Failed CEOs Should Take Their Lumps

What can be done about lavish severance packages for chief executives who made a mess of their companies and were forced out after share prices tumbled and blameless employees lost their jobs?

It has regrettably become common in recent years for executive severance to be negotiated during the hiring process, when a corporate board of directors is trying to recruit a star chief executive officer. The severance agreement becomes part of a contractual commitment that is often unrelated to the circumstances of the executive's eventual firing. It's legally difficult for the board to void the contract. On occasion, though, shareholder suits have resulted in a reduced severance package.

To complicate matters, severance is often structured as deferred compensation for an executive's earlier successes, before things fell apart. Discredited CEOs always argue that they were not overpaid at termination, considering the rise in share price they achieved for stockholders during the good times.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

My solution? Companies shouldn't make severance commitments when hiring executives that might later haunt them, especially if the CEO is terminated for cause. Executive-compensation consultants (who, by the way, played a big role in pushing up CEO pay) warn that this would make it difficult for boards to hire top talent. Nonetheless, I think it's a reform that is long overdue.

An ethical CEO should be embarrassed about receiving a lavish severance package after his or her errors of judgment caused severe distress for shareholders and especially for employees. (Then again, CEOs are not usually noted for their humility.)

To do the right thing -- and also to defuse public condem-nation and head off shareholder suits -- terminated CEOs and other top executives should voluntarily decline a large portion of their severance. Or, even better, they could offer to give most of their undeserved windfall to rank-and-file employees who lost jobs as a result of their mismanagement.