Business Capitulates and Goes Green

Holman Jenkins wrote a blunt, clear and scathing piece in yesterday's Wall Street Journal about American business' capitulation on the topic of global warming.

Nevermind that the evidence is still unclear as to whether or not humans are the major contributing factor, or even a significant contributing factor, to the current apparent rise in the Earth's temperature. Or that no less a figure than Bjorn Lomborg repeatedly counsels against ill-considered action on the still-misunderstood phenomenon and its consequences.

It seems that US CEOs have decided, especially with the recent change in 'leadership' on Capitol Hill, that some sort of legislation is heading their way. So, rather than gird for battle with court litigation and/or better-funded science, the corporate leaders are throwing in the towel, and attempting to cash in on whatever new constraints Congress will enact.

Jenkins recounts how each CEO is going about pushing for carbon emission restraints, taxes, etc., on other companies, but not their own. Or pushing for cap limits and tradeable emission rights, in order to make a profitable virtue out of what is now an apparent vice- free dumping of pollution into the atmosphere or water.

One of the things that most troubles me about the attitudes of these businessmen is that they wrongly seem to feel that any opportunity to sell something constitutes growth. In this case, nevermind that the actual activity of responding to 'global warming' will cost untold millions in terms of foregone growth.

Rather, it seems to me to be the same sort of logic that sees "growth" in cleaning up and rebuilding after a hurricane. That is, you'd really rather not have had the initial destruction occur in the first place. Any 'growth' really involves one person's loss becoming another's 'gain.' But the system loses value.

In their rush to grab the low-hanging fruit of the legislative 'response' to presumed global warming, these corporate titans seem to be missing the overall admission they are making that they are doing material environmental damage. And that much productive growth will now be foregone, as resources are directed to 'solving' a 'problem' we still are not sure is primarily caused by human activity.

I fear this knee-jerk reaction by corporate CEOs, and their surrender on the issue of whether there actually is a problem that mankind can solve, will come back to haunt the US economy.

Home Depot & Corporate Governance- Again: Frank Blake's Compensation Package

Today's Wall Street Journal ran an article detailing the compensation package of Home Depot's replacement CEO, Frank Blake.

I must say, it looks as if Home Depot's board has begun to come to its senses. According to the WSJ,

"Chief Executive Frank Blake didn't just accept a compensation package significantly less than the one his predecessor Robert Nardelli received. He also rejected the big retailer's first offer as too rich.

Among other things, Mr. Blake balked at getting restricted stock, which has value even if the share price declines. So the compensation committee dropped plans to give him restricted shares, according to someone close to the situation.

Mr. Blake preferred equity grants tied to performance measures, a salary of less than $1 million and a total package worth less than what Lowe's Cos. CEO Robert Niblock gets, this individual said.Mr. Blake wanted "to be totally aligned with shareholders," a second knowledgeable person noted.

According to a letter he signed Tuesday, Mr. Blake gets a $975,000 salary this year and could receive a $975,000 long-term incentive award, plus an annual bonus of twice that amount if he meets performance goals. Home Depot gave him, among other things, performance shares initially worth $2.5 million that could pay out even more after three years, based on the company's relative total shareholder return, compared with Standard & Poor's 500 companies. He also gets $2.5 million of options that he can begin to exercise only if Home Depot maintains a 25% increase in its share price above the grant date level for at least 30 straight trading days. He must also wait a year before he can begin exercising these options, which the company said would be awarded next month.

In 2005, as executive vice president of business development, Mr. Blake received $685,192 salary and an $825,000 bonus. He also got $2.9 million in restricted stock awards. Lowe's CEO Mr. Niblock received a salary of $850,000 and a $2.6 million bonus. He received $4 million in restricted stock."

While I applaud the board's restraint, and Blake's sensibility, in the design of his compensation package, I'm now somewhat mystified by how it justified his nearly-equally lavish compensation as EVP of business development. A job, by the way, which he seems to have bungled, given HD's miserable growth record under Nardelli-Blake.

On one hand, Blake's sub-$1MM salary comes close to my own recommendation that CEO's be paid a more modest fixed salary. And I wholly endorse the performance share values being tied to HD's total return performance, relative to the S&P, I don't think the board went far enough on this measure. I think the total amount should be a function of this measure, not just, as the article describes, some amount in excess of the initial $2.5MM.

