What Hath Nardelli Wrought?

The press has been abuzz with the spectacle of the $210 million package awarded to Home Depot’s former CEO Bob Nardelli to go away (in fairness, all but the last $20 million was already due him).

So far, however, the noise is disproportionate to the event. Although the New York Times ran a gushing piece on the new-found power of shareholder activista like Richard Whitworth of Relational Investors, which had held a 1.2% stake and was pushing for a special committee of the board to be established to review Nardelli’s pay (which had totaled $123.7 million, according toe the Times, from his arrival in 2000 to 2005, while the stock had fallen by a split adjusted 3%), it’s not clear how much credit they deserve.

The Home Depot case may have less to do with shareholder pressure and more with the concerns of a single director, Kenneth Langone. As the Times pointed out, Langone was responsible for recruiting Nardelli, who was then perceived as a star at General Electric, and hence bears significant responsibility for the compensation package that became such an embarrassment. It was Nardelli’s intransigence, and his refusal to renegotiate his agreement, that led the famously loyal Langone to turn on him.

But was this really due to Relational Investor’s prodding? Or perhaps is this an unexpected benefit of Eliot Spitzer’s suit to recover some of former NYSE CEO Richard Grasso’s $190 million package? Langone, as head of the compensation committee, is a defendant in the case. He has continued to support Grasso’s pay (what choice does he have at this point?) but may have decided that he no longer wants to be the poster child of supine directors. And Barney Frank’s plans to hold three weeks of hearings on the issue of executive pay may also have played into his decision.

The real test of whether this ouster is an outlier, or a sign or more fundamental change, is how some of the looming shareholder battles (such as Applebee’s, Borders Group, and the New York Times itself) turn out.

The most sensible (and not terribly optimistic) commentary predictably comes from the Financial Times. John Plender writes:

Investors should be forever grateful to Robert Nardelli, the chief executive of Home Depot who has just walked off with a $210m (£108m) severance package in exchange for years of lacklustre share price performance. For while it is galling to see failure so handsomely rewarded, he has at least demonstrated beyond all doubt how the arguments used by corporate America to justify the stock options culture are palpable nonsense.

Mr Nardelli’s pay since taking office at the giant retailer in 2000 has been valued at more than $240m with much of it in the form of options. This, according to options advocates, aligned his interests with those of shareholders. Some alignment: shareholders in Home Depot lost real money, while Mr Nardelli secured a king’s ransom. Alignment with or without options is anyway a pipedream…. No pay package will ever pull off the alignment trick, whatever pay consultants – an unregulated and conflicted bunch – may claim.

Myth number two is that CEO pay determination is a market process. The reality is that the nomination and compensation committee members who secured the services of Mr Nardelli after his failure to win the top job at General Electric were a bunch of nervous, over-awed pussy cats. Because they were under pressure to deal with an awkward succession problem they decided to take a man with no retail experience at his own valuation….

A third myth is that it is worth paying a fancy price to be rid of a serial underperformer. Yes, the share price jumped on the announcement of Mr Nardelli’s departure. But a rewards-for-failure system sends very dangerous incentive signals. If CEOs know that they win regardless of performance, what does it do to their strategic judgment?….

A final myth is that stock options have no cost….Lucian Bebchuk and others at Harvard have shown that the cost has been very significant in relation to profits. Then there are wider costs, which include the demotivation of the workforce – something at which Mr Nardelli excelled….

The least bad solution, then, is to engage shareholders and give them a UK-style vote on CEO pay….We also need to recognise that pay consultants’ methodologies are still in the stone age, with heavy reliance on total shareholder return, which can reward people with stock market windfalls, and earnings per share, a malleable number to which Home Depot shifted when it suited its book. If we have to have such measurements, something closer to economic value added would make more sense.

And then we have a radical program from an unexpected quarter, Herb Greenberg in today’s Wall Street Journal: do away with employment contracts, get rid of severance packages, and quit tying pay to stock price. As appealing as this proposal sounds, at this juncture, it’s not a recommendation, but a fantasy.

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