Paying CEOs to Fail

Scott MacDonald thinks the contract language and hiring processes for chief executive officers need to change. As he sees it, some CEOs are great leaders who deserve their seemingly extravagant salaries, but others are highly paid despite their poor performance. And even when they’re fired, they don’t lose out because they’re given a golden parachute — millions of dollars for failing, he says.

In some back-and-forth with me recently about this, MacDonald — former CEO at the Australian company Investa, who wrote a book about his experience there, Saving Investa: How An Ex-Factory Worker Helped Save One of Australia’s Iconic Companies (here’s his website’s information about the book and here’s the Amazon link) — said this to me:

“Every year, we read stories of corporate boards of directors firing a senior executive for unsatisfactory performance and then paying the executive millions of dollars upon his or her departure.

“Several years ago, for example, the Walt Disney Co. hired Michael Ovitz [as president] and then terminated him 14 months later. Ovitz reportedly received a severance package of $140 million. Recently, Wells Fargo admitted that thousands of their employees opened new accounts in customers’ names without consent to generate bigger fees and commissions. The scandal has damaged the bank and led to many investigations and potential fines. The person in charge of the retail division where the scandal occurred announced her retirement and reportedly received about $125 million upon her departure.”

MacDonald says the real problem stems from the narrow definition of “cause” in current CEO’s employment contracts; specifically, the clause that says the executive may be fired “for cause,” in which case nothing more is owed to him or her.

But the definition of cause is still limited to being found guilty of felony acts, committing fraud or stealing from the company. It almost never includes poor performance.

MacDonald’s had a successful career as a CEO turning around struggling companies, often by addressing performance issues. Through his years of experience, he says,

” … the benefits gained from changing personnel have always outweighed the short-term financial cost … . Once, I fired a talented chief financial officer because he was not a team player, typically promoting himself while disparaging other team members. The cost of his termination was significant because being a bad team member was not defined in his “for cause” contract definition, but the entire company performed much better after his departure.”

So how did “cause” become so narrowly defined and almost unenforceable? It’s unclear, MacDonald says, but he has a theory, based on the past 40 years of business as usual, and it even includes human resources. Here’s how he lays it out:

“Generally, a board retains an employment consultant to help negotiate the contract or provide an opinion that the contract is fair and competitive in the industry. The same consultant will often seek to see human resource-related consulting services to CEOs in the future. If a consultant recommends approval of a CEO’s favorable employment contract, the consultant is more likely to be favorably considered when that CEO approves hiring an HR consultant.

“After one board agrees to a narrow definition of ’cause,’ it quickly becomes cited by other executives and their attorneys as the standard. … When an executive is terminated for poor performance but not ‘for cause’ … he or she is typically entitled to all the compensation and benefits that he or she would have received if he or she had not been terminated. This usually includes salary not yet paid, bonuses not yet earned, stock options not yet vested and various other entitlements. If a terminated executive has three years left on a contract, the company often has to pay three years of full compensation as if the executive had been a stellar executive.”

So what can we do to turn this around? Simple. According to MacDonald, just broaden the definition of “cause.” Successive years underperforming [against] a pier group of companies should be cause for termination. And if a dispute occurs over the performance measures, submit it to an arbitration panel for resolution.

Other items we might consider cause for dismissal could include successive poor results on confidential employee surveys, failure to meet budget targets in successive years, failure to follow written directives from the board … his list goes on.

Companies that provide audit services to another company are generally not permitted to provide other consulting services to avoid influencing the impartiality of the audit. Similarly, says MacDonald, “companies that provide employment-contract services could be forbidden from providing other consulting services to the company involved.”

Finally, he says, when an employee is terminated without cause, he or she should not be paid full bonuses for all the remaining years of their contract. “Clearly,” he says, “the bonuses would not be earned.”