1. Employment Agreements

The employment of many senior executives is governed by an employment agreement. Employment agreements normally define the terms and conditions governing an executive’s employment, including:

• Term of employment and contract renewal provisions
• Position, title, and reporting relationship
• Minimum compensation opportunities, including base salary, target bonus opportunity, and eligibility for long-term incentives
• Vacation, executive benefits, and perquisites
• Severance protection in the event of termination

When an executive is hired, the terms of an employment agreement may require extensive negotiation. This often results in locking the company into commitments that are difficult to unwind. If the company unilaterally eliminates certain benefits or otherwise changes the terms of employment, the executive may be eligible to receive severance from the company by triggering the agreement’s “good reason” termination provision (i.e., the executive can claim that the company effectively terminated his or her employment by materially changing employment terms).

Another issue with individual employment agreements is that they can result in disparate treatment among the executive group based on the timing of when they join the company, as well as the individual executive’s aggressiveness in negotiating the terms of employment. Provisions that may be acceptable to the company for one executive may become problematic if provided to many executives. However, once one executive establishes the precedent for a particular provision, other executives will likely negotiate for similar treatment. This is especially true because employment agreements with executive officers are required to be filed with the SEC, making the terms public knowledge.

For these reasons, we suggest that companies avoid entering into employment agreements with executives whenever possible. Instead, a preferred approach is to use an executive severance policy to cover all similarly situated executives under comparable terms. The most critical protection that an employment agreement provides is protection in the event that the employee is terminated or constructively terminated through a material reduction in responsibilities or compensation. Severance policies provide this protection to senior executives but give the company flexibility to change the program without obtaining the consent of participants. A severance policy also reduces the likelihood of executives negotiating for concessions at termination. Shareholder advisory groups and other external observers tend to be highly critical when companies make special payments to terminated executives.

Another approach is to have a standardized employment agreement that provides a consistent, basic level of protection for all executives at a particular level within the company. This can allow the company to avoid negotiating unique provisions. In addition, if the employment agreement is structured so that it expires after a fixed term or contains a notice period that allows the company to revisit the terms, the company retains a degree of flexibility.