HR Magazine - October 2000: Golden Handcuffs

Vol. 45, No. 10

These deals give executives unique compensation packages -- and punish them financially if they jump ship.

The multinational corporation’s management team knew that the company was going down the tubes. The board of directors figured the only solution was to get great talent into the executive suite and keep it there long enough to make a difference.

Getting the executives in the door was one thing. Getting them to stay, in today’s job market, was another. Even when you’re offering a salary that makes a half-million dollars look like chump change, it’s not that hard for the multinational next door to offer your superstars more.

So this company cut a deal: Top executives would be allowed to sock away up to 100 percent of their income each year in a nonqualified deferred compensation plan. The company would match 50 cents for every dollar that they deferred. The execs could live off the income from their stock options, paying a smaller capital gains tax to the Internal Revenue Service each year, instead of income tax on their huge salaries. If the executives stayed until they were fully vested, the company would pay their taxes when they cashed out of the plan.

Expensive? Yes. Effective? Very, because, if the executives left before becoming vested, they kissed every dime of the company’s match goodbye. And they’d get hit with a huge tax bill when they withdrew all of their own money from the plan, says Weldon Baird, managing partner at The Todd Organization, an Atlanta-based company that designs executive retention plans.

In short, if you leave, you lose—big time. Welcome to executive retention, Machiavelli style.

The idea is to slap “golden handcuffs” on key employees. Although definitions vary, the general idea of golden handcuffs is to cause financial pain to senior managers and executives if they leave your employment. Usually, a golden handcuff is a benefit, payment or incentive linked to the recipients’ staying, says Brent Longnecker, executive vice president of Resources Connection, a Houston consulting firm that specializes in executive pay issues.

Forge Unique Handcuffs

There are many kinds of golden handcuffs, ranging from the fairly common to the exceedingly rare—the corporate example above falls into the latter category. But with golden handcuffs, there’s no need for standardization.

“While there’s only one way to do a qualified 401(k), or a qualified pension, there are literally thousands of ways to do golden handcuffs for nonqualified employees,” says Baird. The advantage is that you can design a different package for each individual. Stock options aren’t your superstar’s thing? Maybe the executive would like to have his estate taxes covered or his child’s college tuition bill paid.

You can make whatever your high flyer wants—and you can afford—happen. “You can determine what’s important to the employee and match their needs with some kind of incentive program that has some strings tied to it,” says Ray Silverstein, president of PRO-President’s Resource Organization, a Chicago-based consulting firm. “One size does not fit all.”

The downside for HR is that, the more you custom-fit golden handcuffs to individual executives, the more of an administrative burden those handcuffs become. And most golden handcuffs must be expensive to be effective, Silverstein points out. Also, although key executives know the you-leave-you-lose rules up front, no one loves a company that threatens to slash his net worth. So, if you hope not to burn bridges with your departed execs, then golden handcuffs are probably not your best bet. But if you want to avoid seeing your executives depart in the first place, golden handcuffs can be an important strategy.

Paying Back Bonuses, Expenses

While there are many ways you can tie someone to a company financially, the simplest ways are the most common. “The golden handcuffs I see are generally attached to some kind of hiring or retention clause, and it’s generally one to three years in length,” says Jerome Mattern, SPHR, chairman of the Society for Human Resource Management’s Compensation and Benefits Committee.

This could be as simple as requiring an employee to reimburse the company for a hiring bonus or moving expenses if the person leaves for a new job within a one- to three-year period. The downside: This does relatively little to hold very wealthy executives who can shrug off the financial hit.

Another way to slap golden handcuffs on high-level employees is to mirror the strategy of “handcuffing” lower-level employees. For rank-and-file workers, retirement plans have long been used to keep them in their jobs. For highly compensated executives, legal limits on retirement income make traditional plans less meaningful and therefore less effective as ways to keep them on board.

To bring the power of retirement back to bear on highly compensated executives, various kinds of nonqualified deferred compensation plans may do the trick. Typically, these are set up as 401(k) mirror accounts. To the executive, it seems just like a 401(k) account, allowing the executive to put aside some of his own salary, with a match, to pay out either at retirement or at some point in the future. This allows highly compensated executives the flexibility of investing money for retirement without immediate tax consequences. Another tactic along these lines is to provide a supplemental employee retirement plan that could act just like a pension, as long as the employee makes it to retirement with the company.

The major disadvantage of retirement-based handcuffs is that they are less effective with younger executives, points out Alan Johnson, managing director of Johnson Associates, a New York-based consulting firm.

