Every October, some 50 former Home Depot managers, calling themselves the Former Orange-Blooded Executives, after the home-improvement chain's trademark bright orange color, gather in Atlanta to reminisce, chat about new jobs and pass around pictures of their children.
The discussion inevitably turns to the changes at Home Depot under its chief executive, Robert L. Nardelli. A growing source of resentment among some is Mr. Nardelli's pay package. The Home Depot board has awarded him $245 million in his five years there. Yet during that time, the company's stock has slid 12 percent while shares of its archrival, Lowe's, have climbed 173 percent.
Why would a company award a chief executive that much money at a time when the company's shareholders are arguably faring far less well? Some of the former Home Depot managers think they know the reason, and compensation experts and shareholder advocates agree: the clubbiness of the six-member committee of the company's board that recommends Mr. Nardelli's pay.
Two of those members have ties to Mr. Nardelli's former employer, General Electric. One used Mr. Nardelli's lawyer in negotiating his own salary. And three either sat on other boards with Home Depot's influential lead director, Kenneth G. Langone, or were former executives at companies with significant business relationships with Mr. Langone.
In addition, five of the six members of the compensation committee are active or former chief executives, including one whose compensation dwarfs Mr. Nardelli's. Governance experts say people who are or have been in the top job have a harder time saying no to the salary demands of fellow chief executives. Moreover, chief executives indirectly benefit from one another's pay increases because compensation packages are often based on surveys detailing what their peers are earning.
To its critics, the panel exemplifies the close personal and professional ties among board members and executives at many companies — ties that can make it harder for a board to restrain executive pay. They say this can occur even though all of a board's compensation committee members technically meet the legal definition of independent, as is the case at Home Depot.
"When you have a situation like this where it is so incestuous, it creates uncertainty whether Nardelli's pay is a reflection of these relationships or from his performance," said Jesse M. Fried, a professor of law at the University of California, Berkeley, and co-author of a book on executive compensation, "Pay Without Performance."
A showdown could occur at the annual meeting tomorrow as firms that advise large shareholders and activist groups are urging shareholders to withhold votes from several directors. The shareholder groups are also seeking the right to vote on the compensation committee's annual report and plan a rally outside the meeting in Wilmington, Del., to protest Mr. Nardelli's pay.
None of the current or former members of the compensation committee returned calls seeking comment, and the company would not make Mr. Nardelli available.
In an e-mail statement, Mr. Langone said: "Each and every board member at Home Depot is totally independent. Candidates for service have been suggested and put through the nominating process by a wide variety of directors, myself included. That is why there is such a diversity of thought, opinion and experience on the board and why our discussions are open, robust and objective."
Mr. Langone was instrumental in bringing the former G.E. star into the company. While he is not on the compensation committee, he has led the committee that nominates directors for the last seven years.
No stranger to controversy, Mr. Langone is currently under fire for his role as head of the compensation committee at the New York Stock Exchange, which granted the former chief executive Richard A. Grasso a pay package worth more than $140 million. Mr. Grasso sat on Home Depot's board from 2002 to 2004, including a stint on the compensation committee.
Mr. Langone "created the Home Depot board in his own philosophical image," said Richard Ferlauto, director of pension investment policy for the American Federation of State, County and Municipal Employees, whose pension fund owns shares in the company. "Arguably, Langone is the ringleader and the one who pulls the strings in this network," he added.
Riches With Restraint
The co-founders of Home Depot, Arthur M. Blank and Bernard Marcus, grew very rich on company stock that soared in value. But under them, Home Depot embraced a culture of restraint when it came to pay, said Paul D. Lapides, a corporate governance expert at Kennesaw State University in Georgia. "Bernie and Art took home a salary of $1 million or less and refused bonuses. The attitude was one of 'we're all in this together,' " said Mr. Lapides, who has never worked at Home Depot but has studied the company for years.
Representatives of Mr. Marcus and Mr. Blank, both retired from Home Depot, said neither would comment for this article.
Since hiring Mr. Nardelli, 58, the board has awarded him more than $87 million in deferred stock grants and $90 million in stock options, according to an analysis by Brian Foley, a compensation consultant in White Plains. Mr. Nardelli's salary, bonuses and a company loan make up most of the rest of his $245 million compensation.
Even last year, when Home Depot's stock was unchanged, the board raised his salary 8 percent, to $2.164 million, and increased his bonus 22 percent, to $7 million.
By contrast, from 2000 until his retirement early last year, the former chief executive of Lowe's, Robert L. Tillman, was awarded less than a quarter of what Mr. Nardelli was awarded through the end of last year, according to Mr. Foley. The many connections among Home Depot's directors cause some critics to ask whether the nominating committee is failing in finding truly "independent" board members. "The fact that you have so much overlapping boards here says to me: what was the nomination process to get on the board here, how wide was the net really cast?" asked Eleanor Bloxham, president of the Value Alliance, a group that advises companies on corporate governance issues.
The net may not have been cast much farther than Mr. Langone's circle of friends and associates, critics say. For instance, there is Bonnie G. Hill, who leads the Home Depot compensation committee.
