Underperforming CEOs with Multimillion-Dollar Payouts

With all of the noise surrounding the mortgage and credit markets the past couple of months, it was easy to miss the side story coming out of all of this turmoil: Corporate boards continue to award multimillion-dollar pay packages to managers who have been removed for poor performance. Considering all of the investor angst that followed Bob Nardelli's $210 million parting gift from  Home Depot (HD) earlier this year, it surprises us that there has been so little uproar about the exit packages recently awarded to the CEOs of  Citigroup (C) and  Merrill Lynch  as they were forced out the door. Even though each of these firms tried to make it look like they were doing the right thing by offering no severance to their departing CEOs--neither of which had employment contracts in place--the packages doled out to each executive demonstrate the lengths to which corporate boards will go to ensure a "soft landing" for their departing CEOs.

Although it would be easy to blame the billion-dollar write-offs and the lost shareholder value at both banks this past quarter on the unprecedented turmoil that has enveloped the mortgage and credit markets, a lot of the blame surely rests at the feet of the outgoing CEOs--namely, Charles Prince at Citigroup and Stanley O'Neal at Merrill Lynch. During their time at the helm, both CEOs pushed their firms into more aggressive growth strategies, such as underwriting highly profitable collateralized-debt obligations that ultimately soured as the mortgage and credit markets seized up. Although both men have also been credited with many positive moves during their years at the top, it will ultimately be the write-offs ($8.4 billion at Merrill and $5.9 billion and counting at Citigroup) and the precipitous decline in the shares of each company's stock that will be their lasting legacy.

This only serves to make the way each man departed these firms--by retiring rather than being terminated--seem all the more troubling. Each company highlighted the fact that their departing CEOs would not receive any severance, which was a welcome relief after seeing Bob Nardelli cart away $20 million in cash severance earlier this year that wasn't in his employment contract with Home Depot. However, by letting them retire rather than being terminated, the boards allowed each man to walk away with millions of dollars' worth of restricted shares and unvested stock options. In the case of Charles Prince, the board at Citigroup even ensured that he would be paid his full salary until the end of the year and still receive the unpaid portion of his 2006 bonus that had been banked for payment at the end of 2007. In the table below, we include Charles Prince on our list of recent--and pricey--CEO departures.

Estimated Payouts to Departing CEOs
	Stanley O'Neal Merrill Lynch	Charles Prince Citigroup	Bob Nardelli Home Depot	Hank McKinnell Pfizer
Cash Severance			$20,000,000	$14,000,000
Annual Bonus/Salary		$12,500,000	$9,000,000
Long-Term Incentives	$9,000,000			$18,300,000
Restricted Stock	$86,000,000	$10,700,000		$5,800,000
Stock Options	$35,000,000	$1,300,000	$7,000,000	$5,800,000
Deferred Stock		$16,100,000	$121,000,000
Deferred Compensation	$5,000,000			$77,900,000
Other Entitlements			$18,000,000	$600,000
Unused Vacation				$300,000
Pension/401(k)/Other Plans	$25,000,000	$1,400,000	$2,000,000
Other Retirement Benefits			$33,000,000	$82,300,000
Total Package on Departure	$160,000,000	$42,000,000	$210,000,000	$205,000,000
Based on figures pulled from company filings with the SEC, as well as from media reports following each CEO's departure.

We see it as a bit odd to have a CEO "retire" and still be allowed to fully vest their equity holdings before heading out the door, especially after a bout of poor performance that resulted in billions of dollars in lost earnings and market capitalization. Although each man put in more than 20 years at his respective firm--entitling both to some level of recognition--we think that the boards are doing a huge disservice to shareholders by allowing them to walk away with millions of dollars' worth of restricted shares and unvested stock options. Some might argue that the boards could do nothing to stop each executive from cashing in on his equity and retirement holdings, because these plans were covered by agreements that were outside of the control of the compensation committees at each firm; however, we think the boards could have negotiated much harder terms from their departing CEOs.

In his letter to  Berkshire Hathaway (BRK.B) shareholders in 2004, Warren Buffett wrote: "In judging whether corporate America is serious about reforming itself, CEO pay remains the acid test." Although we've come a long way in just the past couple of years, it looks like we've still got a long way to go. Despite the SEC's new disclosure rules for executive compensation, and the public outcry over multimillion-dollar payouts to poor-performing CEOs, corporate boards continue to find ingenious ways to skirt their responsibilities to shareholders. By clouding compensation disclosures in their proxies with vague and inconsistent language, and allowing executives who should have been terminated to retire with their benefits fully intact, it certainly looks as though boards continue to serve the interests of management rather than those of shareholders.

Even long-standing proponents of pay for performance like Michael Jensen and Kevin Murphy, whose ground-breaking work in the late 1980s on performance pay and management incentives led to an acceleration of the use of stock options in executive compensation, have admitted that things have gone terribly wrong. As they see it, too many CEOs receive high pay without creating any additional value for shareholders. In their soon-to-be-released book, CEO Pay and What to Do about It: Restoring Integrity to Both Executive Compensation and Capital-Market Relations, the two have put together a handful of proposals that they believe can help corporate boards negotiate much tougher contracts with top executives, hopefully benefiting both management and shareholders over the long term. While we'll have to wait until the end of the year to see what Jensen and Murphy are proposing, we have our own thoughts on what the top proposal should be: If it wasn't earned, it should be returned.

In the meantime, we're left with the reality of the executive compensation system that exists today, which tends to reward failure far more often than its does success. In fact, more recent events remind us of Warren Buffett's more poignant remarks on the subject of executive pay (from Berkshire Hathaway's 2005 annual report): "Getting fired can produce a particularly bountiful payday for a CEO. Indeed, he can 'earn' more in that single day, while cleaning out his desk, than an American worker earns in a lifetime of cleaning toilets. Forget the old maxim about nothing succeeding like success: Today, in the executive suite, the all-too-prevalent rule is that nothing succeeds like failure."