Conducting thorough due diligence with respect to a target company’s compensation plans, employment agreements, employee benefit plans and employee policies is an integral component in evaluating a potential merger or acquisition. For an acquiror, another significant piece of the overall picture with respect to compensation, however, is the impact of a merger or acquisition on executive compensation and the payments and benefits to be provided to executives upon a change-in-control. Below is a brief summary of what constitutes a change-in-control event and some of the benefits that executives typically receive upon a change-in-control.
Change-in-control (CIC) arrangements
According to Meridian Compensation Partners, the primary purpose of CIC provisions (also known as golden parachutes) is to keep executives focused on pursuing all corporate transactions that are in the best interests of shareholders, regardless of whether those transactions may result in executives’ job loss. Most CIC arrangements define change in control to include mergers, acquisitions (hostile takeovers via share acquisition or board takeover), and liquidation. Companies can have either a single trigger, double trigger or modified single trigger for CIC arrangements. If there is a single trigger, benefits will be provided to executives upon the occurrence of a CIC. For a double trigger, executives will only receive CIC benefits upon a qualified termination (terminations for cause are typically excluded) within a specified period following the CIC (typically 12-24 months). A modified single trigger is a hybrid of the single and double trigger approaches and allows executives to voluntarily leave during a specified period following a CIC (typically the 13th month) and still receive CIC benefits. The Canadian Coalition for Good Governance, in its Executive Compensation Principles, takes the view that CIC provisions should have a double trigger.
If the target company is a US company, additional considerations with respect to CIC arrangements include: (i) whether the target company needs to conduct a shareholder advisory vote to approve the golden parachute compensation arrangements for its executives (also known as say on parachute votes) in order to comply with SEC rules, (ii) whether deferred compensation payments to executives upon a CIC will be non-compliant with Section 409A of the Internal Revenue Code (the Code), and (iii) whether parachute payments to executives are or will be in excess of allowed payments under Section 280G of the Code. Contravention of Sections 280G and 409A of the Code can result in substantial taxes being assessed upon executives.
Benefits upon a CIC
- Severance: Severance for executives upon a CIC is typically expressed as a multiple of their pay, with pay including salary and target bonus. A multiple of 2-3x pay is common for the highest tier of executives, including the CEO. Institutional Shareholder Services, in its Canadian Proxy Voting Guidelines for TSX-Listed Companies, states that severance payments more than 2x cash pay (defined as salary and bonus) are excessive and will not be viewed favourably.
- Equity incentives: A CIC will often result in accelerated vesting of time-vested equity incentives such as stock options, prorated payout of performance-based share or cash incentives, and the release of any restrictions on restricted shares held by executives.
- Retirement plans: If the target company has a retirement plan in place for its executives, upon a CIC the target company may award additional retirement credits or make contributions to executives’ retirement plans, or less frequently may credit executives with service up to retirement age, even if the executives are not near retirement age.
- Other benefits: Many CIC arrangements continue to provide health benefits to executives for a period of time following termination (typically 1-2 years). Less likely, but seen from time to time, is the continuation of perquisites for a certain period of time following termination.
Based on the foregoing, it is evident that CIC arrangements can take a variety of different forms depending on the amount and type of benefits that are included in a parachute package. Excessive packages are widely criticized by both shareholders and regulators alike. As such, a balanced approach is essential in designing CIC arrangements that will keep all parties satisfied.
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