When Bruce Karatz departed in November 2006 as the CEO of KB Home, after an internal investigation found he had backdated his own stock option grants to boost his compensation, he was the highest paid among 11 major homebuilders, including those that are bigger and more profitable.[1] 

He also was one of the highest-paid chief executives in the United States and received the second-largest pay increase among 83 CEOs of large companies who held their job over the 10-year period between 1995 and 2005.[2] Since 2001, he has made nearly $166 million from exercising stock options.[3]

The internal investigation into the backdating of stock options at KB Home blamed Karatz and Gary A. Ray, the head of human resources, for altering the dates of grants between 1998 and 2005.[4] 

As a result of the backdating, the company said it would need to restate more than three years of financial results and incur an additional compensation expense of more than $41 million.[5] The company also is under criminal investigation by federal prosecutors,[6] in addition to a formal investigation by the U.S. Securities and Exchange Commission.[7] 

The terms of Karatz’s employment agreement provide for an exit package worth as much as $175 million in severance pay, pension benefits and stock.[8] KB Home also would take care of his legal fees in connection with the stock options investigation, under the terms of his agreement with his company.[9] 

However, KB Home has frozen Karatz’s pay until an agreement is reached regarding how much he actually will receive.[10] KB Home and Karatz have not yet agreed on his right to the outstanding stock options granted to him,[11] and Karatz has so far agreed to give up $13 million in disputed stock option gains.[12] 

It is unclear what the company’s ultimate position will be regarding how much Karatz will get, though investors expect the company to withhold any payment that is undeserved. However, because Karatz’s exit package is part of a legally binding employment agreement, it would be difficult for the company to defend its position if it decided not to pay Karatz.

As a result of the stock options backdating scandal, the company adopted a new policy requiring all stock option grants and their terms to be approved by the board compensation committee[13] and created a non-executive chairman of the board, a chief compliance officer,[14] and did not grant any options to any executives in 2006.[15]

KB Home has made some positive steps in corporate governance; however, it still signed new CEO Jeffrey Mezger to an employment agreement. If Mezger is terminated involuntarily under a change in control, he will receive a potentially sizable golden parachute. 

Though the cash severance portion of his severance agreement is limited to $12 million, the agreement also provides Mezger with accelerated vesting of equity, pension, deferred compensation and performance shares upon a change in control.[16] Moreover, KB Home will continue to provide health benefits, pay Mezger’s taxes that arise from his golden parachute and even pay the taxes that arise from this tax payment.[17]