Charlie Munger conducted an interesting interview recently with the Los Angeles Times in which he was asked about his thoughts on executive compensation. As Warren Buffet's right-hand man, he has a lot of experience in both the world of investments and management. In the interview he expresses the many problems with executive compensation and the efforts being made to curb it. In the end, he admits that it may be unsolvable.

Here is the text from the interview:

Q. How did CEO compensation get so out of whack?

A. Some of the worst sinners are compensation consultants. I have always said that prostitution would be a step up for these people. "Whose bread I eat, whose song I sing."

It isn't that the CEOs are such terrible people, it's that the system, with its envy-driven compensation mania, has developed to a place where it brings out the absolute worst in good people.

Q. What about corporate directors? There's been a move to pay them more and try to make them more accountable. Would that help?

A. Paying directors more is going to make the compensation excesses harder to fix. The more you pay directors, the more the directors are going to want to pay the CEO. Putting more duties on the directors and giving them more money is like trying to extinguish a fire by pouring gasoline on it.

If I were running the world, I would not allow directors to be paid at all. I would make directors be exemplars and serve just as they serve on the boards of Harvard and Yale.

Q. What about putting limits on how much a CEO can be paid?

A. Congress tried to do that in 1993 by passing a prohibition on pay of more than $1 million. You can see how effective that was. I think you can assume that any law will be promptly evaded.

I don't see blanket limits as a good idea because it's not the dollar amount that's a problem. No one is the least mad when Tiger Woods earns $18 million. They figure he's earned it. What makes CEO pay so difficult is that only a few of the people who are earning these huge amounts are actually worth it. Everyone else figures they have to keep up, or recognize that their guy isn't as good. Who wants the recognition that the company down the street has a remarkable CEO, but we have a mediocre klutz?

I like the idea of high pay for people who are really worth it. The problem is that most of them are not. Every mediocre employee who rises through to the ranks to become CEO thinks he should retire rich. It's crazy.

Q. What is the solution?

A. The reason this has grown to such an extreme degree is that it is so hard to do something about it. It's like autocatalysis in chemistry--it's a reaction that just feeds on itself and keeps ballooning. If more executive compensation issues required shareholder approval, I think that might dampen some of the excess. That has been suggested, and there is a lot of discussion around that subject. But there are also a lot of malcontented nuts in the world, and you wouldn't want the malcontents to get too much power. I don't know. Just because something is a serious problem doesn't mean that you can fix it. There's an element of tragedy in this because some very good people are acting in some very bad ways.

Q. You don't seem to have much hope that things will change.

A. There's always hope. But, frequently, when things are very excessive, the correction is very painful. Korea had cowboy capitalism, with low fiduciary standards, and things got worse and worse. They had to go through a total collapse and a huge scandal, but it's now largely fixed.

I would like to see CEOs act as exemplars. I would like them to realize that they are setting an example when they are setting their own pay. But CEOs are very pompous and they assume they are right about everything. Saying that to them would be a total waste of breath.

I don't want to spend my life nattering against my friends' pay. But if you think there's an easy solution, you don't understand the problem too well.

We have had an enormous improvement in the garden variety of corporate fraud in America, in pretending to earn money that you did not. But the next level of reform will be much harder. In my opinion, not enough executives have gone to jail.

Home Depot's ex-CEO Robert Nardelli has become a media target after he resigned, revealing his 'golden parachute' amounting to over $210 million. This pay came in addition to his existing $300 million in compensation, which he received during the course of his tenure at the Home Depot. Meanwhile, shareholders suffered through sub par performance when compared to Lowe's (Home Depot's main competitor). Most investors fail to realize that this type of compensation is actually quite common in corporate America. Here are a few of the most notable instances of over-compensation in the past:

Pfizer's Henry McKinnell left the company with a $213 million pay package with an $83 million pension. This came despite shareholder losses amounting to over $137 billion during his tenure. Sovereign Bank's Jay Sidu left the company with over $44 million after being removed via a long proxy battle with shareholders. Many other CEOs were removed from their posts with tens of millions of dollars of compensation, from companies like Morgan Stanley (Philip Purcell), Viacom (Tom Fretson), and Hewitt-Packard (Carly Fiorina).

