In Depth
A severance agreement is a contractual provision in an executive's employment agreement that specifies the financial arrangements upon involuntary termination, being fired without cause or resigning for "good reason" (typically defined to include material reductions in pay, authority, or relocation requirements). Severance packages for S&P 500 CEOs typically include a cash payment of one to three times the sum of base salary and target bonus, accelerated vesting of a portion of unvested equity awards, continuation of health and welfare benefits for 12 to 24 months, outplacement services, and sometimes continued personal security. The total value of severance packages for top executives can range from $5 million to $100 million or more, depending on the size of the company and the executive's equity holdings. Companies must disclose estimated severance payments under various termination scenarios in the proxy statement, presented in a "Potential Payments Upon Termination or Change of Control" table. Best governance practices include requiring executives to sign restrictive covenant agreements (non-compete, non-solicitation, confidentiality) as a condition of receiving severance, imposing a "double-trigger" requirement for enhanced severance following a change of control, and avoiding tax gross-ups that make the company responsible for the executive's personal tax liability on severance payments. Compensation committees must balance the need to provide reasonable protection that attracts executive talent against the governance risk of excessive guaranteed payouts that insulate executives from the consequences of underperformance.