2. Key Issues for the Target/Acquired Company
Prior to the signing of the merger agreement, the target company should ensure that there is a clear understanding of the impact of a potential merger/acquisition on its employees. In particular, the compensation committee has an important role in making sure that the executive leadership team and employees remain with the company through the close of the merger. The committee should make sure that prior to the merger agreement being signed, severance or retention agreements are in place for critical executives and staff that may lose their jobs following the close of the transaction. The compensation committee should recognize that not all mergers/acquisitions make it to closing and that the company will be at risk if they lose key employees before the close of the merger, particularly if the deal does not ultimately close.
Many mergers are subject to extensive regulatory and anti-trust review. There are some cases where more than a year can pass between the announcement of the merger and its close, particularly in highly regulated or concentrated industries. It is important for the committee to understand what flexibility it will have to modify compensation arrangements over this period of time. Ideally, the committee should ensure that ordinary course annual incentive and long-term incentive awards can be maintained while the deal is pending. In some cases, merger agreements forbid the granting of additional equity awards without the approval of the acquiring company. This can be a problem if the timeframe from approval to close extends beyond the period when annual equity awards would typically be made.
It should also be noted that the acquired company will have to include a say on golden parachutes proposal in its merger proxy. This allows for shareholders to weigh in on whether or not they approve of the merger-related compensation provided to named executive officers of the acquired company. While the majority of these proposals tend to pass, roughly 10% to 15% of them fail depending on the year. The primary drivers of failure tend to be high severance amounts and problematic practices (e.g., excise tax gross-ups, single trigger acceleration of equity).
Key Questions for Committee Members to Ask:
- How will the merger impact outstanding annual incentives and long-term incentive awards?
- Are there adequate mechanisms in place to ensure that we will retain key talent from the acquired company through the close of the transaction? If there is talent required post-acquisition, do we have “retention hooks” in place?
- How will the compensation program need to change following the acquisition to recognize the new composition of the company? Will we need a new peer group? New performance measures?