The discount CEO

Posted by Marc Hodak on May 21, 2007 under Executive compensation | Comments are off for this article

I guess it makes sense for a retailer to be the first to experiment with a bargain CEO. Sharper Image took a step advocated by many governance mavens to improve their bargaining position in negotiating for an outside CEO. They avoided identifying a single “gotta have” person, then trying to negotiate pay from a position of potentially failing to get him or her. As Pearl Meyer noted, this creates a situation where if “they find the person they think will make a difference, the cost is immaterial.” Instead, Sharper Image decided to take the pressure off themselves by identifying back-up candidates in case their first choice got too demanding. Fine so far, but then they looked at the sticker and got all Jack Benny.

Their compensation consultant conducted a peer analysis to determine that the board needed to be prepared to pay a target salary plus bonus of $1.5 million plus 150,000 options per year to attract current or past CEOs identified by the board’s search firm. Even though this was not much less than the current CEO was making, all things considered:

The potential price tag dismayed board members. “Everybody raised their eyebrows,” remembers Morton E. David, chairman of the nominating committee and former CEO of Franklin Electronic Publishers Inc. “Nobody was happy with the numbers” amid Sharper Image’s declining revenue, he explains. “Money was an issue. For some people, it was the prime issue.”

Directors decided to seek alternative candidates who had not run public concerns, and likely would cost less. Mr. David says they gave Mr. Levin [the interim CEO] authority to offer such a candidate “materially less” than a seasoned public-company chief would have demanded.

So, the board decided that brand-name was too expensive, and decided to take a chance on discount–someone less “seasoned.”

Now, I’m not one to automatically exclude the less obvious candidates for any position, but to do so for the CEO position based on price? To save $700,000 per year? Sharper Image has a $170 million enterprise value. A CEO that could bring their return on capital up to the industry median, where they were just a few years ago, would generate over $50 million per year in extra EBITDA, easily tripling the company’s market value. A merely “very good” CEO, one able to return the company to profitability, might generate a 50 or 100 percent return–not bad, but not 200 percent. In other words, the potential difference between the best and next best CEO could easily be hundreds of millions of dollars. And they’re concerned about $0.7 million per year?

Admittedly, no one can predict which candidate in the field would turn out to be the best. There is no guarantee that the guy who costs the most would actually be the best. There are many qualitative characteristics a board should consider before paying top dollar for someone who might not be a good fit, regardless of their track record. But to eliminate contender because of a cost that could easily be a fraction of value added does not seem like good governance to me.

No one can predict how this will all turn out, of course, but for what it’s worth, Sharper Image’s stock dropped 1.5 percent upon the release of this story (the market was flat), shedding about $2.5 million in market value. That would be net of the cost savings on the CEO.