When CEOs are terminated, oftentimes the boards of directors approve the payments of outrageous amounts of money for the CEOs to walk away quietly. These golden parachutes soften the blow to the egos of the CEOs (everyone and everything have a price), but engender serious concerns for the other other stakeholders of these companies. The average worker is lucky to get a paltry severance package when s/he loses a job. Shareholders are stuck with the payments, and possibly dismal returns during the CEOs’ tenure. Society as a whole becomes more unstable as income gaps widen exponentially.

Why do boards favor golden parachutes when they get rid of CEOs?

There are likely two main reasons why CEOs are terminated. The directors might lose confidence in the leadership abilities and talents of the CEOs. The directors might conclude that the CEO is no longer the right person to lead the company.

The removal of Fritz Henderson at GM is a case in point. The board no longer bought into his strategy and vision, and apparently he was unwilling to heed their advice. In such cases, the payment of severance is warranted and might be required by the employment contract. The appropriate level of compensation should be the present value of the remaining expected compensation under the existing employment contract. Any more would be excessive and unnecessary, unless of course, the employment contract called for more. In such cases, the board has likely done a poor job in negotiating the contract.

The second reason is termination for cause. “Cause” should be clearly defined in the employment contract, and there should be ample precedence for the definition either in legislation or in wrongful dismissal cases. In cases where there is legitimate cause, there is no obvious reason for paying any severance, let alone rich, golden parachutes.

So why do boards approve compensation in these cases?

To answer this question, I draw upon my experience as a director of a public company, where after a lengthy and acrimonious struggle among the directors, we fired the CEO for cause. But we gave him walking away money, and did not reveal the real reasons for his dismissal.

A board might be concerned about a possible lawsuit by the CEO for wrongful dismissal. The cause for termination might be border-line and so a board might be uncertain whether a court would find in favor of the company or the CEO. Thus to avoid the legal costs and a high probability of paying damages, which could be quite substantial, the board decides to offer a payout.

Or a board, even when there is little doubt that there was legitimate cause, might not want “dirty laundry” aired in public. This might come back to haunt one or more of the directors and lead to shareholder lawsuits that ensnare all of the directors.

In the case of the company with which I was involved, there was no doubt that there was justifiable cause. Indeed, the report of an independent forensic accountant recommended his dismissal for cause. But I was outvoted by my fellow directors. I wanted the CEO dismissed without any compensation and the reasons for his dismissal reported to the securities commission. I was prepared as a director to live with the consequences, which likely would have involved a shareholder lawsuit. The majority of the directors disagreed, and favored a payout to silence the CEO so that we could keep the matter confidential and greatly diminish the likelihood of any shareholder lawsuit. (Several years later I found that I was blacklisted from joining other boards because of my behavior in this case.)

Directors do not want dirty laundry exposed because of personal liability.

There is a problem with this argument however. CEOs in such cases are not likely to want their actions exposed in court and possibly in the press. They might threaten legal actions, but they are likely bluffing and boards should be willing to call their bluffs. In some cases, a CEO would not be bluffing – some CEOs are so arrogant and vengeful that they will cut off their noses to spite their faces. The exposure of any wrongdoing in these cases should have a cleasning effect on other boards. That is, other directors should be much more careful in turning a blind eye to questionable actions.

I strongly believe that transparency is important in capital markets.

And many times, CEOs have outstayed their welcome and exceeded their best before dates. Fixed term contracts (three year maximum) with no guarantee for renewal or compensation for non-renewal, and clear definitions of cause are starting points for eliminating unnecessary and costly golden parachutes. Further, boards should not include any friends of the CEOs.

The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.