Did Moral Management Kill American?
These days when honest CEOs who take a stand get funny looks, any story of moral attributes from executives is a little shocking. One of the latest standouts in honorable actions rises from the dust of American Airlines and its parent company AMR's (OTC: AAMRQ) bankruptcy. Former CEO Gerard Arpey left the company without a huge severance package after he disagreed with the tactical bankruptcy that will likely lower labor costs and attempt to reduce promised pensions.
Did Arpey harm shareholders with his own moral compass? Will American start charging for carry-ons in overhead bins like Spirit (NYS: SAVE) , or for each breath from an oxygen mask? And what can an investor learn from AMR's bankruptcy?
A company man
Arpey joined American right after college, eventually filling the roles of CFO in 1995, COO in 2000, and CEO in 2003. While he was CEO of AMR, competitors US Airways (NYS: LCC) , Northwest, and Delta (NYS: DAL) all went bankrupt. But Arpey avoided bankruptcy and, in a 2010 interview with The Street, said American "will emerge as a successful company that honored its commitments and its pension obligations and that was guided by principles of doing what's right."
However, Arpey failed and he stepped out of the CEO role when American declared bankruptcy last November. What helped bring down American?
In the past three years, American's wage expenses amounted to 26%-31% of revenue, whereas Spirit's and US Airways' wages as a percentage of revenue hovered around 20%. American estimated it had a total of $600 million in extra labor costs compared to competitors. Nevertheless, Arpey believed bankruptcy was never a choice: "It is not good thinking -- either at the corporate level or the personal level -- to believe you can simply walk away from your circumstances."
But not a shareholder man
While honesty and moral actions may prove important for a company like Whole Foods, whose brand relies on a certain customer perception, American paid extra labor costs without realizing any benefit from the moral high ground. And even if customers did, for some reason, appreciate American's avoidance of bankruptcy and attempt to honor benefits, the unions did not. Arpey spent five years trying to create new labor agreements without success. Without any new labor agreements, American's labor costs remained 21% higher than Delta's, the largest airliner.
Unable to cash in any goodwill from staying out of bankruptcy, American's earnings crashed, as did its stock when it finally admitted defeat. Now, all 2.4 million of Arpey's shares, along with any public shareholders', are close to worthless.
What's next for American? It plans to cut 13,000 jobs out of 88,000 current staff and cut its pensions. Delta, who merged with Northwest, is rumored to be looking at AMR, and US Airways, as potential acquisitions.
Investors in American were not rewarded for Arpey's conscience because no matter how much integrity Arpey had, he still failed to turn around the company. To an investor, bankruptcy now or 10 years ago both equals a poor return. What can this teach you about future investments?
For one, it's difficult for even superb management to turn around a poor business model. You may adore Reed Hastings for his disruptive idea of Netflix, but if you don't believe in the future of a streaming media business model, don't invest just because of Hastings.
Also, just because management properly aligns with shareholders, like Arpey himself owning 2.4 million shares, does not mean the stock is destined for greatness. While being a good signal for an investor, both you and management could lose, just as easily as you and management could win.
While the retirement savings accumulated by American employees could be reduced, you could potentially protect your retirement by considering the high-quality stocks outlined in our special free report: "3 Stocks That Will Help You Retire Rich." Pick it up now, it's free!
At the time this article was published Fool contributor Dan Newman still is amazed by how airplanes fly. He also holds no shares in any of the companies mentioned above. Follow him @TMFHelloNewman. The Motley Fool owns shares of Whole Foods Market. Motley Fool newsletter services have recommended buying shares of Whole Foods Market and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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