Those Golden Parachutes Are Expensive

The news that Cesare Geronzi received a €16.65m bonus payment for leaving Generali after less than a year at its helm is now barely remembered. But it is only the last in a series of cases that have make severance packages the most controversial component of compensation packages for upper-level executives and top managersalso in Italy.
So-called golden handshakes are included in individual contracts by which the company commits itself to paying a considerable sum of money in case of termination of the employment or collaboration relation of a top executive. Until recently, such clauses were de facto non-derogable and severance bonuses were due even if the executive had operated ineffectively and had been removed or if he/she resigned, or even if company results had turned to be negative. It is precisely this unconditional right to major severance compensation, independently of the reasons for termination or company performance that has come under heavy criticism by shareholders and public opinion. Italian and European regulators have thus intervened to curb the negative effects of this phenomenon. Over the last years, the Italian regulatory framework has been upgraded, putting in place some norms concerning listed companies.
The new measures basically cover three aspects: upper limits in terms of multiples of the base salary; the possibility/necessity of including claw-back clauses (according to which payment is suspended or must be returned in the case of, even ex-post, negative company performance); and higher information transparency on the nature and entity of clauses relating to severance packages.
Even if such innovations will be fully valid only in 2012, it is natural to wonder whether and how listed companies are working to conform to the new norms. A research study by the Bocconi Department of Management and Technology focusing on severance packages for chief executives of FTSE/MIB companies covering the 2000-2009 ten-year period has come up with interesting data. In the sample examined, there were 24 cases of payment of severance packages. Almost half of the cases concern companies operating in the banking and insurance industry. The average value of severance packages is €5.6 million. EU directives put at two base salary annuities the maximum amount of severance packages, and Italian regulations have embodied such constraint only generically (article 7 of the Code of Self-Discipline), saying that amounts are to be calculated in terms of multiples of the base salary. The study has calculated the amount of severance packages as multiples of base salaries over the last decade, to ascertain how far Italian business practices are with respect to the new directives. The calculation was possible only in 19 out of 24 cases, and of these only 4 (i.e. 21%) respect the limit of two yearly salaries. As far as claw-back clauses are concerned, the study highlights that none of the FTSE-MIB companies has provided for them, and that in 20% of cases severance bonuses were paid also in case of negative business performance.
Even if the excesses in severance packages paid in executives in other countries did not occur in Italy, the study call for current practices to be significantly revised along three lines: higher sobriety; higher correlation with company results also over the long-term; and better information transparency. In terms of information transparency, research findings show that in many cases the amount of severance packages is not predetermined and is not an integral part of compensation policies formulated in companies (by compensation committees). Balance-sheet information has been found wanting and not standardized, and severance pay items are not listed in their various components. Neither corporate governance reports are particularly helpful: in 2009 only 10 companies out 40 considered have included information concerning benefits to be paid to the CEO in case of unanticipated termination of the employment contract, and listed the criteria to be used to calculate the amount of severance pay. Golden handshakes are neither good or bad intrinsically, but must be used appropriately. They must not be conceived as surrogates of short- or long-term incentives or, even worse, as additional compensation deprived of any logic. They can be useful in two cases: when companies want to avoid the cost of litigation over termination of the executive contract, or when they intend to stave off behavior unaligned with the interests of the company by administrators and top managers who feel their positions threatened during takeovers (M&As). The latter are two important aspects when it comes to ensure rapid processes of entrepreneurial and managerial turnover.