From Backboards to Boardrooms — The Value of a Proven Winner

The Toronto Raptors are the 2019 NBA champions! As the city of Toronto basks in the glory of a championship team, the rest of the league asks themselves: “What can we learn from this year’s champions?” While there were numerous factors that played a role in the Raptors’ championship, such as the emergence of Pascal Siakam and Fred VanVleet, not having to face LeBron James in the playoffs and some untimely injuries for the Golden State Warriors, the ultimate reason is Finals MVP Kawhi Leonard.

Kawhi Leonard was acquired last summer in a blockbuster trade that saw the Raptors send 22-year old Jakob Poeltl, a 2019 1st round draft pick, and DeMar DeRozan to the San Antonio Spurs. In exchange, Toronto received Kawhi Leonard, Danny Green and cash. It was a bold move. DeMar DeRozan was arguably the face of the Toronto Raptors; a homegrown talent and 4-time All-Star. Kawhi Leonard was a former NBA Finals MVP coming off a major injury who only had one year left on his contract. It was a high risk, high cost move with a potential for a large reward or a catastrophe. As we know now, the risk paid off.

While 29 other NBA teams ruminate as to whether moves such as the Leonard trade are a valid way to win a championship, it is fun to contemplate whether any lessons can be learned from the Raptors in the context of executive compensation. Are there any parallels in the corporate world that we can draw to the Raptors and Kawhi Leonard?

At first thought, the answer is no, of course not. An NBA team is markedly different from a corporate executive team and the two can’t be compared. The NBA’s best players are in their 20s and early 30s. A CEO is typically in their 50s or 60s . Being a great NBA player is arguably based on freakish physical ability coupled with mental discipline. Being a great CEO is arguably based on experience, leadership and long-term vision underpinned by core intellectual ability. Further, NBA players are governed by a Collective Bargaining Agreement (CBA) with strict rules around compensation and are paid predominantly in guaranteed salary with minimal incentive provisions. CEO compensation is less bound by rules but is closely scrutinized and predominantly composed of non-guaranteed incentives.

That said, there are parallels in the corporate world to the Raptors acquiring Kawhi Leonard, where a company brings in a proven winner at great cost and with potentially great risk. For example, we highlight when Canadian Pacific Railway Limited (CP) appointed Hunter Harrison as its CEO in 2012.

Like the Raptors, CP was a company that was floundering and looking for something to get them over the hump. While its stock price had rebounded from the lows of the 2008-2009 recession, it hadn’t yet returned to its 2007 peak. Activist investor Bill Ackman was not content with the direction of the company, and instigated a proxy battle that ultimately ended with the CEO of CP and many of its Board members leaving the company, and Hunter Harrison coming on as the new CEO of CP.

Much like Kawhi Leonard, Hunter Harrison, the former CEO of CP rival Canadian National Railway Company (CN) was a proven winner. Similarly, bringing him to CP would come at a high cost. Although CP didn’t give up a 4-time all-star, a prospect or a draft pick, they did agree to pay Mr. Harrison over $33 million in forgone share awards and pension benefits that were withheld by CN. Furthermore, Mr. Harrison’s regular total direct compensation (Salary + Short Term Incentive (STI) + Long Term Incentive (LTI)) was much larger than that of his predecessor.

Despite the high cost, Mr. Ackman and CP were vindicated, as CP stock almost doubled within a year of Mr. Harrison becoming CEO, with the stock price ultimately increasing by over 250% during his tenure. Furthermore, revenue increased by 20% from 2011 (the year before he took over) to 2016 (the last full year he was CEO). More impressively net income increased by 280% in the same time frame, outperforming its competitors.

If we examine the financial impact that Leonard had on the Raptors, early indications are that the franchise value and the overall value of its owner Maple Leaf Sports and Entertainment (MLSE) have also rapidly increased. In 2018, the franchise was valued by Forbes at $1.4 billion (USD). Earlier this year, the franchise was valued at $1.7 billion by Forbes, but now experts have estimated the value at between $1.8 billon and $2 billion.

What are the lessons here?

There are a few. First, if a company (or a team) makes a big change, then judgment should be reserved until the impact of the change can be properly observed or measured. Second, the cost paid to bring that person aboard can be worth it. CP paid tens of millions of dollars to Mr. Harrison, but those millions are small when compared to increases in profitability and market capitalization that CP enjoyed during his tenure as CEO. We have dealt only with the upside of these types of hires. There will be time to consider any downside as we reflect on the impact of the Kawhi Leonard trade on the Toronto Raptors for seasons to come.