Putting Stock in Executives

Stock options with a vesting period are another common retention tool. (A stock option gives its holder the right to buy stock at a certain price. The idea is that the employee gets the option to purchase stock at a lower price than the price at which the stock is currently trading.) Typical vesting periods range from one to three years, and they often include some kind of a rolling schedule. As executives become fully vested and able to exercise some options, they pick up other options with a new, later vesting period.

The employer benefit to this form of stock options is obvious: The executive’s compensation is tied to the performance of the organization as a whole, and he doesn’t get the goodies unless he stays. But “it’s only going to be a good handcuff if the stock goes north,” says Longnecker. Given the stock market’s recent gyrations, leaving your retention strategy up to market forces might be risky.

You also can use other forms of stock—such as restricted stock or phantom stock—to offer executives lucrative deals. Phantom stock doesn’t really give the employee actual stock or stock options but credits an account with units of phantom stock for which the employee receives a certain payout if he makes it to retirement or to the end of a designated vesting period. Phantom stock does not confer any voting privileges. Restricted stock is actual stock but employees hold it under restricted conditions that limit their ability to sell it.

There’s one big caveat to stock options of any type. Make sure that all your executives don’t become vested at the same time, cautions Longnecker. One large law firm in Houston made that mistake, and all its top executives felt flush enough to leave in the same year, he says. And they’re not the only executives taking a hike thanks to stocks.

“A number of companies are finding that the golden handcuffs have backfired and turned into golden wings,” says David J. Dell, research director of capabilities management and HR strategies at The Conference Board, a business research organization in New York.

Also, as stock options become more popular for all employees, they may not matter as much to executives, notes Neal Weber, a partner with the compensation and benefits practice at consulting firm KPMG in McLean, Va. “Executives already own so much company stock they’re almost choking on it,” says Weber. “Any employee can have stock options; an administrative assistant can have stock options,” he says. “When I think of golden handcuffs, I’m thinking about something that’s extra special. The term ‘golden’ implies a lot,” he says.

Houses, Tuition and Insurance

Other types of executive handcuffs are more unusual than stock deals or deferred compensation plans. Some employers dig into their executives’ specific needs or desires and meet them, as long as the executives stay in place.

For example, some top brass may prefer their golden handcuffs in the form of educational benefits trusts. “It’s something we’re beginning to see more and more of,” says Weber.

“Educational benefits trusts are designed to pay the educational costs of an executive’s children,” he explains. The company can simply put money in a trust for the executive’s children, or it can allow the executive to defer some income in an account while the employer provides a generous match. The end of the vesting period will coincide with the year Junior heads off to college. For an executive with young children, this could be an effective handcuff for a long time.

Another tactic is to offer an employee a loan on a house and then forgive the loan a little at a time over a few years. That way, if the employee leaves during the period of the loan, the employee owes you that money. Longnecker once designed a plan for a company that was eager to attract and retain a top-level executive. The company loaned that executive $5 million, and the company forgave the loan at the rate of $1 million a year, for five years. The executive not only stayed the five years but also works for the same company today.

Employers also can offer what’s called a “split dollar” insurance plan, Baird says. Some executives have large estates that will be subject to hefty tax bites when they die. To address this concern, some companies foot the bills for certain life insurance policies, the proceeds of which will be paid to family trusts, estate-tax free, after the executive dies. An executive who leaves the company before death or retirement loses that insurance. If you’re considering split dollar insurance, check the details carefully; premiums may not be deductible by either the employee or the employer, and there are other possible tax implications for the employee.

Still another golden handcuff is particularly appealing to traditional-economy companies nervous about losing their leaders to high-growth start-ups that offer hot stock options, says George Bostick, partner at Sutherland, Asbill and Brennan LLP in Washington, D.C. In rare cases, the older companies provide employees with equity in firms other than their own. For instance, if a company has many subsidiaries, and one is in a high growth industry, an executive could get stock in that fast-growing subsidiary. Or the company can create a fund for investments in totally separate firms and give executives a share of that fund—and a share in the thrill of a stock-market gold rush. Because the practice raises securities law and tax law issues, some employers steer clear of it.

Remember that no matter how much it may hurt an executive financially to leave you, if someone is truly ready to leave, no handcuff will work. “A golden handcuff is a speed bump, not a brick wall,” Johnson notes. “Turnover is a complicated issue, and there are lots of factors at play. Money is just one of them.”

Alison Stein Wellner is a freelance business writer based in Newark, Del.