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As always, first things first: Let’s define Change in Control.
A Change in Control (CIC) happens when one or more of the following occurs:1
- A company or investor acquires a certain percentage of stock (This could be defined as a specific percentage, or could conversely be defined as a change in majority ownership)
- The composition of the board fundamentally changes
- Certain business conditions such as a merger happen
- Liquidation/dissolution of the company occurs
- There is a major asset sell-off
As you’ll notice from reading the above lists, CICs are fairly common – though less likely the larger an organization is.
The question is: What is the right way to compensate executives for any unvested equity (and expected salary and cash bonuses) in the event of a CIC?
Essentially, when a change in control happens the leadership team will often find their jobs as currently constructed in jeopardy. The CEO/CFO/COO etc. will likely no longer be leading the parent company (and their direct reports will by extension have diminished roles). This change in control at the very least carries with it a loss of job influence, if not scope.
There is also a risk that some executives will be severed (either because their job is no longer needed after a restructure, or because the acquiring company/investor wants to put someone new into the position).
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…So what’s the right way to compensate executives for these factors? Should impacted executives immediately receive their unvested equity at CIC?
…Or should they only receive it if the new parent company/investor severs them (or declines to continue utilizing the existing equity structure)?
On one level this is a non-issue. The number of executives impacted by a CIC – and the amount it would cost to pay them off by allowing their equity to vest early and give them severance – is negligible to most firms that find themselves in situations like this.
Conversely, public sentiment has really shifted against huge payouts for outgoing executives post 2008 financial crisis.
In a very real sense, lots of smart people have put tons of energy into addressing what amounts to a non-issue (from a company bottom line standpoint) to placate activist shareholders and a public frustrated by current economic conditions (and looking for someone to direct their frustrations at).
With that said, today’s economic climate is the one we live in and so this stuff matters. Keeping that in mind, most companies have adopted a “double trigger” qualification under which change in control payouts can occur. Essentially, in most companies with CIC agreements in place the following two things must happen for an executive to get a severance package:
A. There is (as discussed above) a company change in control
B. The executive is either terminated, leaves for a good reason, or his/her job materially changes 2
A “material change” in job duties and responsibilities could be many things, such as:
- The acquired company no longer being the parent company (making the roles of the acquired company executive’s jobs smaller in scope by definition)
- A re-organization that changes the scope of an executive’s role
- Removal of an executive from a key committee and/or role (an example would be a CEO retaining his job as President but losing the Chairmanship)
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A “typical” severance package in this case would be 2-3x base pay and 2-3x target bonus in the year of termination, as well as any unvested equity being paid out early. The taxes on these packages might also be grossed up, and the executives might receive some continuation of health benefits (24-36 months is typical). 3
I’m fine with these sorts of payouts, honestly. Having talked to leaders in compensation with more experience dealing with this issue than me, I have a preference for the double trigger for CIC payouts, but beyond that I don’t think there is anything egregious here (although grossing up early payouts is probably a bit much).
I think that any company needs to make sure that its executives are neutral in their assessment of any acquisition offer – and if executives risk losing money in the form of salary, bonus and unvested equity if acquired then they lose that neutrality. At the same time, there is a risk that if executives are compensated too handsomely in the event of an acquisition that they can become biased in the direction of being acquired even if this isn’t in the best interest of shareholders.
Ultimately, proxy advisory firms like ISS and Glass Lewis are going to drive what companies pay out going forward. Say on Pay Legislation like the Dodd–Frank Wall Street Reform and Consumer Protection Act has given the “For” or “Against” votes from advisory firms considerable sway over most company executive pay policies. An ISS “Against” vote costs a company (on average) about 30% of shareholder support. This isn’t typically enough to cause a company to fail (only 3% of companies failed their SOP vote in 2012), but it’s enough to be embarrassing (and theoretically put the board and CHRO on the hot seat).
Anyway, we’re at 1,000+ words so I’m going to wrap this one up.
As always, please share your thoughts below.
If you have questions about something you’ve read here (or simply want to connect) you can reach me at any of the following addresses:
SomethingDifferentHR@gmail.com OR firstname.lastname@example.org