A recent survey in the US of executive severance (or termination) arrangements across 160 companies in the S&P 500® provides a basis for comparison with Australia’s termination payment arrangements.
It is useful to know how Australian companies with US executives can compete as ASX listed company termination payment arrangements have always been closely scrutinised. Since 2011, termination benefits have been limited to 1 x fixed pay unless shareholders approve of a greater amount. In addition, the Australian limitations extend beyond KMP to executives directing subsidiary operations overseas (see HERE) .
The key findings are based on disclosures made by the US companies in respect of their severance arrangements in FY17 (i.e. the financial year ended 31 December 2017) and did not have regard for severance on change in control .
- 65% of the companies disclosed termination payment arrangements that provide cash payments to the equivalent of Australia’s key management personnel (KMP)
- Cash termination payments are always made on an involuntary termination without “cause” – that is, on company-initiated terminations. The termination payments are only half as likely to be triggered upon a voluntary termination for “good reason” (both are referred to as “qualifying terminations”).
- In 2017, the termination payment arrangements in 76% of the surveyed companies were based on a fixed multiple of “pay”:
- For CEOs, 61% of the companies based the termination payment on a 2× multiple
- For other key executives, 42% of the companies used a 2× multiple and 40% used a 1× multiple
- The majority practice is to define pay as the sum of base salary and bonus (with bonus typically defined as current year target bonus):
- For CEOs, the most prevalent formula (46%) used to determine the termination payment was 2× the sum of base salary and bonus
- For other key executives, the most prevalent formulas used to determine the amount of termination payments are 2× the sum of base salary and bonus (32%) and 1× base salary (23%).
Readers will note that the implications of this definition of “pay” combined with the typical 2x multiple means that a CEO or other executive may be entitled to a termination payment in the US of up to 4 x fixed remuneration. This is well in excess of Australia’s 1x fixed remuneration unless there is shareholder approval for termination benefits of a greater value.
This can be difficult for Australian companies with US operations as the termination payment limits of the Corporations Act 2001 apply globally to executives beyond the KMP level.
Vesting and Settlement of LTIs
The survey found that the treatment of LTI awards upon a qualifying termination varied by type of award:
- A majority of the companies (63%) forfeit non-vested stock options upon a qualifying termination
- In contrast, one-half of the survey group fully or partially vest restricted stock/restricted stock units upon a qualifying termination
- For performance shares, market practice is roughly split among the survey group of companies between forfeiture (49%) and full or partial vesting upon a qualifying termination (46%).