President Bush addressed executive compensation in his "State of the Economy" speech today, delivered from New York City - the financial center of the world. President Bush reported that the economy has seen a faster-than-expected growth of 3.5% in the final quarter of last year. And while he did not go into any specific new laws that may go into effect, he did at least address the issue of executive compensation. He voiced his opinions on lavish salaries and bonuses for corporate executives, standing on Wall Street to issue a sharp warning for corporate boards to "step up to their responsibilities" and to tie compensation packages to performance. The president also recognized the continuing anxieties about the financial future, despite a string of reports that provide some reason for optimism. Finally, he noted that some workers are being left behind in the booming economy and that the disparity between the rich and the poor is growing, which is an issue that would need to be addressed.

A recent survey put out by PricewaterhouseCoopers and the Corporate Board Member magazine showed that directors still don't have as much control over corporate dealings that many believe is needed to curb super-sized compensation. The 1,300 directors polled indicated that one of the major problems is that in over half of the company's the CEO also served as chairman of the board. However, they also stated that they didn't want change; only 8 percent of the directors said that they would like more boardroom control while 59 percent said that they don't want the chairman position to be an independent director. Surprisingly, more directors were worried about the reprecussions associated with losing their CEO without a succession plan than they were awarding a CEO a $10 million bonus when their company's stock declined for the past two years. Another interesting statistic showed that less than half of those surveyed said their boards use tally sheets to add up total compensation, and about 20% directors said that they didn't know what the CEO would collect if they were terminated, retired or were subjected to a takeover. This lack of confidence and oversight in the boardroom is the reason for many of the problems surfacing with executive compensation. Perhaps this new wave of shareholder activism will help motivate change in a group of people that appears to be so resistant to it.

Executive compensation will be the focus of legislators again tomorrow as the Senate will vote on new tax legislation designed to impose higher taxes on executives, Wall Street banks, and other large companies. The move comes as the Democrat-controlled Congress continues to close loopholes and increase the costs of fraud in order to fund promised tax relief for the middle class and businesses. The new legislation, which will likely become law in a few months, could add up a collective $800 million tax bill for U.S. executives. The money will then be used to offset the costs of more than $8 billion in tax relief for small businesses hit by the upcoming rise in the minimum wage.

Specifically, the new legislation limits the amount of money that can be classified as "deferred compensation". While old laws allowed millions of dollars to be deferred (and therefore tax free), new legislation would limit this amount to just $1 million per year or the average of the previous five years salary (whichever is lower). Any amount above that would incur a hefty 20% penalty. The measures, however, were criticized by business organizations and executive pay consultants, who insist that they will encourage companies to pay higher salaries and bonuses to compensate for the higher taxes. Whether this is true or not remains to be seen; however, this is definitely a story to follow.

Applebees, Inc. (NDAQ:APPB) shares moved down $0.08, or 0.32%, to $24.74 today after Breeden Partners criticized the company's performance and governance and made several recommendations to the company's board of directors in a Schedule 13D/A filing with the SEC. The hedge fund began its letter by pointing out APPB's chronic under-performance compared to other company's in its peer group. They noted Applebee’s performance was 113.3% worse than Darden, 51.7% worse than the S&P 500, and 47.4% worse than the 75th percentile of the casual dining peer group. Next, Breeden pointed out the company's deteriorating fundamentals by showing declining same-store sales (5.2% to -1.0%), declining operating margins (16% to 12.4%), and declining return on capital invested (16% to 10%). The hedge fund noted that many of these problems stemmed from:

1. A fundamentally flawed growth strategy
2. Ineffective leadership during several years prior to Dave Goebel becoming CEO
3. Serious ongoing internal weaknesses in marketing and finance
4. Poor capital allocation policies
5. Excessive overhead costs
6. An ineffective board
7. Poor governance practices of various types
   