The owner of a corporate-governance consulting firm, Ms. Hill is on the board of Yum Brands with Mr. Langone. Until recently, she served on the board of ChoicePoint, another company with which Mr. Langone has deep ties, including serving as a director. Mr. Langone's statement defending the ties of board members said the idea that they could not share friendships was ridiculous: "It not only sets up a make-believe standard but it is designed to please an agenda driven by activists with ulterior motives."
Ms. Hill is also on the compensation committee of Albertson's, the grocery chain, where she is determining the pay for the chief executive, Lawrence R. Johnston, who is also a Home Depot director. "Would Johnston be as eager to promote strict pay practices on the Home Depot board, where one of his pay setters is in a position to apply the same pay principles to his own pay package?" asked Jackie Cook, a senior research associate at the Corporate Library, an institutional advisory firm in Portland, Me.
Mr. Johnston was at G.E. at the same time as Mr. Nardelli, running the appliances unit.
Mr. Johnston turned to a well-known compensation lawyer, Robert J. Stucker, to negotiate his compensation package at Albertson's when he joined in 2001. Mr. Stucker had negotiated Mr. Nardelli's package at Home Depot just months earlier.
When it comes time for Mr. Nardelli to renegotiate his own contract, Mr. Johnston, as a member of the Home Depot compensation committee, is forced to negotiate against his own lawyer, said Charles M. Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. "By utilizing the same legal counsel, if there's ever a dispute between the company and Mr. Nardelli over pay, it puts a member of the compensation committee in a very awkward position," Mr. Elson said. A call to Mr. Stucker was not returned.
More links to G.E. are evident with Claudio X. Gonzalez, a board member. The longtime chairman and chief executive of Kimberly-Clark de Mexico, a unit of Kimberly-Clark, Mr. Gonzalez has known Mr. Langone and Mr. Nardelli for years as a G.E. director.
Besides Mr. Gonzalez and Mr. Johnston, the compensation panel includes three other current or former chief executives: Angelo R. Mozilo, who heads Countrywide Financial; John L. Clendenin, the former chief of BellSouth; and Richard H. Brown, the former chief of Electronic Data Systems.
Mr. Brown also has ties to Mr. Langone, who, as an investment banker, took Electronic Data Systems public in 1968 and was a large E.D.S. shareholder for years. Later, at his own investment bank, Invemed Associates, Mr. Langone underwrote security offerings by E.D.S. while Mr. Brown was chief executive. Mr. Brown is not up for re-election to the Home Depot board this year.
In his statement, Mr. Langone said: "Dick Brown is one of the finest business minds this country has ever produced and I am proud to call him my friend. He was not suggested for service on the board by me but I heartily endorsed the idea."
This Year's ' Disney'
The ire of shareholder activists was raised even more with the addition of Mr. Mozilo to the board in February. Mr. Mozilo now sits on the compensation committee.
His pay package, which is bigger than Mr. Nardelli's, already made him a target of governance groups. Last year alone, Mr. Mozilo took home $70 million, including salary, bonus, stock options, payments for tax- and investment-advisory services and country club memberships. "Good grief," said Paul Hodgson, a compensation analyst at the Corporate Library. "He's hardly likely to be an influence of restraint given his own pay package."
Shareholder activists are taking a more aggressive stance toward directors this year. "Home Depot, I think, is the Disney of this shareholder season," said Mr. Ferlauto, referring to the 2004 annual meeting of Disney shareholders at which 45 percent of the votes cast were withheld from the chief executive, Michael D. Eisner, in part because of his pay. Mr. Eisner later resigned.
At the Home Depot annual meeting tomorrow, several factions are recommending that investors withhold support from most of the directors. The dissidents include A.F.S.C.M.E.; the state pension fund of Connecticut; the California Public Employees Retirement System, the country's largest public pension fund; and Institutional Shareholder Services, which advises pension funds and mutual funds.
I.S.S. claims there is a "disconnect" between Mr. Nardelli's pay and Home Depot's performance. "Moreover, poor compensation design, a lucrative employment agreement, and arguably egregious compensation practices call into question the fitness of the company's Compensation Committee members to serve as directors," the advisory firm said in a report it issued two weeks ago.
The board disagrees, saying that it based Mr. Nardelli's pay and bonus last year on the company's "outstanding operating performance," his "continuing success in developing a new foundation for long-term growth" and his "continuing superior leadership," according to a statement from the company.
Mr. Langone concurs. "I have long felt that Bob Nardelli's abilities are absolutely first rate," he said in his statement. "He's doing a great job and the strong fundamentals he has built during his tenure are proof of his keen leadership. There are a whole variety of long-term indicators I find encouraging such as earnings growth, sales growth, equity value in the brand as well as systematic enhancements put in place companywide that have dramatically improved efficiency."
