When a CEO dogged by accusations of arrogance, poor performance, and excessive pay finally gets shoved out the door, and the board still gets grief for ousting him—well, then you know you have a problem.
Such is the tale at Home Depot, which finally fired Chief Executive Officer Robert Nardelli on Jan. 3 after nearly a year of simmering shareholder wrath. Nardelli’s tenure included six years of a sagging stock price while competitors leaped ahead, and a 2006 annual meeting where he ordered directors to stay away and did not take questions from shareholders.
Then there’s the small matter of his $210 million severance package, too, including $20 million just for leaving.
All those sordid details have left governance experts just as disappointed with Home Depot’s board as shareholders were with Nardelli. Critics fault board members for creating the current tense atmosphere around the company when they gave Nardelli a lucrative compensation and severance package upon hiring him away from General Electric in 2000. Another complaint: The board never should have agreed to stay away from Nardelli’s now infamous 2006 shareholder meeting.
So, how can board members at other companies avoid the Home Depot scenario?
Mays
“Any director who is uncomfortable has two alternatives,” says Randall Mays, president and chief financial officer of Clear Channel Communications, one time director for XM Satellite Radio, and current chairman of Live Nation, an entertainment company spun-off from Clear Channel. “They can resign or attempt to initiate change.”
Geoff Loftus, vice president at the Society of Corporate Secretaries and Governance Professionals, is equally frank: “Directors must be willing to lose the relationship with the CEO or leave the board.” But, he adds, “I don’t think most of them are.” Most directors, he says, are unwilling to risk losing the prestigious opportunity of sitting on the board.
Perhaps the best way to avoid such unpleasant, and public, standoffs is to intervene before a CEO is hired. The key, Loftus says, is to lay out the job description and terms of compensation clearly and firmly while recruiting the CEO. “If you mess it up at that point, it is hard to straighten it out,” Loftus warns.
For example, to avoid a repeat controversy in the future, Home Depot announced after Nardelli’s departure that it changed the company by-laws to require that two-thirds of independent board members approve any such compensation deals. Previously, only a simple majority was needed.
Cunningham
In addition, experts recommend that directors hire compensation consultants before they enter into negotiations with executives. These consultants will be able to provide critical data on pay levels the CEO’s peers enjoy, for example. “I serve on three boards and I would never get into negotiations without a consultant,” stresses Jeffrey Cunningham, chairman and CEO of Directorship.com, an online clearinghouse of information for board directors. CEOs must also develop more sensitivity to the public perception of their pay, he adds.
James Melican, chairman of Proxy Governance, also recommends that boards insist upon more say in certain areas of company expenditures. One example: Companies making political contributions, a practice that will be in the crosshairs of numerous shareholder activists this proxy season. More broadly, Melican says, boards should exert their voice over “anything where the CEO has free rein.”
Still, even Melican concedes that such oversight can start a board sliding towards keeping its CEO on too short a leash, and that should be avoided as well. “Every board gives the CEO a certain amount of leeway,” Melican says.
Lipman
Others recommend the creation of an independent, non-executive chairman or a lead outside director to act as a counterweight to the CEO, who can be the rally point for disenchanted directors. Fred Lipman, a partner at the Blank Rome law firm, notes that if Home Depot had an independent chairman (Nardelli held both titles), that person could have stood up to the audacious request that directors not attend the annual meeting in 2006—which turned into a publicity nightmare for the company.
Another way directors can avoid being steamrolled by an imperial CEO is to hire their own staff, specifically a board secretary whose sole responsibility is to report to the directors. So far, however, only the board of UnitedHealth—no shining example of governance either, thanks to an enormous options backdating scandal—has fully adopted this policy. “It’s important for the board to have its own independent sources of information,” Lipman says, although he admits that an internal auditor can play a similar role, even though he is employed by the company.
Not everyone, however, agrees with many of these recommendations. Loftus is skeptical whether a board secretary would be willing to confront the CEO if the board isn’t getting the information it wants.
Loftus also doubts compensation consultants would help contain executive pay packages. Since so many companies want to be in the top quartile of pay and attract stellar talent, compensation consultants may well just “jack up the price … They always come back with the results you are seeking.”
Rather, Loftus says, if a board decides after the fact that it overpaid a CEO, directors should insist on renegotiating the contract. The downside: “This almost never happens,” he says. “It’s a conversation very few directors and CEOs are willing to get in to.”
That is not to say such negotiations never happen. In late December, Sharper Image announced that it had cut the severance of former Chairman and Chief Executive Officer Richard Thalheimer to a little less than $1.8 million, from a minimum of $5 million that he reportedly was entitled to under his 2002 employment contract. He will also receive a nonqualified retirement benefit of $3.9 million.
Loftus encourages other boards to be bold. “If as a board you feel the CEO is earning his money, then you must be able to express that concretely and clearly to shareholders and the press,” he says. “No one did that [at Home Depot]. It comes down to how willing directors are to be honest and push back. You can have independent directors who are also puppets.”
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