WSJ: For Boards, Firing Or Keeping a CEO Can Be Tough Call

Great article from today's Journal:

By JOANN S. LUBLIN
October 22, 2007; Page B1

Citigroup Inc.'s directors stood by Chief Executive Charles Prince last week as the nation's largest bank reported a 57% drop in third-quarter earnings. But the expression of support did little to allay speculation abut Mr. Prince's future. The reason: Boards of directors of struggling companies typically trumpet their faith in the chief until the day they force him or her out.

Deciding whether to unseat a leader poses a dicey dilemma for directors. Wait too long, and they risk letting a bad situation get worse. Act too quickly, and they may short-circuit a potential recovery and create a demoralizing power vacuum.

"Nobody has mapped this process so well that they could give you a cheat sheet," says Paul Danos, dean of the business school at Dartmouth College in New Hampshire and a director of General Mills Inc. and BJ's Wholesale Club Inc. Frequently, Mr. Danos suggests, the decision comes down to "whether you have someone to replace him with."

More directors are struggling with the issue at a time of growing board authority, increasing investor impatience and shrinking CEO tenure. As at Citigroup, directors of Alcatel-Lucent and Motorola Inc. also recently backed CEOs Patricia Russo and Ed Zander, respectively, amid shareholder complaints. Earlier this month, Sprint Nextel Corp. CEO Gary Forsee resigned after his fellow board members launched a search for his successor.

And on Friday, a union group demanded the immediate departure of Countrywide Financial Corp.'s Angelo Mozilo. The founder of the biggest U.S. home-mortgage lender "cannot be trusted to steer Countrywide out of the morass into which he has led it," said William Patterson, executive director of CtW Investment Group, the investment arm of labor federation Change to Win. Its unions' pension funds own about 3.5 million Countrywide shares.

Mr. Mozilo couldn't be reached to comment. Countrywide didn't comment about the union group's letter, sent to the Countrywide board.

Even these days, directors often act reluctantly. Board members feel uncomfortable pushing aside a chief executive whom they chose and like, says Jeffrey Sonnenfeld, a senior associate dean at Yale University School of Management. " 'The devil we know is better than the unknown,' " many tell Mr. Sonnenfeld.

But directors tend to lose confidence and replace a chief executive when they see serious ethical lapses. Among other factors that can tip the balance are a pattern of business mistakes, concealment of critical information from the board and an extensive exodus of senior management. They are less likely to change leaders simply because a few institutional investors gripe about a depressed share price.

Sometimes, board members' faith is rewarded. General Motors Corp. CEO Rick Wagoner seemed endangered last year as GM sales fell, losses mounted and billionaire Kirk Kerkorian, holder of a big GM stake, agitated for big changes. Jerome York, Mr. Kerkorian's top representative, briefly joined GM's board and criticized Mr. Wagoner for moving too slowly to fix deep-seated problems such as high employee costs, declining car sales and overlapping brands.

But Mr. Kerkorian unloaded his entire stake late last year, and Mr. Wagoner remains in charge. GM said Thursday that third-quarter vehicle sales grew 4% despite continued declines in North America. GM also recently concluded a new labor agreement that will allow it to cut costs by billions of dollars and shift health-care expenses to a union-administered fund. GM's share price has nearly doubled since April 2006.

"The company is looking better," says Charles Elson, head of the Weinberg Center for Corporate Governance at the University of Delaware's business school and a director at AutoZone Inc. and HealthSouth Corp. "It's a classic example of where the board stuck by the CEO," he adds.
On the other hand, Mr. Elson says directors of Home Depot Inc. "should have moved earlier" to oust former CEO Bob Nardelli, who quit in January. Mr. Elson thinks Home Depot directors were slow to react to growing investor concerns about Mr. Nardelli's sizable pay package, his management style, the depressed share price and inroads by rival Lowe's Cos. "It will take a long time to reinvigorate the morale of their employees and get customers back," Mr. Elson says.

Frank Blake, the Home Depot executive who succeeded Mr. Nardelli, soon decided to shed the wholesale-supply business. But Home Depot got less than it initially expected for the unit because of the summer credit crunch. And since Mr. Blake took command, its shares have fallen
farther amid the housing downturn.

Home Depot directors insist they didn't wait too long to remove Mr. Nardelli. They promoted
Mr. Blake to vice chairman last fall, then discussed succession for months before concluding the company needed fresh leadership, one person close to the board recalls. "Not only did [the board] act in a timely fashion, but in an orderly and complete fashion," this person says.
Directors remain convinced Mr. Blake "is everything this board expected and desired in a leader," says Kenneth G. Langone, Home Depot's lead director. Mr. Nardelli declined to comment through a spokesman for Chrysler LLC, where he is now chief executive.

Activist investor Ralph Whitworth, who played a key role in events leading to Mr. Nardelli's departure, believes Sprint Nextel directors were also too patient. Signs emerged late last year that Sprint was losing ground -- even though it had paid $35 billion to buy a hot rival the year before. Millions of its cellphone subscribers had defected to competitors. Remaining customers were switching to less profitable calling plans.

Mr. Forsee "lost credibility with investors over a year ago," maintains Mr. Whitworth, whose Relational Investors LLC owns roughly 1.9% of Sprint's shares outstanding. "As soon as CEOs lose credibility, they should be out of there."

A Sprint spokeswoman has said the board decided to seek Mr. Forsee's successor because "it is the right time to put in place new leadership to move the company forward." Paul Saleh, the finance chief, will lead Sprint until the board completes its search. Through an acquaintance, Mr. Forsee declined to comment this past weekend.

Of course, many deposed CEOs think their boards forced them out too soon. Specialty retailer Sharper Image Corp. terminated Richard Thalheimer, its founder and chief executive, in September 2006 after two years of losses and a long sales slump. The move occurred the same month that directors formed a special panel to review stock-option grants, including those to Mr. Thalheimer, and said the company would restate financial results.

Mr. Thalheimer urged board members to postpone action until mid-2007. "I felt we were on a trend line that showed improvement," and the accounting discrepancies didn't involve fraud, he says. "But they disagreed with me."

The founder's ouster shocked long-time colleagues, hurting morale and productivity, recollects Craig Trabeaux, former executive vice president of retail operations. "It was a major distraction" for employees, who feared wider job losses and store closings, he says.

Steven A. Lightman, an outsider named Sharper Image's CEO last spring, has yet to revive the company's fortunes. The retailer recently reported a wider loss for the fiscal second quarter ended July 31. September same-store sales fell 21%. With no turnaround in sight, "it's easy to say [the termination] was premature," Mr. Thalheimer contends.

Jerry W. Levin, Sharper Image's chairman and former interim chief executive, says the board is "confident it made the correct decision" in removing Mr. Thalheimer. He also notes that the unanimous vote "included two long-tenured directors chosen by Richard Thalheimer." A turnaround specialist, Mr. Levin joined the board in July 2006 with support from a dissident shareholder group.

Directors chopped more than $3 million from Mr. Thalheimer's severance to offset his windfalls from favorably priced options, a December regulatory filing stated. The retailer later restated results for three fiscal years and the subsequent quarter ended April 30, 2006.

Write to Joann S. Lublin at joann.lublin@wsj.com

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