In the final installment of our mini-series, Kavea has explored the varying dynamics of Executive Compensation plans in transaction events. Within this context, compensation plays a pivotal role in the success and smooth execution within a mergers and acquisitions (M&A) setting. This setting impacts both the buy-side and the sell-side. Aligning executive incentives with strategic objectives while addressing legal, financial, and operational concerns is essential. This article explores how executive compensation is managed in M&A transactions, with examples and references to legal precedents where applicable.
1. Seller’s Perspective: Executive Compensation Dynamics
“Golden Parachutes”
Golden parachutes—lucrative severance packages provided to executives upon a change in control—are a common feature of M&A deals. These agreements typically include cash payouts, accelerated equity vesting, or other benefits triggered by termination or significant role changes.
- Legal Precedent: Internal Revenue Code Section 280G governs “excess parachute payments” in the U.S. If payouts exceed three times the executive’s 5-year average annual compensation, the excess may not be tax-deductible for the company, and the executive could face a 20% excise tax. This rule ensures golden parachutes are structured thoughtfully to avoid undue tax liabilities and “reasonable” payments to the executive team. However, in the event there is an excise tax due, Kavea has supported clients in offsetting these potential liabilities to reduce the taxable amount due.
- Example: When Disney acquired 21st Century Fox in 2019, senior executives at Fox, including CEO James Murdoch, received significant severance payments. These payouts were structured within regulatory guidelines to ensure compliance and stakeholder approval.
General Market Plans
In order to mitigate and create reasonable plans, organizations in most instances develop a formal change-in-control policy for executive officers (and in a minority of cases for non-executives). Specifically, these policies follow reasonable and customary practices with the following as the key considerations:
- Single or Double Triggers:
- Single Trigger: A single trigger would make a payment to recipients upon the closing of the transaction regardless of continued employment.
- Double Trigger: A double trigger would make a payment to recipients upon the closing of the transaction and the subsequent loss of employment within a pre-determined period of time to minimize bad behavior in timing termination (reasonable ranges include 6 months before and up to 24 months after a transaction event).
- Base Salary Multiple: Depending on the triggering event, a multiple of base salary will be provided to offset the loss of employment. The specific multiple of salary varies across titling structures, organizational size, and industry. Common multiples are 1.5–3x salary for CEOs and 0.5–2x for other key executive officers. In organizations that have a formal policy for non-executives, there will typically be a calculation to determine individual payouts (common formulas include 1 month of pay for every year of service).
- Bonus:
- Current Year Bonus: The current year in many cases will be in process, and as a way to mitigate less-than-favorable treatment, organizations will employ a “better than” mechanism whereby payouts will be determined based on the better of the pro-rated results or the two/five-year average payouts.
- Bonus Target: Similar to base salary multiples, bonus payouts are consistent with those multiples to offset the loss of employment.
- Benefits: Common benefits include COBRA coverage for 6–36 months and potentially outplacement services in order to source new employment.
- Equity Treatment: Executives often hold equity or stock options that may be affected during an acquisition. Common treatments of these awards include:
- Acceleration of Vesting: Unvested shares vest immediately, providing immediate financial rewards.
- Cash-Out: Executives receive a payout for their shares based on the deal valuation.
- Rollovers: Shares are converted into the buyer’s equity, retaining alignment with the new entity.
Retention Bonuses
To maintain continuity and ensure a smooth transition, acquiring companies will in many cases offer retention bonuses and/or time-based vesting equity to key executives employed by the selling entity. These retention packages are typically contingent on meeting specific milestones during the integration phase or require a specific time of employment before being fully “earned.”
- Case Study: In the Dell-EMC merger (2016), EMC executives received retention bonuses to help manage the complex integration of the two technology companies, one of the largest tech mergers in history.
Severance and Role Elimination
Executives from the selling company may face termination or role changes post-merger, especially if their roles overlap with those in the buyer’s organization. Severance packages, typically pre-negotiated, provide financial security in these situations.
2. Buyer’s Perspective: Managing Costs and Incentives
Aligning Compensation Structures
Post-acquisition, the buyer often recalibrates compensation for retained executives from the seller to align with the buyer’s pay structure and strategic goals to assimilate the two compensation philosophies and potentially differing cultures. This includes:
- Adjusting base salaries.
- Offering long-term incentives, such as restricted stock or performance-based equity.
- Example: In Amazon’s acquisition of Whole Foods (2017), executives at Whole Foods were retained and offered revised compensation structures aligned with Amazon’s performance-based culture.
