Let’s take a bit of a breather from the news about John Thain and Merrill Lynch. (We’ll come back to that momentarily, no doubt.) In all the excitement, we almost overlooked an important column by the Wall Street Journal’s Holman Jenkins. In today’s Journal, Jenkins urges some sobriety in the face of losses at Wall Street firms, something that’s been sorely absent in recent weeks.
Indeed, at some point—after the executions of Stan O’Neal and Chuck Prince and while the mobs were turning their attention to Bear Stearns’ Jimmy Cayne—the urge to overthrow the heads of so many Wall Street firms began to take on tones that almost recalled the French Revolution. After losses at Bear Stearns were less than expected, Cayne now looks safe but it’s worth taking a step back and wondering if anger at chief executives over losses might have gone too far.
Certainly calls for jailing O’Neal or Prince—as we heard from Bill Lerach, a plaintiff’s laywer who is himself on the way to prison—went too far. Losing money is not a crime, at least not yet. But the more broadly felt outrage at the size of severance packages for O’Neal and Prince were only slightly more measured. As Holman points out,
“Misplaced moralizing over business losses also infects the discussion of exit packages. Notice how these discussions substitute the language of reward and punishment for what are really matters of contractual relations and strategic, before-the-fact incentives.”
To wit, Merrill Lynch CEO Stan O’Neal’s severance is not a bonbon from a loving board, but what the board feels legally obligated to pay him, based on commitments made before the results of his tenure were known. Nor was he without proper incentives, then or now. His chief performance pay was Merrill stock, and his holdings are worth millions less than they were before the subprime losses emerged.
That won’t satisfy Mr. Lerach, who thinks Mr. O’Neal should be imprisoned. But nobody in his right mind would take the job on such terms given the risks entailed in running a modern business, including the risk of civil or criminal litigation if things go sour. Indeed, what towering pay in the risk-taking professions really may be telling us is how utterly averse to risk-taking ordinary human nature is.
One fact that will surely drive the Lerach’s of the world up the wall is that the recent ousters on Wall Street are likely to result in even higher pay for management. The risks of running a bank or a brokerage are greater now than they have been at any time in the past—risks of prosecution, lawsuits, and ouster—and the top managers will demand to be compensated for those risks. Already the wires are carrying stories telling us that one of the surviving CEOs—Lloyd Blankfein of the House of Goldman—may receive as much at $75 million this year.
Losing Money Is a Crime [Wall Street Journal]
Qwest said this morning that chief exeuctive and board chairman Richard Notebaert plans to step down as soon as a successor is found.
Sunday was a banner day for executive compensation. Make that a banner headline day. The business section of the Sunday New York Times was largely devoted to articles
decryingreporting on executive compensation, including reporter Eric Dash’s long, splashy article on executive exit compensation. Now they’ve assembled an online version of the special section with over two dozen pieces on executive comp.
So what’s inspired all this? Well, for that we turn to a Wall Street Journal editorial from a few weeks ago which explained that the SEC’s new disclosure rules for compensation have brought us far more information, inviting exactly this kind of media attention. Unfortunately, the rules produce information which is somewhat misleading, a fact that the New York Times notes, although it doesn’t let this get in the way of reporting the scandal that executives get paid a lot! The most important thing the Journal editorial notes is that the new disclosure rules are particularly bad at revealing whether executive’s are getting paid for performance.
Proxy season is under way, and as companies file their annual reports we can expect a spate of “analysis” stories purporting to tell us just how much America’s top executives are making. These stories will also purport to demonstrate that there is no pay for performance at the top of publicly traded companies by comparing stock appreciation with the pay as disclosed under a new SEC rule.
These stories will be wrong. This is so for the simple reason that the SEC’s new standard is not designed to measure pay-for-performance.
Caveats aside, the niftiest function of the special section tries to address the very question that the Journal warns us about: executive pay for performance. Interestingly, however, it seems to undermine the hypothesis that executive pay is a scandal. It’s an interactive graphic that allows readers to compare company performance to executive pay along a couple of different axes. What’s clear from the graph is that, for the most part, improvements in executive pay seem pretty well correlated with company performance. (But keep in mind that measuring CEO performance over just one year is not necessarily fair or reflective of shareholder interests). Go ahead and play yourself!
Executive Pay [New York Times Special Section]
While Gret-Gret more or less blew a gasket over Bob Nardelli‘s exit from Home Depot–she describes it as a “watershed,” a “warning shot,” a “defenestration,” as an end to “arrogance”–slightly more sober reflection on the meaning of it all is going on across the interwebs.
Ted Frank at PointofLaw.com points out that when Nardelli took the Home Depot job, he had to leave behind millions of dollar GE stock options. What’s more, anyone who bought or held onto the stock after Nardelli was hired in 2000 knew or should have known about Nardelli’s severance package.
Economic theory teaches us that when a rare commodity with uncertain future value like an MVP shortstop or GE executive is subject to an auction, the winner of the auction will probably be the party that most overvalues the commodity: the concept of bidders’ remorse. And perhaps Home Depot overpaid for the privilege of hiring Nardelli. (Press coverage is sneering that the Home Depot stock price dropped during Nardelli’s reign, but, aside from omitting dividend payments, that drop reflects much more how bubbly Home Depot stock was in 2000, when it had a 46 P/E ratio. Nardelli doubled Home Depot profits; improved shareholder returns by repurchasing 10% of outstanding stock; quintupled dividends; increased the net profit margin; and the stock has been very profitable for those who bought it in late 2002.)
