Golden Handcuffs Definition
Golden Handcuff is referred to the employer offering a valuable incentive to the employee in order to bind them and stay in the company for an extended period of time. For an employee to stay with an employer, the latter should provide a financial incentive and the former should be in a position to accept the incentive.
Why Companies use Golden Handcuffs?
When an employer hires an employee, the company incurs cost even before the employee performs any valuable duty. For example, the Company incurs a cost on hiring, onboarding, orientation, etc., and these do not pay back the company.
Now, to make profits from the employee, the employer must retain the employee for a certain period. To pull out parallels in financial terms, the initial costs on the employee are like fixed costsFixed CostsFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity. over which a monthly cost is a salary (which is the variable cost).
Now, if the employee has to provide services that meet the break-even pointBreak-even PointBreak-even analysis refers to the identifying of the point where the revenue of the company starts exceeding its total cost i.e., the point when the project or company under consideration will start generating the profits by the way of studying the relationship between the revenue of the company, its fixed cost, and the variable cost. for the company, he has to, first, stay long enough to do that. How will an employer, without breaking the regulations, let the employee stay for that period? He offers an incentive, which pays off when he stays long enough – options that vest after a certain period or any other incentive. These incentives help the employer in holding on to the employee.
Example of Golden Handcuffs
Let us assume I am an employer, and I want to hire 2 people to whom I shall pay 5000$ a month. From each of them, I will get an income of 7500$ per month, but that will happen only after 3 months. To hire each employee, it would cost me around 7500$ – essentially, to hire, train, and put them into work.
If the employee leaves in 2 months, my net lossesNet LossesNet loss or net operating loss refers to the excess of the expenses incurred over the income generated in a given accounting period. It is evaluated as the difference between revenues and expenses and recorded as a liability in the balance sheet. would be 10,000$ paid for the employee as salary and 7500$ invested in training this employee and another 7500$ in training an additional employee. For me, to keep this employee working with me, I would give him options that vest at the end of 2 years – worth 10,000.
In these 2 years, I would be getting a 21-month profit from the employee of 52,00$. In this, I will pay the 10,000S to the employee as promised. It makes a situation where the effective efficiency has grown such that even if the total amount paid is high, the profits are equally higher.
Let us look at the following words from their investor relations report of Microsoft
“We grant stock-based compensation to directors and employees. At June 30, 2013, an aggregate of 425 million shares was authorized for future grant under our stock plans, covering stock options, stock awards, and leadership stock awards. Awards that expire or are canceled without delivery of shares generally become available for issuance under the plans. We issue new shares of Microsoft common stock to satisfy exercises and vesting of awards granted under all of our stock plans.”
This para is an excerpt from the Microsoft investor relations statement. If we go to the above link and read more about the options and vesting period, we can see it in detail. As a company gives more stock optionsStock OptionsStock options are derivative instruments that give the holder the right to buy or sell any stock at a predetermined price regardless of the prevailing market prices. It typically consists of four components: the strike price, the expiry date, the lot size, and the share premium., more people tend to stay back with it. Microsoft, which is, as of July 22, 2019, biggest company in the world via market capitalization, cannot keep employees to itself without giving them a bit more pay than what they needed.
The higher the cadre, the more the percentage of salary comes from the options – which are the golden handcuffs. It might not be the company doing it, recently Elon Musk put out a statement that he will be paid only when Tesla will reach a 1 trillion-dollar company, and that boosted the confidence of the shareholders. This statement shows another application of how to use incentives to hold on to people.
- The advantages are there for both the organization and the employee. The employee will be able to get lucrative pay packages and see his true worth in a company. The more the pay structure, the employee might stay longer with the company and work more for the company – this is what the company wants.
- For companies, hiring and replacing executives or any other employee might be a difficult task to pull off. There is a lot of risk in hiring a new employee – especially when a lot of other things are involved.
- The companies can use it as a statement to provide the benefit of the doubt to the shareholders. As we spoke about, Elon Musk used this golden handcuff and handcuffed himself to Tesla. Since people believe Musk is the most crucial person in Tesla, and he will be there for long, the share prices have risen. It is how companies can use golden handcuffs to make an impression.
- The employees might not have the morality to work. Higher the pay packages, the more the employees will work for the money and not the job. It decreases the overall morality of the company and creates a tough situation for the management to handle.
- Someone can always offer better. The underlying assumption of golden handcuffs is that the company offers people a package that keeps the person out of moonlighting. However, if a company doesn’t realize a person’s real worth, the market will eventually determine the true value and offer to the person. In such cases, even golden handcuffs are not useful. Someone else can just provide a better package deal.
- The probability analysis of having such employees in the organization will be complicated. If we have 100,000 employees (like Microsoft) who all have options assigned to them, one fine day, all the options will vest, and that will create a sudden hike in people resigning.
Golden handcuffs are for companies who can’t motivate employees with the type of work they do. Managers should be careful while they use such options to hold on to the managers. They are like weapons – can lead someone to a position of power, or a disaster.
This article has been a guide to what are Golden Handcuffs and its definition. Here we discuss why companies use golden handcuffs along with examples, advantages, and disadvantages. You can learn more about financing from the following articles –