Last year Home Depot reported record earnings per share, record gross and operating margins and record sales of $81.5 billion. Yet, over the last five years, Home Depot stock has fallen 12 percent, performing worse than its peers and the Standard & Poor's 500 index, which fell 4 percent. Mr. Nardelli has also created a fair amount of friction since he joined the company, say some of his critics among the Former Orange-Blooded Executives, a few of whom were forced out once Mr. Nardelli took over. He moved quickly to introduce G.E.-inspired performance measures; issued edicts about store displays to managers who once enjoyed a great deal of autonomy; and replaced several longtime Home Depot executives with former G.E. associates.
Today, two of Home Depot's four highest-paid executives hail from G.E., including its director of human resources. A third executive, the general counsel, Frank L. Fernandez, was a lawyer in upstate New York who was occasionally hired as an outside counsel for G.E. when Mr. Nardelli ran its power systems group in the area.
In his latest moves, Mr. Nardelli is trying to retool Home Depot, snapping up lumber and building materials companies last year in order to push into the professional contractor market.
"He has made a big decision to get into the supply business, and Wall Street has greeted that decision with a yawn," said Eric Bosshard, a stock analyst at FTN Midwest Securities who does not own shares in the company. Despite these bold moves, Home Depot did not even know it was looking for a fix-it man when Mr. Nardelli hit its radar in the fall of 2000. The chief executive at the time, Mr. Blank, one of the co-founders, was actually on the hunt for a second-in-command, someone he could groom to take over his job eventually.
Those plans went out the window over Thanksgiving weekend that year when Mr. Nardelli, who had been in charge of G.E. Power Systems for five years, learned he had lost out to Jeffrey R. Immelt to succeed G.E.'s longtime chief executive, John F. Welch Jr. (Mr. Nardelli may have lost the battle for the title, but he is winning in the total compensation wars. Mr. Immelt has been awarded $108 million since taking over as G.E.'s chief, according to Mr. Foley, while the company's stock has fallen 19 percent.)
Mr. Langone, who sat on G.E.'s board and had watched Mr. Nardelli's career, moved fast to avoid losing the executive star. Hard-charging and ambitious, Mr. Nardelli was interested, but not in a No. 2 position. Worried he would go elsewhere, the Home Depot board decided Mr. Blank should step aside and Mr. Nardelli, who had no retail experience, should take his place.
Luring an executive of Mr. Nardelli's repute, however, came at a high price. Despite the fact that Mr. Nardelli had little incentive to remain at G.E., he required that he be "made whole," meaning he would have to be paid for what he was walking away from. He was given a stock option grant of 3.5 million shares. One million of those shares vested immediately and were worth $25 million.
That was just the beginning. He also received perks like use of a company plane for personal trips; a new car every three years, one similar in price to the Mercedes Benz S series; and a $10 million loan with an annual interest rate of 5.8 percent that would be forgiven over five years.
That $10 million loan wound up costing shareholders $21 million after the board agreed to pay all taxes on it, a so-called gross-up. Congress banned loans like this in 2002 after Mr. Nardelli joined the company.
And when it appeared that Mr. Nardelli might not hit one of the few performance goals the board had set to cause payment of a long-term incentive plan, the board lowered the goalposts, according to the Corporate Library.
The target for Mr. Nardelli had been total shareholder return — share price increases plus reinvested dividends — compared with a peer group, and the company was performing poorly by that measure in 2003, according to the Corporate Library. But that year, the board changed the target to one of growth in average diluted earnings per share, which takes into account the per share earnings decrease that occurs when stock options are awarded. In a report released in March of this year, the Corporate Library labeled Home Depot one of its 11 "Pay for Failure Companies."
A Question of Incentives
The change in the incentive target appeared to be "designed to ensure a payout," rather than provide an incentive to improve performance, the report said. Other critics say the new hurdle is even easier to hit with a board-approved share-repurchase program. Since 2002, the company has bought back nearly $10 billion of its own stock.
The one threat to Mr. Nardelli's pay is a proposal by A.F.S.C.M.E., the government workers' union, that would allow Home Depot shareholders to approve or reject the report from the compensation committee. But even if the proposal is accepted, any future rejection of the board panel's compensation report would be merely symbolic. The board can simply ignore shareholders and pay executives what they wish.
So far, similar proposals have been rejected at two other companies whose executive pay A.F.S.C.M.E. identified as a problem: Merrill Lynch and U.S. Bancorp. The Home Depot board is urging its shareholders to vote against the proposal.
Skepticism about Mr. Nardelli's strategy to move the company away from its retailing roots and concerns about a cooling in the housing market have caused some large investors to move out of the stock, said Michael E. Cox, a stock analyst at Piper Jaffray in Minneapolis, who does not personally own shares in the stock.
But like the majority of analysts on Wall Street, Mr. Cox recommends Home Depot's stock to investors because he believes that Mr. Nardelli's strategy will pay off in the long term for the company.
Furthermore, Mr. Nardelli's reputation has not been tarnished, insisted Gerard R. Roche, the high-profile recruiter who helped bring Mr. Nardelli to the retailer. "I know he has been approached by other companies. There are a number of people interested in lifting Nardelli out," Mr. Roche said. "I can tell you there are a number of companies telling me to get them another Nardelli."
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