While there are many highly paid CEOs that deserve the pay they receive, there are countless others that profit handsomely while shareholders suffer through losses. While new executive compensation disclosure rules should help increase transparency, there is still a lot of work left to do before we see executive interests truly aligned with shareholder interests.

The Home Depot, Inc. (NYSE:HD) surprised investors today when CEO Robert Nardelli announced his "mutually-agreed" resignation. The news comes after shareholders expressed concern with the company's lackluster performance and excessive executive compensation. Happiness over his resignation was quickly quelled, however, when investors discovered his $210 million golden parachute that came in addition to his already excessive $300 million in compensation during his tenure. The future also remains uncertain for shareholders, as the board and company plans remain intact. Leading the shareholder rebellion to institute real change is Relational Investors - an activist hedge fund that is now reportedly considering a proxy battle in order to institute change. Whether or not this takes place remains uncertain; however, the battle for shareholders is only beginning at the Home Depot.

View Nardelli's Compensation

Apple Computer, Inc. (NDAQ:AAPL) released its 10-K annual report today after delaying it while the company investigated irregularities with the company's stock option grants. In the explanatory note in the beginning of the filing, Apple noted that while the company would face an $84 million charge related to the stock option grants, Steve Jobs and other senior executives would not involved in the scandal. Al Gore, chair of the special committee, said, "The board of directors is confident that the company has corrected the problems that led to the restatement, and it has complete confidence in Steve Jobs and the senior management team". The company found that while Jobs was aware of, or recommended the selection of, some favorable grant dates, he neither benefited financially from them nor "appreciated the accounting implications" of his actions. Consequently, Steve Jobs' and other executives appear to be safe, and the company's stock has rebounded 5% in today's trading.

Comstock Resources, Inc. (NYSE:CRK) CEO Jay M. Allison exercised 45,000 options yesterday in a transaction worth over $1.39 million. According to the form 4 filing with the SEC, Allison exercised the 45,000 options at $3.88 per share and then immediately sold them at $31.32. The filing also noted that he gave away 25,000 shares as a gift. Comstock's stock has been on a bull run since October, rising from $26 to $33 before retracing slightly over the past few sessions. Sometimes insider selling is seen as a lack of confidence in management; however, in many cases it is simply timely portfolio diversification for executives.

Comstock Resources, Inc. (Comstock) is engaged in the acquisition, development, production and exploration of oil and natural gas. The Company's oil and natural gas operations are concentrated in the east Texas/north Louisiana, southeast Texas, south Texas and Mississippi regions. In addition, the Company has properties in other regions in Arkansas, Kansas, Kentucky, New Mexico and Oklahoma. The Company owns 48% of Bois d'Arc Energy, Inc., which conducts exploration, development and production operations in state and federal waters of the Gulf of Mexico.

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The U.S. Securities and Exchange Commission caused some controversy yesterday after it reversed an earlier decision to force executives to disclose the face value of stock grants as they are given to executives. This rule is one of many that came as the result of an executive compensation overhaul earlier this year. Specifically, this new change, going into effect immediately, allows companies to disclose only the portions of the stock grants that are usable by executives. This allows companies to dispense stock grants to executives that will not be disclosed to investors until they are exercisable. While many people have criticized this move, SEC Chairman Christopher Cox insisted that this rule was actually what the commission intended when it first adopted its new executive compensation policies. The only two major problems seen with the new rule were policies dealing with retirement and resignations. When executives retire, their stock grants are immediately expensed at full value. This means that those retiring executives may appear overcompensated, when in fact they are on par with others. Meanwhile, if an executive leaves a company before the full value of their options vest, then the full amount would be reported when there was actually nothing received. While the SEC noted these problems, they argued that these new policies needed to be pushed out before early 2007, when many companies will be reporting under the new regulations.

