A Report on

Stock Offerings and Investor Monitoring

SUBMITTED TO
Dr. M. Farid Ahmed

Professor
Financial Markets and Institutions
Course no: F-304
Department of Finance
Faculty of Business Studies
University of Dhaka

SUBMITTED By
Musarrat Jabeen
18th Batch
Section B
ID:18-200

Department of Finance
Faculty of Business Studies
University of Dhaka

Date of Submission
7th July, 2014

Introduction

Stock offerings and monitoring by investors are very critical issues with respect to financial
market and institutions. Stock offering is the prime function of a corporation and later it is
monitored by investors to make sure that their capital is well protected and being taken care of.
This is way I have chosen the topic Stock offering and investor monitoring as my topic for the
report of the course Financial Markets and Institutions (F-304). This report is prepared in two
parts. First part describes stock offering and the later part talks about monitoring by investors and
financial managers.
Firms raise funds so that they can expand their operations smoothly. This fund can be raised
publically or privately. If the corporation is privately managed, it can raise funds from public. It
cannot issue its stock it market. It will have to go for private equity funds or venture capital. But
public limited corporations can raise fund from public by selling their shares to them. If the
corporation goes public for the first time, the process is called Initial Public Offering (IPO). It
will have to sell its shares in the primary market. Afterwards it can sell those in the secondary
market like DSE, CSE with the help of the brokers.
The second part of the report comprises monitoring by investors and financial managers.
Investors are the owners of the corporations but they do not manage its operations. This
responsibility is vested on the management. But investors and management often have
conflicting interests which results in agency y problems. This creates the need for monitoring by
investors. They take different initiatives like shareholders activism, shareholder lawsuits, proxy
contest etc.
The operation of a corporation is also monitored by other corporations of the same nature. This is
because they want to capitalize on that. If they feel they can better manage that corporation, they
take it over. But takeovers are no piece of cakes. It involves a difficult process. Many people are
laid off as a result of it. So, there are barriers to the market of corporate control like antitakeover
amendments, poison pills, golden parachute which makes the process much more difficult to
handle and expensive. However, markets for corporate control are important because they make
sure that every corporation is being managed well. If there were no such mechanism,
management would feel free to operate according to their own interest which could harm the
investors. But corporate control keeps managers on track since they have the fear to lose their job
and power.

Part One

Stock Offerings
Stock offering is the process of raising capital through the sale of shares in an enterprise. It
essentially refers to the sale of an ownership interest to raise funds for business purposes. Equity
financing spans a wide range of activities in scale and scope, from a few thousand dollars raised
by an entrepreneur from friends and family, to giant initial public offerings (IPOs) running into
the billions by household names such as Google and Facebook. While the term is generally
associated with financings by public companies listed on an exchange, it includes financings by
private companies as well. Equity financing is distinct from debt financing, which refers to funds
borrowed by a business.
Stock can be offered in two ways to raise equity:

Private Equity
Public Equity

Private Equity
When a firm is created, if founders typically invest their own money in the business, it is called
to be financed by private equity. The founders also invite their friends and family to invest equity
in the business. This is referred to as private equity as it is privately held. Young businesses use
debt financing from financial institutions and are better able to obtain loans if they have
substantial equity invested. Over time, businesses commonly retain a large portion of their
earnings and reinvest it to support expansion. This serves as another means of building equity in
the firm.
The ultimate aim of private equity investors is to create value. As such, they look for
high quality management teams with a credible plan to grow their business. Private equity
investors are long-term investors and work with the companys management to improve the
companys performance and strategic direction by aligning incentives, improving business plans,
making operational improvements and strengthening corporate governance. With this mentality
to buy and help build, coupled with a disciplined approach to organizational governance, private
equity investors display a nimbleness and adaptability that raises the value of their investment
and ensures that value can be realized in the future.
Private equity can be financed by:

Venture Capital
Private Equity Funds

Venture Capital

Venture capital is a source of financing for new businesses. Venture capital funds pool investors'
cash and loan it to startup firms and small businesses with perceived, long-term growth potential.
This is a very important source of funding startups that do not have access to other capital.
Most venture capital comes from groups of wealthy investors, investment banks and other
financial institutions that pool such investments or partnerships. This form of raising capital is
popular among new companies, or ventures, with a limited operating history that cannot raise
capital though a debt issue or equity offering. Often, venture firms will also provide start-ups
with managerial or technical expertise. For entrepreneurs, venture capitalists are a vital source of
financing, but the cash infusion often comes at a high price. Venture firms often take large equity
positions in exchange for funding and may also require representation on the start-up's board.
Terms of a Venture Capital Deal
When a VC fund decides to invest in a business, it will negotiate the terms of its investment,
including the amount of funds it is willing to invest. It will also set out clear requirements that
the firm must meet, such as providing detailed periodic progress reports. When a VC fund
invests in a firm, the funds managers have an incentive to ensure that the business performs
well. Thus, the VC fund managers may serve as advisors to business. They may also insist on
having a seat on the board of directors so that they can influence the firms future progress.
Often, the VC fund provides its funding in stages, based on various conditions that the firm must
satisfy. In this way, the VC funds total investment is aligned with the firms ability to meet
specified financial goals.
Exit Strategy of Venture Capital Deal
An important aspect of venture capital investing is the exit strategies. Venture capital funds
primarily invest with an exit in mind after a few years. After successfully funding at seed, preproduction, production and expansion stages, a venture capitalist will start assessing exit
strategies. The exit in the form of disinvestment or liquidation is the last and final stage of the
venture capital funding. The key types of liquidation/disinvestment are trade sales, sale of quoted
equity post initial public offering (IPO), and write-offs. Lets look at each of these in detail:
Trade Sales: In this type of strategy the private company is sold or merged with an acquirer for
stocks, cash, or a combination of both.
IPO: If the company has done well, the venture capital investors will take the IPO route, by
issuing shares registered for public offering. An example is the upcoming Facebook IPO, which
is expecting to raise about $15 billion through IPO and is valued at approx. 100 billion. The
venture capital investors and other private investors will get their portion of shares who can put
them in the open marketplace for trading after an initial lock-in period.
Write-offs: These are voluntary liquidations that may or may not result in any proceeds.

Apart from the above three types of disinvestment, there are a few other options:
Bankruptcy: The Company may just go bankrupt.
Buy-back: In this method the entrepreneur buys-back the investment share from the venture
capitalists and takes it back to being a privately held company.
Investors who invest in a venture capital fund get distributions of public stock or cash from
realized venture capital investments. Sometimes the fund may require further investments from
limited partners. At other times, they may make cash or share distributions at random times
during the lifetime of the fund. Investors can sell their interests to another buyer if they find one.
In a bad case scenario, some funds find themselves with highly illiquid, barely there companies.
In a good scenario, they have good investments, which they disinvest from at a stage and find
new investments to fund.
Private Equity Fund
Private equity funds pool money provided by institutional investors and invest in business. They
also rely heavily on debt to finance their investments. Unlike VC funds, private equity funds
commonly take over business and manage them. Their managers typically take a percentage of
the profit they earn from their investments in return for managing their fund. They also charge an
annual fee for managing the fund. Since they commonly purchase a majority stake or all of a
business, they have control to restructure the business as they wish. They sell their stake in the
business after several years. If they were able to improve the business substantially while they
managed it, they should be able to sell their stake to another firm for a much higher price than
they paid for it. Alternatively, they may be able to take the business public through an initial
public offering (IPO) and cash out at that time.
Public Equity
When a firm is financed by issuing its shares in stock market and raising fund from public, it is
called to have a public equity. Going public has two effects on firm. First, it changes the firms
ownership structure by increasing the number of owners. Second, it changes the firms capital
structure by increasing the equity investment in the firm, which allows the firm to either pay off
some of its debt or expand its operations or both.
Why Go Public?
Most companies go public to:

Raise capital for expansion efforts or to pay back debt.

Provide an exit for existing investors whether the company is PE-owned, VC-backed,
or owned by a small group of individuals or a single person.

Reward employees Making employees work crazy hours for 5-10 years is tough to pull
off, but the lure of an IPO that will make them all wealthy is a great incentive for them to
stick around.

Market themselves Especially for lesser-known companies in boring industries, an

IPO is a great way to increase prestige and attract new investors, partners, and customers.

Initial Public Offering

The first sale of stock by a private company to the public. IPOs are often issued by
smaller, younger companies seeking the capital to expand, but can also be done by
large privately owned companies looking to become publicly traded. In an IPO, the
issuer obtains the assistance of an underwriting firm, which helps it determine what
type of security to issue (common or preferred), the best offering price and the time
to bring it to market.