8. Inability to make timely decisions of consequence

The letter then moved into an area that is generating an increasing amount of press coverage - executive compensation. Breeden noted that even while the company has lost million in value over the past few years, executives were still granted over $30 million in bonuses! They also uncovered some other highly questionable executive perks, including personal use of corporate aircraft and even the use of shareholder funds to pay executives' personal income taxes. Perhaps the hedge fund said it best:

"We do not believe that shareholder interests are served by turning corporate aircraft into flying limousines for senior executives’ personal vacations. Just as importantly, this practice is inconsistent with the wholesome “neighborhood values” that Applebee’s claims to embody as a company. I am quite certain that most Applebee’s customers would be shocked to find out that a portion of the cost of their meal goes to fly the former CEO back and forth to his beach house aboard a corporate plane ... In addition to not requiring executives to pay any of the costs for their personal travel, the Committee has taken the extraordinary step of requiring shareholders to pay the income taxes owed by the CEO and other senior executives for their aerial vacation tours."

Clearly, there is a disconnect here between management and shareholders that the board is failing to correct. To address these issues, Breeden made several recommendations to the company's board of directors:

1. There should be a moratorium on any incentive compensation for any tier one executives so long as TSR remains negative. Similarly, incentive compensation should be zero if the company remains in the fourth quartile of relative performance in generating TSR.
2. A large proportion of incentive compensation (such as 50-75%) should be based on relative measures of performance compared to the company’s publicly traded casual dining competitors shown on page two of this letter.
3. Growth in average per restaurant royalty fees from franchise operations should be included as an incentive target for relevant executives (including the CEO and CFO), since franchisees represent 73% of the company’s system.
4. The level of free cash flow would be a healthy measure for some portion of incentive opportunities, especially for the CEO and CFO.
5. Minimum relative performance in generating TSR or EVA (such as being in the top 20%) should be a significant part of every executive’s target incentive eligibility. All executives should have a vital stake in the company outperforming its peers.
6. Personal use of corporate aircraft should be banned. Tax gross-up payments made during the last three years should be repaid to the company.
   

Combined, hopefully these changes will be implemented by the company's board of directors and management in order to protect the company's integrity and restore shareholder confidence in the company. The changes could also help the Applebees boost their performance and better motivate management to deliver shareholder value. Meanwhile, investors can track management's compensation and perks at ExecutiveDisclosure.com.

Executive compensation is clearly an issue that will dominate the 2007 proxy season for public companies. Today, a group of institutional investors - comprised of public pension funds, labor funds, asset managers, and foundations - announced a campaign to petition U.S. corporations to give corporate shareholders an advisory vote on executive compensation packages. The group, which was organized by American Federation of State, County and Municipal employees' (AFSCME) Employees Pension Plan and Walden Asset Management, said that it has filed shareholder resolutions at 44 public companies in the United States.

The group of investors are seeking an annual, non-binding advisory vote on the summary compensation table that every corporate board presents to investors in its yearly proxy statement. According to the group, these resolution were only submitted at companies where pay has been excessive or where there has been a misalignment between pay and performance over the past three to five years. Their target companies include the likes of Affiliated Computer Services, Citigroup, Coca-Cola, Exxon Mobil, Home Depot, Jones Apparel, Merck, Nabors, Pfizer, Qwest, Time Warner, UnitedHealth, and Wal-Mart.

The idea is good in theory, but will it work? The group is quick to note that similar resolutions were filed with a half-dozen other companies in 2006 and averaged more than 40 percent support in its first year, including 44 percent support at Sun Microsystems and Countrywide Financial, 43 percent support at Sara Lee, 41 percent at US Bancorp, and 40 percent at Home Depot. Moreover, the group points out that the strategy has already been successfully implemented overseas. The United Kingdom passed a law in 2002 requiring publicly traded companies to give shareholders an up-or-down advisory vote on executive pay, and the U.K. system has successfully restrained the growth rate of CEO compensation there ever since.

