A Safe Landing? Golden Parachutes and Corporate Behavior

Abstract

The original motivation for golden parachutes was to provide managers the incentive to maximize shareholder wealth without concerns of job loss from change of control. But they may also create the incentive to run down a firm and make it an attractive takeover candidate, especially in the case of poorly performing firms that require substantial turnaround effort. Such concerns led to the U.S. Congress passing laws that limit tax deductibility to golden parachutes and levy additional taxes on such payments. Our study of a sample of 245 first-time golden parachute adopting firms during 1980-94 indicates that such concerns (and the legislation) are misplaced. Regardless of whether they are under- or over-performers prior to parachute adoption, managers do not appear to run down their firms: They do not put the firm up for sale any more often than average, CEO turnover does not increase, and firms' operating, financial and stock performance subsequent to adoption show no evidence of value destruction. In contrast, we find a dramatic increase in both inward and outward corporate control activity, leading us to the conclusion that golden parachutes have simply given managers the confidence (and a cushion) to restructure their firms without having to worry about losing their jobs from the firm being put in play.