Employment agreements between publicly-traded issuers and their executive officers often contain severance pay provisions that are heavily negotiated at the time of entering into the agreements. The purpose of this post is to consider whether the amount of contractually-provided severance pay could, over the employment term, be reduced proportionate to the increase in the executive’s wealth accumulation over the same time period (i.e., an inversely proportional relationship between the amount of severance pay and the amount of wealth accumulation by the executive over the employment term).
- Severance as Bridge Pay. As background, contractually-provided severance pay is often required in order to incent the executive to take employment with the issuer. A purpose of severance pay is to protect the executive’s financial downside should his or her employment with the issuer terminate earlier than originally contemplated by the parties. Thus, it could be argued that the amount of severance pay should be limited to the amount that is necessary to “bridge” the financial gap between the executive’s termination of employment with the issuer and his or her finding replacement employment. And the more senior the executive’s position, the longer the financial bridge. For example, it may be reasonable for a CEO to negotiate a severance pay package consisting of 2x base salary plus bonus because it may take him or her longer to find replacement employment (i.e., there is only one CEO per prospective employer).
- Should Bridge Pay Decrease as Wealth Accumulation Increases. The case for financial downside protection is strong at the beginning of an employment relationship, especially since the executive is not likely to have accumulated wealth (e.g., equity compensation) if his or her employment is terminated earlier than anticipated by the parties. However, what about the situation where the executive accumulates substantial wealth over the employment term in the form of equity awards and annual bonuses? Arguably the executive does not need financial downside protection in this situation because he or she already received the benefit of his or her bargain. So should his or her severance pay be contractually reduced as he or she accumulates wealth within the issuer?
The answer depends upon the facts and circumstances (e.g., whether it is intended for the executive to be provided sufficient equity awards to make the provision worthwhile) and the negotiation power of the parties. [An obvious point that is specifically intended as a punt by this author.] That said, the concept is doable if the parties can agree on the financial data points needed to draft the inversely proportional sliding scale.