Whether or not this plan will work remains to be seen - the vast majority of shareholder resolutions will be voted upon this spring during 2007 stockholder meetings. Until then, investors wishing to learn more about executive compensation and how it relates to a company's performance can visit ExecutiveDisclosure.com, which includes free charts comparing compensation vs. performance, compensation vs. industry compensation, and much more!

Apple Computers (NDAQ:AAPL) co-founder and CEO Steve Jobs has found himself in the spotlight again after sources said he was being questioned by the U.S. Department of Justice and the Securities and Exchange Commission last Thursday. While reportedly "flanked by lawyers", very few details of the event have been released to the public. Steve Jobs was most recently put in the spotlight after reports surfaced that he was granted 7.5 million stock options that were backdated by two months. Apple subsequently confirmed that documents were falsified to create the impression that the options were approved at a board meeting that never took place. While no criminal chages have been filed, this ordeal may prove to be a blow for Apple's iconified CEO who has been a media darling for several years. With more than 200 companies already implicated in the growing options backdating scandal, this is definitely a story to watch closely.

Home Depot (NYSE:HD) shareholders suffered another setback today after their request to freeze Robert Nadelli's $210 million severance package was denied by a Georgia state judge. Moreover, since the court case delayed payment of compensation, the court also ordered that the payment process be sped up. The General Employees' Retirement System for Pontiac, Mich. first sought the injunction in early January after widespread anger over the ex-CEOs generous retirement package.

Meanwhile, Home Depot said that it has tightened its regulations by adding provisions enabling the company to recoup compensation paid to executives that commit fraud. The company also said that it has increased the number of directors on the compensation committee in order to increase scrutiny over executive pay. While many shareholders remain disgruntled over the situation, the company argued that it has learned from its mistakes and instituted measures to prevent future abuse. You can check out the compensation amounts of other Home Depot executives by visiting ExecutiveDisclosure.com.

The Senate approved measures last week aimed at making it more difficult for executives to protect their compensation from creditors in the event of a bankruptcy. These measures came in response to Enron, Worldcom, and other scandals in which executives made away with millions while shareholders lost their entire investment. The new regulations put a $1 million limit on what many highly paid executives can place into a tax-free deferred compensation plan. The new provision, which was passed unanimously with a larger bundle of legislation, will also greatly increase taxes for a number of highly paid executives by millions of dollars over the next 10 years. The measure is part of a dozen other provisions aimed at limiting corporate and executive tax loopholes, after widespread abuses in the corporate world.

A new study on Director influences on CEO compensation (full report) shed additional light on an issue that has been receiving a lot of press.

Here are a few exerpts summarizing their findings:

This paper explores how networks of directors affect CEO compensation. We map the entire network of all board members of S&P 1,500 firms between 1996-2004, and generate network measures that capture several dimensions of these connections. We present strong empirical evidence that firms that have more connected board members, and whose board members are connected to better connected firms award a higher compensation to their CEOs. Controlling for firm size, investment opportunities, industry, and performance, a CEO of a firm which is in the top quintile of connected firms receives a 10% higher salary and a 13% higher total compensation than a CEO of a firm which is in the bottom quintile of connected firms. These results are robust to alternative explanations such as interlocked boards, busy boards, and entrenched boards; they are also robust to the independence of the board, geographic location of the firm, different governance measures, and potentially unobserved CEO or firm characteristics. These results highlight the important role that board networks play in the decision to compensate a CEO. Outlandish goodies are showered upon CEOs simply because of a corporate version of the argument we all used when children: "But, Mom, all the other kids have one."

These results highlight the importance of understanding the intricate ways in which a board of directors makes decisions. We present evidence that the decision regarding CEO compensation is highly affected by a unique characteristic of the board - how central it is in the overall director network.

