(Editors' Note: This letter was sent by the author to the independent directors of Aaron's on March 28, 2014.)
Dear Independent Members of the Board of Directors of Aaron's (NYSE:AAN):
On March 26, 2014, Aaron's announced that its Board of Directors had adopted majority voting for directors in uncontested elections. This token step only highlights the substantial problems with Aaron's governance practices, and further demonstrates the need for change at Aaron's.
As we have made clear in prior letters, Aaron's governance failings go far beyond a lack of majority voting in uncontested director elections. For example, Aaron's continues to have a "staggered board", despite the well-established and documented trend in favor of declassifying boards so that all directors are accountable to shareholders each year. This is for a simple reason: numerous studies have documented that staggered boards result in lower firm value. See Lucian A. Bebchuk & Alma Cohen, The Costs of Entrenched Boards, 78 JOURNAL OF FINANCIAL ECONOMICS 409 (2005); Olubunmi Faleye, Classified Boards, Firm Value, and Managerial Entrenchment, 83 JOURNAL OF FINANCIAL ECONOMICS 501 (2007).
Not content with just having a staggered board, Aaron's has contrived a board structure that is actually illegal. Contrary to Georgia law and Aaron's own bylaws, both of which clearly state that board classes should be divided as evenly as possible, Aaron's nine-member board is composed of one class of two directors, one class of three directors and one class of four directors. Having the three classes divided in this way is both illegal and illogical. The Board should immediately rebalance itself so that there are the same number of directors in each class. And if the Board was truly committed to acting in the best interests of shareholders, it should go one step further and give shareholders a binding opportunity to remove the staggered board at this year's annual meeting.
We believe that Aaron's governance problems have only served to perpetuate the larger business issues facing the company. For example, we recently noted that Aaron's has engaged in another tactic that can only be described as a short-term desperation effort to buy the support of certain constituencies at the expense of shareholders and the long-term health of the company's business. We are, of course, referring to the decision announced this week - which we can only assume had the support of the Board of Directors given its financial impact - to suspend the $800 per month advertising fee charged to franchisees, with Aaron's and its shareholders now bearing these costs. With 781 franchised stores, this decision shifts $7.5 million of annual costs from the franchisees directly to Aaron's shareholders. What is this other than a bribe to muzzle the open revolt in Aaron's franchise community? Yet again, Aaron's shareholders are being forced to pay for management's mistakes, which have resulted in tens of thousands of customer losses in 2014 alone at a cost to Aaron's, its franchisees and its shareholders of tens of millions of dollars. Perhaps we could understand a decision to take $7.5 million from shareholders' pockets if it was in support of a strategy to win back customers, but we will never understand a decision to impose a significant cost on shareholders that is not intended to fix the business. We've said it before, but it bears repeating: Aaron's current management team is out of time.
At the managers' meeting this week, we understand that John Schuerholz spoke about how to turn around a losing team. It is a sad commentary on the state of Aaron's, when one of its own directors stands before 2,300 of the company's senior leaders and talks for 30 minutes about turning around a losing team. If Aaron's is truly as strong as it has ever been -- as management has repeatedly asserted -- it is odd that Mr. Schuerholz would spend any time discussing turning around a loser, and not focus instead on continuing to build a winner. We hope that each of you were present to hear Mr. Schuerholz's remarks.
Very truly yours,
Brian R. Kahn
Vintage Capital Management, LLC
Disclosure: I am long AAN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.