Module 5: Takeover Defenses — Wall Street Instructors

Golden Parachutes

The term “golden parachute” describes a defensive measure used by a company to prevent hostile takeovers. With golden parachutes, employers enter into agreements with key executives to pay amounts in excess of their usual compensation in the event that control of the employer changes or there is a change in the ownership of a substantial portion of the employer’s assets. Top executives are provided with a financial soft landing if a takeover results in their discharge. The company initiating the hostile takeover must either absorb the associated increased costs when acquiring the corporation or back down from the takeover.

Please note: Golden parachute payments do not have to be made under a legally enforceable agreement or contract — a formal or informal understanding will suffice. An oral agreement is enough even though it would not be legally enforceable under state contract law. Not having a written agreement, however, is a surefire invitation to be sued by a corporation’s shareholders who may want a takeover to proceed and don’t want oral agreements to stand in the way.

What Is a “Golden Parachute”?

Golden parachutes are payments made to “disqualified individuals” that are contingent upon a change in the employer’s ownership. Disqualified individuals are any of the employer’s employees or independent contractors who are shareholders, officers, or highly-compensated individuals (one of the employer’s top one percent or 250 employees in terms of compensation, whichever group is smaller).

A payment is generally treated as a golden parachute payment if it meets all of the following conditions:

It is in the nature of compensation and is made to or for the benefit of a disqualified individual at any time during the 12-month period immediately before the date of ownership or control change
It is contingent on a change in the ownership of a corporation, in the effective control of a corporation, or in the ownership of a substantial portion of the assets of a corporation
It has an aggregate present value of at least three times the individual’s base amount of compensation

A parachute payment can be in the form of cash or property, and may include the spread on the exercise of a stock option, pension proceeds, insurance or annuity proceeds, or payments made under a covenant not to compete.

Excess Parachute Payments

Congress viewed excessive golden parachute payments as detrimental to the interests of shareholders and a deterrent to corporate acquisitions, and enacted restrictions that limit such payments.

If payments are determined to be excess parachute payments made to disqualified individuals:

The excess payments are not tax deductible by the employer
Executives receiving such payments are subject to a 20% excise tax on the excess amount, in addition to regular income taxes
The excise tax is withheld by the employer for payments considered wages and is not deductible by the recipient
Excess payments are also subject to Social Security (FICA) taxes when paid

The following golden parachute payments are exempt from these penalty provisions:

Payments from certain small business corporations (S corporations)
Payments from corporations that, immediately before the change in control, have no stock readily tradable on an established securities market
Payments to or from certain qualified plans, including pension, profit-sharing, and stock bonus plans
Certain payments of reasonable compensation for personal services

Safe Harbor Rule: Golden parachute payments up to three times annual compensation fall under “safe harbor” rules. Plans that exceed that level are subject to the 20% excise tax. Given the complexity of executive compensation packages — including valuing stock options — executives should obtain expert advice on how a proposed golden parachute plan may affect them personally.

Silver, Tin and Pension Parachutes

Golden parachutes are primarily used to shelter top executives in the event of a hostile takeover. Similarly, silver, tin, and pension parachutes are used to provide benefits to employees — but to a more broadly based group.

🥈 Silver Parachutes

Provide benefits to a broad base of employees in the event of a hostile takeover. Similar in structure to golden parachutes but covering a wider employee group rather than just top executives.

🪙 Tin Parachutes

Essentially severance payments for rank-and-file employees that activate if a hostile takeover costs employees their jobs. Many consider these an even better takeover defense than golden parachutes — large numbers of employees can add up to a larger total package even if individual payments are less.

💼 Pension Parachutes

Increase retirement payments to employees in an employer’s defined benefit pension plan. Activated only after a change of corporate control triggers automatic termination of the retirement plan — excess assets are then used to provide additional benefits for all active and retired participants.

⚖️ Rules & Tax Consequences

The same rules and tax consequences that apply to golden parachute payments generally apply to silver, tin, and pension parachutes. An important difference: silver, tin, and pension parachute payments are not subject to the 20% excise tax on excess payments because they are made to rank-and-file employees rather than disqualified individuals.

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