Let's be clear about something. Blake has failed as EVP of business development. The firm hasn't developed sufficient new business. That's been a key problem. Now, with the departure of the failed prior CEO, Nardelli, the board is paying Blake what appears to be, for three years, approximately $5.5MM for even a poor performance. To me, that's just too much. It appears that Blake has already pocket in the range of $6MM from his time at HD already. Therefore, he now has essentially nothing to lose.

Ask your average US middle-level manager if he'd like the opportunity to earn $6MM for the next three years, even if he fails to meet his objectives. It's a job nearly anyone would want.

I think that means it's too rich of a deal. Given what I've learned about corporate performance from my research, I see the attainment of consistently superior total returns as sufficiently rare, and so valuable, as to merit significant incentive for its achievement. But anything less should just get a 'decent' salary. Something south of $1MM/year, with no bonus.

So, yes, the Home Depot board is heading in the right direction. And Blake is obviously astute enough to avoid the greedy behavior of his predecessor and colleague. But I think the company is still vastly overpaying on the come for performance it has no reason to believe it will realize from its new CEO.

Why is the Home Depot board giving away its shareholders' money so easily in the absence of performance guarantees, or evidence that consistently superior performance is likely under Blake?

Addendum: It's Davos Time Again

Yes, it's that time again. Time for the business, economic and cultural elites to gather at Davos.

Luckily for Maria Bartiromo, that's her reporting location for the next week. Timely? But of course.

Based upon today's Wall Street Journal article, about which I wrote here, this morning, I'd say Maria's very glad to be overseas for a few days.

Not that her interviews have gotten any better. She's still asking her typical softball questions, then turning on her 'amazed' facial expression, no matter what her interviewee says. Well, it's either 'amazed,' or 'furrowed brow deep thought.'

When is CNBC going to jettison the on-air-heads, male and female, and start cultivating more reporters and anchors who can actually express themselves articulately about business and economic issues without looking like they're reading it all off of a teleprompter?

More on Prince's Poor Leadership at Citigroup

Today's Wall Street Journal offered some rather specific examples of Chuck Prince's failure to lead or manage the overly-large, diverse financial services mess that we know as Citigroup.

Most of the article details the curious and extravagant behaviors of Todd Thomson, the recently departed head of the firm's wealth-management unit. By the way, in his eagerness and persistence to find something that Sallie Crawcheck might be able to do, he claims to have fired Thomson because he needed to get Crawcheck into that job immediately. No telling whether her junior analyst skills will be any more relevant to running Citi's wealth management group than they were for her as the company's ineffective CFO.

But, back to Thomson. Yesterday's Journal article, discussed in this post, here, described a China business trip from which Thomson returned early, with a 'non-Citi person,' stranding the Citi staffers he had flown over on the corporate jet. Today, we learn that person was non other than CNBC's leading on-air-head staffer, Maria Bartiromo. Sounds like a pretty cozy world up there at altitude, doesn't it?

Further, the Journal piece divulges that Thomson planned to spend $5MM of his unit's budget to feature Ms. Bartiromo and Robert Redford as hosts on a new television series to air on Redford's Sundance Channel.

How did Prince let things get so out of hand? According to the article, the firm's CEO has silently fretted over Thomson's spending and management of the Citi wealth management unit for some time. But, he did nothing until recently. Even the firm's largest individual shareholder, Prince Alwaleed, expressed dissatisfaction with the firm's expense growth.

What I find additionally remarkable, in addition to Prince's inability to execute on fundamentals like expense management, and to be allowed by his board to bumble this issue for so many years, is the lack of judgment of Thomson, a senior executive whom Prince left in place for so long.

Thomson had preceded Crawcheck as CFO, under the Weill regime which built the current, unwieldy structure that Citigroup operates. Along with extravagant spending on marketing and infrastructure for his wealth management unit, Thomson seems to have believed that hobnobbing with, or was it dating, CNBC's Ms. Bartiromo, and including her in luncheons with clients in the Far East, would add value to his unit.

My point is, Bartiromo is among the least capable of the many female anchors and reporters on CNBC. Unlike Becky Quick, Michelle Caruso-Cabrera, or Erin Burnett, all of whom demonstrate an on-air ability to hold intelligent, probing and useful dialogue spontaneously with interviewees, Bartiromo can be frequently seen squinting to read her teleprompter, so that she knows what she's supposed to ask next. She rarely, if ever, asks an intelligent or germane, follow-on question of an interviewee. Like Sue Herera and Liz Claman, Bartiromo seems more infatuated with her interview subjects than capable of providing any independent thought or critical questions.

