Out At Home Depot
COVER STORY PODCAST
In the end it came down to the headstrong CEO's refusal to accept even a symbolic reduction in his stock package. Home Depot Inc.'s (HD ) board of directors wanted their controversial chief executive, Robert L. Nardelli, to amend his whopping compensation deals for recent years. After he pulled down $38.1 million from his last yearly contract, angry investors were promising an ugly fight at the company's annual meeting in May. Nardelli agreed that he would continue to receive a guaranteed $3 million bonus each year, but not more. When board members asked him to more closely tie his future stock awards to shareholder gains, he refused, according to people familiar with the matter. Nardelli has complained for years that share price is the one measure of company performance that he can't control. After weeks of secret negotiations, things came to a head at a board meeting on Jan. 2, leading to Home Depot's stunning announcement the next day that the company and Nardelli had "mutually agreed" that he would resign.
"The board loved him and hates the way this ended up," says a person familiar with the matter. But in a season of growing antipathy toward extravagantly paid executives, the directors felt they had no choice. On his way out the door, however, Nardelli negotiated another jaw-dropper: a $210 million retirement package that assures that he and his former employer will remain at the center of the swirling debate over CEO compensation. Nardelli declined to comment.
The sudden fall of one of America's best-known CEOs illustrates how perilous times have become for corporate leaders. Pointing to gargantuan pay and widespread manipulation of stock options, institutional shareholders are calling for top executives and board members to be held accountable. At Home Depot there were other points of contention: a sluggish stock price in an otherwise rising market and Nardelli's notoriously imperious manner. Judged solely by certain company financial measures, Nardelli, 58, should have enjoyed acclaim for transforming Home Depot from a faltering retail chain into an earnings juggernaut. Driven by a housing and home improvement boom, sales soared from $46 billion in 2000, the year Nardelli took over, to $81.5 billion in 2005, an average annual growth rate of 12%. Profits more than doubled, to $5.8 billion that year.
During the current housing slowdown, however, the financials have eroded. In the third quarter of 2006, same-store sales at Home Depot's 2,127 retail stores declined 5.1%. And with the stock price recently stuck at just over 40, roughly the same as when Nardelli arrived six years ago, he could no longer rely on other sterile metrics to assuage the quivering anger his arrogance provoked within every one of his key constituencies: employees, customers, and shareholders. Nardelli's "numbers were quite good," says Matthew J. Fassler, an analyst at Goldman Sachs Group Inc. (GS ) But "the fact is that this retail organization never really embraced his leadership style." The CEO's reputation also suffered because of Wall Street's affection for Home Depot's smaller archrival, Lowe's Companies (LOW ), whose stock price has soared more than 200% since 2000, while Home Depot's shares declined 6%, according to Bloomberg data. A simmering options backdating investigation at Home Depot hasn't helped matters either, though an internal company review has thus far exonerated Nardelli.
At another time, Nardelli's impressive operating numbers might have saved him. Perhaps he would have learned to temper an ego nurtured during a long career at General Electric Co. (GE ). But in a prolonged season of hostility toward overweening CEOs, the former GE power systems phenom couldn't hold on. "He's not a very humble guy. He seems to have enormous energy but needs to be front and center, and that can wear on the board and the employees after a while," says Edward E. Lawler, director of the Center for Effective Organizations at the University of Southern California's Marshall School of Business.
Before the final fallout over pay, the half-hour that defined Nardelli's tumultuous tenure began at 9 a.m. on Thursday, May 28. That was the time set for the giant home-improvement retailer's 2006 annual meeting in a Wilmington (Del.) ballroom. The assembled shareholders--a sparse crowd of longtime stockholders, employees, and union representatives--expected the usual corporate routine: a presentation on the state of Home Depot's $81.5 billion business, a vote on an assortment of shareholder proposals, and plenty of time for questions aimed at Nardelli and the other 10 members of Home Depot's board.