Pfizer, Inc. (NYSE:PFE) revealed today in an 8-K filing with the SEC that its former CEO, Henry A. McKinnel, could receive more than $180 million in retirement benefits after he leaves the company in February. This news comes shortly after the ex-CEO was forced into early retirement in part due to investor concern over his excessive compensation benefits. These benefits include $13,278,518 in supplemental savings; $41,769,089 worth of deferred performance-contigent shares; $22,862,334 in deferred bonuses; and, a lump sum pension totaling $82,305,823. While the executive has served the company for 35-years, investors have been critical of executive compensation as the stock's price has suffered in recent months.

Home Depot (NYSE:HD) may find itself in more trouble soon after Relational Investors announced that it wants an independent committee appointed by the board to evaluate the company's management and direction. This move comes after the company has already faced widespread criticism for its executive compensation policies and subpar stock price. According to the letter to management:

"We believe the Company's board of directors is presented with enormous responsibility and opportunity to reverse the Company's chronic inferior stock price performance experienced since 2000. We attribute this performance to deficient strategy, operations, capital allocation, and governance.

We are planning an advocacy program designed to spur positive action to address these deficiencies. In that vain, under separate cover we have submitted the attached Notice of Shareholder Proposal. This notice was timed to satisfy the deadlines set forth in the Company's Bylaws.

We would like to meet with you and representatives of the Company's board of directors at the earliest convenient time. At that meeting, we would like to discuss this proposal and other steps we are considering, which include nominating one or more directors for election to the Company's board of directors at the Company's 2007 Annual Meeting of Shareholders." (Read More)

The company immediately rejected the request, however, in it's response:

"The Home Depot(R), the world's largest home improvement retailer, announced that it has received notice from Relational Investors, LLC, an investment firm, that Relational intends to submit a proposal at the next annual meeting of shareholders of The Home Depot. The proposal will request that the board of directors of The Home Depot appoint a special committee of independent directors to evaluate the strategic direction of the Company, the performance of management and strategic alternatives for the
Company. Relational notified the Company that this proposal is part of an "advocacy program" planned by Relational with respect to the Company, that Relational plans to solicit proxies to have its proposal adopted, and that Relational may nominate one or more directors for election at the 2007 annual meeting. In addition, Relational has requested a meeting with The Home Depot's chief executive officer, Bob Nardelli, and members of the Company's board of directors.

The Company said that its board of directors recently completed a strategic review and that it will oppose the resolution and proxy solicitation that Relational intends to pursue.

The Company also said today that its board of directors unanimously supports the management team and its plan to continue enhancing value for all shareholders through the execution of its current strategy. During the past six years, the Company has delivered strong financial results. Sales at The Home
Depot have nearly doubled, from $45.7 billion in 2000 to $81.5 billion in 2005, and earnings per share have increased more than 140 percent in the same period. From 2001 to the present, the Company has invested more than $29 billion back into the business, through capital and acquisition spending, while also returning over $20 billion to shareholders in the form of share repurchases and dividends, including two dividend increases of 50 percent each this year. This includes, most recently, issuing $5 billion in debt and announcing a $3 billion accelerated share repurchase. Since 2002, when the Company's share repurchase program began, The Home Depot has repurchased approximately 450 million shares, or 19 percent of its outstanding shares. This demonstrates the Company's balanced approach to capital allocation through business investments and cash returned to its shareholders.

The Home Depot has advised Relational that it will arrange a meeting shortly after the first of the year to discuss its concerns, consistent with The Home Depot's policy of engaging in an open and direct dialogue with shareholders.

Relational indicated in its notice that it has recently become a shareholder of The Home Depot. Relational further indicated that its various affiliates own approximately 12,966,338 shares of The Home Depot's common stock, or roughly 0.6 percent of the common shares outstanding. The Home Depot's correspondence with Relational is attached." (Read More)

In an interview with the Associated Press, Relational Investors manager Whitworth, said: "There is no accountability to shareholders. Since Nardelli was made president in 2000, he’s taken hundreds of millions in compensation, but the company’s return to investors has been almost nothing. There needs to be someone making sure management is watching the store." And it's true, while the CEO has received $240 million in compensation this year, the company's stock rose merely 3%. Moreover, the company's main competitor, Lowe's, increased over 170% during the same time period! Clearly change is needed here and Relational Investors may be the best bet for investors.