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Nardelli's severance

Who exactly is hurt by Bob Nardelli's paycheck that it's creating such outrage?

In 2000, GE picked Jeff Immelt to replace Jack Welch as CEO. That made the two "losers" in that battle, Jim McNerney and Bob Nardelli, also groomed for the top GE job, high-in-demand free agents. A bidding war arose for their services; Boeing picked up McNerney, and Home Depot agreed to pay the price of a New York Yankees infield to get Nardelli—a price that included a negotiated gigantic severance at the back end. These promised payments were necessary to induce Nardelli to leave behind the millions of dollars of stock options he was surrendering by leaving GE. Unlike, say, liability costs, which are variable costs that rise with every worker hired, every store opened, and every good sold, such severance payments are fixed costs, and are swallowed entirely by shareholders.

Economic theory teaches us that when a rare commodity with uncertain future value like an MVP shortstop or GE executive is subject to an auction, the winner of the auction will probably be the party that most overvalues the commodity: the concept of bidders' remorse. And perhaps Home Depot overpaid for the privilege of hiring Nardelli. (Press coverage is sneering that the Home Depot stock price dropped during Nardelli's reign, but, aside from omitting dividend payments, that drop reflects much more how bubbly Home Depot stock was in 2000, when it had a 46 P/E ratio. Nardelli doubled Home Depot profits; improved shareholder returns by repurchasing 10% of outstanding stock; quintupled dividends; increased the net profit margin; and the stock has been very profitable for those who bought it in late 2002.)

But, with a very few exceptions not relevant to this discussion, no one was forced to be a Home Depot shareholder. Someone could anticipate that large sums of shareholder money would eventually be paid to Nardelli on the back end when he was first hired. If one disapproved of the pay package Nardelli was destined to receive, there was a very easy solution: divest the stock, and invest in another company that did not bid on former GE executives to become their CEOs. (Of course, then one would have missed the huge profits in the run-up on Boeing stock.) Investors who think that GE experience created magical CEO abilities worth a premium in the marketplace were free to invest in Home Depot. Home Depot stock went up over 20% in December 2000, the month that Nardelli was hired: it would have been easy to sell the stock if one disapproved of the generous employment contract while the market basked in the glow of the hiring. No one paid Nardelli a dime who didn't agree in advance to pay him that dime.

Do I think Nardelli was worth hundreds of millions of dollars? Probably not: it's hard to believe that there weren't Moneyball candidates for the CEO position who were capable of equal- or higher-quality results for much cheaper. I also don't think Carlos Lee is worth $100 million, but the fact that the Houston Astros blew that sum on a mediocre outfielder doesn't demand federal regulation, as opposed to, at worst, mocking those who made those decisions.



Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.