RICH rewards for departing bosses are not popular. After Sir Fred Goodwin led Royal Bank of Scotland into a ditch and dumped the bill on British taxpayers, he left with a pension of over £700,000 ($980,000) a year. The Sun, a tabloid, said he had “screwed the nation”.
Yet golden parachutes have their uses. If well-designed, they align the boss’s interests more closely with those of shareholders. Suppose, for example, a takeover is brewing. Takeovers are usually lucrative for shareholders of the target firm: in America between 1990 and 2008, they have received a median premium of 35%. But the boss’s interests are quite different. If the firm is acquired, he is likely to be fired.
A golden parachute can persuade the boss not to obstruct a takeover. But their notoriety dissuades firms from using them. Dirk Jenter of Stanford University and Katharina Lewellen of Tuck Business School find that golden parachutes are rarer and stingier than they should be.
To test whether bosses block takeovers, they looked at what happens when they are nearing retirement, and therefore have no future career to sacrifice. Using data on American public firms from 1992 to 2008, they found that companies with a boss aged 65 or over were 50% more likely to be taken over.
Another paper, by Eliezer Fich and Ralph Walkling of Drexel University and Anh Tran of Cass Business School, found that when golden parachutes are larger, proposed mergers are more likely to be completed, but buyers pay less for the shares of the target firm. The data from Mr Jenter and Ms Lewellen show that when the boss of the target firm is old, buyers pay an average premium of 26%. For younger bosses, the premium is 33%. This makes sense. If younger bosses are more reluctant to sell, it will cost more to overcome their objections.
So boards must strike a balance. If the boss’s golden parachute is too miserly, he may block a deal that would benefit shareholders. If it is too generous, he may fail to negotiate hard with potential buyers. As with real parachutes, poor design can have serious consequences.