Time Out Between Nardelli Meltdowns

January 9 2007 by JP Donlon


When given the unceremonious boot by Home Depot’s board Bob Nardelli walked away with a bundle. Nardelli, a former protégé of GE €˜s Jack Welch, courted trouble with critics ever since the company’s annual general meeting when he convinced board members not to attend for reasons which he did not entirely explain at the time. Shareholder activists and pundits in the mainstream media were outraged over the $210 million severance. “We’re aghast at the level of compensation Nardelli is walking away with – this is money directly out of shareholders’ pockets,” Richard Ferlauto, director of pension investment policy for the American Federation of State, County and Municipal Employees, complained in the New York Times the day Nardelli was axed.

The embattled former chief was already a target for criticism for having received $120 million in compensation, excluding stock options, during his first five years as CEO.

Like the Claude Rains character in Casablanca who expressed “shock” that gambling was being conducted in Rick’s Café, Nardelli’s critics seized upon the figure as proof of his cupidity not to mention the craven stupidity of Home Depot’s board of directors. Some folks called for the SEC to impose a “Nardelli Law” which would fix “excessive CEO” pay once and for all.

But Nardelli’s generous pay package, many of the details of which were reported in the press at the time, was an established fact when he was hired in 2000. After Welch named Jeff Immelt his successor top GE talent like Nardelli cut loose to find the best deal available. This was before the dotcom bubble burst and the 9/11 downturn. Critics seem to forget that in terms of business culture the year 2000 was another country.  

And Nardelli’s package isn’t as high as the supposed windfall reaped by other CEOs who passed their sell-by date. Last July Hank McKinnell left Pfizer with $213 in severance. Carly Fiorina must be ready to claw her lawyers’ eyes out for only walking away with a $29 million pittance in 2005.

Part of the confusion results from our terminology. Such payouts aren’t so much severance as a cost-of-talent fee since all of these arrangements are negotiated before the CEO takes the job. In future, companies would be well advised to call it what it is: a hiring cost.  Why do people who know (or should know) this become apoplectic when the parachute is triggered? Why also do pundits, while not actually saying directly, create the impression that the amount results from the largesse from the board of the company when in fact, these numbers were baked in the cake long ago?  In addition, most CEO severance arrangement include pension and benefit payouts representing years of accumulated earnings-monies the CEO earned in previous years but for tax and other planning reasons  remain vested in the company. Yet when reported in the media,  the numbers create the impression of a surreptitious “bonus” to which the person was not entitled.   

What surprises is not just the outrage but the sudden vitriol. Not long ago Nardelli was described as the best thing to happen to Home Depot since the saber saw. “Hard-charging” and “aggressive” were meant as high praise.  Suddenly he is a GE-bot cum terminator who is “dismissive-indeed openly contemptuous of the folksy environment nurtured by predecessors Bernard Marcus and Arthur Blank.”  He is said to have stripped store managers of autonomy, recruited dozens of “hard-ass former military officers,” and was notorious for sending abusive e-mails to store managers who didn’t shape up. One report even compares him to “chainsaw” Al Dunlap. Golly. How does one go from a savior to an SS Oberfuhrer in a week?

Time for a reality check. Before Nardelli was recruited chiefly by HD co-founder and board member Ken Langone, Home Depot was a company with many fiefdoms many of which were intent on doing their own thing. An end cap in one store was unlikely to be seen in another. Each store cut its own deals with vendors. Until 2002, the company didn’t have a proper e-mail system. Management communicated via faxes to every store manager. The smart ones waited until the end of the day when the last fax rescinded the six received that morning. Many managers sat in their offices for two or more hours a day listening to voice mails instead of being out on the floor with their people.

When Nardelli came on board there was no chief human resource officer in a company of 300,000 associates where personal is critical. The company went from having 150 different appraisal formats to one. Pay grades with pay-for-performances standards were established for the first time as were benefits to part-time associates. A success-sharing scheme was introduced where $47 million was paid in its first year to hourly associates.  By 2004 Nardelli personally reviewed over 3,000 individual profiles of associates at the end of annual HR review. In addition, board directors were expected to visit stores around the country and to report on those visits to the full board. Every other quarter board members were scheduled to spend one full day with a division president or a functional leader without Nardelli or a member of corporate management attending.  Is this the action of a martinet?

It’s true that Nardelli’ failed to maintain the rate of performance and earnings growth of earlier years. EPS doubled under his leadership and sales increased from $45.7 billion to $81.5 billion but his job became more difficult when housing market tanked. He sought to counterbalance this by expanding into Mexico and China and by diversifying into wholesale supplies. Perhaps these moves were ill considered, but he took the risk which is what CEOs are paid to do. And the jury is till out on this.  

What about overall economic value created? 

“EVA has continued to increase quite substantially at Home Depot,” says Bennett Stewart, co-founder of Stern Stewart and CEO of EVA Dimensions, a New York based performance advisory firm. “The company has maintained a high return on capital, well over its costs of capital, and continued to achieve significant overall sales growth.  The stock price and MVA have not followed suit, however, because the “future growth value,” which is the portion of company’s value attributable to the expected present value of the future growth in EVA, has shriveled.  This could indicate that Nardelli was taking short term action to boost profit that will reduce long run potential EVA, or that the industry is maturing faster than investors expected as both Home Depot and Lowe’s have raced to open stores (and Lowe’s future growth reliance as also fallen quite significantly, adding weight to this interpretation), or that Home Depot is undervalued as investors have piled on the anti Nardelli bandwagon.” 

Some investors argue that he was taking the company into lower margin businesses, which may well be true. So if the tiff is over strategic choices in addition to management style, why did the board choose Frank Blake, another former GE executive, and insist there is to be no change in strategy?  Like Nardelli, Blake has no retail background either.   

The one-time chief of GE’s turbine business committed his share of bonehead moves. For example, he never replaced the head of operations preferring instead to reassign duties in an effort to streamline bureaucracy. His decision to keep directors away from the AGM and his mishandling of shareholder outrage was remarkable for its obtuseness in someone otherwise very intelligent. It is evident he was not a warm and cuddly boss. But since when was this news to anyone acquainted with his three decades at GE? In the end he created his own firestorm. Having learned his lesson he will stay clear of public companies. Can there be any doubt that the folks at Blackstone, Carlyle Group, Texas Pacific, or Bain Capital are wooing the hell out him as I write this?  Private equity would be only too happy to overpay for a CEO like him.

In 1993, Congress prohibited CEO pay of more than $1 million. You can see how effective that was. One can assume that any subsequent law will be promptly evaded also.  Placing limits on CEO pay in terms of multiples of the average worker is also a non-starter. Can you imagine setting Tiger Woods earnings on a multiple of what the average duffer takes in?  

Milton Friedman once said that the cure for high prices is high prices. The problem of CEO pay assuming there is one is much the same. Companies and boards can always find someone who will run their company for less money. But will they take the time to search for a talented no-name CEO when a branded celebrity with a proven track record beckons?

If you would like to speak out, please eMail me at: jpdonlon@chiefexecutive.net