How to Prepare an Initial Public Offering (IPO)

When a corporation decides to go public, a portion of it will be put up for sale to the public
through the sale of stock. An Initial Public Offering (IPO) is the first offering of shares of a
privately held corporation to the public. The main reason to have an IPO is to bring money into
the business. It is often the main way that a start-up company will be able to make the money it
needs to succeed in the market.
Determine if your company is eligible to go public. In order to qualify for an IPO, generally
the business must be proven to be profitable and have a significant amount of assets. Since there
are no set requirements to define eligibility, consider scheduling a meeting with an investment
banker or outside consultant to determine whether your company is of the type that the public
would want to invest in.
Contract with an investment banker. An investment banker will help determine how much
money you should raise, at what price the shares should be sold, and what portion of the
company should be offered in the IPO. The investment banker serves as an underwriter in that it
will agree to purchase all of the shares that the company decides to offer.
Draft a prospectus and file it with the Securities Exchange Commission (SEC). The SEC
calls this document S-1. Its purpose is to disclose the details of the company. In the initial
prospectus -- the first document filed -- the terms of the IPO (the number of shares and the price
per share) will likely not be finalized, but they are included as an estimate of what the final terms
will be. The initial prospectus is filed early on in the IPO process. In the final prospectus, filed
shortly before the IPO, the amount of shares and share price of the offering are fixed.

Present the opportunity to potential shareholders. Before the actual IPO, the banker and the
corporations top officials will give presentations to individuals and other organizations to entice
them to purchase the shares of the IPO. The investment banker selects the potential investors
based on the type of business that wishes to go public and the interest that the potential investor
may have in the corporation. This process results in non-binding commitments, called
subscriptions, to purchase shares. It is largely used as a tool to determine whether the public
will be interested in investing in the company, as discussed in the first step, as well as to
determine the price of the shares.
Sell the shares to the investment banker. On the day of the IPO, the investment banker will
purchase the shares and simultaneously sell them to investors. The bankers purchase price is the
IPO price minus the commission, which usually hovers around 7 percent. The shares can now be
publicly traded.
Secondary Market
A market where investors purchase securities or assets from other investors, rather than from issuing
companies themselves. The New York Stock Exchange and the NASDAQ are secondary markets.
Secondary markets exist for other securities as well, such as when funds, investment banks, or entities
such as purchase mortgages from issuing lenders. In any secondary market trade, the cash proceeds go to
an investor rather than to the underlying company/entity directly. A newly issued IPO will be considered a
primary market trade when the shares are first purchased by investors directly from the underwriting
investment bank; after that any shares traded will be on the secondary market, between investors
themselves. In the primary market prices are often set beforehand, whereas in the secondary market only
basic forces like supply and demand determine the price of the security.

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Obligations of Stock-brokers to Their Customers

Accepting a customer to open a customer account for trading
Executing the customers order for buy or sell as per their written or telephonic order
Providing trade confirmation report on the executed order with details within 24 hours
of trading
To replace the defective script or refund the money to the customer with interest @2.5%
per month from the date of settlement of transaction to date of refund, along with the
benefit accrued, if any, provided complaint is lodged within 10 days of book closure or 6
months of settlement date, whichever is earlier, for the defective script as per the
settlement of transaction regulations of stock exchanges
To settle the customers complaint, if any, against the stock-broker concerned
To keep separately the customers securities from others securities
To keep separately the customers money through consolidated customers bank account
from the brokers money

Responsibilities of investors to their stock-brokers

Signature of the investor/client in the Customer account information to form an
contractual agreement
To know the client code number for trading
Introducers information
Terms & condition attached in the form for margin facilities
To set rate of Commission for trading by negotiation
To take acknowledgement receipt for share deposit with the signature of the authorized
person of stock-broker
To take money receipt for fund deposit with the signature of the authorized person of
stock-broker
Declaration given in respect of shares trading by director or sponsor etc.

Obligations of the investors for the market

Investors should not be involved to Create artificial price through Syndication and
Manipulation by involving with issuer companies
Not to Influence issuer companies to inflate financial report and declaring artificial
dividend
Not to Influence/ Misguide others investors for trading
Not to open more than one account in different brokers and merchant banks for ill
motives
Not to involve for spreading rumor or phony information in the market

How to Trade in the Stock Exchange

Trading of securities on the stock exchanges can only be done through brokers of the
concerned exchanges
An investor is required to open an account with a broker by filling-in a prescribed
Customers Account Information Form
For trading in the demoted securities it is required to have a Beneficiary Owners (BO)
account with a Depository Participant (DP) in addition to the aforesaid account
An investor can trade through a broker either in cash or credit
The credit transaction, however, is subject to the provisions of Margin Rules, 1999
Trading in the securities can be executed through written orders submitted to the
concerned broker
Telephonic orders can also be submitted provided that such orders shall be confirmed in
writing within 24 hours
The price of the securities cannot go beyond specified circuit breaker range and an
investor can quote at the tick price of the securities as specified by the exchanges.
Short-selling of the securities are prohibited if it is not done under Dhaka Stock Exchange
(Short Sale) Regulations 2006
Based on price, orders may be of the following categories, namely:Limit order; and

