Finns crestfallen as golden parachute tangles up Nokia

All this cash should soften the landing. Sheba_Also

After the revelation that Stephen Elop, the CEO of Nokia, received a bonus of €18.8m following the company’s merger with his former employer Microsoft, executive “golden parachutes” are back on the public agenda.

Golden parachutes are clauses that mean if a company is taken over or there is some other fundamental change in how it operates, the CEO will receive a bonus pay off. In the case of Elop, his contract stipulated that if there was a change of control in the company, then he would receive a hefty bonus of 18 months base salary plus shares.

The size of the bonus shocked many people in Finland. But what is particularly controversial about Elop’s bonus is that gave him the incentive from the very beginning of his job as Nokia CEO to sell the company out. If there was a change of control, then he stood to collect a handsome bonus without all the hard work of actually managing a tech behemoth through a challenging period of change.

Merger fever

The broader practice of giving CEOs golden parachutes was unheard of until the 1980s in the US. But during that decade, the US economy was seized by merger and acquisition fever and the number of corporate takeovers skyrocketed.

This meant the position of many CEOs became increasingly fragile. To guard against this, many pushed to have a clause written into their contract that if there was a significant change in the company – such as a change in control – then they would receive a generous bonus.

The result was that golden parachute clauses were widely adopted. In 1980 just a handful of US fortune 500 firms had them. By 1990, it was more than 300. And what is even more striking is that golden parachutes became less controversial. In 1980, over 60% of articles in major US newspapers discussing golden parachutes pointed out they were controversial or contested practices. By 1990, only about 35% pointed out potential controversies. Golden parachutes had shifted from being a strange and deviant practice, to being a normal part of good corporate governance.

But normal does not necessarily equate to good. So why is it that companies adopt them in the first place? As one might expect, you can find a number of stauch defenders of the practice. CEOs themselves would point out that the practice is one way of creating a little fairness in this world of rapid corporate change. Despite the images we usually have of CEOs as all-powerful figures, their grip on corporate power has been steadily eroded during the last three decades.

It means that the shelf life of the average CEO in a fortune 500 company is now just 4.6 years. Simply getting to this position in the first place takes an average of 23 years. CEOs argue that to recoup the long hours and expensive divorces they have put into building their career, it is necessary they have a little certainty in the form of a golden parachute clause.

Some say that golden parachutes don’t just make the CEO feel more secure, they also benefit shareholders. One Harvard financial guru argues that by ensuring that the boss had nothing to lose if their company was taken over, CEOs would be unlikely to put up stiff resistance to take over offers. With a parachute, acquisitions that increase shareholder value would not be derailed by greedy CEOs seeking to hold onto their position. Indeed, one study showed that simply announcing that a firm had decided to put in place a golden parachute policy led to a rise in share price.

Destroying value

But recent evidence does not paint such a rosy picture. Putting a golden parachute in place certainly seems to encourage CEOs to encourage takeovers, but this is not necessarily a good thing.

One of the few hard and fast rules in the world of corporate finance is that the great majority of merger and acquisition activities actually destroy shareholder value. They also typically lead to significant losses of jobs, longer-term capacity such as innovation and local investments by companies.

The only people who consistently gain from the merger game are those who are in the market for companies. These are the lawyers, bankers, consultants and others who all do the very expensive work that comes with a large deal.

What this means is that putting into place a golden parachute policy is likely to encourage CEOs to court potential buyers of their company. And when this acquisition happens it will more than likely destroy shareholder wealth, lead to job losses and damage the community the firm operates within.

A CEO has walked back into his old job €18.8m better off, and a nation has lost its flagship company. If this isn’t an example of private gain and public pain, I’m not sure what is.

Found this article useful? A tax-deductible gift of $30/month helps deliver knowledge-based, ethical journalism.