There are several theories as to why this difference exists. Some argue that this study is evidence of corporate back-scratching - or friends-of-friends networks, while others insist that it highlights a greater move towards self-serving practices. However Dale Oesterle, a law professor at Ohio State University, doesn't think it's that complicated. He believes that it is simply the fact that a board member with a reputation for supporting CEOs gets other jobs; an outside directors that is friendly to CEOs on one board gets selected by other CEOs for other board positions. Regardless, the study does further illustrate the many issues that must be addressed to fix the many problems associated with executive compensation in corporate America.

Caremark Rx Inc.'s (NYSE:CMX) deal with CVS Corp. (NYSE:CVS) unfairly favors company insiders, according to a shareholder lawsuit brought to court by shareholders attempting to block the merger. Shareholders were also infuriated earlier this month when the company's board voted unanimously to block a higher, rival offer from pharmacy benefit manager Express Scripts Inc. (NDAQ:ESRX).

What's so unusual about this deal? Well, first of all, the Caremark-CVS deal has a whopping $675 million breakup fee - much larger than that of many large PE buyouts that took place recently. Secondly, Caremark executives and directors would also receive lucrative director positions at the combined company and could use the company's sale to free themselves from possible penalties and fines from an investigation by the Securities and Exchange Commission into potential backdating of stock options. In fact, CEO Edwin 'Mac' Crawford Thirdly stands to gain $48 million in stock, severance payments and consulting fees as part of the CVS deal. Finally, while the CVS offer is for stock in the company, and the Express Scripts offer was for stock plus a cash premium to shareholders. This is not to mention that the entire transaction took place near the stock's 52-week low, which is highly suspect.

Clearly there are plenty of reasons for concern. Lawyer Stuant Grant said it best: "Our main gripe is this was a sweetheart deal that gave the insiders a lot more than the outsiders". Whether or not this can be successfully resolved depends largely on the sentiment of larger institutional shareholders.

The Walt Disney Company's (NYSE:DIS) CEO Bob Iger revealed a $24.9 million pay package in a recent 14A proxy filing with the SEC. The compensation package included $2 million in salary, a $15 million cash bonus, and a $4.3 million payout from the vesting of performance options. Moreover, Iger also received $666,000 expense reimbursements for auto benefits ($14,400), personal air travel ($67,879), and security ($578,656). And this comes in addition to another $2.92 million in Disney stock options granted during the company's fiscal year. While this package pales in comparison to recent $100 million compensation packages, it still represents significant reimbursed expenses at the cost of shareholders. This is also a significant raise over his previous salary as COO, where he received $9.24 million in salary and cash bonus, $500,000 in restricted stock, 274,241 stock options, and other compensation of $1.02 million. But with Disney stock reaching new highs, he could be worth the price...

Metropolitan Capital urged Cyberonics (NDAQ:CYBX) shareholders to send a message to the company's board today in a press release intended to inform shareholders of its own nominations to the company's board of directors. In the press release, the company outlined the problems facing the company, and why change is necessary in order to unlock shareholder value in the long-term. These problems ranged from lack of board supervision to backdating scandals to poor corporate governance. Here's an overview of the fund's concerns:

"Lack of Board Supervision - The current members of the Board failed to adequately supervise and hold management accountable, and during a period of significant share price underperformance, on multiple occasions, approved compensation and severance packages for the former CEO that we consider to be highly excessive and inappropriate in light of the Company's poor share price performance and the circumstances surrounding his departure.

In contrast to the losses incurred by Cyberonics shareholders over the last few years the former CEO banked tens of millions of dollars in compensation, restricted stock awards and sales proceeds from options grants all thanks to the largesse of the incumbent Board. Even after his forced resignation, under a cloud of suspicion, and in the wake of the options back- dating scandal that has been so costly to Cyberonics shareholders, the present Board authorized a severance package for the former CEO that we value to be worth at least $5 million. Ask yourselves, "how did this severance package serve the shareholder's interests?"