Market order
Limit order: Limit order must have a price limit which ensures that the order shall be
traded at the price equal to or better than the limit price.
Market order: Market order is the order to be executed at the touchline price. A market
order is matched immediately on arrival in to the trading engine at the touchline price.
All orders will match automatically.
Orders which are at the most favorable price, that is, at the lowest selling or highest
buying price, shall be executed first. If two or more orders are listed in the order book at
the same price, the oldest order shall be executed first.
Orders that cannot immediately be executed shall be queued for future execution in a
specific order of priority mainly based on price and time of entry.
If an order is executed partly, the remaining part of such order shall not lose its priority.
The queue priority is determined by the system through an interactive process.
Trade Confirmation

Trade confirmation note is a proof of the transaction issued by broker;

The broker shall issue a trade confirmation note to his client within twenty four hours of
the execution of order and it should be numbered and time stamped;

The trade confirmation note shall show:

Date of the trade;
Name and quantity of the security bought or sold;
Price of the security, brokerage and other charges;
The order and howla or contract note number and date; etc.

Some Basic points for making Investment in the secondary

market
Investments in capital market are primarily made either for capital gain or for getting
regular income as dividend;

 Before making investment decision one should determine his own objective for
investment.
Common objective of investment in secondary market is to maximize profit from bullish
market and or minimize loss from bearish market.
After determining the objective, the investor should analyze the financial statements of the
company and decide to invest in the shares of that company.
Industry of the company and their average return for last few years;
Management of the company
Earnings per share (EPS), Price Earnings ratio (P/E), Dividend, Dividend payout ratio,
Net asset value per share, No. of shares outstanding, Market price and its fluctuation,
growth rate, market position etc. of the company;
Product, technology, market position of the product etc. of the company;
Turnover rate of the shares or liquidity position etc.

PART TWO
Investor Monitoring
Since a firms stock price is related with its performance, the return to investors is dependent on
how well he firm is managed. A firms managers serve as a agents for shareholders by making
decisions that are supposed to maximize the stocks price. The separation of ownership (by
shareholders) and control (by managers) can result in agency problems because of conflicting
interests. Managers may be tempted to serve their own interests rather than those of the investors
who own the firms stock. To solve these problems, various forms of corporate governance are
used by shareholders. They rely on board of directors of each firm to ensure that its managers
make decisions that enhance the firms performance and maximize the stock price. Shareholders
monitor their stocks price movements to assess whether the managers are achieving the goal of
share price maximization. If the share price is lower than expected, shareholders may attempt to
take action to improve the management of the firm.

The easiest way for shareholders to monitor the firm is to monitor changes in its value (measured
by share price) over time. When the stock price declines or does not rise as expected,
shareholders may blame the weak performance on the firms managers.
Shareholder Activism

Shareholder activism is the way in which shareholders can assert their power as owners of the
company to influence its behavior. Activism covers a broad spectrum of activities. Activism
includes voting with ones feet (exit), private discussion or public communication with
corporate boards and management, press campaigns, openly talking to other shareholders,
putting forward shareholder resolutions, calling shareholder meetings and ultimately - seeking
to replace individual directors or the entire board.
In some cases shareholder activism is directed against other large shareholders, not against
directors. Shareholder activism can be collaborative, in particular when it is conducted in private.
Shareholder activism is controversial. Proponents argue that companies with active and engaged
shareholders are more likely to be successful in the long term than those that are left to do what
they choose. Vigilant shareholders are said to play the role of fire alarms and their mere presence
can alleviate managerial or boardroom complacency. When companies perform poorly,
shareholders activists are said to play the role of fire brigades that bring about change and more
quickly than would have been the case had the fire brigade been on strike.
Opponents say that "shareholder activism" is a euphemism for disruptive, uninformed, populist
ranting or "take the money and run". In its extreme forms activism is said to be an extortion
scheme that weakens strong companies. More fundamentally, there is disagreement about how
much power shareholders should delegate to corporate boards and when direct shareholder action
becomes necessary and on what terms.
Proxy Contest
A strategy applied a group of shareholders are persuaded to join forces and gather enough
shareholder proxies to win a corporate vote. A proxy contest occurs when the acquiring company
attempts to convince shareholders to use the proxy votes to install new management that is open
to the takeover. The technique allows the acquired to avoid paying a premium for the target. It is
also called proxy fight.
Shareholder Lawsuits
Investors may sue the board if they believe that the directors are not fulfilling their
responsibilities to shareholders. This action is intended to force the board to make decisions that
are aligned with shareholders interests. Many lawsuits have been filed when corporations prevent
takeovers, pursue acquisitions, or make other restructuring decisions that some shareholders
believe will reduce the stocks value.

