Golden Parachute: Meaning and Examples
EA
Summary:
Ensuring a company executive experiences a soft landing when dropped from a company, a “golden parachute” might better be called a “golden severance package.” Top executives can receive a golden parachute package when their company gets acquired and they are consequently terminated. Golden parachutes guarantee executives are well compensated when they must be let go. These arrangements can include stock options, severance payments, retirement packages, cash payments, and more. Golden parachutes come with tax implications and controversy.
The golden parachute is not self-explanatory. If you’ve never heard of it, chances are you can’t figure out what it means by the name alone. Once you learn what it means, you’ll understand why it’s called what it is. It’s a significant severance agreement that business executives benefit from in the event of their termination. Not every executive gets a golden parachute. Keep reading to learn the causes and effects of golden parachutes.
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What is a golden parachute?
When one company acquires another, executives at the acquired company face the possibility of termination. Golden parachutes offer these executives compensation packages in the event of a merger or takeover that costs them their jobs.
Golden parachutes: common benefits
Top executives sign contracts that guarantee significant benefits in the event of their corporate-restructure-based termination. Common benefits of golden parachutes include the following:
- Cash bonuses
- Stock options
- Retirement benefits
- Severance packages
- Legal fee compensation
- Continued enrollment in pension plans
- Continued or accelerated vesting
Golden parachutes are commonly enacted by high-ranking executives in merger-prone industries. Common industries in which executives might use golden parachutes include the following:
- Health care
- Technology
- Financial services
- Retail
How do golden parachutes work?
Golden parachutes are a special type of employment contract that only goes into effect under certain conditions for certain top-level employees. The terms of a golden parachute are outlined in a contract between a company and an executive.
The United States Securities and Exchange Commission (SEC) requires that golden parachutes be approved by company shareholders. A corporate scenario must meet required conditions for an executive to receive the benefits promised in a golden parachute package.
A key distinction — though only shareholders must approve golden parachute arrangements, shareholders are not the only people who have a reason to care about, and who are affected by, corporate decisions. You should make a point of learning the difference between stakeholder and shareholder and how each affects every business.
What triggers a golden parachute?
Two distinct occurrences trigger a golden parachute. Both of these events must occur for executives to receive golden parachutes:
- A publicly traded company is acquired.
- Key executives are terminated.
Reasons for executive termination can be self-inflicted or company-inflicted via the takeover process. Top management executives commonly resign or are let go due to relocation or a decrease in the scope of responsibilities.
Tax implications of a golden parachute
Excessive golden parachute payments face hefty taxes. Sections 4999, 280G, and 162(a) of the Internal Revenue Service (IRS) Internal Revenue Code outline tax regulations concerning golden parachutes.
How to tax golden parachutes
There are three main golden parachute tax requirements as stated by the IRS:
- Per Section 4999, golden parachute payments are subject to a 20% excise tax on “excess parachute payments.” This 20% is in addition to normal income taxes. Internal Revenue Code Section 280G defines “excess payments.” If golden parachute payments exceed three times an individual’s average base compensation over the past five tax years, the payments are deemed excessive. Therefore, the individual and company are subject to tax penalties such as the 20% excise tax.
- Section 280G states that golden parachute payments as non-deductible for the company.
- Per Section 162(a), any compensation over $1 million is not eligible for tax deductibility unless it’s linked to an executive’s performance. This section generally applies to low-performing, high-ranking executives who lose their jobs in a merger or takeover.
How is this an excise tax?
Most of us think of excise taxes as fitting the following definition offered by Merriam-Webster: “an internal tax levied on the manufacture, sale, or consumption of a commodity.” It’s hard to see how a tax on golden parachute benefits fits this definition.
Merriam-Webster, however, does provide an additional definition: “any of various taxes on privileges often assessed in the form of a license or fee.” While many of us might have been aware that licenses and fees can be excise taxes, we might not have realized that licenses and fees are only part of a larger class of taxes on “privileges.” However strange it may seem to those of us accustomed to speaking of excise taxes more narrowly, this extra tax on too-large golden parachute payments is an excise tax according to the IRS:
The Code requires that the excise tax payable under IRC § 4999 be administered as an income tax.” — IRS Golden Parachute Payments Guide
When it comes to taxes, you can’t count on common sense
This excise tax on big golden parachutes is far from being the only instance where common usage and common sense don’t help you understand the tax code. Businesspeople and others with complex taxes often need professional assistance or professional tools to avoid costly tax errors.
Pros and cons of golden parachutes
Golden parachutes have many critics. There are also many supporters of golden parachutes. It’s a controversial topic because it involves the ethics of compensating already well-compensated individuals. Let’s dive into the arguments on each side.
Golden parachute examples
Adam Neumann
In 2019, SoftBank acquired WeWork. WeWork cofounder Adam Neumann stepped down as a result of the merger. SoftBank gave Neumann a golden parachute package totaling $1.7 billion. The package included $1 billion in stock options, a $185 million consulting fee, and $500 million in credit.
Jack Welch
Jack Welch was the Chief Executive Officer (CEO) of General Electric. His golden parachute equaled $417,361,902 — one of the largest golden parachutes ever given to a CEO. When he was terminated, he received a stellar severance package. There was some scandal involved that eventually led to a change in golden parachute disclosure requirements.
Ed Whitacre
Ed Whitacre is the former CEO of AT&T. At the time of his retirement in 2007, he received the largest golden parachute package ever given by the company. His package included a $160 million pension, $24,000 per year in auto benefits, home security fees, country club fees, and use of the company jet.
Pro tip — Nowadays, the term “golden parachute” is used more liberally to describe executive severance packages. You may hear the term “golden handshake” used interchangeably with “golden parachute.” Very similar to golden parachutes, golden handshakes differ in that they tend to go further with more lucrative severance packages. The examples you heard above may be considered golden handshakes or golden parachutes.
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Key takeaways
- Golden parachute provisions in employment contracts guarantee executives additional compensation if the company goes through a merger or takeover.
- For key executives with golden parachute arrangements to receive the benefits, two conditions must be met. First, the company must be acquired. Second, the key executive must be terminated as a consequence. Depending on specific provisions of the executive’s employment contract, eligibility for the agreed-to golden parachute will kick in at this point.
- The Internal Revenue Code sets limits beyond which golden parachute executive compensation packages are deemed excessive and subject to penalties in the form of additional taxes.
- Golden parachutes can be controversial. Proponents and opponents argue about the ethics and necessity of their use. The SEC has increased regulations on golden parachute transparency in response scandals over the years.
FAQ
Are golden parachutes legal?
Golden parachutes are legal when they comply with employment contract terms and follow SEC and IRS regulations. If parachute benefits exceed the limits set by these regulations, or if they are structured in a way meant to obscure their value and circumvent the regulations, they may be considered illegal.
Why is it called a golden parachute?
It’s called a golden parachute because it plays on the analogy of an executive jumping down from a high-up role and benefiting from a sweet severance package on the way down.
Do golden parachutes still exist?
Golden parachutes do still exist. One of the most recent notable golden parachutes was given to the CEO of Moderna, Stephane Bancel.
Why do CEOs get a golden parachute?
CEOs get a golden parachute when they leave a company after a merger or acquisition because of their tenure and contribution to the company and to encourage a smooth transition.
Keep learning with SuperMoney — A thriving business should award more than just its top executives. If you are a business owner, an untapped resource for rewarding your employees could be your business credit card rewards. Find out how to use rewards from a business credit card to reward employees.
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