 "A two-way street")
Guess what is keeping human resources managers awake at night in these times of uncertainty? No, it is not pay and perks or how to attract and retain talent. Severance pay of key top-management executives are consuming HR managers, placement consultants and recruitment specialists as more and more organisations learn from international hiring best practices, hire top talent from overseas markets or send Indian managers to difficult overseas postings. "What used to be the last page in an employment contract until a few years ago, has now travelled right upfront, and occupies a large section of pay arrangement/contract today," says an HR director with a top e-commerce firm based in Delhi.
The design of a severance pay package, to a large extent, depends on an employer's objective. They can serve a variety of purposes - including acting as a recruitment tool, to reward an employee for lengthy service, or to provide an employee with some sort of financial protection in the event of job elimination, downsizing or a sale of the business. Whatever the objective, employers and advisors must be mindful of the legal traps posed by severance pay arrangements. So more and more companies are seeking expert tips from lawyers and other consultants with domain expertise, who can guide them in a manner that a key human resource tool doesn't end up becoming a burden for either of the two parties involved.
The so-called golden parachutes or severance protection for senior-level executives are no longer reserved for CXOs of top IT companies and MNCs in India. Says Ashutosh Khanna, client partner, Korn Ferry, "Severance pay is insurance plan offered to CXOs. It is becoming sector agnostic and prevalent in areas where the element of uncertainty is higher. The high risk CXO profile where one is hired for a very quick turnaround is especially seeing handsome severance packages in India. However, it is less prevalent in case of internal hires."
"Attractive severance packages are being rolled out in the IT, pharma, health care, life-sciences and the banking and financial services sector," adds James Agrawal, managing director, BTI Consultants.
As it gets difficult to attract talent at the top level, severance packages are offered to sweeten the deal. Another factor that is driving the trend in India is the start-up boom. E-commerce players are leaving no stone unturned when it comes to hiring talent. Apart from million dollar packages, stock options, joining bonuses, companies are also offering hefty severance packages to lure professionals from others sectors. "In India, the golden parachute has taken on a different spin as far as start-ups are concerned," says Hemant Upadhyay, managing consultant and leader of executive rewards practice, Hay Group. "Golden parachutes become very helpful in cases of change in control (CIC). It plays a key part in negotiation between the investors and the founder CEO or a CEO hired from outside. Investors ensure the CXOs handsome severance packages - equity and cash - if they can take the company to the next level and are able to get good valuation and better exit for them."
That said, the size of severance packages in India are nowhere near international markets. "About 30 per cent companies have an official severance policy, which is typically one's month basic pay multiplied the by number of years of service," says Kunal Sen, senior vice-president TeamLease Services. "The maximum severance pay that has been paid by an Indian firm is in the range of $10 million, which is very small compared to what an US companies would pay-say, $40 to $60 million," says Rajeev Thakur, director & CEO, Grassik Search.
The trend started with IT companies, most of which follow a standard severance policy. "All the IT companies have a standard model for severance package, which is equal to a certain number of months multiplied by years of service. For instance, at the director level, it would be one month multiplied by years of service, at the vice-president level it would be 1.5 months multiplied by years of service and at the executive vice-president level it would be two months multiplied by years of service," says Sen of TeamLease Services.
As things stand, severance packages are becoming a hygiene factor and since most companies have a 'non-compete' clause, an attractive severance package given to a downsized CEO ensures he won't join a competitor within the time frame mentioned in the non-compete clause," says Agrawal of BTI Consultants.
So what are the downsides, if any? And how does a contract ensure it is a win-win for both the employer and an employee?
Some argue that severance packages can lead to a crisis in leadership if the CXO focuses on their benefits rather than his performance. "You cannot reward people for failure. From the companies' point of view, it means to attract talent and hedge risks. It is more a supply and demand issue. But it has become a self-fulfilling process as the hired person is entitled to severance pays whether he/she performs well or not. So they have incentives to do well and also incentives not to do well. On the flip side, the cost of replacement of the CXO becomes high. So even if the CEO is not performing, the high cost attached to his replacement, keeps the employers from dismissing him, resulting in an erosion in shareholder value," adds Upadhyay of Hay Group.
On the other hand, there are instances of companies that roll out attractive severance packages just to ensure the person on the way out does not give it a bad name, which has a repercussion on future hiring. "We have also seen severance packages being negotiated and companies feel they are not tied to what is mentioned in the terms of the employment," says Agrawal of BTI Consultants.
So should the golden parachute be contingent on performance? Yes. Golden parachute is part of employee reward mechanism and companies should understand how effectively they can use it. Boards need to do a cost-benefit analysis and find out what are they driving through these severance packages. "Shareholders are pushing back on clauses to link severance packages to performance. The bone of contention arises if the CXO walks away with a cool severance package when the company is not doing well or the CXO hasn't performed well. You cannot dilute shareholders' value on non- performance. That is the clause organisations are talking about. It is becoming conditional," says Khanna of Korn Ferry.
The only alternative to efficiency is certain death. In today's competitive, boundary-less, dynamic economies, the message to corporates is 'profit or perish'. In such times where companies are evaluating headcount, role efficiencies and reorganising structures on a regular basis, redundancy is slowly becoming part of life for executives across industries. This brings us to the question of severance.
It is interesting to observe how golden parachutes are finding their way in most executive compensations. Some experts are of the view that golden parachutes are an essential element of executive pay in these uncertain times. Not just to protect the executive's interest but also keeping in mind that top executives typically forced to give up independence and control when their companies are acquired may be excessively reluctant to sell and often impede or derail an acquisition.
