What is a Golden Parachute?

If you are hired in a top-level executive position your employment contract usually has several statements about what types of benefits you can expect to receive if your employment is terminated. These clauses in the contract are called a golden parachute, since they will effectively give the employee a soft, safe and valuable “landing,” if he or she loses his/her job. They can be offered under many different circumstances and the benefits of being fired can be tremendously lucrative.

Frequently golden parachute clauses contain language that states these benefits may only be available if a company is taken over by another company and the employee thus loses his or her job. If enough employees in the upper echelons of a business have golden parachute options in their contracts, it can discourage another company from trying to annex or take over a business. It can cost too much money to provide these benefits for a lot of employees.

Typical benefits in a golden parachute include allowing the employee to own or purchase huge amounts of stock at reduced rates, and giving the employee generous cash or severance pay allowances. In certain circumstances, the golden parachute can include payouts of well over a million dollars, and provides a type of what is called a perverse incentive. This is a type of incentive with unintended consequences. In this case, the hope is that golden parachutes will consequently discourage hostile takeovers.

On the other hand, it can be argued that an unintended consequence of golden parachutes is the possibility that executives might facilitate a takeover of their company in order to benefit from receiving attractive payouts and stock options. These clauses that define end benefits have to be precisely worded, and many argue that in some cases they do not define enough, and people who have no rights to payouts get them. They may not take into account the competency factor. If a company must terminate someone’s job due to lack of competence, the person may still get golden parachute payouts depending upon the precise wording in his or her contract.

Investors can be frustrated by golden parachute options for this specific reason. If job competency is not listed as an important part of earning severance pay, a company can lose money by having to provide parachutes for fired executives. Lower level employees may also pay for these “parachutes,” by losing their jobs if a company must cut back on expenses due to paying large severance amounts to incompetent CEOs.

The golden parachute should not be confused with the golden handshake. This is a related term, and is usually extra bonuses or severance pay meant to encourage long time workers to retire more quickly. For doing so, they’ll receive better retirement options and clear the way for a company to hire workers at a lower rate of pay.