Contract Negotiations

by Tom Lovett, President, Lovett and Lovett Executive Search

Richard Scott, ousted head of Columbia/HCA Healthcare, collected $10 million in severance in July 1998. It was in his contract with the company. Contracts no longer contain such generous terms. And they are being used a lot more now. Before, only CEOs and other top executives were expected to sign contracts, but now, the practice has found its way to lower rungs of management as well.

According to a 1992 study conducted by Hewitt Associates, a Lincolnshire, Illinois-based consulting firm, 82 percent of surveyed companies offered contracts to their CEOs; only 35 percent offered them to more than 10 executives. Now, potential employees with marketable skills at all levels are in a much better bargaining position, and use this fact to secure contracts with highly favorable terms.

What are typical elements in an executive contract?
The basic purpose of a good contract is to avoid litigation. Settling disputes becomes simple and less expensive for both the employer and the employee with a well thought-out contract. Both parties stand to gain from the safeguards built into it. It does not have to be a long, difficult document and can be tailored to suit any employee.

While there is no “one-size fits all” template, there are some standard elements found in most contracts. Those that protect employees include the position that is being offered and accepted, compensation, whether the employment is for a set length of time or “at will,” job content, responsibilities, salary reviews, vacation times, relocation costs, and severance terms. Termination and severance issues can be particularly significant. An executive may want three months of pay plus one month for each year of employment, if terminated without cause.

From a company standpoint, non-compete, confidentiality and indemnification clauses are critical. They are designed to protect intellectual property such as patents and product designs. Non-compete clauses prevent ex-employees from working for competitors for a given length of time; confidentiality bars them from disclosing company information. Indemnification clauses provide inoculation from financial losses arising from another’s actions. Executives are asked to indemnify their employers against any bad-faith conduct and conversely, companies may also indemnify executives for civil litigation, but will not protect them from criminal charges.

Where are executive contracts headed?
Again, there is a noticeable increase in the number of executive contracts. Savvy executives know their worth in the market and have begun seeking companies that provide contracts. Another important trend emerging is that pay is linked to performance and this is clearly stated in most contracts. CEOs may ask for the moon and get away with it, and company boards will give them half the moon at the time of joining and half after they show results. This trend has reduced executives’ clout considerably, and has increased their accountability to the board of directors. Investors are scrutinizing executive pay and perks and studying their impact on company performance and profitability like never before.

Also, boards now put a lot more time and effort into reviewing employee agreements. The average length of a CEO contract has reduced; and “evergreen contracts,” common in the past, are fading away. Contract renewals are headed from automatic to not; and only 53 percent of CEO contracts contain clauses that automatically extend their employment terms, a number significantly lower than just a few years back, according to Clark/Bardes, a Barrington, Illinois based human-resources consulting firm.

Contract negotiation mantras for executives
The best time to start contract negotiations is after the offer has been made. It is good practice to take some time to review the offer, if necessary with an attorney, and then get back to the company with all the changes needed. Revisiting the contract again and again for different points may make the employee seem disorganized, a risk best avoided. Correctly assessing oneself is important – it would be wise not to be unduly modest while speaking of accomplishments. Some CEOs tend to lower the stock price of the company they leave and increase the one’s they join, and such people are in great demand. Obviously, such an executive can ask for almost anything and most likely, will get it.

It is a contradiction of sorts that while more employees are leveraging their worth to get better contract terms, there is increased pressure on them to perform and live up to expectations and fulfill their obligations. Securing the best contract terms depends on many factors including past performance, current business climate and quite simply, the executive’s powers of conviction. As Peter Lynch, one of the greatest investors of all time puts it, “The person that turns over the most rocks wins the game. And that has always been my philosophy.”