But something strange soon became apparent: The board wasn't there. Citing time constraints and the imperative of working on important matters back home at Atlanta headquarters, the eminent overseers of Home Depot failed to show up at their own event. That left Nardelli to handle the meeting on his own. He did that in an abrupt 30 minutes. Shareholders were limited to just one question each. A digital clock timed them: One minute, then the microphone cut off.
Nardelli spent much of last spring offering half-hearted mea culpas for the board's disappearing act. "We tried a new format. It didn't work," he said. But then, as the months unfolded, it became clear he had a problem on his hands that he couldn't just summarily dismiss. A chagrined board signaled that it planned to reduce his 2006 pay package, setting the stage for the ultimate Jan. 2 showdown on the stock plan.
Nardelli arrived at Home Depot after losing out in 2000 in a three-way race to succeed GE's legendary Jack Welch. Despite that setback, Nardelli was anointed one of Corporate America's most talented executives, and Home Depot seemed to have scored a big victory by snaring him. Almost immediately, he embarked on an aggressive plan to centralize control of the nation's second-largest retailer after Wal-Mart Stores Inc. (WMT ). He invested more than $1billion in new technology, such as self-checkout aisles and inventory management systems that generated reams of data. He declared that he wanted to measure virtually everything that happened at the company and hold executives strictly accountable for meeting their numbers. All this was new at a relatively laid-back organization known for the independence of its store managers and the folksy, entrepreneurial style of retired co-founders Bernard Marcus and Arthur M. Blank. One of Nardelli's favorite sayings is: "Facts are friendly." He seemed less concerned about people being friendly. Some saw this as a strength. "This guy is maniacal about goals, objectivity, accomplishments within the boundaries of the values of the company," Kenneth G. Langone, the third co-founder of Home Depot, a member of its board of directors, and a strong Nardelli ally, said in a 2004 interview.
But among many of Home Depot's 355,000 employees, especially rank-and-file workers in its orange big-box stores, there was little sympathy as Nardelli dug himself into a deeper and deeper hole. They resented the replacement of many thousands of full-time store workers with legions of part-timers, one aspect of a relentless cost-cutting program Nardelli used to drive gross margins from 30% in 2000 to 33.8% in 2005. As the news of his resignation on Jan. 3 shot through Home Depot's white-walled Atlanta headquarters and reached stores, some employees text-messaged each other with happy faces and exclamation points. "I think that it is being received well. Most people believed that Bob was autocratic and stubborn," says an assistant manager in an Atlanta store who asked not to be named.
Possibly more devastating to his chances of a longer reign at Home Depot, Nardelli alienated customers just as thoroughly as he did employees. Staffing cuts led to persistent complaints that there weren't enough workers in Home Depot's cavernous stores to help do-it-yourself customers. That was a marked change from the era when Blank and Marcus, who started the company in 1978, preached that employees should "make love to the customer." In 2005, Home Depot slipped to last among major U.S. retailers in the University of Michigan's annual American Consumer Satisfaction Index. To try to make amends, Nardelli announced a plan in August to add 5.5 million man-hours back to stores and invest $350 million to spruce up aging outlets. "Bob Nardelli is a smart man, but he doesn't need to be in a high-profile business like retail," says a former top Home Depot executive. "He needs to be in manufacturing, a business that does not have such consumer attention."
Indeed, Nardelli's data-driven, in-your-face management style grated on many seasoned executives, resulting in massive turnover in Home Depot's upper ranks. Former chief marketing officer John H. Costello, a retailing veteran from Sears Holding Corp. (SHLD ), quit in late 2005, and Carl C. Liebert III, the executive vice-president who oversaw store operations, resigned last October. "He would say that you're just not leadership material, you're just not Home Depot material, you're just not the type of person we need," says a former senior executive. Managers who weren't hitting their numbers--"making plan" in Home Depot parlance--were routinely culled, their posts often filled with former executives from GE. That led some bitter insiders to dub the company "Home GEpot." In fact, since 2001, 98% of Home Depot's top 170 executives are new to their positions; 56% of the changes involved bringing new managers in from outside the company.