Monitoring by Financial Managers

Financial managers of firms closely monitor their own firms stock price and the stock price of
related companies. If they believe that the stock is undervalued, they may attempt to capitalize
on this discrepancy, as explained below:
Stock Repurchase
Stock repurchase is usually an indication that the company's management thinks the shares are
undervalued. The company can buy shares directly from the market or offer its shareholder the
option to tender their shares directly to the company at a fixed price. In general studies have
found that stock prices respond favorably to stock repurchase announcements. It implies that the
announcement signals managements perception that the share price is undervalued. The market
responds favorably to this signal.
Benefits of Stock Repurchase
1. Signal to the market that the board thinks the company is strong. When a company is
buying back shares, it sends a message to the market. Since the company board knows
the best about the company, the markets often think that the company is getting healthier
and puts lesser pressure on the board from activist investors.
2. Compensate for stock options & bonuses. Companies give out stocks to their
employees in the form of options & grants. This increases the number of outstanding
shares. Many companies want to keep their outstanding shares stable. So, they
compensate from the issue of new shares by buying back some of the old shares from
public.
3. Push up the stock price. The stock repurchase reduces the float (number of stocks held
by the public) thereby causing a scarcity of the company's shares in the market. The
company could then use a favorable market condition to reissue these stocks to public
and make a gain (these gains will not be reflected in the profits, as a trading gain on one's
own shares is not allowed to be reported in income statement).
4. Support the price. When a company is pummeled by the market, key institutional
shareholders would press the company to support a price". This is because the poor
performance of the company would reflect badly on the institutions (portfolio managers,
pension funds) when they send out their periodic statements to their investors.
Potential Dangers of Stock Repurchases
There are some real dangers with stock repurchase programs. These include:

If management spends too much cash as part of the stock repurchase, liquidity could be
hurt. When the economy goes off a cliff, it's possible the firm would have to declare
bankruptcy because they didn't have enough current assets to make it through the crisis.

If the price paid for each share as part of the stock repurchase is too high, a stock
repurchase can literally destroy value. It would be like purchasing $1 bills for $2. Despite
owning more of the company, long-term shareholders would be poorer following the
transaction.

If an acquisition comes along that management really wants, it may do stupid things to
close the deal, such as issuing new shares at a lower price than it paid as part of the stock
repurchase plan.

Stock buyback programs take advantage of supply and demand by reducing the number of shares
outstanding, increasing EPS shareholder value, float and ultimately the price of stock. In
addition, they are often a wise use of excess cash and can create tax opportunities for the
investor. However, not all buybacks are actually implemented so caution and research is
advisable.
Market for Corporate Control
Market for corporate control, sometimes called external corporate control, usually comes into
play when a firms internal governance (board of directors) fails. It often refers to a takeover
market where underperforming or undervalued firms become attractive takeover targets by
potential acquirers. When firms perform poorly it often reflects poor internal governance and
therefore external governance control will kick in. Potential acquirers might buy up a large
amount of a target firms equity in order to take control of the board and subsequently replace the
top management team because poor performance often reflects poor management. The aim of a
takeover is to revitalize a poorly run company and achieve higher profitability after restructuring.
Potential acquirers believe that they can manage the target firm more effectively than the current
set of the top management team. The threat of takeover can serve as a last governance
mechanism by aligning the interests and goals between executives and shareholders and thus put
additional pressure on managers to perform more efficiently.
Barriers to Market for Corporate Control
The power of corporate control to eliminate agency problems is limited due to barriers that can
make it more costly for a potential acquiring firm to acquire another firm whose managers are
not serving the firms shareholders. Some of the most common barriers to corporate control are
indentified next:
Anti takeover Amendments
Some companies use formal methods that are put into place prior to an actual takeover
attempt. Known as anti takeover or shark-repellent devices; they are designed to make
a takeover more difficult. Before describing them, it is useful to consider their
motivation. The managerial entrenchment hypothesis suggests that the barriers erected are to
protect management jobs and that such actions work to the detriment of stock-holders. On
the other hand, the stockholders interest hypothesis implies that corporate control contests are
dysfunctional and take management time away from profit-making activities. Therefore, anti

