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Leadership & Organisations

A case of poor corporate governance?

Theo Vermaelen |

On August 6, Hewlett Packard’s board forced CEO Mark Hurd to resign after the conclusion of a sexual harassment investigation. Hurd had apparently been accused by Jodie Fisher, a marketing contractor, of giving her less business with the company because she did not respond to his sexual advances. Fisher worked for HP from 2007 to 2009 helping to organise networking events. Hurd denies all the charges and the HP board also agreed that he did not violate the company’s sexual harassment policies.

Hurd settled with Fisher for an undisclosed amount before resigning. Such a settlement is not necessarily an admission of guilt as going to court would be far more expensive than settling. Although the board concluded that Hurd was wrongly accused of sexual harassment, he was still asked to resign because he allegedly inappropriately charged expenses related to meetings with Fisher for a total amount of up to $20,000. As a result, the board stated it had lost its ‘trust’ in the CEO. There is some irony in the fact that the board blamed Hurd for wasting shareholder’s money on Fisher, while Fisher blamed him for saving shareholder’s money at her expense.

On the day of the announcement, HP’s market value fell by $10 billion, close to a 10 per cent decline, consistent with the view that the market believed Hurd’s leadership was worth $10 billion to HP shareholders. This is not surprising as he is credited by Wall Street for turning around HP, making it the number one technology company in terms of revenue. During his tenure HP’s stock price doubled, largely outperforming market indices. Typically the removal of a CEO is preceded by a bad performance, not an extremely good performance. So in these normal cases, stock prices may actually rise when the CEO is removed because it may lead to better leadership. For example, when Hurd’s predecessor, Carly Fiorina, was fired in February 2005, HP’s stock price jumped by seven per cent. This is probably a downward-biased estimate of value creation as the stock market should only respond to unexpected events – and CEO departures after poor performances are less unexpected than after excellent performances.

An alternative interpretation of the stock price decline is that there was another, dark reason for firing Hurd. But Cathie Lesjak, the CFO and new interim CEO of HP, stated in a press conference that the resignation had nothing to do with the company’s operational performance.

Some may argue that the stock price decline was an overreaction. However, so far the stock price has not recovered. It is true that on August 30, HP announced a $10 billion share buyback programme, something which is consistent with the overreaction hypothesis. However, the buyback came only after HP stock price was hammered further as a result of the bidding war between HP and Dell for 3Par, especially after HP made a bid for the company at a 200 per cent premium above pre-announcement market prices. The buyback seems to be intended to reassure markets that HP is not going to waste all its excess cash in other value-destroying acquisitions.

Hurd has since been named co-president at Oracle Corp and I tend to agree with Larry Ellison, CEO of Oracle, who stated that HP’s board made a big mistake here, incompatible with its fiduciary duties toward shareholders. While the board has argued that Hurd was fired because it could no longer trust his judgment and values, the relevant question is whether these interfered with his ability to create value for shareholders of HP. Shareholders appoint board members because they trust the board to respect their fiduciary duties. This trust seems to be lost here as well. Another mistake was to listen to the APCO public relations firm who reportedly advised the board to disclose the accusation of sexual harassment, even though an investigation found that he hadn’t violated the company’s sexual harassment policy.

If Hurd had behaved inappropriately by charging expenses that were not really business expenses, he should be asked to pay them out of his own pocket and that should be the end of it. The punishment should be proportional to the crime and the punishment should not come at the expense of stockholders whose wealth depends on Hurd’s leadership skills, not his testosterone levels. Adding insult to injury, Hurd has now been awarded severance payments of at least $12 million paid by the same stockholders.

The only defence the HP board can put forward is that, when it asked Hurd to resign, it underestimated the CEO’s ‘market value’. First, it could cite a precedent: in March 2005 Boeing removed its CEO, Harry Stonecipher, because of an affair with a company executive. On that day Boeing’s stock price declined by only one per cent, although, like HP, Boeing had outperformed the market significantly with Stonecipher at the helm. However, Stonecipher was 68 and Hurd is 53. So the meek market response to the removal of Boeing’s CEO was probably related to the fact that, at 68, Stonecipher was close to retirement anyway. A second similar argument the board could make is that apparently some investors supported the decision to fire Hurd. Presumably these investors were not asked after they lost 10 per cent of their wealth, but before. If they agreed to the plan to fire him, they also did not know to what extent the market value of the company was driven by the CEO.

On August 13 a major stockholder, Brockton Contributory Retirement System, filed a lawsuit against the board. However, the lawsuit misses somewhat the point as it only wants the board to recover the severance payments to Hurd and return them to the company. Severance payments of $12 million will do nothing to the stock price of a $100 billion company and will benefit no one except lawyers. Shareholders will only get their $10 billion back if Hurd gets his job back or if the board finds someone with the same ability to create shareholder value.

The first option evaporated on September 7, when Hurd became co-president of Oracle. On a day when the NASDAQ fell by 1.1 per cent, Oracle’s stock price increased by 5.9 per cent. This 7 per cent abnormal return translates into an $8 billion increase in Oracle’s market value. Once more, Wall Street showed it loves Mark Hurd.

Disclaimer: I don’t know Mark Hurd or Jodie Fisher, and am not an HP shareholder. I simply believe that capitalism can only survive with good governance and what we have witnessed here is not an example.

Theo Vermaelen is Professor of Finance at INSEAD.