Public companies are rapidly modifying their executive change-in-control (CIC) severance arrangements in response to mounting pressure from activist shareholders, proxy advisory firms and corporate governance experts.
Evidence of the impact of this external pressure is seen in the number of large public companies modifying their CIC severance arrangements in one or more of the following ways to:
■ Reduce participation;
■ Reduce cash severance multiples;
■ Subject future equity awards to double- trigger vesting; and
■ Eliminate excise tax gross-ups.
Meridian’s 2011-2012 study of executive CIC arrangements among representative companies of the Standard & Poor’s 500 index reveals the prevalence of these and other changes to CIC severance arrangements as follows:
■ Prevalence of cash severance benefits. Nearly three-quarters of study group companies provide cash severance benefits to their named executive officers (NEOs) in connection with a CIC (which has changed little from historical practice). We anticipate that the prevalence of CIC cash severance benefits will remain fairly constant over the next few years.
■ Cash severance multiples. Cash severance multiples are trending down from 3× to 2× (typically of base salary and bonus) for top executive officers. For CEOs, the 3× cash severance multiple remains the majority practice; however, at nearly a quarter of companies, the CEO’s cash severance is based on a 2× multiple. For other senior executive officers, the 3x cash severance multiple is no longer a majority practice, giving way to the 2× multiple at slightly over 40 percent of companies. We anticipate that cash severance multiples for CEOs will continue to trend down to 2×; however, a fair number of companies will continue to maintain a 3× multiple. For other NEOs, we expect that the 2× multiple will soon become the majority practice.
■ Prevalence of accelerating vesting of LTI awards. Over 90 percent of study group companies accelerate the vesting and payout of LTI awards in connection with a CIC. We expect the prevalence of this practice to remain high. However, vesting triggers are evolving in this area.
■ Treatment of time-based equity awards.Historically, the
overwhelming majority of companies automatically vested time-based equity awards solely upon a CIC (single trigger). Our study found that only about 50 percent of companies continue to use single-trigger vesting, but well over 30 percent of companies vest timebased equity awards upon a double trigger (i.e., vesting upon a qualifying termination of employment following a CIC). We expect double-trigger vesting will become the majority practice, requiring both a defined CIC and either a termination of employment or no conversion of unvested equity into the acquiring company’s shares.
■ Treatment of LTI performance-based awards. Similar to time-based equity awards, single-trigger vesting of LTI performance-base awards is declining but still a significant practice. About 60 percent of companies vest performancebased awards solely upon a CIC, while about a third vest upon a double trigger. While we anticipate the prevalence of double-trigger vesting will increase, we expect it will generally be limited to awards subject to performance measures that remain relevant post-CIC.
■ Prevalence of excise tax gross-up provisions. Approximately 60 percent of companies cover top executive officers under excise tax gross-up provisions. However, based on forward-looking proxy disclosures, we project that less than 30 percent of companies will maintain excise tax gross-up provisions for NEOs within the next few years.
The trend of eliminating tax gross-up provisions will continue and ultimately the prevalence of these provisions will become nominal.
Overall, the speed of change in CIC severance agreements has been dramatic. If your CIC severance program has not been reviewed in the past 24 months, it is clearly time to do so.
Donald Kalfen is a partner, Michael Powers is a managing partner and Daniel Rodda is a senior consultant at Meridian Compensation Partners, an independent executive compensation-consulting firm.