Options Back-dating Scandal - Over an extended period the Company appears to have engaged in a process of options back-dating and spring-loading. The fallout from this malfeasance continues to be felt by the Company and its shareholders. In late November, when the Audit Committee announced the completion of their review of the Company's stock option practices, the Company estimated a charge of $10 million would be taken. The Company trumpeted its ability to "move forward from this point and execute on its business plan." By last week, the charge had increased to over $18 million-but unfortunately this time there was no boastful press release-that information had to be dug out of the Company's 10K, which was finally filed, albeit nearly six months late. As shareholders we must ask ourselves, "is this lack of transparency the best way for the Company to move forward and begin to rebuild its credibility?"

Lack of Good Corporate Governance - The incumbent members of the Board have seemingly been inured to issues of deficient corporate governance and have only reluctantly begun to address those issues under the threat of court action and in the face of our proxy fight.

Shortly thereafter, the Board approved a new five year contract for the former CEO-despite his having nearly three years remaining on his existing contract! The NEW contract increased his base compensation by more than 50% and included a substantial grant of restricted stock. Little more than a year later, the same Board found itself approving the aforementioned $5 million severance package for that former CEO.

Failure to Separate the Offices of CEO and Board Chair- It took nearly six months from the time we first raised the need to separate the posts of CEO and Board Chair with Company representatives for the Company to implement this basic and widely accepted policy of sound corporate governance (and this was only done after the former CEO, who also held the title of Chairman of the Board resigned under the weight of the options scandal).

Failure to Timely Hold Annual Meeting- After months of our petitioning them to do so, the Board only agreed to hold its 2006 annual meeting of shareholders on Feb 1, 2007, in order to settle the suit we filed in the Delaware Chancery Court to compel the Company to set a meeting date."

This information is not only important for Cyberonics shareholders to consider, but also shareholders in other companies. Many of the issues listed are precursors to problems - shareholders should be on the lookout for these warning signs before its too late.

Home Depot (NYSE:HD) investors are asking a Georgia judge to block the retailers from giving a $210 million severance package to former CEO Robert Nardelli. The shareholder group, led by Pontiac (Michigan's employee retirement fund), have filed a temporary restraining order in Superior Court of Fulton County. And this isn't the first time that Pontiac and HD have met in court - back in September, the fund charged that HD executives and board members had backdated options. While the company admitted that this was true, they maintained that it happened before Nardelli's tenure. We will not know the outcome of this case for several weeks; however, it is becoming increasingly apparent that executive compensation is likely to remain a hot-button issue throughout 2007.

Highly paid executives have recently found themselves under increasing pressure from shareholder activism groups, and new SEC regulations only make their situation worse. While some of these executive pay concerns are justified, there are many instances in which high pay is justified. For example, successful CEOs that specialize in turn-around situations typically command a higher premium because of the increased risk. However, many members of the media and shareholder activism groups fail to differenciate these CEOs. This is causing many highly paid CEOs to migrate to private equity controlled companies, according to a report from the New York Times.

Private equity groups can offer these CEOs many benefits that are impossible to obtain at most public companies, but are often much more active in their oversight. For example, many private equity groups prefer to give CEOs a significant stake in the company, which can help them generate real wealth if the company performs well. However, if the company doesn't perform as expected, it is a lot easier for the PE group to fire the executive than it would be to oust them from a public company. Moreover, the executive may not see a lot of monetary gain if the company does not perform well. However, many highly paid executives in the world of public companies have excellent management ability, and therefore are more apt to take on such opportunities. The downside, of course, is that the move may draw an increasing amount of talent from public companies to private companies.

The Home Depot Inc. (NYSE:HD) announced today that it would be reforming its executive compensation procedures after the ousting of the company's former CEO Robert Nardelli. Nardelli was awarded more than $225 million in compensation during his six years with the company. According to an 8-K statement filed with the SEC, "On January 4, 2007, the Board of Directors of the Company approved an amendment to Article II, Section 6 of the Company’s Bylaws to require that two-thirds of the independent directors of the Board approve any compensation granted to the Company’s Chief Executive Officer." Investors are hoping that these changes will help prevent any future problems with executive compensation.

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