Rethinking Chutes: Incentives, Investment, and Innovation

Abstract

Eighty-two percent of public firms have golden parachutes (or “chutes”) under which CEOs and senior officers may be paid tens of millions of dollars upon their employer’s change in control. What justifies such extraordinary payouts? Much of the conventional analysis views chutes as excessive compensation granted by captured boards, focusing on the payouts that occur following a takeover. Those explanations, if they ever were complete, miss the mark today. This Article demonstrates, theoretically and empirically, that chutes are less relevant to a firm during a takeover than they are before a takeover, particularly in relation to firms that invest in innovation. Chutes assure managers of realizing the long-term value of their work, even if the firm is later acquired. As a result, managers are more likely to make specific investments in innovation whose value may not be realized for some time — but that which are essential to sustaining long-term performance. Moreover, when granted, a chute’s expected cost is a small fraction of what may be paid, reflecting the real likelihood a payment will never be made. That cost is more than offset by the value of the specific investments in innovation that managers are now more likely to make. Consequently, granting chutes tends to increase the value of innovative firms — promoting, rather than jeopardizing, shareholder interests in such firms. Nevertheless, an analysis of chutes as a valuable tool in promoting innovation is largely missing from the corporate law scholarship, with important consequences. Two, in particular, are the negative view of proxy advisors on chutes, and recent federal Say-on-Golden-Parachute legislation that mandates certain types of disclosure regarding chutes. We recommend changes that properly reflect the low expected cost of chutes and their positive effect on innovation