Ownership is more than owning shares

The way Buffalo Wild Wings describes how CEO Sally Smith gets paid is typical of big public companies, explaining that a lot of her pay is "performance-based, not guaranteed, and fully at risk."

This approach, according to its latest proxy statement, results in "a close alignment" between what executives like Smith earn and how well the shareholders do.

Well, that alignment isn't nearly close enough for Mick McGuire of Marcato Capital Management. His spirited campaign to win four board seats at the Buffalo Wild Wings upcoming annual meeting included an April letter suggesting that the board fire Smith.

One of his main gripes is that she has never bought a single share of her company's stock on the open market. In fact she has actually sold a few of the shares she has earned as CEO. McGuire demanded a CEO who thinks more like an owner.

This is just the kind of claim that makes activists so irritating, this insistence that CEOs aren't acting for shareholders if they so much as sell a single share of stock. If that's the standard — a CEO has to be 100 percent all in, never sell a share and maybe even personally guarantee the headquarters lease — then the activists may as well go after the CEO of the other 49 companies on the Star Tribune 50 list.

Without even checking the details of the proxy statements, you know stock grants or options have been part of what these executives earned. And no, executives still don't really think just as if they own the company. What they want is to get paid for the hard work they do. And they know if they do their jobs well, the pay that comes in form of shares should reward them very well.

What McGuire is really talking about is another version of what's called the principal-agent problem. McGuire's fund — now up to nearly a 10 percent stake — is an owner, or the principal, of Golden Valley-based Buffalo Wild Wings. As an investor Marcato can't actually run Buffalo Wild Wings, so it has agents like Smith to look after its interest.

Any business without an owner who is also a manager has this same problem. Generally, with independent boards, compensation committees, auditors and other things that small business people don't need, the public companies do pretty well managing this problem.

But McGuire may not quite grasp that only business owners really think just like owners, as the effect on behavior seems to come from an emotional attachment, not financial. Watch a business owner closely and you will see things like the boss bending over to pick up trash that employees stepped over without noticing.

Likewise, there's nothing more fundamental to business owners than controlling the checking account. A corporate manager will sign off on spending because it's in the budget, and the check will get "signed" by a check-signing machine. A small-business owner might have a budget, yet that doesn't mean a buying decision has been made. Money is spent only if it looks absolutely necessary that day. And odds are he or she will sign the check personally.

Marcato hints at the principal-agent problem elsewhere in its case for change at Buffalo Wild Wings. Marcato wants to see what's called the "asset-light" strategy, selling off more than 500 corporate-owned restaurants and turning over the money to shareholders. The company can collect a risk-free franchise royalty on sales.

Marcato seems to think the franchisees, as owner managers, will do a better job managing these restaurants. On one of its slides Marcato highlights how labor costs at the largest franchisee were 24.8 percent of sales last year vs. nearly 32 percent at restaurants Buffalo Wild Wings owns. The implication is obvious, that the owner operators (never mind that this franchisee is also publicly held) are spending their own money so they do things like send staff home if the dinner shift isn't busy enough.

It took just one phone call, to restaurant industry executive and consultant Allan Hickok, to blow a hole through this thesis. "Speaking categorically, that franchisees always outperform the franchiser, that is simply not true," he said. "It doesn't even make common sense."

Some franchisees do very well, others do much worse. There's a lot of reasons for the variation, including — and maybe particularly — whether the corporate parent picked good operators to build restaurants in the first place.

An outstanding example of the asset light strategy as McGuire favors coming completely undressed is happening at Applebee's, one of two concepts franchised by California-based DineEquity.

Applebee's is a mainstream, casual dining chain of about 2,000 restaurants that got its start nearly 40 years ago. At the time it was acquired by its current owner about 10 years ago, the plan was to "refranchise" the corporate-owned Applebee's units by selling almost all of them to franchisees and using the money to buy back stock and pay dividends. The strategy worked great — for a time.

Domestic same-restaurant sales for Applebee's started shrinking in the third quarter of 2015 and every quarter since then the trend has been worse, with same-restaurant sales most recently shrinking by about 8 percent. The parent's stock has slipped nearly 40 percent this year, its longtime CEO and the champion of the asset-light strategy abruptly left and the Applebee's chain has started shrinking.

Analysts are starting to wonder if there's a fundamental problem with the model, as too many decisions get made by people with not enough skin in the game. It's the franchisees who have to live with the promotion ideas and other initiatives cooked up by the franchiser, including Applebee's wood-fired grilled steak strategy last year.

Customers apparently heard wood-fired grilled steaks and concluded Applebee's just got unaffordable.

If DineEquity owned the restaurants, this blunder would have been a killer. At a minimum, as owners DineEquity would have tested the new concept longer before rolling it out. The parents' finances reflect the small hit from collecting a franchise royalty on lower sales, but compared to an owner operator the franchiser no longer has that much at risk in the decisions it makes.

That is, in this example of the model McGuire favors, there may not be enough people at headquarters thinking enough like business owners.

lee.schafer@startribune.com 612-673-4302