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A Warning Shot by Investors to Boards and Chiefs
By Gretchen Morgenson
New York Times
Thursday, January 4, 2007


Arrogance has never been attractive in a leader.  Now, in corporate chief executives anyhow, it may be a career ender.

The surprising defenestration yesterday of Robert L. Nardelli, head of  Home Depot and one of the nation’s most imperious and highly paid chief executives, was a victory for shareholders hoping to force corporate directors to be more accountable on the increasingly incendiary issue of executive pay.

Even though the board gave him $20 million that was not a part of his employment contract, perhaps smoothing his way out the door, the departure seemed to be a watershed.  No longer can executives demand — and directors happily grant — contracts worth hundreds of millions of dollars without at least some shareholders uttering a peep.

Indeed, Mr. Nardelli’s resignation seems to indicate a rising fear among Home Depot’s directors that they would be subject to even more investor ire and personal embarrassment during the 2007 proxy season than they encountered in 2006, when Mr. Nardelli ran the annual shareholder meeting like a lord over his fief.

“The departure of Nardelli is good news for shareholders,” said Frederick E. Rowe Jr., a money manager in Dallas and president of Investors for Director Accountability.  “To borrow from Winston Churchill, this is the end of the beginning in the war to make directors accountable to the shareholder owners they represent.”  Mr. Nardelli’s fall from the executive firmament was fairly stunning.  In just six years, he went from being one of the most sought-after chief executives, forged in the management crucible that is General Electric, to a top target of investors outraged by his $245 million in total pay over the last five years.  That amount was seen as completely at odds with the dismal performance of Home Depot stock on his watch.  Yesterday, the shares closed at $41.07, almost 6 percent lower than they were the day Mr. Nardelli arrived at Home Depot in December 2000.

“C.E.O.’s now will understand that they’ve got to put their conscience and shareholder wealth well above their personal gain,” said Jeffrey M. Cunningham, chairman and chief executive of Directorship, an online information service for board members.  “Boards create termination packages when no one even contemplates there is going to be a termination and they are extraordinarily rich.  You are going to see all those plans rethought and rationalized for the new environment.”

Shareholders of Home Depot have been smoldering for several years about the company’s executive pay practices.  Back when Mr. Nardelli arrived, for example, shareholders raised eyebrows after the company granted him a $10 million loan that it subsequently forgave.  He has earned $20 million to $37 million each year since he joined the company.

In 2004, the company quietly changed the measurement it used to calculate long-term incentive pay for executives, upsetting investors when they learned of it later.  Previously, the performance measure was based on a peer-group comparison, but the new measure involved only the company’s growth in earnings per share.  It was more easily reached because it was based solely on Home Depot’s performance not that of other companies.

To some shareholders, changing the performance target in the middle of a year seemed an attempt to ensure a payout despite a dismal performance.

“We had a problem with that change,” said Bess Joffe, manager for the Americas at Hermes Investment Management, a money management firm owned by the British Telecom Pension Scheme, the largest pension plan in Britain.  “After all, shareholders don’t get to change the terms under which they bought their shares midstream.”

But it was not until last year that Home Depot’s shareholders began to express serious disenchantment with the company’s directors over Mr. Nardelli’s pay.  Last March, about two months before Home Depot’s annual shareholder meeting, the board was named one of the 11 worst executive pay offenders by the Corporate Library, a corporate governance research firm.  In the weeks leading up to the meeting, shareholder advisory firms recommended withholding votes from Home Depot directors to voice their dismay over the disconnect between performance and pay at the company.

But Mr. Nardelli’s biggest error, and the act that may have set his demise in motion, was his shocking decision to run the annual meeting last May alone, insisting that his directors stay away and limiting questions from the shareholders.

“I’ve never heard of anything like that happening before, where directors don’t show up,” Ms. Joffe said.  “It’s the one time of year that shareholders have a right to be present and stand up and speak their mind and directors have to respond.”

Stockholders were outraged.  At least 30 percent of shareholders voting at the meeting withheld support from 10 of the company’s directors.  Some 32 percent withheld support from Mr. Nardelli.  Almost 36 percent of those voting withheld support from Claudio X. Gonzalez, chairman and chief executive of Kimberly-Clark's Mexico operations and the director who had headed the compensation committee when the company changed its performance goals midstream.

Many shareholders also favored a proposal urging the Home Depot board to allow its investors to vote on an advisory basis to approve the company’s compensation;  40 percent voted for the measure.

Shareholders also supported a measure that would have required the board to accept resignations from directors who failed to receive support from a majority of votes cast.  After the meeting, Home Depot said it would require such a vote from shareholders for the election of its directors.

Even so, the company continued to tinker last year with its pay practices in a way that may have been intended to generate pay for Mr. Nardelli in periods of poor performance at the company.  Last November, a Home Depot spokesman disclosed that the company’s huge stock buybacks, which have the effect of increasing earnings when measured per share, would be included in the calculation of long-term incentive targets.  In previous years, the effects of the buybacks were excluded from the calculations.

John A. Hill, the chairman of Putnam Funds, was one investor whose organization voted against Home Depot management at last year’s meeting.  He said he was optimistic that Mr. Nardelli’s resignation signaled a new responsiveness among corporate directors.  But he is uncertain.

“I think if a lot more shareholders withhold their votes for this board in the upcoming proxy season over their agreement with Nardelli, then it will really start to have an impact,” Mr. Hill said.  “But as long as it is a minority, it won’t.”

Mr. Hill personally experienced Mr. Nardelli’s disdain toward his shareholders.  As chairman of Putnam Funds, he wrote a letter after the annual meeting to Mr. Nardelli explaining why he had not earned the funds’ support at the election.  He did not get a reply until August, when a reporter asked Home Depot why the chief executive had not responded to one of its large shareholders.

“He had become a lightning rod with the stock down,” Mr. Hill said.  “But his not replying to our letter showed an arrogance there that came in on him.”

It seems that “my way or the highway” — Mr. Nardelli’s message to Home Depot’s beleaguered shareholders in recent years — does not play that well anymore.

http://www.nytimes.com/2007/01/04/business/04place.html?ref=business&pagewanted=print