Common Sense
Rewarding C.E.O.’s Who Fail
Associated Press
Léo Apotheker, fired by Hewlett-Packard, will walk away with $23 million for 11 months' work.
By JAMES B. STEWART
Léo Apotheker’s short, turbulent reign as the chief executive of Hewlett-Packard was by nearly all accounts a disaster. The board demanded his resignation, and if ever there was a case for firing someone for cause, this would seem to be it.
Just three years after the financial crisis generated widespread public outrage that Wall Street chief executives walked away with hundreds of millions in bonuses and other compensation after driving their companies into insolvency and plunging the nation’s economy into crisis, multimillion-dollar pay for failure is flourishing like never before. H.P. is simply the latest example, albeit an especially egregious one. It’s hard to fault Mr. Apotheker for taking what H.P. offered. But among the many questions shareholders should be asking the board is why it approved an employment agreement for Mr. Apotheker that arguably made it more lucrative for him to fail — and the sooner the better — than to succeed.
“It’s a great irony that spectacular failure is rewarded lavishly,” John J. Donohue, a professor at Stanford law school and the president of the American Law and Economics Association, told me. “It is a terrible mistake to set up a structure where the top person walks away with millions even if the company is laid waste by their poor decision-making, yet this is what’s happening. It’s a shocking departure from capitalist incentives if you lavish riches on the losers.”
He added that it’s especially shocking at H.P., which fired its previous two chief executives before Mr. Apotheker and had to make multimillion-dollar payments as a consequence. “After what H.P. had gone through, you’d think the board would have been on their toes rather than asleep at the switch again,” he said.
Experts said Mr. Apotheker had what amounts these days to a fairly standard termination agreement for a chief executive. In the event he was terminated for “cause,” his contract, a summary of which H.P. filed as an exhibit to a Securities and Exchange Commission filing, provided a cash payment of twice his base pay (of $1.2 million, or $2.4 million); his earned but unpaid bonus (his “target” bonus was $2.4 million a year); any accrued but unused vacation — and “no further compensation.” That would add up to a maximum of about $4.8 million. But he wasn’t fired for cause.
In the rarefied world of high-level executive compensation, “cause” is a term of art that long ago parted company with standard usage. “Cause is a foreign concept to the general public, at least when it appears in executive employment contracts,” observed Mike Delikat, head of the global employment practice at Orrick Herrington & Sutcliffe, who said he’d litigated many such provisions on behalf of major companies. “Most people are employed at will, which means they can be fired any time and for any reason unless the reason is an unlawful one like discrimination. But ‘cause’ is a negotiated term. It is often very narrow, limited to things like conviction of a felony or a complete failure to perform material duties under the contract.”
Mr. Apotheker’s contract wasn’t quite so narrow (“I’ve seen worse,” said Mr. Delikat). But it did narrowly construe “cause” to mean only “material neglect” of his duties or “conduct” that he “knew or should have known is materially inconsistent with the best interest of, or is materially injurious to, H.P.” While such clauses may be open to interpretation, the board appears to have given no consideration to firing Mr. Apotheker for cause, which might be difficult to establish considering the board backed his various strategic initiatives, however ill-fated they proved to be.
Once Mr. Apotheker was being terminated “without cause,” a clause in his agreement kicked in that accelerated the grant of 200,000 shares of “sign-on equity grants” and another 76,000 restricted shares and 608,000 “performance-based restricted units” as “long term incentives.” You’d think that long-term incentives would no longer be necessary or appropriate for someone who’d just been fired, and that anything “performance based” would be rendered moot by the plunge in H.P.’s stock price during Mr. Apotheker’s tenure. On the contrary. Thanks to his termination, “all restrictions shall be released” on the grants of restricted stocks, and the supposedly performance-based awards would assume that he was employed “through the end of the performance period,” according to his contract summary.