takeover devices ensure more attention being paid to these activities and are in the interest of
stockholders. Moreover, the barriers erected are set to cause individual stockholders not to
accept a low offer price but to join other stockholders in a cartel response to any
offer. Therefore, and to takeover devices would enhance shareholder wealth,
according to this hypothesis.
The Poison Pill
A shareholder rights plan, also known as a "poison pill", is one of the most effective defense
tactics available to publicly traded corporations. A poison pill is designed to make the transaction
being pursued by a hostile bidder extremely unattractive from an economic perspective,
compelling the bidder to negotiate with the target's Board of Directors.

There are two types of poison pills:

1. A "flip-in" allows existing shareholders (except the acquirer) to buy more shares at a discount.
2. A "flip-over" allow stockholders to buy the acquirer's shares at a discounted price after the
merger.
Generally, a poison pill issues rights to all existing shareholders, with the exception of the hostile
suitor, to acquire stock of the target (or of the aggressor upon a subsequent merger) at prices
significantly below market. These rights are triggered by certain specified events, such as the
announcement of a cash tender offer or the acquisition by an outsider of a specified percentage of
the target's shares. Thus, a poison pill is effective because it dilutes the economic interest of the
hostile suitor in the target, making the transaction both economically unattractive and impractical
if pursued on a hostile basis.
How it works/Example:
There are many poison pill strategies that have been used by companies against hostile takeovers
and corporate raiders. For example, offering a preferred stock option to current shareholders
allows them to exercise their purchase rights at a huge premium to the company, making the cost
of the acquisition suddenly unattractive. Another method is to take on a debt that would leave
the company overleveraged and potentially unprofitable.
Some companies have created employee stock ownership plans that vest only when the takeover
is finalized. In addition to a dilution of the stock value, such employee benefits may result in an
employee exodus from the company leaving it without its talented workforce (which is often one
of the drivers of the acquisition).

Another example is to offer a series of golden parachutes for company executives. This could
also make the takeover of the company prohibitively expensive the buyer had planned to replace
the top management.
Finally, one non-financial method of a poison pill is to stagger the election of the board of a
company, causing the acquiring company to face a hostile board for a prolonged period of time.
In some cases, this delay in gaining control of the board (and therefore the votes necessary to
approve certain key actions) is a sufficient deterrent for a takeover attempt.
An extreme implementation of a poison pill is called a suicide pill.
Golden Parachutes
Golden parachute is the name gives to the benefit provided, usually to top executives, that
provides income when the person is terminated or forced out of the company before the end of a
specific period of time.
Many employees have a severance provision as part of their employment contract. Often it is
something like a week's pay for every year you worked for the company if you are laid off. Some
executives will have larger severance guarantees, like six to twelve months salary, if they are let
go. Generally, these are just called severance packages and not golden parachutes.
The term golden parachute usually is reserved for the large severance arrangement paid to a top
executive. In an attempt to make a job offer more attractive to a top candidate the company may
offer that executive a large salary, a big benefit package and a number of other incentives. One of
those incentives often is a package of cash, stock, continuation of insurance and club
memberships, and anything the executive requests that will be paid if the executive is terminated.
This package is called a golden parachute.
The golden parachute is called that because it provides a "soft landing" for a terminated
executive. Golden refers to the fact that it's money or other income.
Sometimes there is a legitimate concern that the executive might be forced out. For example, if
the company is bought by another company the CEO will leave because the combined company
doesn't need two CEOs. In such cases, the golden parachute makes sense. The size of the golden
parachute may be out of proportion to the severance packages of employees or other executives,
but there is justification for it to exist.
In other cases, the CEO is forced out because of poor performance of the company under his
direction. In these cases, the golden parachute is still paid because it was part of the contract that
was negotiated as part of the deal to hire that person. Executives love golden parachutes. Boards

of Directors comprised mostly of other executives, like them too. Shareholders generally don't
like them because they can reward poor performance.
As a rule, regular employees have a provision in their contract that their severance won't be paid
if they are fired for cause. That same provision should be in all golden parachute agreements, but
it either isn't there or is ignored.

Bibliography

Financial Markets and Institutions Jeff Madura

www.investopedia.com
www.wikipedia.com
www.businessdictionary.com
www.financialdictionary.com
www.wikinvest.com