Severance and change-in-control agreements provide for payments to executives and other individuals in the case of termination. If properly constructed, severance agreements can be a valuable tool to help protect the interests of a company while also attracting key talent and incentivizing them to work in the best interest of shareholders, rather than solely to protect their job.
By providing severance in exchange for demanding non-compete, non-solicitation and non-disparagement restrictions against an executive, the Board can better protect the company.
Change-in-control arrangements relate to payments made to executive departures triggered by a merger, acquisition or divestiture. The prevailing practice is for "double-trigger" change-in-control arrangements that activate upon a business change of ownership if the executive also loses his or her job. Change-in-control arrangements encourage senior executives to seek out and execute sale or merger opportunities that add to shareholder value while reducing the impact of losing their job.
A Strategic Approach to Severance
The Center On Executive Compensation believes that severance and change-in-control arrangements can play a constructive role in the recruitment and retention of key executives. However, they should be carefully structured to support the company’s business strategy and serve the best interest of the company and shareholders.
Additionally, companies should fully explain and disclose their philosophy around the use of severance and the purpose of existing severance and change-in-control arrangements.
Executive transitions represent significant risks to shareholder value. A core responsibility of the board of directors is to ensure (to the extent possible) that the company has a clearly defined succession plan. Furthermore, a key component of attracting top talent into executive roles is a fair severance and change in control plan.
Though the plans often receive negative press, they serve to protect shareholder value by ensuring executives are neutral on potential economic transactions and laying the groundwork for succession planning.