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The rise and (maybe) fall of the golden parachute

Roland Smith has been the CEO of Office Depot for approximately 16 months.

During that time, the company’s stock — at least before it announced a merger with Staples in February — declined slightly, while the S&P 500 rose by double digits. Its sales, in a long slump affecting most brick-and-mortar retailers, continued to fall amid store closures and layoffs.

And yet, if Smith’s position is wiped away by the merger, he’ll get a glittering “golden parachute" — $46.8 million, $39.3 million of which comes in the form of fully vested stock and stock options. That’s way more than his $1.4 million salary in 2014, and even his $3.15 million bonus. Office Depot’s board signed off on the goodbye package, but shareholders could only take a non-binding vote to disapprove it.

The practice of sending executives off with golden parachutes is ubiquitous in corporate America — but shareholders are pushing back, in ways that could substantially deflate them.

On Wednesday, the Council of Institutional Investors — whose members hold over $3 trillion in assets — approved a policy encouraging shareholders to require that boards consider executive tenure and performance before signing off on those giant stock awards. The idea: To make sure a CEO is still incentivized to do well by the company rather than rush it towards a merger.

“We’re trying to encourage companies to mitigate the risk that corporate assets would pay for failure,” explained Scott Zdrazil, director of corporate governance at Amalgamated Bank, who has been pushing for the change for several years.

At the moment, 92 percent of Fortune 200 CEOs would get the entirety of their stock awards automatically, with no opportunity for boards to trim them based on poor performance or even the length of time they’ve served. Since more than 75 percent of compensation now comes in the form of equity — itself an attempt to align executives’ interests with the health of the business — that represents a significant loss to the company’s net worth.

"When we were reading proxies for the companies in our portfolio, we noticed that companies paid lip service to pay for performance, but didn't extend it to pay packages,” Zdrazil says. So Amalgamated, which is the country’s only union-owned bank, began floating shareholder resolutions at its portfolio companies that would make sure those equity packages didn’t have to be granted automatically. Occidental Petroleum was among the first to adopt one, followed by several other companies in the energy sector.

Decades ago, however, golden parachutes were invented to fix another problem in CEO incentives. It was the 1980s. Hostile takeovers were rampant, and shareholders didn’t want personal financial considerations to be a factor in CEOs’ actions.

"Golden parachutes were created to provide a cushion for executives who might lose their jobs after a takeover, so that when they’re considering bids, that would keep them a little more objective,” says Carol Bowie, head of Americas research at Institutional Shareholder Services. "What happened over the years was that they morphed into big windfalls."

Over the years, firms found ways to protect themselves from corporate raiders, through defense mechanisms like poison pills and differential value stock. Now, most mergers are voluntary. But the golden parachutes continued to balloon, even after Congress attempted to constrain them by imposing taxes on eye-popping payouts in the 1990s; the 2000s saw 21 CEOs sent off with compensation packages in excess of $100 million. From a shareholder perspective, they were starting to tilt CEOs’ interests in favor of agreeing to mergers, rather than keeping them impartial — especially if the company wasn’t doing well, and brokering a sale was a lucrative way to move on.

The Dodd-Frank Act of 2010 empowered shareholders to vote on those packages. It took a while, however, for them to start using that power to crack down. Disapproval votes are still comparatively rare. A record number of such shareholder proposals passed in 2014 — five — and they’re all non-binding.

But as merger and acquisition activity rises from a low point in 2013, and the value of executives’ stock awards soars, there could be more instances where shareholders have the opportunity to weigh in. That’s why the Council of Institutional Investors’ new policy could be important: If a company’s board does allow executives to cash in their equity awards all at once in the event of a change in control, the policy says, they should provide a detailed explanation of how that contributes to shareholder value.

(Important caveat: There’s a strong case to be made that shareholder value doesn’t always match the interests of the public writ large, but when it comes to executive compensation, they tend to align well.)

It will take a while before the policy to take hold in the rest of corporate America. Zdrazil, of Amalgamated Bank, says they’ve got shareholder resolutions in at YUM brands, McDonald’s, and ConocoPhillips. And still, there’s no guarantee that overall executive pay will decrease — but at least CEOs will know that their ultimate payouts could depend on how good a job they do before selling.

“Executive compensation packages are still very large, and in general they’re not getting any smaller," says ISS’s Bowie. “But boards are much more conscious of shareholders’ strong desire to see those packages linked to shareholder performance. Now, shareholders are really looking at the nuts and bolts.”