Nardelli's relationship with Wall Street analysts was often just as frayed. He chafed at their constant focus on "same-store sales," a standard retail measurement that tracks sales at stores open at least a year. In Nardelli's view, same-store sales was an out-of-date metric because Home Depot was diversifying away from being strictly a retail operation. Under his leadership, the company has invested more than $7.6 billion to build Home Depot Supply, which provides services to professional contractors. With $3.5 billion in revenue in the third quarter of 2006, up 159%, HDS accounted for 15% of total Home Depot sales. In Nardelli's view, this successful new arm can't be accurately measured on the basis of same-store sales.
Credit Suisse First Boston (CS ) analyst Gary Balter says Nardelli didn't get along well with Wall Street because he was unhappy with analysts' skepticism of the move away from consumer retailing and into servicing professional contractors. "He blamed a lot of his problems on Wall Street," says Balter. "But Wall Street wanted to see results, and they just weren't there."
The lack of results, at least in terms of an improving stock price, gradually stirred anger among shareholders. Speculation mounted late last year that Home Depot could be a prime target for private equity firms hungry for retail assets. While the company spent $20.3 billion to buy back shares and issue dividends under Nardelli, investors saw almost no gains in their share value. Their frustration was exacerbated by Nardelli's eye-popping pay package: more than $200 million in salary, bonuses, stock options, restricted stock, and other perks over the last six years.
Last month, activist investor Relational Investors sharply criticized Home Depot management and called on the board to form a special committee to review the company's direction and even the possibility of a sale. Relational attributed Home Depot's difficulties to "deficient strategy, operations, capital allocation, and governance." After the announcement of Nardelli's leaving, a source familiar with Relational called the departure "a positive" but added that "the major strategy, capital, and management issues remain. Fresh new blood remains an objective."
It wasn't only activist investors like Relational who had grown tired of Nardelli's leadership. He irritated Atlanta locals, too. In a Nov. 25 letter to Nardelli, reviewed by BusinessWeek, A. Leigh Baier, an Atlanta attorney and Home Depot shareholder, requested that the company's board include a "non-binding" resolution in Home Depot's proxy statement allowing shareholders to vote on whether "they are in favor, or opposed to, the board of directors of Home Depot terminating your contract." Explaining his now-moot proposal, Baier says, "You can't s--t on your employees and deliver" results.
Others remain outraged, even with Nardelli gone. A group of unions whose pension funds own shares in Home Depot plans to challenge his $210 million payout at the annual meeting in May. Meanwhile, in Washington, Representative Barney Frank (D-Mass.), the incoming chairman of the House Financial Services Committee, said in a statement on Jan. 3: "The actions of Home Depot's Board of Directors to simultaneously dismiss Robert Nardelli and provide him with $210 million in severance is further confirmation of the need to deal with the pattern of CEO pay that appears to be out of control."
It's unlikely Home Depot's new chief executive, Frank Blake, will change the Nardelli-driven demand for data and centralized control. A former Deputy Energy Secretary and GE veteran, Blake played a key role in executing Nardelli's strategy at the retail chain. But company executives say he lacks Nardelli's sharp edges and prefers to build consensus rather than dictate orders. While Blake is an unknown to many Home Depot employees, the Nardelli departure was already brightening the mood at some company stores. "It's amazing the reaction of people on my floor. People are openly ecstatic. High-fiving," said an Atlanta store operations manager only hours after the Jan. 3 announcement. "There's a group talking about going to happy hour at noon."
Corporate America hasn't seen the last of Bob Nardelli, however. According to people familiar with the situation, while store workers were celebrating, the former CEO was already fielding calls from private equity firms interested in his formidable operational talents. The bright side for Nardelli in the world of privately owned corporations, of course, is that he won't have to deal with any annual meetings or shareholder questions.
By Brian Grow, with Dean Foust in Atlanta; Emily Thornton, Roben Farzad, Jena McGregor, and Susan Zegel in New York; and Eamon Javers in Washington