Shooting Down Golden Parachutes
Plenty of so-called solutions make sense in theory, but prove to be absolutely horrible in practice. Discussions about executive pay issues fall along those lines; those who defend the often insane levels of CEO pay these days often make compelling theoretical points about why such policies make sense, but real results end up being quite negative for shareholders.
"Golden parachute" good-bye packages for chief executive officers fit into this area. In fact, a recent study underscores the fact that they have a detrimental effect on long-term shareholder wealth.
The real costs of golden parachutes
The study, "Golden Parachutes and the Wealth of Shareholders," by Harvard Law School's Lucian Bebchuk, Alma Cohen, and Charles Wang, brings up good reasons to doubt that golden parachutes are good for anyone except the chief executive officers who are guaranteed to receive them.
The authors point out that golden parachutes were devised to prevent chief executive officers from thwarting acquisitions of their companies, since they're promised a handsome payout upon losing control of their companies. The conventional wisdom is that shareholders should take on the often brutal costs of these good-bye packages in order to grease the wheels for profitable merger and acquisition activity.
In addition, the authors also concede the point that companies offering golden parachutes do in fact show a higher chance of being acquired or at least fielding some offers.
However, the ultimate conclusions the authors draw show ugly outcomes for long-term shareholders. As Bebchuk reported in a piece for The New York Times, "Companies that have adopted golden parachutes tend to see their valuations (relative to their industry peers) erode over time. Such companies have lower valuation already before adopting a golden parachute, but their value declines further in the subsequent several years."
The Times piece highlighted a few egregiously high good-bye packages awarded after M&A activity. Take North Fork Bancorporation's former CEO John Kanas, who got $135 million when Capital One Financial (NYS: COF) bought his company in 2006. For a more historical example, way back in 1993, Medco Containment Services' CEO Martin Wygod received $150 million in cash and stock when Merck (NYS: MRK) swept in and took over his company.
The maniacal side of M&A
The study brings up many interesting questions for shareholders. One aspect I'd like to explore: M&A mania is a perfect example of what too often goes wrong in our marketplace, so why do we encourage it? Too many investors love such short-term events, and don't even care whether the actual result is the destruction of value.
How many mergers and acquisitions can you think of that were overpriced and underperformed? Last summer, I contemplated M&A and the drive to overpay. Go back over the annals of history and you'll find many acquisitions that companies later pretty much admitted were overpriced by taking non-cash accounting charges.
Examples of the phenomenon include eBay (NAS: EBAY) and Skype ($1.4 billion write-off), Procter & Gamble (NYS: PG) and Gillette ($1.5 billion write-off), and Microsoft (NAS: MSFT) and aQuantive (taking the proverbial cake with a $6.2 billion charge).
It's a sad commentary on our marketplace that so many investors get excited about mergers and acquisitions even though so many of the deals actually end up destroying value instead of creating it. Pair this with paying out huge golden parachutes for the privilege of being at the right place at the right time, even if the deal is ultimately a loser, and you can see why we have some seriously questionable incentives. CEOs and short-term traders are the beneficiaries; shareholders and the financial health of actual businesses suffer over the long haul.
When it comes to corporate governance policies, there's a lot of work to do in reversing the damage that has been done over the course of decades. That damage often cedes too much money and power to managements, makes it difficult to topple underperforming boards of directors, and ends up incentivizing short-term behavior and destroying long-term value.
A new emphasis on true long-term shareholding should help continue to throw light on faulty policies like golden parachutes. The truth is, true ownership and responsibility wouldn't entail bailing out in the first place. So let's take aim at such counterproductive policies before they ruin our future returns.
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