Big Red Car here. The weather in the ATX could not possibly be or get better. It is 70F this morning and the sky is clear. CAVU — ceiling and visibility unlimited.
On Earth as it is in Texas. [Well, it’s likely going to be inching close to 95F today, so let’s pick our poison carefully. Haha, Big Red Car, you are a card.]
So we have been discussing the C Level Employment Agreement and we were focused on the issue of termination of the agreement. To get our minds right about this issue, we understandably have to focus on what happens when the Employment Agreement is, in fact, terminated.
One of the outcomes is that the CEO will be eligible to receive a Severance Package. So let’s take a second to discuss that issue.
Remember we discussed the manner in which the Employment Agreement could be terminated. Look at those issues here — The C Level Employment Agreement — Termination.
As you can see, there may be some conditions wherein it is not appropriate that the CEO receive a severance package — such as if the Board terminates the CEO “for cause”.
In other circumstances, the CEO should be entitled to a severance package.
Today’s post will discuss how such a severance package should be configured.
Remember the well crafted CEO level compensation package is designed as discussed here — The Design of Compensation Packages for C Level Execs and Senior Management.
The severance package can be viewed as a continuation of that compensation package for a sufficient period of time for a CEO to find alternative employment.
[Remember when we are discussing these things, we are often viewing them from the perspective of a CEO as The Boss was always a CEO for the last 33 years and the Big Red Car is carrying The Boss’s water. Boards may have different views of things and there should be some healthy professional tension on these matters but as a general matter these things are typically defined in a pretty tight shot group.]
The typical CEO Employment Agreement is going to be for 3-5 years in duration with the ability to renew and amend it at the end of that period of time. It is probably fair to say that most CEOs are not going to serve for much longer than 10 years. [The Boss was President, CEO and Director of a private company for 12 years and a public company for a similar time period but those both represent arguably longer than normal tenures.]
The Big Red Car will put a stake in the ground and say that as a general concept the CEO should expect to receive one year’s compensation as the core of a Severance Package.
The sticking points then become such things as the receipt of short term incentive compensation as part of the determination of “one year’s compensation”.
Here is an outline of what the Big Red Car thinks is fair:
1. Sixty days written notice of termination [remember the company is going to want to ensure continuity between the former CEO and their new CEO];
2. One year of salary and benefits (cash value);
3. The short term incentive compensation paid on the last calendar year;
4. The immediate vesting of any and all long term incentive compensation (e.g. stock options); and,
5. The cash value of any “something special” compensation.
In the course of dealing with these matters, there are several other attendant issues which should also be addressed.
Boards should not be tempted to “game” the compensation by which it is meant to discourage the Board from taking a look at the balance of the term of the Employment Agreement and see if there is a less expensive alternative to paying the full Severance Package. If you are going to terminate a CEO, then terminate the CEO. Do not play games. This works both ways.
Make sure that any deferred compensation issues are appropriately addressed. Deferred compensation always presents a problem when it is precipitously paid, as inadequate planning is almost always attendant in the form of payroll taxes and income tax withholdings.
Make certain that such issues as competition, luring away employees, disparagement and a recommendation are dealt with immediately. In the best of circumstances, such issues were addressed in the original Employment Agreement. It is not prudent to wait until everyone is irked and the emotion of termination is injected to try to negotiate a reasonable walk away position on these issues.
As a policy directive, a time period should be consistent. If the company is going to pay a Severance Package of one year’s compensation as a benchmark, then it is not unreasonable to expect a former CEO to refrain from competition, tampering with employment relationships and disparagement for a similar one year time period. Why not?
In presenting a termination or in dealing with termination, it is always helpful to have all the work done up front and have the entire transaction fully documented at the time of termination. These things do not age well and once a bit of emotion is riled up and allowed to marinate, things can get ugly.