Why American Apparel's CEO Must Resign, and Why He Probably Won't

Last Updated Aug 2, 2010 6:23 PM EDT

The resignation of American Apparel (APP)'s accounting firm, and the admission that that its financial numbers from 2009 onward may be inaccurate, brings the company to the brink: Can American Apparel survive if CEO Dov Charney refuses to step down? Even if you're familiar with the company, it's an astonishing question. Troubles at the company were seen coming a mile away -- I suggested AA was marginally profitable and drowning in debt back in January 2009 -- and therefore eminently avoidable.

The tantalizing dilemma facing AA's shareholders and creditors is this: Somewhere inside this company is a viable retail clothing business (its total sales are still growing even though same-store sales are in decline). Charney's mismanagement has ruined that business. He must be removed as CEO. But Charney owns 53 percent of APP's shares, and thus completely controls the company. If he wants to go down in flames, into bankruptcy, no one can stop him.

It would be a dramatic end for a company -- a man, really, as Charney essentially is his company -- that turned modern fashion advertising on its head. Before AA, fashion ads tended to be exquisitely shot, well-lit, art-directed mini-movies with famous models and actors. Charney, who shoots his own ads, showed you could sell clothes with grainy Polaroids of no-name girls (as long as those girls were mostly naked).

Yet we could be at the end. Normally, when a company gets into this type of difficulty, investors and creditors approach the CEO with loaded guns: Leave, or we'll force you into bankruptcy and take your company from you. CEOs have no choice, as they generally don't own a majority of their own firms.

As a majority owner, Charney can't be threatened. If he wants to commit business suicide, he can. That's a real possibility: The quality of Charney's decision-making has been in decline over the last two years:
There's a way out of this, of course: Charney needs to step aside and accept a non-management creative director role. He can remain in charge of the ads and the styling, but his investors should bring in experienced retail store management. To make this plan work, Charney needs to agree to sell more than 3 percent of his holdings so that the company can become a takeover target if its performance doesn't improve. That plan might actually make Charney rich by increasing the value of the stock.

The really scary thing about all this is that as the majority holder, Charney has seen his fortune decimated. His current holdings are worth somewhere near 10 percent of their uppermost value. And that's not including the money that Charney has lent his own company from time to time.

A rational person would have given up control of AA to someone more qualified to run it. The fact that Charney hasn't done that suggests ... well, let's just see how this whole thing pans out.

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