In many ways, corporate America for the last few years has been defined by excess. The early part of the decade saw the historic scandals at Enron, WorldCom, Adelphia and others in which greed-driven corporate officers destroyed billions of dollars of shareholder value solely in an effort to enrich themselves. While illegal methods of compensation have largely been curtailed, there are still many corporate officers earning far more than their performance merits.
Yet, in spite of the negligence exhibited during the past few years, current events in regard to executive compensation portend to change the way in which excess is regarded to corporate America. The attention that has been brought by Home Depot CEO Bob Nardelli’s grossly disparate severance package and private equity acquisitions will change the way executive compensation is regarded.
Home Depot, the No. 2 retailer behind Wal-Mart in the United States, has seen stagnant growth during the last few years under Nardelli and has been losing market share to its principal competitor, Lowe’s. Yet for anyone tracking the situation at Home Depot, the deteriorating situation would not be apparent by viewing the compensation of Nardelli. The CEO, who left the company earlier this month, received $38 million in compensation in 2005, placing him among the highest paid CEOs in America. Yet that number paled in comparison to the amount Nardelli received in 2006, just to leave the company. Mr. Nardelli received $210 million to leave a company whose stock price was below the level it was when he began at Home Depot five years before.
Stockholders have shown justifiable outrage at Nardelli’s compensation package. It has shown that too many corporate boards in existence today are overly responsive to CEO demands. Furthermore, the trend is also noteworthy in that it indicates to shareholders that the board does not always protect their interests. This is a potentially huge problem for the capital markets because it breeds a lack of confidence in corporate governance and could potentially stunt investment. The events at Home Depot are not unique occurrences, either, with similar scandals involving executive pay at companies like UnitedHealth and NYSE. The relative concurrence of these events, though, and the negative publicity that has accompanied them, should hopefully serve as a future deterrent to compensation packages of a similar nature.
Before any further examination, it should be noted that it is excessive pay in the face of poor performance that is the problem — not large salaries in general. For example, on the surface, Nardelli’s 2005 compensation is much less than the $58 million Goldman Sachs CEO Lloyd Blankfein received in 2006. But the situations behind each are completely different. Goldman Sachs set a Wall Street record in profit for the year with more than $9 billion earned. In this instance, when profit nearly doubled from the previous period and with share price increasing more than 50 percent in the past year, Mr. Blankfein’s compensation could be viewed as commensurate with the performance of the company.
It is in a similar vein as Goldman Sachs that private equity firms will affect the practice of executive compensation. Due to the relatively short amount of time that companies purchased by private equity firms are brought back public, performance and streamlining are the primary points of concern. Thus, there is a greater push for strong performance and better devices controlled by the private equity firms to effect that change, and principal among these is compensation. By offering pay packages to executives that are largely performance-based, private equity offers an incentive for individuals to avoid stagnation and merely accumulate paychecks. Rather, they are encouraged to be proactive in changing the company for the better. As such, it will not be unheard of for executives to earn nine-figure compensation packages, but like Mr. Blankfein, compared with the value that they will be creating over the same period, the deal is in the favor of the future shareholders.
While executives and their compensation will almost always be at some relative level of odds with the interest of shareholders, the current conditions of the market signal that an acceptable compromise between performance-based compensation and the long-term interest of shareholders is within reach.
Mike Skelly ([email protected]) is a senior majoring in finance and political science.