But, with a very few exceptions not relevant to this discussion, no one was forced to be a Home Depot shareholder. Someone could anticipate that large sums of shareholder money would eventually be paid to Nardelli on the back end when he was first hired. If one disapproved of the pay package Nardelli was destined to receive, there was a very easy solution: divest the stock, and invest in another company that did not bid on former GE executives to become their CEOs. (Of course, then one would have missed the huge profits in the run-up on Boeing stock.) Investors who think that GE experience created magical CEO abilities worth a premium in the marketplace were free to invest in Home Depot. Home Depot stock went up over 20% in December 2000, the month that Nardelli was hired: it would have been easy to sell the stock if one disapproved of the generous employment contract while the market basked in the glow of the hiring. No one paid Nardelli a dime who didn’t agree in advance to pay him that dime.
Vitaliy Katsenelson writes on his Contrarian’s Edge blog that the likely lessons of Nardelli’s departure for CEOs won’t be Gret-Gret’s favored lessons.
The ousting of Bob Nardelli sent a wrong message to American CEOs: it taught them an incorrect lesson – manage the stock, not the company.
As Herb Greenberg mentioned in his column, if Home Depot’s (HD) stock went up while he was in charge he would still have a job, though he’d be $210 million poorer.
Bob Nardelli was a terrible stock promoter (not his job), but he did a terrific job managing the company (his job). As I mentioned in the past, from the time Nardelli took over Home Depot in 2000, Home Depot’s earnings have grown at an amazing clip of 20% a year, revenues over 15%, net margins have increased and return on capital went up every single year. The stock has not gone anywhere during his leadership because it was grossly overpriced in 2000.
And, of course, it is this reluctance to become a huckster for a company’s stock that has led many managers to decide that maybe they’d fair better as a private concern.
Nardelli’s severance [PointofLaw.com]
Blame Home Depot’s Board, Not Nardelli [Contrarian's Edge]
Okay. Now that we’ve recovered a bit from our shock at reading that former Home Depot CEO BOb Nardelli was getting $210 million on his way out the door, we’ve got something a bit more substantial to say about it than the obligatory mouth wide open gasp. And here it is: Nardelli’s exit will probably have the effect of increasing CEO compensation, at least marginally.
Although there will be some temporary populist (it’s the word of the day!) outrage, the impression that Nardelli was forced out so suddenly from Home Depot after a long tenure there–
he was one of the founding partners (We were totally wrong on this. No excuses.)–should only increase the fears of would be chief executives about their job security. (If Home Depot can throw Nardelli overboard so quickly, no one is safe!”) Which means that boards seeking to lure chief executives away from their current positions to lead a company–Nardelli came to Home Depot after coming very close to becoming CEO of GE–will need to make even larger promises of severance if things don’t work out. This is more true of companies with troubled prospects—who arguably need the very best leadership—since running these companies is far riskier than running a bright, shining market star. So expect to see more huge exit packages handed over to CEOs who have lead troubled companies, and more populist outrage over CEO compensation. And, of course, more opportunities for private equity companies that don’t have to deal with pesky shareholders and can afford to pay a CEO for what they are worth.
We were going to try our usual contrarian take here and explain that $435 million over six years isn’t that much money. But you know what? It is. Especially with
falling profits diminishing profit growth and declining market share.
We know that Bob Nardelli was probably forced out but really, how much forcing does it take when a guy’s got $210 million in severance coming to him? We keep thinking that Nardelli was probably humming “Damn, It Feels Good To Be A Gangster” as he walked out the door yesterday.
Home Depot Inc., the world’s largest home-improvement retailer, ousted Chief Executive Officer Robert Nardelli after investors criticized him for earning $225 million during his six-year tenure.
Home Depot invited further criticism by sending Nardelli, 58, off with $210 million as part of his separation package. Vice Chairman Frank Blake, 57, will replace Nardelli immediately, the company said in a statement.
Home Depot lost market share to Lowe’s Cos. since Nardelli started in December 2000, and the shares declined 7.9 percent. The company is headed for its smallest annual gain in profit in at least nine years.
Home Depot’s Nardelli Ousted After Six-Year Tenure [Bloomberg]
The Wall Street Journal’s running a fascinating story on its front page this morning about how attempts to regulate executive pay have failed, backfired or led to underhanded compensation techniques such as backdating or spring-loading options grants.
A good example of this is the attempt to regulate “golden parachutes”—the payments executives receive in the event of a takeover. These were originally intended to align management interest with shareholders—without them management might oppose takeovers that would benefit shareholders but might result in management being replaced. But when the parachutes got too golden for some, politicians stepped in to try to clamp down on the practice by taxing it. Guess what happened?
In 1983, Bendix Corp. CEO William J. Agee received $3.9 million over five years after his aerospace, auto-parts and machine-tools concern was acquired by Allied Corp., an industrial conglomerate. It was one of the decade’s first bruising takeover battles, sparked by Mr. Agee when he tried to buy aerospace and defense firm Martin Marietta Corp. The size of his parachute, as well as the circumstances in which it was paid, created a furor.
The following year, Congress slapped a special tax on golden parachutes. “The Bill Agee Bill,” as some at the time dubbed it, taxed awards valued at more than three times an executive’s average compensation over the previous five years.
Rather than curbing pay, the law had the opposite effect. Despite a few well-publicized examples, golden parachutes were rare before Congress intervened. In a survey of companies named in either the Fortune 1000 list or the S&P 500 index, a mere 8% gave at least one executive a golden parachute before the law was passed. By taxing parachutes at a certain level, Congress in effect blessed their existence. It also gave the technique a publicity boost.
Behind Soaring Executive Pay, Decades of Failed Restraints