Golden parachute refers to an agreement between an employee and an employer under which the employer promises large financial benefits to the employee when he is terminated due to a merger or an acquisition of the company. It can be understood as a compensation offered to certain employees when they are terminated before their contract ends.

A Golden parachute clause can discourage companies from a merger or from getting acquired due to the large financial sum involved. This clause is usually included in the agreement of the top executives in a business. The purpose of offering a golden parachute is to ensure that the employee is not disadvantaged or forced out of the company.

Companies may offer golden parachute benefits in the form of cash, a special bonus or stock options. Golden handshake is also a clause much like the golden parachute with the only difference of inclusion of severance packages offered upon retirement too.

Why was the golden parachute clause introduced?

The golden parachute clause was introduced to protect the shareholders and other higher-level executives in case of a merger or a takeover. The term was first used in 1961 and in the 1970s firms began introducing the golden parachute clause in their employment contracts.

Over time the intent with which the golden parachute clause was included in an employee’s contract started to change, with newer modifications making it too lenient at times. In current times, the clause has come to be interpreted as a lot more than what it originally was supposed to represent.

During the 1980s, the golden parachute became a standard norm followed by various companies. Even small firms adopted a golden parachute clause to protect their employees. Companies would include monetary as well as other benefits for their employees in case the company undergoes a merger, takeover or anything alike.

At the same time, companies have expanded the golden parachute and have introduced more leniency to it, causing some to believe it serves as a free pass for top level employees to leave office with a truck load of money and other benefits.

How are golden parachutes beneficial?

Golden parachutes can be beneficial for both employee and employer, in the following ways:

• Employee: The biggest advantage of a golden parachute clause for an employee would be the purpose behind the clause, i.e., the protection of said employee in case of a merger or acquisition. It acts as a security for the employee and is an insurance for the long term, making the position more lucrative for applicants. A job with a golden parachute clause is guaranteed to attract more applicants and would be highly valued compared to a job without the clause.

The other advantage for employees is avoiding inadvertent takeovers by big firms. Big companies might be tempted to acquire a well performing firm and its top-level employees. In the presence of a golden parachute clause, companies would give a second thought before they acquire a firm due to the costs involved, thus, protecting the employees from structural changes to the firm.

A golden parachute also offers clarity to an executive when faced with the dilemma of whether to get into a merger or not. When an employee has guaranteed financial benefits post the merger and has the option of retaining his job in case the merger does not happen, then he would act in the best interest of the company. An employee that has nothing to lose either way would act according to what is best for the company.

• Employer: An employer may benefit from a golden parachute as well. In the case of employee termination post a merger or acquisition, employers might be faced with the accusation of unfair treatment of their employees. A golden parachute allows employers to maintain cordial relations with the fired employees as well as it avoids legal proceedings by the latter. Thus, an employer could include a golden parachute clause to protect himself as well.

What are the issues associated with the golden parachute clause?

Golden parachutes may sometimes be too expensive for companies and thus, might not be feasible for small firms. Moreover, the clause is only included in the contracts of few selected employees and is not made available for the entire employee base.

Another critique of the golden parachute is the leeway provided under current modifications of the golden parachute contracts offered by companies. Some contracts may allow employees to walk away with a large sum of money rather than act in the best interest of the company.  They might also shirk from their work and underperform as they would earn a guaranteed sum of money once they are terminated.

In addition to these issues, golden parachutes might not discourage mergers as is expected out of such a contract. Many opponents of the policy argue that the cost associated to a golden parachute may be too miniscule compared to the overall cost attached to the merger. Thus, the cost of a golden parachute might not be enough to discourage a merger, which would make them highly ineffective.