Executive pay issues at "merger time": it is precisely the balance between "indifference to a merger" and inappropriate motivation to do a deal at a lower premium that compensation committees need to get right.

Author:Kay, Ira T.
 
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As the stock market recovers from its collapse a year ago and as the economy sputters towards recovery, merger and takeover activity is also recovering. This seems like an appropriate time for boards, especially compensation committees, to take a close look at their pay packages, especially those protecting their executives at a change in control (CIC).

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The fundamental theory behind CIC protection remains valid. Basically, these protections continue to level the playing field for the executives so that they are not resistant to mergers and takeovers. The great hostile takeover battles of the '80s and '90s were essentially eliminated by CIC protection. That is, the executive team at most companies is now economically indifferent between a takeover--presumably at a significant premium--and three or more years of continued employment at the existing pay package. They are presumably able to focus on what is best for the shareholders--in terms of both whether to do a deal at all and at what premium. In fact, a casual scan of most proxies, especially companies with underpriced stocks with underwater stock options, shows that most executives today are typically much better off financially if their company is being taken over.

There are indeed circumstances where the CIC protection can actually become a poison pill, either discouraging the deal or lowering the premium. We have been involved with several transactions where the CIC protections were large enough that the target boards were able to renegotiate part of the employment agreements with their own executives, especially relating to severance or 280G tax gross up. In one instance, the reductions that the executives accepted were large enough to raise the buyer's offer price. While these cases are the exception, CIC protection can be an irritant to shareholders and an embarrassment to the board.

It is precisely that balance in takeover protection between "indifference to a merger" and inappropriate motivation to do a deal at a lower premium that committees need to get right. Furthermore, pay package scrutiny at a merger by shareholders, the media, and the potential excoriation and reputational risk to board members, makes the stakes even greater. Good planning, analytics and good governance, along with a cooperative executive management team, can go a long way towards improving the relationship with shareholders and balancing the interests of all stakeholders.

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