Joshua Kennon writes a regular column for About.com titled Investing for Beginners and he recently penned a note entitled "Why Home Depot Shareholders Have Lost Their Mind" (link here). Mr Kennon is a self-styled value investor in the vein of Benjamin Graham and Warren Buffet, so it's interesting to see his defense of what I will politely call the "lavish" compensation scheme of Home Depot CEO Bob Nardelli. One should note that even Kennon doesn't defend the utterly idiotic shareholder meeting performance by Nardelli or the HD Board of Directors, as I had discussed here.
Nardelli has been awarded an incredible $250M in compensation ($125M of it in cash) since he joined Home Depot 5 years ago. During that time period, HD stock has dropped almost 50%, to $37 from $70. Kennon's seemingly rational defense is that it's the stock market's fault since it doesn't recognize that HD is actually a much better company now (see performance graphs ), with a tripling of net income on a lower number of shares & higher dividend, and that he'd be thrilled to see the CEO receive a package twice as large if Nardelli could continue to deliver on those results, stock price movement be damned.
Let's take a look at the pay package to see what motivates Nardelli. In the old days, Fortune 500 CEO's got reasonably large salaries, bonuses and perks, but the criticism was that their compensation didn't align with shareholders. So, following the lead of Silicon Valley, they added a large dose of equity-based compensation to "align shareholder interests" - however, they didn't reduce the base compensation at all, which defeats the entire point. This leads to the current Nardelli package, which is a "Heads, I win, Tails, You Lose" scenario for HD shareholders. If HD stock goes down, Nardelli does incredibly well ($25M a year) - if HD stock goes up, Nardelli makes an even larger sum of money ($50M+)- so where is the performance risk and the resulting shareholder alignment?
Mr Kennon makes the point that shareholders need to focus on long term results, not the short term stock moves and financial results (which is I suppose why Home Depot no longer publishes same store sales as they drop each month), and quotes the guru Graham in backing it up, making the point that now that the stock has plunged, the company is a great deal for value investors, which may be cold comfort for those HD shareholders without $25M pay packages. I generally agree - so as a shareholder, why are we compensating Nardelli at such a furious rate on an short term basis when his stock position (5,000,00 shares already owned) is going to be worth so much in the long run? Shouldn't his interests already be aligned with ours from a stock position? Doesn't $25M in cash on top of those stock awards seem a little bit excessive, even to the Gordon Gecko Greed is Good crowd? Let's remember that it's not as if Nardelli started the company, working out of his garage for years - he was awarded all of this by the Board in the last 5 years.
So I don't think HD shareholders "have lost their mind" when they criticize the Nardelli's insane pay package - I think that any self-titled value investor like Kennon "has lost his mind" to believe that companies must pay their CEO's at stupidly high levels for both short term AND long term performance. And I hold out the companies Kennon mentions, such as Washington Post and Wal-Mart, as prime examples of companies that pay competitive wages without simply pillaging shareholders, as the Board of Directors at HD has decided to do while shamefully refusing to actually meet with them at the Shareholders meeting.
Nardelli 2005 Compensation
Salary - $2.164M
Bonus - $7.0M
Restricted Stock Award - $14.6M
Long Term Incentive Payout - $2.4M
Other Comp - $539K
590,000 stock options - Black-Scholes value - $8.1M
Nardelli's Original Big Pay Outs (outside of his "usual" $25M in salary, bonus, stock, etc. each year)
$10M loan, 20% forgiven every year
3,500,000 options - Black-Scholes value - roughly $50M
Retirement Benefits - $4.5M a year
If terminated - $20M cash plus everything vests, etc.
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