A parachute payment is a lump sum of money a company pays to an executive when they leave their job, usually because of a merger, acquisition, or hostile takeover.

The payment is meant to cushion the financial blow of sudden job loss. It typically covers several months or years of salary, sometimes plus bonuses, stock options, or other benefits the executive would have received if they had stayed. The amount is usually set in an employment contract before any change of control happens, so both the executive and the company know what will be owed if the situation arises.

The term "parachute" comes from the idea that the payment lets an executive float safely to the ground after being ejected from a sinking ship. The payment is most common in large corporations and among senior leadership—CEOs, CFOs, presidents, and board members—though some mid-level executives also have these clauses in their contracts.

Key Takeaways

  • A parachute payment is triggered by a change of control, such as a merger or acquisition, and is written into an executive's employment contract before that event occurs.
  • The payment typically covers multiple months or years of salary, plus bonuses and sometimes stock benefits, depending on what the contract specifies.
  • Golden parachutes (larger, more generous packages) and silver parachutes (smaller packages for lower-level executives) are the two main types.
  • The IRS taxes parachute payments as ordinary income, and executives may owe a 20 percent excise tax on the amount that exceeds three times their average annual compensation.

Why companies offer parachute payments

Companies use parachute payments to recruit and keep senior executives. A strong parachute clause signals to a candidate that the company will protect them financially if the business is sold or taken over, which reduces the executive's personal risk in taking the job. Without this protection, talented leaders might refuse high-level positions in industries where acquisitions are common.

Parachute payments also serve the company's interests during a sale or merger. If executives know they will be paid well if the deal goes through, they are more likely to cooperate with the transaction rather than fight it or leave before it closes. This makes the deal easier and faster to complete, which can be worth far more to the buyer than the cost of the parachute payments.

Golden parachutes versus silver parachutes

A golden parachute is a large, generous package offered to top executives—usually the CEO, president, or CFO. These can be worth millions of dollars and may include multiple years of salary, bonuses, accelerated vesting of stock options, health insurance continuation, and outplacement services. A golden parachute might may provide an executive receives two to three years of pay plus benefits if a change of control occurs.

A silver parachute is a smaller package offered to mid-level managers and other senior staff below the C-suite. These typically cover three to twelve months of salary and basic benefits. A bronze parachute, though less common, is an even smaller package for lower-level employees.

The size of the parachute depends on the executive's salary, position, and negotiating power. A CEO at a Fortune 500 company might negotiate a golden parachute worth $10 million or more, while a vice president at a smaller firm might receive a silver parachute worth $500,000 to $2 million.

How parachute payments are triggered

A parachute payment is triggered by a change of control, which the employment contract defines precisely. Most contracts specify that a change of control occurs when one of the following happens: a third party acquires more than 50 percent of the company's voting stock, the majority of the board is replaced within a set period, the company is sold or merged, or there is a substantial change in the company's business or assets.

Some contracts include a "double trigger" clause, meaning the parachute is only paid if both a change of control occurs AND the executive is fired or forced to resign within a certain time after the change. This protects the company from paying executives who stay on and continue working for the new owner. Other contracts use a "single trigger," meaning the payment is owed as soon as the change of control happens, regardless of whether the executive keeps their job.

Tax treatment of parachute payments

The IRS treats parachute payments as ordinary income, meaning they are subject to federal income tax at the executive's regular tax rate. If an executive receives a $2 million parachute payment and is in the 37 percent tax bracket, they will owe roughly $740,000 in federal income tax on that payment alone, plus state and local taxes depending on where they live and work.

In addition, if the parachute payment exceeds three times the executive's average annual compensation over the five years before the change of control, the amount above that threshold is subject to a 20 percent excise tax. This is a penalty tax designed to discourage excessive parachute payments. For example, if an executive's average annual compensation is $1 million, and they receive a $5 million parachute, the $2 million above the $3 million threshold would be subject to the 20 percent excise tax, adding $400,000 to their tax bill.

The company may also be prohibited from deducting the parachute payment as a business expense if it exceeds the three-times threshold, which creates a financial incentive to keep parachute payments reasonable.

Parachute payments in practice

When a company is acquired, the buyer and seller negotiate who pays the parachute obligations. In most cases, the buyer agrees to assume the parachute payments as part of the deal, because the seller's executives need to be paid to stay through the closing and cooperate with the transition. The cost of the parachutes is factored into the purchase price the buyer is willing to pay.

If the buyer refuses to assume the parachutes, the seller must pay them from the sale proceeds before distributing money to shareholders. This reduces the amount shareholders receive, which can make the deal less attractive to the board and shareholders, so most buyers agree to take on the obligation.

In rare cases, an executive may negotiate a parachute payment that is triggered even if they voluntarily resign after a change of control, or one that includes a "gross-up" clause requiring the company to pay the executive's excise tax bill. These are less common in modern contracts because they are expensive and often draw criticism from shareholders.

Frequently Asked Questions

Is a parachute payment the same as severance?

No. Severance is paid when an employee is laid off or fired for any reason, and the amount is usually negotiated at the time of termination. A parachute payment is specifically tied to a change of control and is set in the employment contract years in advance. An executive might receive both a parachute payment (triggered by a sale) and additional severance (if the new owner later fires them).

Can an executive refuse a parachute payment?

Technically yes, but it is rare. An executive who refuses the payment may do so to avoid the tax bill or for other personal reasons, but the contract still obligates the company to offer it. Some executives donate parachute payments to charity to reduce the tax impact, though this does not eliminate the tax liability.

Do parachute payments happen in private company sales?

Yes. Private companies often include parachute clauses in executive contracts, especially if the founder or owner plans to sell the business. The parachute protects the executive if the new owner decides to replace them after the sale closes.

What happens to a parachute payment if the deal falls through?

If the change of control does not happen, the parachute is not triggered and no payment is owed. The clause remains in the contract and will be triggered if a future change of control occurs. Some contracts include a "walk-away" fee if the company itself cancels a deal that was already announced, but this is separate from the parachute.

Are parachute payments controversial?

Yes. Shareholders and the public often criticize large golden parachutes as rewarding executives for leaving, especially if the company was struggling before the sale. Some argue the money would be better spent on employees, research, or shareholder returns. However, parachutes remain common in large corporations because they help attract and retain top talent.