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The real cost of firing a CEO: showing top execs the door can be an expensive proposition — and not just because of hefty severance packages - Corporate Governance - Statistical Data Included

Chief Executive, The, April, 2002 by Pamela Mendels

When G. Richard Thoman resigned from Xerox Corp. after only 13 months as CEO in May 2000, the struggling photocopier company reached deep into its pockets to see him off.

Thoman had left under pressure from dissatisfied board members of the Stamford, Conn.-based company, which was reeling from a stock price nose-dive, a botched sales-force reorganization and back-office consolidation that left the company in chaos. A $13 million deferred compensation plan payment was only one feature of his severance package. Then 55, Thoman also received a bonus of $376,000, a $200,000 payment in place-of-life insurance, office assistance for two years and an $800,000 annual payment for life, according to SEC filings.

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Thoman's multi-million-dollar send-off-and he had supporters for his decisions during his tenure -- was hardly unique. Ample packages for departing CEOs are so common that they barely merit headlines anymore. But huge as they can be, such payments are often the most obvious costs that corporations incur when an out-of-favor chief leaves. In no way are they the only costs. A company pays dearly when it loses prized talent and when worthy projects are left on drawing boards.

To be sure, boards of directors rarely consider dismissing a CEO without good reason, and nine times out of 10 they act wisely, says Charles M. Elson, director of the Center for Corporate Governance at the University of Delaware at Newark. Still, he warns, "a termination is never without costs," and sometimes, he says, the expense can be substantial.

That observation rings with particular resonance today as CEO firings have become almost humdrum. Jacques Nasser, former CEO of Ford Motor, and Linda Wachner of Warnaco, an apparel company, are among the latest members of a swiftly growing club. In the early 1970s, about 10 percent of CEOs left large, publicly traded companies under pressure, according to a recently published study in The Journal of Finance. By the early 1990s, that figure had jumped to 23 percent, says Mark R. Huson, a University of Alberta at Edmonton finance professor who is one of the study's authors.

Some of the costs of firing a CEO are easy to measure. "Golden parachute" severance guarantees, for example, are now standard in CEO employment contracts. Unless the chief has been convicted of a felony or engaged in other beyond-the-pale behavior, the company usually has to pay up, says Edward C. Archer, managing director at Pearl Meyer & Partners, a New York-based executive compensation consulting company.

A typical severance package starts by giving the departing boss twice his or her annual salary and bonus, but some agreements provide for much more. After Jill Barad resigned at the board's urging from toy maker Mattel in February 2000, she received five times her annual salary; forgiveness of a company loan to buy a home; a $3.3 million payment to offset certain taxes; and an assortment of other features, including temporary security services.

After paying the departing CEO, companies must cough up to find a replacement. Gerard R. Roche, senior chairman of the executive search firm Heidrick & Struggles, declines to say how much he charges clients, but confirms that the industry average is about one third of the incoming CEO's first-year total compensation which could include salary, bonus and stock options.

How much can that come to? One of Roche's own headline-grabbing projects in 2000--matching the former top General Electric executive Bob Nardelli with The Home Depot--is likely to have cost more than $1 million. An employment agreement contained in a quarterly filing with the Securities and Exchange Commission spells out that Nardelli is entitled to an annual base salary of at least $1.5 million and a bonus of at least $3 million.

Other measurable costs stem from the effect of the CEO's departure on interests outside the company. Suppose, for example, the executive had pushed for a merger or acquisition that faltered after he or she left. Sometimes, the company left at the altar is entitled to compensation for the unconsummated union, notes Dan Ciampa, co-author of Right from the Start: Taking Charge in a New Leadership Role.

A stable stock price can be another casualty. In a recent study looking at CEO turnover at large public companies from 1979 to 1995, three researchers found that stock price volatility was up to 25 percent higher at companies where the chief's exit was forced than at companies where the CEO left voluntarily. Further, this higher level of volatility persisted on average for two years after the departure. Wide stock-price fluctuations, in turn, can adversely affect all kinds of corporate matters, says Jay Hartzell, co-author of the study and assistant professor at the University of Texas' McCombs School of Business in Austin. A potential merger partner, for example, might insist on payment in cash rather than stock because of the uncertainty of the stock price.

Personnel in peril

Unexpected CEO departures can have subtler, but no less damaging, effects as well. For example, there's the impact on employee morale, especially among senior managers, who may wonder if theirs will be the next head on the chopping block. A spirit of innovation and willingness to take risks can disappear for a while, too, as employees wait to see what's expected of them in the new regime. And boards can create a particularly sticky situation when the CEO does not leave altogether, but is diplomatically set aside in another role at the company. Richard Brenner, CEO of The Brenner Group, a company in Cupertino, Calif., that finds executives to fill temporary jobs, recalls placing an interim CEO at a software company whose previous CEO had been given another title. The ex-chief retained the loyalty of the rank-and-file, however, and the result was a successor who would find his own directives being countermanded by his predecessor.

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The real cost of firing a CEO: showing top execs the door can be an expensive proposition — and not just because of hefty severance packages - Corporate Governance - Statistical Data Included

Chief Executive, The, April, 2002 by Pamela Mendels

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