You'd think that if Thomson wanted to impress his wealthy clientele, he'd have brought a better-qualified financial media personality than Ms. Bartiromo.

It doesn't say much for Thomson's judgment, or Prince's, for letting him function in an uncontrolled manner for so long.

Why is the exodus at Citi stopping with Thomson? Why aren't Crawcheck and Prince following him out the door? Can anyone truly claim that the loss of all three of these senior executives would actually further impair Citi's continuing inferior total return performance for its shareholders?

In the interests of Citigroup's ability to earn consistently superior total returns for its shareholders, and based upon my research findings, I think its board needs to consider large-scale housecleaning at the senior management level. The current management is focused on the wrong things, and inept at motivating the diverse company to execute on its plans. How much worse could they do with the current regime?

Corporate Performance and Scale: Citigroup

Yesterday's post on executive compensation and increasing sizes of large corporations has had me reflecting the issue of size for the last day.

What should we mean by corporate "size?" Assets? Revenues? Income? Employees? Market share?

It's not a trivial issue. I looked at all four of the internal corporate bases for scale when I conducted my proprietary research on corporate performance. However, after reading The Economist's report on executive pay, and noting the steady upward trend in corporate size, in terms of assets, I began to wonder if we have now crossed over the tipping point of size, as it relates to companies' ability to achieve consistently superior total returns.

I believe that my ideal company would be small, in terms of employees, but large in terms of revenues, income, and market share. When asset sizes growth is accompanied by employee growth of similar rates, I suspect that the seeds of faster unraveling of that growth are sown.

When I opened this morning's Wall Street Journal to read the right-hand column piece about Citigroup's woes, and Sallie Crawcheck's re-assignment, I immediately thought of the executive compensation topic, and corporate size.

Chuck Prince has failed at managing the unwieldy financial services behemoth that his predecessor, Sandy Weill, glued together. It's pretty obvious by now that it is simply too large and diverse for any one CEO to competently and effectively run in a manner which rewards shareholders with consistently superior total returns.

Thinking of size in another company, GE, and my post last August, here, I believe there's a case building for more corporate spinoffs, and fewer mergers.

There seem to be at least three colliding trends here.

First, we have ever-larger corporations, which show no evidence of being able to produce more companies which can consistently deliver above-market-average total returns for investors.

Second, we have conspicuous examples of very large, multi-unit, diversified conglomerates, such as GE and Citigroup, which are ineptly run by CEOs who succeeded the architects of the current confiruration.

Third, we have the increasing availability of technology and collaborative ventures which allow smaller, more nimbly-run firms to get access to needed technologies, products, or markets, without having to necessarily 'acquire' the assets and employees to do so. And to use advanced communications, logistics, transportation and marketing technologies to manage what they have more productively and efficiently.

The result, ideally, should be rising market values, market shares, and total returns for companies which do not grow assets or employees as fast as they grow revenues and incomes.

In a manner of speaking, is this not what some of the private equity buyouts are effecting with their purchases of poorly-performing, large companies?

I believe we are now seeing a period in which the escalated sizes of compensation packages, as discussed in The Economist's report, to reflect increasing corporate sizes, are drawing attention to the fact that the performances of such organizations are flagging. And that smaller, better-managed entities carved out of these merged giants would probably be more sensitive to markets, customer needs, competitive forces, and shareholders. This could result in more well-managed, smaller, but still above-minimum-economic-sized firms in which shareholders could invest.

More on Executive Compensation: The Economist's Special Report

Over the weekend, I read The Economist's 20 page special report on executive pay, in the current issue of the British news weekly. The report contains the usual excellent mix of historical information, empirical data and research, and sensible reasoning that I've come to expect from the magazine's reporting.

Of particular interest to me, however, was this passage, found on page 9 of the special report,

"As the average firm size increases, so each company must pay its top executives more. When managers control more assets, they can make more of a difference to absolute profits. Hence, in a competitive market full of bigger companies, boards will be prepared to spend more on talent. Using a schematic mathematical model, two American-based European economists, Xavier Gabaix and Augustin Landier, concluded that the sixfold increase in the size of American firms between 1980 and 2003 may account for much of the sixfold increase in managers' pay during that period. Tiny differences between the abilities of top managers could explain large differences in pay. Chart 2, from another study, shows how in historical terms the level of pay is still relatively low in relation to the size of companies."

To be honest, this particular piece of data was news to me. I suppose the continuing drumbeat of mergers should have alerted me to the trend, but I had no idea that the asset sizes had increased to this extent.

