A Creative Approach to Severance and Change In Control Multiples

“Pay for failure” without a doubt is one of the more toxic topics when discussing executive compensation. When attracting a new executive, balancing “downside protection” vs. “over-the-top party favor” has its own set of unique challenges. If an executive is a top quartile performer, companies are making every effort to retain their top talent. Given the competition for top quartile talent, odds are stacked against companies in attracting new star performers unless they offer something either
(i) truly unique or (ii) a very compelling risk reward opportunity.

In preparation for a recent presentation for the HR Policy Association and a webinar on severance and change in control practices, one of our analysts came across a great example from the employment contract for the CEO at Cardinal Health (CAH). In this example, the multiple of base salary and bonus that CAH pays to Kerry Clark decreases the longer he is with CAH. By having a variable multiple tied directly to tenure, this protects the executive early in his new position.

“the Company shall pay to the Executive in 24 equal monthly installments, the amount equal to the product of (1) a fraction, the numerator of which is the number of days from the Date of Termination until June 30, 2009 and the denominator of which is 365, and (2) the sum of (x) the Executive’s Annual Base Salary and (y) the Reference Bonus; provided that such amount shall not be less than 1.5 times the sum of the Annual Base Salary and the Reference Bonus;”
Employment Contract dated April 17, 2006

So what does this actually mean? The chart below illustrates how the severance multiple for the CEO declines over time.

If Mr. Clark or the board realizes that this isn’t the right gig for him early on, he is protected with a 3x or greater severance multiple. But over time, as he gets settled into his position, the multiple gradually declines and bottoms out at 1.5x. By having this built directly into his employment contract, this arrangement addresses a major concern of many shareholders.

I hope people find this example to be of interest. If you know of other interesting and unique examples, please let us know.

Thank you for your interest and taking the time to read my blog. A number of my friends have been encouraging me to do this and I finally overcame my coefficient of friction and got the ball rolling. First, I’d like to thank Alex Cwirko-Godykci, Vien Nguyen and Moi Luu in their help and support in getting this launched. Without their hard work and dedication, I would still be sitting on my “you know what” and telling myself I should be doing this while watching the Mets collapse on SportsCenter (hence the orange and blue in our logo).

Why another blog, let alone one from me?

Needless to say, if you’re reading this, you recognize and understand that executive compensation and corporate governance are extremely complex and emotional issues facing board members, executives and HR professionals at EVERY company – whether the company is in the U.S. or abroad, private or public, for-profit or not. It doesn’t matter if the CEO makes $1 or $100 million dollars. The challenge with compensation (and especially for executives) is that there is never a right answer. You pay too low, the executive is discouraged and a flight risk. You pay too high, welcome to the world of shareholder activism. Finding the right balance offers a unique set of complex challenges for board members.

We at Equilar take pride in offering thoughtful and independent analysis on trends that we’re seeing in the marketplace. We like to see ourselves as Switzerland in the whole equation and provide independent and objective analysis as part of this process. Through my blog, I will highlight interesting trends and practices that we’re seeing out in the marketplace and share them with our readers. We hope that you enjoy the examples that we highlight and share them with your friends and colleagues. And, please, we welcome any comments and suggestions. Enjoy!