Tuesday, September 19, 2006

Will Nardelli's Pay Be Retooled?

News Analysis
September 19, 2006

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Will Nardelli's Pay Be Retooled?

Home Depot's board is reportedly considering changing its CEO's compensation package. Here's what that could mean for investors

Directors of The Home Depot (HD) may soon make some renovations, but they won't involve countertops or cabinets. According to a report published Sept. 18, the home improvement retailer's compensation committee will probably revamp Chairman and Chief Executive Robert Nardelli's pay package. Changes to Nardelli's compensation could boost investor sentiment toward the stock, analysts say, though much will likely depend on specifics.

Atlanta-based Home Depot has come under fire recently for its chief's lucrative pay (see BusinessWeek.com, 9/7/06, "CEOs in the Hot Seat"). Since the former General Electric (GE) executive took the helm in December, 2000, he has taken home roughly $200 million in salary, bonuses, stock, stock options, and other compensation. Over the same period, Home Depot's shares have fallen a dividend-adjusted 15%, while rival Lowe's (LOW) stock has surged 178%.

Adjustments to Nardelli's hot-button pay package could have a long way to go in soothing investors' ruffled feathers (see BusinessWeek.com, 7/24/06, "Bob Nardelli Explains Himself"). At Home Depot's May 25 annual meeting, Nardelli was the only board member present and declined to allow general questions. Shareholders withheld at least 30% of their votes for all but one of the company's directors, including Nardelli.

It remains unclear what form changes to Nardelli's compensation might take. Bonnie Hill, Home Depot's compensation committee chairwoman, was unavailable for comment prior to deadline. "It's a given there will be some changes," she reportedly told Bloomberg News, which first reported the likelihood of changes to Nardelli's pay package. "Shareholders want to know we understand their pain."


Home Depot spokesman David Sandor says he can't confirm Hill's comments. "Every year is a blank slate," Sandor says. "The committee meets independently, taps outside advice, and each year makes a new and fresh decision."

Still, better aligning Nardelli's pay with shareholders' interest would likely be a positive for the stock, some analysts say. "It would be a psychological boost," says Standard & Poor's analyst Michael Souers, who has a strong buy recommendation on the shares. "Investors have been somewhat outraged that the stock has languished for the past five years while his pay has been, by any estimation, fairly excessive."

Beyond "psychological" relief, though, rejiggering Nardelli's compensation probably wouldn't have much effect on the company's performance, others say. "As much money as he makes, it's a rounding error on Home Depot's total results," says Morningstar (MORN) analyst Anthony Chukumba, who rates the stock five stars out of five.


Nardelli took in about $38 million in total compensation in 2005, placing him among the ranks of the highest-paid CEOs (see BusinessWeek.com, 5/23/06, "Home Depot's CEO Cleans Up"). At least $6.5 million of Nardelli's base salary plus bonus is guaranteed regardless of performance, according to Institutional Shareholder Services (ISS), a corporate governance advisory service. Lowe's Chairman and CEO Robert Niblock's 2005 base and bonus totaled $3.4 million, not including other compensation.

In May, ISS issued a report advising shareholders to withhold their votes from all directors except new nominee Angelo Mozilo over the compensation issue. "It's clear they don't want a repeat of what happened in 2006 at their annual meeting in 2007," says Patrick McGurn, executive vice-president at ISS. New SEC disclosure requirements could put other companies' compensation practices under scrutiny in the 2007 proxy reporting season, McGurn adds.

Another governance research firm, The Corporate Library, gives The Home Depot an "F" rating on compensation. Ideally, changes to Nardelli's compensation would include limiting his base salary to the $1 million limit for tax-deductible pay, removing the guarantees on his severance pay and pension, and better linking long-term incentives to performance, says Paul Hodgson, senior research associate at The Corporate Library.


A pay change at Home Depot might prompt other companies under fire for excessive compensation to follow suit, according to Hodgson. "This would put significant pressure on some of the other organizations," he says.

Between 2003 and 2004, Home Depot's board changed Nardelli's pay package to emphasize financial performance rather than stock performance. Where previously Nardelli's long-term incentive pay was based on total shareholder return vs. a peer group, this portion of his compensation is now tied to diluted earnings-per-share.

By this and other financial measures, Home Depot has performed solidly under Nardelli's watch, despite its floundering stock price. Per-share earnings actually climbed 147% from 2000 to 2005. Meanwhile, sales increased 78%, from $45.7 billion to $81.5 billion.


Some compensation experts say they won't be satisfied by anything less than "radical" changes to Nardelli's pay package. "He is getting entrepreneurial returns for effectively managerial results," says Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. "Something is wrong in the philosophy of the package that creates those kinds of returns."

Meanwhile, compensation controversy is far from the only challenge facing Home Depot. On Sept. 18, Credit Suisse (CSR) lowered its recommendation on the stock from outperform to neutral, citing the slowing housing market. "Home Depot stock presents a difficult investment dilemma at this time," says Credit Suisse analyst Gary Balter. (Credit Suisse has an investment banking relationship with Home Depot and makes a market in the company's securities.)

For shareholder activists, a renovation of Home Depot's corner office pay has been a long time coming. It's still too early to say whether such changes would help to rebuild the big orange retailer's share price. Other boards will likely wait to see the details before considering similar moves of their own.

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