Kmart's 'loans' to executives really just departure bonuses

By DAVID MOON, Moon Capital Management
June 9, 2002

'Good morning K-Mart Shoppers. We have a blue light special ' but it is not in the store. Please immediately report to the corporate board room for some fantastic bargains.'

When a ship is sinking, it should not be difficult to tell whether or not the captain is trying to help bail water or is actually making the hole in the ship larger. Not so at K-Mart.

Everyone is familiar with the decline and demise at K-Mart. If for no other reason, you are familiar because you do more shopping at Target and Wal-Mart than you used to. And unless your head has been in the sand, you know that K-Mart filed for bankruptcy earlier this year.

What you may not know, however, is that in the days prior to filing for bankruptcy, K-Mart granted millions of dollars of loans to its top executives, supposedly to encourage them to stay with the company and help steer it through difficult times. Without these incentives, the board reasoned that its top executives might choose to jump ship and try to board a more seaworthy vessel. Then-CEO, Charles Conaway, received a $5 million loan. Mark Schwartz, K-Mart's president, received $3 million. K-Mart's CFO (who had only been with the company two months at the time) received a loan of $1.75 million. Between October 2001 and January 2002 (just prior to its bankruptcy), K-Mart granted loans to top executives totaling more than $30 million.

While the loans were supposedly designed to encourage the executives to stay on board, they were actually little more than lovely parting gifts for most of the managers. When Schwartz left the company only weeks after receiving his 'retention loan,' the board forgave the loan, in effect granting an additional $5 million dollars in salary for the president. John McDonald (the CFO who received a $1.79 million of retention loan) had his loan forgiven, despite serving as K-Mart's CFO for ten weeks.

Despite the fact that the loans were granted on the condition that executives remain with the company for several years, nine top executives received more than $18 million in 'loans' which were almost immediately forgiven when the executives left the company.

Almost as disturbing as is the mere existence of these loans is the time at which they were granted. Most of these loans were initiated at a time K-Mart was discontinuing shipments from many of its product suppliers because of a lack of cash available to pay for the products. While the company was struggling to find the cash needed to stock its shelves with inventory (which could then be sold and generate more cash), the company used its dwindling precious cash to pay departure bonuses to many of the managers.

Can you imagine what bonuses the executives might have received had they been even only mildly successful?

Treating the company coffers as a personal piggy bank is hardly a new concept. It happens during normal business environments and it happens at the end of certain business relationships. Just prior to his retirement last year, FleetBoston Financial chairman, Terrence Murray, benefited from a last-minute change in the calculation of his annual pension benefit. After working at the company for more than thirty years, he was well aware of the formula used to calculate retirement benefits. However, with his last minute change, his annual pension income increased more than $3 million, to $5.8 million annually, for the rest of his life. (Mr. Murray's salary in his last year as chairman of FleetBoston was only $992,000.) Despite years of growth under his leadership, in Mr. Murray's last year at the helm FleetBoston's earnings declined 75 percent. Not bad timing on his part, it seems.

The timing of the K-Mart executive's 'retention loans' might have been a bit better, however. The FBI is now investigating K-Mart for financial irregularities and the company is considering whether or not to attempt to recover some of the 'blue-light special' departure bonuses.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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