In an S.E.C. filing this week, H.P. said that 424,000 of Mr. Apotheker’s performance-based rewards remained in effect, and that payment would depend on whether H.P. met certain performance goals. So Mr. Apotheker could be awarded even more as a result of someone else’s performance. H.P.’s board even kicked in some additional benefits that weren’t in his contract, like relocation expenses and up to $300,000 to cover his loss on the sale of his California residence.
Bear in mind that Mr. Apotheker had already been paid “relocation benefits” of $4.6 million and a signing bonus of $4 million on Nov. 29 of last year, so his payments — almost $10 million after he signed on and just over $13 million to leave — would total at least $23 million for 11 months of work. An H.P. spokesperson declined comment on Mr. Apotheker’s contract, but said, “We credit Léo for having made important contributions to the company’s future. We appreciate his efforts and service to H.P.”
Compensation experts say that the primary argument for such lavish termination guarantees is to lure top executives from secure, highly paid positions elsewhere. “From the executive’s perspective, there’s a risk they may not meet the board’s expectations in an extraordinarily challenging business environment,” Mr. Delikat said. “They feel they should be compensated if the board determines they have not performed because they gave up a stable and highly paid position in a company where they had been successful. These top executives are the ‘A-Rods’ of corporate America. Everyone wants star talent. When they jump to a new team, they want what amounts to a ‘no cut’ provision, unless they are paid out on their contract.”
Mr. Delikat readily concedes that Mr. Apotheker may not have been an Alex Rodriguez, and “that the rationale may not apply to him,” since he’d been fired from his previous position as chief executive of the German software giant SAP (after just seven months). Mr. Donohue goes even further: “There’s absolutely no empirical support for the idea that people won’t move unless they get a lavish severance agreement. There may be some exceptional talents that need to be coaxed, but the idea that most executives need this is unbelievable. If you’re a top executive in Silicon Valley, to become the head of H.P., the largest computer company in the world, is a coup. You don’t need to be paid for failure.”
Most people strive to better their circumstances by taking chances, often changing jobs without any guarantees that should they fail, they’ll be paid anything — let alone lavishly. That, as Mr. Donohue points out, is the essence of capitalism. “Imagine if you were applying for a job, and you said, ‘I want to make it clear that if I do a terrible job, I want to walk away with a ton of money.’ Do you think you’d get hired? Yet that’s now standard practice in negotiating executive compensation.”
Can anything be done? To its credit, H.P.’s board seems to have learned a lesson. Its agreement with its newly named chief executive, Meg Whitman, calls only for payments of 1.5 times her annual salary and bonus if she is “involuntarily terminated without cause.” Oswald Grübel, who resigned as chief executive of the Swiss-based global bank UBS a week ago in the wake of a rogue trading scandal, not only accepted responsibility, but had the decency to walk away with a relatively modest termination payment of six months’ salary and some options valued at 1.5 million Swiss francs ($1.66 million) — no restricted stock, no bonuses and no accelerated payments.
But no one I spoke to held out any hope that others would emulate him, or that the system would change anytime soon. Clearly corporations and their boards aren’t doing anything; one of my colleagues at The Times, Eric Dash, reported this week on seven chief executives in addition to Mr. Apotheker who had recently left with multimillion-dollar severance packages.
“The system is a mess; it’s a joke,” the compensation expert Graef S. Crystal told me. Yet Congress has shown scant appetite for remedying even the most egregious practices.
I have a simple proposition: in all employment contracts, “cause” should mean the standard dictionary definition (“sufficient reason,” according to Webster’s). It shouldn’t have a specialized, absurdly narrow meaning only for top executives, such as conviction of a felony. In my experience, when language is seriously distorted — when Wall Street analyst ratings of hold actually mean sell — it’s a sign of trouble.
And the termination benefits extended to top executives should be the same for all employees. I suspect that would swiftly end the practice of bestowing multimillions on those at the top who fail. In my experience, most people don’t resent high pay for outstanding performance. But lavish termination payments ought to be anathema to anyone who aspires to a just society. It’s merit, and not failure, that should be rewarded.
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