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The Grass Isn't Always Greener When the CEO Departs


July 23, 2013

One of the most challenging events for a board is the departure of a company’s CEO. A study by Booz & Company found that 14.2 percent of CEOs at the world’s 2,500 largest public companies were replaced in 2011. This rate of turnover implies that a typical CEO is on the job for about seven years. Of course, some of these CEOs left voluntarily, and others were fired. Two recent incidents of CEO turnover highlight interesting issues related to corporate governance.

Let’s first examine the recent announcement that Christine Day, the CEO of athletic apparel company Lululemon Athletica, was stepping down. In response, the company’s stock price dropped over 17 percent, which translated into a decline of about $2 billion in market value. Clearly, the market interpreted her departure as bad news. This is not surprising, since Day led the company to impressive gains in revenues, earnings and stock returns over her five-year tenure as CEO. On a related note, her total compensation in 2012 was reported to be just under $4.3 million; this appears to have been a bargain, if the market estimates her value at over 400 times that amount.

Lululemon made the headlines earlier in March of this year, when an apparent flaw in product design caused the company to recall yoga pants. The sheerness of the fabric resulted in “too much information” on the part of the wearer.  The recall cost the company over $60 million and resulted in the resignation of their chief product officer. Interestingly, by mid-April, the stock fully recovered from its drop in response to the recall, and then added another 10% or so prior to Day’s resignation. Why? Lululemon did something right, by acknowledging the problem and addressing it immediately.

Question #1: Although Day’s departure appears to be unrelated to the product recall, the firing of the chief product officer was no coincidence. In the current world of nonstop news and close scrutiny, how does a board determine when a firing is justified, versus when it appears to be a scapegoat-seeking witch-hunt? Where is the line?

Another example of CEO termination, which also occurred within the apparel industry, was the firing of George Zimmer, the founder of Men’s Wearhouse. The stock of MW dropped about 3 percent on the announcement of his termination.  In this case, the departure was the result of a disagreement between the CEO and the board. In an open letter, Zimmer accused the board of focusing on short-term results, and stated that the board’s behavior “suggests that the directors were more concerned with protecting their entrenched views and positions” than in maximizing long-term shareholder value. Zimmer owns less than 4% of the company he founded, so he is not in a strong position to mount a challenge without additional financial backing. This illustrates a classic governance and control problem faced by founders: growth requires capital, and external equity dilutes their ownership. In 1998, Zimmer owned over 12% of equity in MW, and his ownership was surely even higher at the company’s founding.

Question #2: How should a founder approach the question of growth? What is the appropriate balance between raising capital and diluting ownership? How can a founder assess the long-term impact of financing decisions?

Time will tell how the situation at Men’s Wearhouse will play out. For now, George Zimmer doesn’t like the way it looks — I guarantee it.

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