An Analysis Of Executive Pay After Big Mergers

The rash of corporate mergers and acquisitions erupting in recent months is fueling a re-examination of big pay packages for top executives at acquired companies.

Earlier this month Equilar, a compensation analysis firm in San Mateo, California, reviewed the executive compensation and severance plans triggered by 10 mergers and acquisitions announced last year. Although not often a fair measurement, executives and companies draft compensation and severance agreements based on what their peers are receiving.

Equilar picked 10 deals from various industries for its analysis:

AT&T Wireless Services and Cingular Wireless;

Bank One Corp. and JP Morgan Chase;

FleetBoston Financial and Bank of America;

John Hancock Financial Services and Manulife;

Travelers Property & Casualty and St. Paul;

Wellpoint Health Networks and Anthem;

Public Service Enterprise Group and Exelon;

Rouse Co. and General Growth Properties;

Sears Roebuck & Co. and Kmart;

SouthTrust and Wachovia.

Seven of the 10 chief executives of the acquired companies stand to receive three times their base salary and bonus as well as medical and life insurance for at least three years after leaving the newly merged companies, according to Equilar.

Of the five newly merged companies that disclosed how much severance top executives would be paid, the median severance payment was $20.4 million.

Equilar found that at six companies the severance agreements were triggered if the chief executives were fired without cause or for good reason during a certain period of time after the change in control. In the other four agreements, the chief executives receive their full severance payments even if they leave the company voluntarily for any reason usually six months or a year after the merger.

Single Trigger

While compensation expert Claude Johnston, a managing director at Pearl Meyer & Partners in New York, said the amounts are staggering, attorneys and consultants agreed that Equilar’s findings reflected a pay package’s typical components, which haven’t changed much in two decades. And they didn’t expect the amounts to change anytime soon, despite outcries from shareholder groups.

Meyers

“Because there are more mergers now, more change-of-control packages are being triggered so more people are paying attention, but I suspect the prevalence of these packages hasn’t changed,” said Arthur Meyers, a partner in the Boston offices of Palmer & Dodge.

Equilar found that in nine out of the 10 deals, the mergers triggered early vesting of stock options held by employees at the acquired company. Some experts said, however, that the accelerated or immediate vesting of options is becoming a less common practice.

“I was somewhat surprised that many of the options had a single trigger of accelerating stock options,” said Meyers. “Some companies do this as a partial bonus but it begs the question for those who are critical thinkers: “Why are you doing this?’”

Some critics of shortening vesting periods say it allows chief executives to cash in on stock options and then flee the newly merged company, no longer caring about that entity’s outcome.

Stock options, typically a large component of compensation plans, also are often either converted into options of the acquiring company or newly merged entity, or they are cancelled and exchanged for cash. Equilar found that in seven of the 10 deals, the target company’s stock options were converted into options to purchase shares of the combined or acquiring company. In the other three deals, options were cancelled and exchanged for cash.

Angelides

California state Treasurer Phil Angelides believes options for top executives in mergers should not be accelerated. “When executives engineer a merger," says Angelides, "they should not be allowed to cut loose their own financial fate from the performance of the business combination they have put together.”

“By requiring their unvested options to be converted into options in the new company,” Angelides said in a recent speech, “the policy would link their interests with those of the shareholders.”

Often accelerated or immediate vesting of options and other bonuses have already been written into the executive’s employment contract when first joining a company, executive compensation lawyers said.

Pay-Outs And Motivation

Cohen

“Chief executives and top executives are going to negotiate with their companies strong protections for themselves in the event that there is any future change of control,” said Adam Cohen, a partner in the Washington, D.C., offices of Sutherland, Asbill & Brennan.

However, executives of target companies often negotiate retention bonuses or pay-outs with the acquiring company. But this is where companies have to be careful not to enter into negotiations that interfere with the pricing of the deal, experts said.

As reported in the Wall Street Journal, Massachusetts Secretary of Commonwealth William Galvin has opened an inquiry into Gillette’s sale to Procter & Gamble. Galvin said the size of the payment to Gillette’s chief executive makes him question whether the money was James Kilt’s motivation for the sale, and whether Gillette’s senior officers and directors breached their duty to shareholders by approving the sale.

Gillette Chief Executive James Kilts would receive at least $185 million—about $95 million of which is directly tied to the closing of the deal—when the sale of Gillette to Procter & Gamble is complete.

There were several companies among the 10 deals studied, according to Equilar, that offered the chief executive a retention bonus of up to 125 percent of his base salary if he stayed for a certain period of time after the merger. This has been and continues to be common practice among companies.

For example, Sprint Corp. and Nextel Communications, after announcing last month their $35 billion merger, are offering some of their senior executives bonuses that are more than a year’s salary if they stay at least one year after the deal is completed, according to a filing with the Securities and Exchange Commission.