The giant severance package that Bob Nardelli takes with him from Home Depot raises once more the issue of whether America's CEOs are paid too much. Clearly, Nardelli was.
Resident Fellow and Editor in Chief of The American James K. Glassman
Boards of directors make mistakes, just as owners of football teams and movie producers do. No one knows when a CEO is hired whether he or she will lead a firm to higher profits and a higher stock price. The only certainty is that, in an age of giant global corporations, a CEO's decisions have a huge effect on a company's performance.
Evidence? When the announcement came Wednesday that Nardelli was out, Home Depot's stock jumped, and the company's market value increased by almost $2 billion. Investors were saying that Nardelli's successor was worth that much more to the company than Nardelli was.
In other words, CEOs count, so the demand for a potentially great one is high. The supply is small. So, naturally, the price--in terms of compensation--can be tremendous. If a change in CEOs can boost a firm's value by $2 billion, then is the pay for a CEO who makes $8 million a year (the average last year for CEOs of the big public companies of the S&P 500) too high?
CEO pay has jumped by a factor of six since the early 1980s. That may sound like a lot, but, according to research by economists Xavier Gabaix of MIT and Augustin Landier of NYU, the increase "can be fully attributed to the six-fold increase in market capitalization of large U.S. companies during that period."
CEOs are paid more because they run bigger, more valuable companies. Makes sense.
When politicians and editorialists call for constraints on CEO pay, they need to realize what's at stake in tampering with a system that is working extremely well. With 5 percent of the world's population, the United States is home to half the world's largest companies. A survey by Forbes finds U.S. businesses the most profitable in the world in nearly every sector: finance, capital goods, retailing, energy, computer software, and on and on.
Are some CEOs overpaid? Of course. So are some basketball players. The notion of linking CEO pay to performance is a good one, but, in order to lure a top executive away from another company, boards have to offer guarantees, including big severance packages. Otherwise, the executive won't jump ship.
My worry is that the political pressure on public companies is causing some boards to offer CEOs too little. "The best and brightest minds," said an article by Dominic Basulto in The American, the magazine I edit, "are increasingly drawn from running key businesses to other pursuits that may not be as socially useful--but pay much more."
Those pursuits include managing hedge funds, where the rewards for being right about the direction of Euro-bond interest rates can run into the billions of dollars.
Average shareholders, as opposed to the activists that grab the headlines, should be happy to reward superb leaders. As for CEOs who aren't worth what they get, there's a quick remedy: Sell the stock.
That is what shareholders of Home Depot were doing. And the board heard the message.
James K. Glassman is a resident fellow at AEI and editor in chief and executive publisher of The American.