Golden parachutes: CEOs and the exercise of social influence - compensation packages given to chief executive officers in the event of their termination or resignation

Administrative Science Quarterly,  Dec, 1990  by James Wade,  Charles A. O'Reilly, III,  Ike Chandratat

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Using an agency theory framework and data on 89 Fortune 500 firms, we assess whether the granting of golden parachutes to chief executive officers is the result of an economically rational process or determined by the social influence of the CEO. While increased takeover risk is associated with a higher incidence of GPs, as predicted by economic theory, CEOs who are able to appoint more outsiders to their board are also more likely to have GPs. These results suggest that both economic and social influence perspectives have merit and that the importance of each may depend on the ownership structure of the firm.

Along with the recent trend in corporate mergers and takeovers have emerged new incentive packages for incumbent management teams as insurance against takeovers. Generally referred to as "golden parachutes" (or GPs), these are contracts between the executive and the employer that provide for additional compensation should a change in control or ownership occur (Krueger, 1985). The magnitude of these payouts can be significant. For instance, ten executives from Primerica recently received $98.2 million as a result of a takeover (Winkler, 1988). Estimates are that approximately 30 percent of the top 250 industrial companies have these, and the proportion is growing rapidly (Adair, 1987). But are golden parachutes a sound idea? Who actually benefits from them, the shareholders or top management? What rationale is used by the board of directors in the decision to grant GPs to management?

Thus far, these issues have generated far more controversy than research. The general argument in favor of GPs is one of aligning incentives between shareholders and management. The logic is that an entrenched management, faced with a takeover bid that may lead to job loss, is likely to resist the offer in order to protect management's jobs, even though such an offer might be in the shareholders' interest (e.g., Jensen and Ruback, 1983). Walkling and Long (1984), for instance, demonstrated empirically that the probability of management resisting a takeover bid is directly related to the takeover's effect on management's personal wealth. Some evidence is also available suggesting that the adoption of a golden parachute is associated with a positive security market reaction (Lambert and Larcker, 1985). From this perspective, GPs provide incentives to management to pay attention to the stockholders' interests and not to the top managers' potential job loss.

But is the decision by the board of directors to award GPs to management solely one dictated by economic rationality? Although the board has the legal right and formal power to hire, evaluate, reward, and fire the chief executive officer (CEO), it has been widely noted that the CEO can also influence the board through persuasion, the selective use of information, control over the agenda, and other tactics designed to influence its deliberations and decisions (e.g., Zald, 1969; Mace, 1971; Mizruchi, 1983; Patton and Baker, 1987). While not possessing formal power over the board, the CEO may be able to exert what social psychologists refer to as "Social influence" (Cialdini, 1984), relying on norms of reciprocity, liking, and social consensus to shape the board's decision making. Consistent with this view, an argument sometimes made in the business press is that boards of directors often rubberstamp management's requests, including providing undeserved compensation such as GPs (e.g., Sherman, 1988). Several studies have suggested that actual relationships between boards and CEOs may be quite different than that assumed in conventional economic theory (e.g., Baker, Jensen, and Murphy, 1988). O'Reilly, Main, and Crystal (1988), for example, have shown that CEO compensation may be strongly affected by social comparison processes operating within the compensation committee. More recently, O'Reilly, Wade, and Chandratat (1990) have extended these findings to show that CEOs may be able to use social influence to affect their compensation. They show that, independent of economic determinants, a CEO's compensation is likely to be significantly higher if the CEO was appointed to the board of directors before the chairman of the compensation committee was appointed. This and other findings led O'Reilly, Wade, and Chandratat (1990) to conclude that compensation decisions by the board of directors may be affected through the exercise of social influence by the CEO over the board.

From an agency theory perspective (Gibbons and Murphy, 1988), there are two possible explanations for the existence of golden parachutes. On the one hand, GPs may act to align the interests of management and shareholders and thus be economically efficient. On the other hand, CEOs (agents) with a high degree of social influence may be able to circumvent the interests of shareholders (the principal) and opportunistically acquire GPs irrespective of the GP's economic value to the shareholders. The purpose of this study is to explore the relative associations of both economic and social influence variables with the incidence of golden parachutes.