The Impact of Golden Parachutes on Fortune 500 Stock Returns: A Reexamination of the Evidence
Mogavero, Damian J., Toyne, Michael F., Quarterly Journal of Business and Economics
Golden parachutes provide executives with a form of compensation insurance in the event they are terminated following a change of corporate control. While golden parachutes alone have only a minor economic impact on potential takeovers, they represent (and often are accompanied by) a class of takeover defense mechanisms that potentially undermine the fundamental responsibility of executives and boards to represent the best interests of stockholders. During the merger wave that began in the early 1980s golden parachutes became increasingly controversial when terminated executives began to receive what often were regarded as unduly large payouts.
Because golden parachutes normally are provided to executives by boards without stockholder approval, their adoption sends a signal concerning the relationship between executives and boards. Corporate proxy statements often include stockholder proposals designed to prohibit golden parachutes. Boards usually respond by recommending that stockholders vote against such proposals because they severely restrict the firm's ability to attract high quality executives. The proxy voting process usually supports boards. True stockholder sentiment can be found, however, in stock returns associated with the announcement of golden parachute adoption.
Lambert and Larcker (1985) conclude that from 1975 through 1982 golden parachute adoptions were associated with positive returns to stockholders. Their evidence is consistent with a hypothesis that golden parachutes improve stock values by reducing conflicts of interest between executives and stockholders during a takeover. Subsequently, the Lambert and Larcker (1985) study often has been used by corporate boards as a rationale for golden parachute adoptions. Born, Faria, and Trahan (1993) provide evidence, however, that the positive returns observed by Lambert and Larcker (1985) may have been affected by investor perception of golden parachute adoptions as signals of pending takeovers. Thus, questions concerning investor sentiment toward golden parachutes remain unresolved.
Our study examines returns to stockholders in a sample of Fortune 500 firms that adopted golden parachutes during the period 1982 through 1990. We explore the possibility that during this time period the motivation for adopting golden parachutes and the subsequent stock returns associated with adoptions changed. Our study period encompasses the rise in takeover activity during the early 1980s and the decline in takeover activity during the late 1980s. Our study period also includes the initiation of several legislative changes designed to regulate golden parachutes. Among these changes is the Deficit Reduction Act of 1984 which denies corporate tax deductions for excessive golden parachute payouts.(1)
The increase in attempts to place restrictions on golden parachutes coincided with an escalation in golden parachute adoptions throughout the second half of the 1980s. Thus, the primary motivation for recent adoptions may be avoidance of future restrictions. If this notion is valid, recent golden parachute adoptions are more likely to signal information concerning executive influence with boards rather than information concerning executive incentives during takeovers. Our evidence is consistent with this notion. We find that stock returns associated with golden parachute adoptions changed from positive to negative during the 1980s.
COMPETING HYPOTHESES OF GOLDEN PARACHUTE ADOPTION
Prior studies have shown that target firm stockholders earn substantial profits when theft firms are acquired (Jarrell, Brickley, and Netter, 1988). Changes in corporate control, however, can cause hardships for terminated executives through loss of wages while they seek new employment, possible reductions in pay levels when new employment is found, and loss of nonpecuniary benefits (Lambert and Larcker, 1985). Advocates of golden parachutes argue that pre-arranged severance agreements reduce conflicts of interest between executives and stockholders during takeovers (i. …