Imagine, you’re getting fired from your job and your employer pays you a hefty amount to sweeten the good bye. Wouldn’t it be an icing on the cake, if you are handed over sizable stock options as well? And when we say – sizable – it’s really sizable – maybe a few 10’s or 100’s of million dollars. All of this, along with a termination letter, or softened announcement of your firing – that makes it look as if you are exiting voluntarily. Sounds like a dream right?

Well, this is an everyday reality for some seasoned executives serving in key roles with top corporates, well funded start-ups, or cash rich conglomerates. While we have mentioned “fired” CEOs in the post title, it’s not just about those who are pushed out. Those who exit even voluntarily also have their severance entitlements – usually better than the ones who are forced out.

This may be true for your organization as well – may be for some executives working at the top management in your company – like CEOs, Managing Directors, and CxOs, etc. Take the example of Former McDonald’s CEO Stephen Easterbrook, who is possibly getting an severance of $42million after he exited, as his actions violated the company policy that forbade managers from getting into a romantic relationship with subordinates.

Another example is Adam Neumann, the Founder and former CEO of WeWork, who walked away with about $1 billion and more after giving up his board seat. These handouts have been knows as “Golden Parachutes”, and are commonly known as “Severance Packages”.

If you look closer at home, in India, you may recall the severance package of a former Infosys CFO, Rajiv Bansal which was around Rs 17 crore. Lots of hue and cry was raised by share holders, founders over the “huge” severance package – a major part of which (Rs. 12 crore – about $ 1.7 million) was withheld citing that it was “hush money” to the CFO for hiding poor corporate governance under the former CEO Vishal Sikka. However, the severance pay was a part of Rajiv’s appointment contract. Later, in September, 2018 – an arbitration panel upheld that he should be paid the entire amount.

Severance pay, forms a key part of their employment contract

Severance agreements are a key part of employment contract, and lists out the benefits that an out-going executive will receive on separation. Depending on the agreement, the separation could be either voluntary or involuntary. There may be clauses related to the separation – about time frames, reasons for separations and how the interest of the concerned executive will be protected if things go south.

If a severance package is negotiated and incorporated in an employment agreement, it works even if the executive is fired, unless there are built in conditions to withhold or claw-back – for example – under cases of ethical or moral lapses.

Also, in return for the severance, the concerned executive has to agree to certain conditions laid out in the agreement – such as non compete ( not working for a direct competitor), adhering to non-disclosure agreements, signing up with a client or a vendor, or starting out in a similar domain. For large corporate, business houses, and high growth businesses – their business plans, strategy, decisions, products are worth millions or billions. Considering that the CEO, members of leadership teams are privy to all of those – its important that these are well protected.

Uncertainties of the job, business, business environment

Despite, once in a while having a questionable conduct, CEOs are by large very motivated, talented and capable leaders with proven track records.

When they’re hired by an organisation, often for troubleshooting or to lead and drive a change in the organizational strategy, these guys put their entire reputation on the line to action the identified plans.

Any failure or misstep hits them hard. If the organisation sees falling fortunes based on their decision, even their credibility comes under scrutiny, thereby also impacting their future career.

Severance packages reflect the uncertainties present during the time of their hiring, and uncertainties regarding the organisation, the market, and lots of other variables which are not under direct control of the concerned.

Severance agreements are negotiated to support the concerned CEOs, CxOs, or leadership team members take decisions and drive actions that are in the best interest of the firm.

It helps attract capable talent

Attractive severance packages, also help attract and hire executives who are most capable of achieving desired results, and may need a cushion in case their decision to take up the seat misfires.

The quantum of severance package is a reflection of expect contribution, uncertainties involved, growth stage of an organisation, structure or the organisation, limitations and roadblocks in leading the turnaround strategy, and lots of related variables. It may also factor in the the role of promoters – the board. If the potential candidate sees a possibility of excess intrusion by the promoter, founder or the board at a later stage, he/she may keep a provision for exiting safely.

Enables decisiveness

Severance packages act as a shield and tools in many ways for the CEO / CxO to be decisive, drive tough decisions, exercise sound judgement and stay focused on the task at hand – betterment & growth of the organization.

It incentivizes risk-taking

CEO severance pay can be viewed as an incentive for risk-taking. Leadership decisions and action clearly impacts the value of the company considering either the fundamentals or sentiments association with the same.

As the company’s stock volatility increases due to CEO risk-taking, the expected value of both ESOPs and severance increases. Businesses leverage severance packages to insure that CEOs accept ambitious projects when they are concerned with their own wealth preservation.

It serves as an insurance in case of internal friction & conflicts

Severance packages act as insurance for CEOs / top executives, as sometimes they can be let go of their position considering management decisions, board decisions related to business reorganization, leadership transition – all of which may not have any thing to do with the concerned executive.

In such scenario’s the concerned executive needs to be protected. This option may exercised by businesses due to some internal management change or because of a conflict between the board and CEO. The severance package acts as the insurance for the CEO until he/she gets another job or gets involved with any other business. 

It serves as compensation for confidentiality & non-compete

Normally senior management & leadership teams, including CEOs are hired under an extremely hardwired employment agreement with non compete, non disclosure clauses, apart from a series of confidentiality clauses. Some of these even forbids a parting executive to take up jobs, consulting assignments in any competitor, or related business, and even forbids them from starting up on their own in similar or related domain, in a foreseeable future.

While, these confidentiality and non-disclosure agreements are to ensure that the business secrets, knowledge gained in the current organization are not passed on to competitors, they may also limit an executives avenues for a gainful employment. A hefty severance package, helps place a comfortable lid on the lips of the parting executive.

The relationship between a business and its CEO is a two-way street, and the company should require performance, but the CEO also needs the power, resources, and time necessary to perform. Thus there is the concept of these severance packages which act as a bridge between the CEO and the organization. There has to be a comfortable exit route when things go south.

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