Change of Control Or Out of Control?

One thing you can count on in any merger or acquisition is that the executives who negotiate them always come out winners.

That's not the case for shareholders, who, according to academic studies, are as likely as not to see a decline in the value of their holdings. Or rank-and-file employees, some of whom inevitably lose their jobs. These deals are not even a sure win for customers, who often suffer from glitches when organizations combine operations.

But there's never any doubt about the executives. The history of mergers and acquisitions is full of deals that fell apart over the issue of which chief executive would wind up running the show. And I've yet to run across the corporate executive who doesn't emerge from a merger with a set-for-life severance payment or a pay-and-stock-option package bigger than it was before.

A case in point is the proposed purchase of Caremark Rx, the pharmacy-benefits manager, by CVS, the pharmacy chain, which was announced late last year.

Under the merger terms, Caremark's top executives, down to the level of senior vice president, are to receive change-of-control payments due under their employment contracts. The top five executives are collectively entitled to about $100 million, with more than half going to Mac Crawford, the chief executive who oversaw the CVS negotiations. Add to that at least another $10 million going to other top executives.

These change-of-control payments are now standard fare in the executive-compensation game. Their purpose is to attract highly sought individuals by offering them a measure of financial security in case they lose their jobs as a result of mergers and acquisitions. In the case of top executives, these provisions are also meant to align their personal interests with those of shareholders, so they remain open to any offer to buy the company that might involve losing their jobs.

We could have a lively debate about the size of these payments, or why comfortable executives ought to be protected from the vicissitudes of market capitalism while the working stiffs are left to fend for themselves. But the more immediate question is why Caremark executives are in line to get any change-of-control payments, given that the merger agreement also guarantees them generous employment contracts in the newly combined enterprise.

To be fair, not everyone is staying. Crawford agreed to step down as an executive and will serve only as chairman of the new board of directors. We also learn from the company's proxy statement that, as an indication of his commitment and confidence in the merger, the 58-year-old Crawford has agreed to reduce his change-of-control payments by at least $10 million.

For the others, however, the question remains: Why should shareholders provide millions of dollars in what amounts to severance payments to executives who aren't being severed?

Caremark officials argue these are not severance payments but "signing" bonuses designed to keep a successful management team in place. After all, under the terms of the agreement, the money will be paid only if the executives remain with the company for three years.

This sounds reasonable, until you think about it a bit. Last year, these executives were apparently willing and eager to work for Caremark for $500,000 or $750,000 a year, plus bonuses and stock options. But now that the name on the door is about to change, we are supposed to believe these same executives are available to do the same jobs only if they get a million-dollar signing bonus.

This isn't the only item that has caught the attention of shareholders. Some have criticized provisions that indemnify executives and directors from lawsuits or legal penalties that might arise from anything they did while at Caremark -- including possible backdating of stock options, which is now the subject of a federal inquiry. Questions have also been raised about the $625 million "breakup fee" Caremark will have to pay if it backs out of the deal and the offer of board seats for many of Caremark's directors.

These concerns take on greater significance now that Caremark's executives and directors have rejected a competing bid from Express Scripts valued at 13 percent above the CVS offer. Irrespective of the other issues raised by the Express Scripts offer, have the views of Caremark executives and directors been colored by the sweet terms they negotiated for themselves in the CVS deal?

That question will be explored by Delaware's chancery court, where Express Scripts and two public pension funds have filed suit to stop the merger. The judge in the case, William Chandler, will have a chance to review all particulars, including evidence of other offers Caremark spurned before it accepted the one from CVS. But the case also gives Chandler an opportunity to set some reasonable limits on the widespread use of breakup fees, indemnification clauses and change-of-control payments, all of which may be of greater value to corporate executives than to the shareholders whose interests they are supposed to represent.