THE SKY-HIGH CLUB.(The Talk of the Town)

Even the most jaded observer of American corporate culture had to blink when, earlier this month, Home Depot's board of directors handed the company's C.E.O., Bob Nardelli, more than two hundred million dollars after pushing him out of his job. Nardelli had not delivered for shareholders: Home Depot's stock price went down about six per cent during his tenure. And, while his operating performance was actually quite good, he would have made a lot of money even if it hadn't been: most of his contract was guaranteed, and, when he had a hard time meeting a particular target for his bonus, the board generously substituted an easier one.

The size of Nardelli's severance was startling, but his "heads I win, tails you lose" arrangement is far from unusual in corporate America these days. For all the talk of restraining C.E.O. pay, most compensation committees remain what Warren Buffett once called them--"tail-wagging puppy dogs." At some companies, this is simply because the C.E.O. has packed the board with cronies. But at Home Depot Nardelli did not pick the board members, and most of them were what are usually called independent directors--ones who don't work for the company or do any business with it. Even when an independent board negotiates a C.E.O.'s contract, however, the directors are often, in a sense, negotiating with themselves. Of the ten independent members of Home Depot's board, for instance, eight are or have been C.E.O.s. Since C.E.O. pay is often driven by comparisons between companies, directors have a certain interest in keeping executive pay high. Furthermore, the salaries keep escalating because, board members argue, there just aren't enough good C.E.O. candidates out there. There's no evidence that this is actually the case, but who is more likely to feel that good C.E.O.s are indispensable and rare than other C.E.O.s?

A more complex problem lies in the nature of the social networks that bind directors and executives together. Home Depot has an exceptionally well-connected board. On average, its directors sit on two other outside boards, and the compensation-committee chairman sits on four. Connections are often beneficial--they insure that people are well informed, creating opportunities for new business. Unfortunately, the more connected board members are, the likelier they are to overpay for executive talent. In some cases, which economists call "interlocking" directorates, this is straightforward: I sit on your board and you sit on mine, and we both have an incentive to be generous. Sure enough, several studies have found that companies with interlocking directors pay C.E.O.s significantly more. Surprisingly, though, connectedness remains important even when the links are not direct. A study of S. & P. 500 companies, by Amir Barnea and Ilan Guedj, finance ...