Here are a few tips for the employers when preparing a severance package:
The design of a severance pay package, to a large extent, depends on an employer's objective. They can serve a variety of purposes - including acting as a recruitment tool, to reward an employee for lengthy service, or to provide an employee with some sort of financial protection in the event of job elimination, downsizing or a sale of the business. Whatever the objective, employers and advisors must be mindful of the legal traps posed by severance pay arrangements. So more and more companies are seeking expert tips from lawyers and other consultants with domain expertise, who can guide them in a manner that a key human resource tool doesn't end up becoming a burden for either of the two parties involved.
The so-called golden parachutes or severance protection for senior-level executives are no longer reserved for CXOs of top IT companies and MNCs in India. Says Ashutosh Khanna, client partner, Korn Ferry, "Severance pay is insurance plan offered to CXOs. It is becoming sector agnostic and prevalent in areas where the element of uncertainty is higher. The high risk CXO profile where one is hired for a very quick turnaround is especially seeing handsome severance packages in India. However, it is less prevalent in case of internal hires."
"Attractive severance packages are being rolled out in the IT, pharma, health care, life-sciences and the banking and financial services sector," adds James Agrawal, managing director, BTI Consultants.
As it gets difficult to attract talent at the top level, severance packages are offered to sweeten the deal. Another factor that is driving the trend in India is the start-up boom. E-commerce players are leaving no stone unturned when it comes to hiring talent. Apart from million dollar packages, stock options, joining bonuses, companies are also offering hefty severance packages to lure professionals from others sectors. "In India, the golden parachute has taken on a different spin as far as start-ups are concerned," says Hemant Upadhyay, managing consultant and leader of executive rewards practice, Hay Group. "Golden parachutes become very helpful in cases of change in control (CIC). It plays a key part in negotiation between the investors and the founder CEO or a CEO hired from outside. Investors ensure the CXOs handsome severance packages - equity and cash - if they can take the company to the next level and are able to get good valuation and better exit for them."
That said, the size of severance packages in India are nowhere near international markets. "About 30 per cent companies have an official severance policy, which is typically one's month basic pay multiplied the by number of years of service," says Kunal Sen, senior vice-president TeamLease Services. "The maximum severance pay that has been paid by an Indian firm is in the range of $10 million, which is very small compared to what an US companies would pay-say, $40 to $60 million," says Rajeev Thakur, director & CEO, Grassik Search.
The trend started with IT companies, most of which follow a standard severance policy. "All the IT companies have a standard model for severance package, which is equal to a certain number of months multiplied by years of service. For instance, at the director level, it would be one month multiplied by years of service, at the vice-president level it would be 1.5 months multiplied by years of service and at the executive vice-president level it would be two months multiplied by years of service," says Sen of TeamLease Services.
As things stand, severance packages are becoming a hygiene factor and since most companies have a 'non-compete' clause, an attractive severance package given to a downsized CEO ensures he won't join a competitor within the time frame mentioned in the non-compete clause," says Agrawal of BTI Consultants.
So what are the downsides, if any? And how does a contract ensure it is a win-win for both the employer and an employee?
Some argue that severance packages can lead to a crisis in leadership if the CXO focuses on their benefits rather than his performance. "You cannot reward people for failure. From the companies' point of view, it means to attract talent and hedge risks. It is more a supply and demand issue. But it has become a self-fulfilling process as the hired person is entitled to severance pays whether he/she performs well or not. So they have incentives to do well and also incentives not to do well. On the flip side, the cost of replacement of the CXO becomes high. So even if the CEO is not performing, the high cost attached to his replacement, keeps the employers from dismissing him, resulting in an erosion in shareholder value," adds Upadhyay of Hay Group.
On the other hand, there are instances of companies that roll out attractive severance packages just to ensure the person on the way out does not give it a bad name, which has a repercussion on future hiring. "We have also seen severance packages being negotiated and companies feel they are not tied to what is mentioned in the terms of the employment," says Agrawal of BTI Consultants.
So should the golden parachute be contingent on performance? Yes. Golden parachute is part of employee reward mechanism and companies should understand how effectively they can use it. Boards need to do a cost-benefit analysis and find out what are they driving through these severance packages. "Shareholders are pushing back on clauses to link severance packages to performance. The bone of contention arises if the CXO walks away with a cool severance package when the company is not doing well or the CXO hasn't performed well. You cannot dilute shareholders' value on non- performance. That is the clause organisations are talking about. It is becoming conditional," says Khanna of Korn Ferry.
| Allow employees to exit on a positive note: Shailja Dutt |
| EXPERT TAKE |
It is interesting to observe how golden parachutes are finding their way in most executive compensations. Some experts are of the view that golden parachutes are an essential element of executive pay in these uncertain times. Not just to protect the executive's interest but also keeping in mind that top executives typically forced to give up independence and control when their companies are acquired may be excessively reluctant to sell and often impede or derail an acquisition.
Here are a few tips for the employers when preparing a severance package:
- Customise the severance package: One size doesn't fit all. The situation must be customised to accommodate the company's culture, the given business situation and the person/people in question. It demonstrates proactivity and guarantees a more positive response to an otherwise difficult situation
- The best severance packages will allow for time (three-six months at the very least), fair financial support (the debate rages from a month to three month salary for every year served), benefits continuation and career transition support
- The severance should include a non-disclosure agreement, a non-compete and non-solicitation clause (time-bound)
- Bonuses should be paid on a pro-rata basis
- Include a positive recommendation as a part of the process for the outgoing employee. The attempt should be to mitigate any negative sentiment and allow employees to exit in a positive manner.
Shailja Dutt
Founder & Chairman, Stellar Search
Founder & Chairman, Stellar Search