McDonald’s Board Turfs CEO and Pays the Price

McDonald's

McDonald’s CEO Steve Easterbrook had been guiding the company very well over his 4-year tenure. He was unceremoniously dumped this week, for reasons that should startle us.

Steve Easterbrook started his career with McDonald’s in 1993 as a manager of one of their restaurants in London. The fast food industry, including McDonalds, has never been known to pay their restaurant staff very much, including their managers, so Steve’s story is truly one of rags to riches as he rose up within the company to become McDonald’s CEO in 2015.

The company has been doing very nicely indeed under Easterbrook’s leadership, and when it comes to the performance of a CEO, the company’s stock is where the bottom line is drawn. McDonalds has averaged an 18% return over the 4 years he’s been in charge, easily beating the S&P 500’s 11% over this time.

This industry has had its challenges, but Easterbrook seemed to bring a more hands-on approach to the role, perhaps due to his experience at every level and in particular with the one that actually worked on the front lines. CEO’s usually start quite a bit higher up on the ladder than the bottom though, and this was probably a real benefit.

All this came to an end on Monday though, as McDonald’s board fired Easterbrook for violating company policy by engaging in a consensual romantic relationship with a fellow employee. The board gets to enforce the rules, and this is within their sphere of decision making, but this decision is a very interesting one indeed.

There are only two possibilities here, which are the board wanting him out for performance reasons, or wanting to get rid of them as a result of the majority of the board simply losing their minds. Maybe the rule violation just served as a lame excuse to fire him due to wanting someone else in charge, for whatever reason, but there also exists a strong possibility that they really were serious about what they said.

The first thing to try to figure out here is whether this was an action that was indeed performance based, and if they looked forward like all boards are supposed to do and saw the company being better off enough with someone new in the role, and then choose to disguise the move by invoking his breaking a petty rule and presuming that would be adequate justification.

This may even make sense, if the lack of performance was significant enough, because they could tell a better story to the market. Instead of tossing him because they felt he was no longer up for the role, they could just say that he had relations with someone at the company and out you go, which would take the real reasons for his departure off the table where they would not even have to defend them.

That seems unlikely though given how well Easterbrook has performed with them. One disappointing quarterly earnings number does not warrant firing, especially when you take a subordinate and throw him into the role and take on the risk that he will provide a lesser degree of performance at the job.

This is a real risk and investors have voiced their disappointment over this change. This might work out, but it’s really not likely that they did this to improve the CEO, it seems much more likely that they actually did it because he had consensual relations with a co-worker, as incredible as that might be.

Few People Seem to Get How Wrong This Was

Perhaps even more surprising, and perhaps what makes this story so noteworthy, is that people just seemed to accept this decision without really thinking about it any more than the McDonald’s board has, which means not at all, or at least not on a level that gets past whatever emotion caused them to react the way that they did.

When we consider such an option, we have to think things through at least a little, and this decision is so disproportionate that it should defy our imagination. This isn’t just akin to putting someone to death for stealing a loaf of bread, it is more like doing that just because they are in a store that sells bread.

There are reasons why companies may want to seek to interfere with the private lives of employees by making rules that may discourage or punish their people from engaging in romantic affairs with one another, but these actions must surely be subject to practicality.

We need to start by looking at the risk of this happening and decide what exposure a company has to it. It’s not hard to imagine situations where an employee may be unduly benefited and the company harmed in some way, for example with one of their restaurant managers promoting someone not based upon merit but upon personal preference.

We are always at risk of these things, and most of it goes on without objection, as if people like you they will tend to want to help you more. Some things, like benefiting family members, may be scrutinized more, but there’s something peculiar about having sex with someone that really gets people’s attention.

Just like working with family members, or any other potential favor that may exist structurally in the workplace, the mere fact that potential exists for this is not reason to prosecute or prohibit this. Cashiers can steal money anytime, and there is therefore the potential, but we cannot reason from this that there should not be cashiers working for us because they could steal.

Some may even wonder what business the company has in their private lives that the company seeks to manipulate and coerce them, merely on the basis that they are afraid that people will get together and then engage in a level of impropriety that affects the company in a material way. It is reasonable for them to want to police this, but not so much with their wanting to define people’s personal relationships with one another.

There are some risks here, and it could also be argued that the higher up the chain someone is, the more impact this risk may have, but we must also realize that the benefits that a higher-up person brings to the job is also higher and much more so in fact.

Let’s say that a CEO makes a cashier an executive of the company not by way of talent but based upon personal affection. This would be something that would be in need of a response, and either way, the cashier goes back. We then need to assess the risk of this happening again, and we can certainly reprimand the CEO, but this might still not have the CEO learning his or her lesson.

We then take the total cost of another mistake like this and multiply it by the probability of it happening, which in a case like this wouldn’t be very high at all, and define the company’s risk.

We don’t want to be seeking to avoid low-risk and not particularly meaningful costs involved by just tossing the CEO, as we only gain a very small amount and this can cost the company literally billions. Our only response to such a notion should be to laugh.

The Punishment Should Fit the Crime

The cost to McDonald’s stock in just the first day after he was tossed out represents an amount that completely overwhelms any risk that keeping him on would present even if he had a track record for abusing his power.

The mere fact that he had the power to commit acts of impropriety by benefitting this friend unduly in a way that would cost the company money was enough for the board. This boils down to a rationale consisting of the idea that you might do something to cost us what is ultimately a meaningless amount of damage that would have no real impact on McDonald’s, so we’ll eliminate this risk by firing you and costing us a whole lot of money as well as reputational damage.

Easterbrook’s reputation may be a little damaged, to the extent that there are others out there that think that firing someone is just cause for such an action, but it is the company’s reputation that should be harmed here, if people took the time to think about all this. Whoever voted for this action are the ones that deserve to be removed, for a level of incompetence that is completely unacceptable.

The only reasonable explanation is that certain members became angry enough that Easterbrook would dare defy company rules that they completely suspended their judgement and just started punching.

Disturbingly, Easterbrook isn’t the first major CEO to be sent packing for such things, and it seems that such a thing as become fashionable. Fashion can be a dangerous tool, as it functions to suspend our judgement in favor of what is in fashion, and when you lose a high-performing CEO over this, this can cause a lot of harm and a lot of money.

In the end though, the board does get to choose, but we would think that more people would take them to task and at least have them try to explain how it is worth it to cause such an upheaval and remove someone who is meaningfully responsible for their revival and success over breaking a petty rule.

In order to make whatever response proportional, this would need to mean that the harm that may be caused by breaking the rule is at least on par with the harm caused to us as a consequence of our actions. There just isn’t a realistic scenario that would have the rule-breaking even weighing anything when measured against their firing this CEO at this point in time.

Given that the new guy, Chris Kempczinski, the former head of U.S. operations, was paraded out immediately after Easterbrook was dismissed, this demonstrated that this was very much a pre-meditated act. This makes it even more condemnable.

Perhaps Kempczinski will be even more capable, and was a star waiting in the wings who the company felt strongly that his time had come. If this was the view, we need to tell it that way, but more likely, they did what we call act on principle and then put it well ahead of the company’s stock they are entrusted to exercise wisdom toward. Wisdom seems to be in shorter supply at McDonalds these days though.

This is not at all about McDonalds having this rule, which they are entitled to, or Steve Easterbrook breaking it. It is about the punishment fitting the crime, and it is McDonald’s who have had this thrown back in their face and is taking most of the punishment for this one being broken.

Monica

Editor, MarketReview.com

Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.