is to limit severance payments. The proposal is substantially similar in each case and typically requests that companies seek shareholder approval for any senior manager’s new or renewed pay package that provides for severance or termination payments with an estimated value exceeding 2.99 times the sum of base salary and target bonus. This shareholder proposal has appeared on proxy ballots at 17 Russell 3000 companies over the last year and received significant shareholder support: in five cases it passed, and in the other twelve, 33-49% of shareholders voted “for.”

The proposals were written to include the value of cash severance and the value of equity awards where vesting accelerates, which means many companies’ existing severance arrangements will exceed the 2.99x threshold, especially for involuntary terminations in connection with a change-in-control (CIC).

Looking ahead, companies may increasingly be compelled to adopt policies to limit executive severance benefits, but doing so could have unintended consequences that may not be in the best interests of shareholders or result in unfair outcomes for covered executives.

After summarizing proposal trends, pointing out that a majority of large-cap companies provide severance in excess of the proposed threshold, outlining one company’s engagement campaign and responsive policy, and explaining “best practices” and purposes of severance benefits, the FW Cook team offers these parting thoughts:

If proposals to limit severance continue to gain traction with shareholders, companies may be compelled to adopt conforming policies. However, doing so could have unintended consequences, including the potential adoption of compensation structures that run counter to traditional “best practices” principles.

Perhaps most importantly, limiting severance could hinder the effectiveness of CIC severance policies that are intended to align executive’s interests with those of shareholders in the context of deal negotiation. At the extreme, without appropriate CIC severance protection, executives may be perversely encouraged to delay or derail a transaction that may be good for shareholders but result in loss of employment and forfeiture of outstanding equity compensation accumulated over multiple years of employment.

We also note that in the context of talent attraction and retention, this type of limitation creates an uneven playing field for public companies versus privately held and PE-backed companies that are not subject to such restrictions. It also handicaps widely held public companies versus controlled companies who can “push through” shareholder approval.

In summary, while efforts to reduce the cost of severance may be well-intentioned, such proposals could have negative implications that outweigh the benefits.

– Liz Dunshee