Shortly thereafter in the article, the report states,

"In fact, the typical chief executive of an S&P500 company, who earned just under $7MM in 2005, according to the Corporate Library, must think he is in the wrong job.....senior investment bankers stood to earn bonuses of $20MM-25MM in 2006 and top traders $40MM-50MM. To qualify for Alpha magazine rankings of the top 25 hedge-fund managers in 2005, you had to earn $130MM."

This puts some things into perspective, does it not? Essentially, we are faced with a simple conundrum which is going to make a lot of people very unhappy. Large corporations have gotten very much larger in the past 20+ years, and, thus, the CEO of such a company has a much larger effect, good or bad, upon the total return of those swollen asset sizes. While the lower-level workers may have experienced productivity gains as well, it's doubtful that they are on a scale of what may be possible for an effective shareholder-wealth creating CEO of a very large-cap US company.

Thus, we have William McGuire, late of UnitedHealth Group, making over a billion dollars based upon the peak value of his options.

On one hand, this aggregation of assets for the average large cap company means more opportunity to add value for shareholders. And, thus, a basis for higher compensation for those CEOs who achieve that via consistently superior total returns. For those that do not, however, it means larger compensation packages for even larger opportunity costs.

Ironically, as the company size has risen so dramatically, the sector which is most-often involved in that activity, investment banking, pays its people even better than the CEOs of the merged companies it creates, as the second quoted passage notes. I suppose this is yet another symptom of industrial sales people typically earning more than the CEOs of the firms for which they work, so it's not, per se, part of the 'problem.'

Returning to the CEO compensation issue, the Economist report also notes, later on in the section, that many boards reward senior executives with options, as if they are free when, in fact, they become costly and dilutitive, on the bases on which they are typically granted.

This brings me to a more detailed idea for CEO compensation, based upon my proprietary research. If a CEO must be paid with options, why not make the maximal value of the options available be the product of the difference of the company's 5-year average total return with the S&P500, and the recent market value of the firm, multiplied by some reasonable fractional value, such as 10%. Thus, the CEO of an outstanding firm which had consistently out-earned the S&P500 would stand to gain 10% of that difference, multiplied by the value of the firm's equity.

Another topic which was discussed in the Economist's report is that of risks borne by CEOs, relative to the compensation they receive for a job that is experiencing a decreasing average tenure. However, from my observations, and discussions with a few CEOs, I believe the report misses an important behavioral aspect of this issue. Most CEOs of large companies would likely do the job for half of what they are paid, simply to enjoy the control of all those assets, as well as the high public profile that often comes with the territory of being a large company CEO. And, as I have contended in prior posts, if a company needs an effective CEO, offering an incentive-rich compensation package with a low fixed component should attract candidates who are confident they can deliver performance for shareholders. Does a board really want a CEO who has to be guaranteed immense riches in order to come aboard and attempt to enrich shareholders at a superior rate to the S&P?

We see far more consistent underperformance than outperformance among S&P500 CEOs, yet, to my knowledge, none of the former return the money as a consequence of their failure. Even GE's CEO, Jeff Immelt, who now boasts that 75% of his compensation is tied to performance, made upwards of $30MM before he took that risk. And, the tie-in is not as draconian as he would have others believe.

What is the price, and for what time period, that boards should pay, on behalf of shareholders, in order to suffer an ineffective CEO? It's as easy to pay little for failure as to pay a lot. Yet, if properly constructed, an effective CEO should, with the same compensation package, stand to make a considerable sum by succeeding for the shareholders.

To me, it seems that running ever-larger companies implies three things. First, it's more important than ever for boards to get compensation policies and levels 'right,' as failure is ever-more costly.

Second, CEOs who do consistently outperform the S&P500 on behalf of their shareholders, are doing a much tougher job, with larger asset bases, than their counterparts of 20-odd years ago were, and deserve much more income for doing so. Those who fail should be both paid much less, until they demonstrate success. If a board still needs to give a CEO 3-5 years to prove her/himself, the least they can do is withhold lavish compensation until the long-term performance record of a CEO is clear.

Third, perhaps the growth in average asset size of large companies is a mistake, viewed from a performance perspective. Should we have expected more consistently superior total return performances from the larger firms, if those mergers were value-creating? If not, perhaps the current outrage over CEO compensation levels is derative of the challenge of running companies that are, in fact, too large to be effectively led to consistently superior total returns.