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American Airlines: How Perception Became Reality

By fumbling executive pay, the legacy carrier lost its workers—and a lot more.
illustration by John Ueland

In business, as in politics, if you’re explaining, you’re losing.

John Kerry learned that when Karl Rove targeted him in 2004. Gerard Arpey and the board of directors at American Airlines should have taken note.

For more than eight years, Arpey led the Fort Worth carrier, maneuvering deftly to stay ahead of bankruptcy. The great escapes ended November 29, when parent company AMR filed for Chapter 11 and he resigned.

Arpey was widely blamed for American’s failure, for not doing enough, and not doing the right things. In my view, he deserved more credit for restructuring the company early, generating newfound billions in bag fees, solidifying a global network, and bringing unusual honor to the job.

But everyone has blind spots, and Arpey never appreciated how American’s executive pay plan undermined much of his good work. His board, which has the ultimate responsibility for that duty, didn’t fix it, either. Together, they held the fatalistic view that the unions would have attacked anything, so why bother?

The compensation system also worked exactly as designed. It rewarded execs when American performed well and punished them when it faltered. In the end, that didn’t matter. The perception—that the pay scheme was rigged to pay off regardless of results—became accepted
as fact.

American never changed the plan in a meaningful way, so its stubbornness looked like arrogance. And what should have been a sideshow
became a defining issue in Arpey’s legacy.

It should go without saying, but let’s say it anyway: American didn’t fail because it overpaid executives. Many big-time CEOs make more in a single season than Arpey did in eight years at the helm. And American lost $12 billion in the decade before Chapter 11, so it obviously had bigger problems, including high fuel prices, painful recessions, and resurgent rivals that became larger and more efficient.

But it was executive pay that cost American leaders the high ground.

In 2003, Arpey helped convince American unions to accept cuts in pay and benefits worth $1.6 billion annually. That allowed the company to avoid bankruptcy, preserving generous pensions and keeping maintenance work in-house and in the United States. Competitors outsourced much of that burden and, in 2010, American had more mechanics than larger United and Delta combined.

Arpey chastised other airlines for using bankruptcy to break union contracts, dump pensions, and stiff lenders and shareholders. He was proud that American was making good on its promises, and he invoked slogans like, “Pull together, win together” and, “Shared sacrifice.” Employees responded with hundreds of ideas to boost productivity and cut fuel expenses.

Then American started making money in 2006 and 2007, and its stock price soared, triggering millions in stock awards for the bosses. Everyday workers, still stinging from their pay cuts, felt like suckers.

Arpey turned down his initial incentive pay, earning kudos from the unions. But in 2007, he cashed in almost $8 million in stock awards and looked like one more corporate hypocrite. Employees never got over it and never stopped complaining about it.

Soon, American needed new, money-saving union contracts, because rivals had used bankruptcy to cut costs deeper. No chance of that. Under Arpey, American failed to get any major labor contract, despite five years of talks and the growing threat of bankruptcy.

In November, with Wall Street nervous, the pilots union rejected an offer with a 4 percent signing bonus, annual raises, and job and pension protection. And negotiators essentially flipped off management: Rather than continue to negotiate, they said they were taking a much-needed break for Thanksgiving.

Soon after, Arpey was gone and American was filing papers in New York. The last shot at avoiding bankruptcy had been squandered.

On cue, complaints about executive pay resumed, even though the trumped-up rallying cry had long been inaccurate. Most union officials realized that Arpey and his team weren’t overpaid, and that most bonuses never came in as reported in proxy filings. But they didn’t set the record straight, instead scoring political points by hammering management.

Up to 85 percent of Arpey’s pay was variable, meaning it would rise and fall with the company’s (usually lagging) performance. Arpey’s pay was targeted at the median of his peers and came in at about half that, and on paper only. His take-home was much lower, because three-fourths of his pay was in stock and he held on to most of it.

By my calculations, Arpey averaged about $1.7 million annually during his tenure, including his big stock sales. In 2010, according to the AFL-CIO, the average compensation for a large company CEO was $11.4 million. Given that American bled red ink for years and went under, Arpey’s pay sounds about right.

Some people say that Arpey shouldn’t have earned that much. That devalues the difficulty of running a company with 65,000-plus employees. And doesn’t Tony Romo get his millions whether the Cowboys win or lose?

Years ago, union leaders went to Arpey to complain privately about executive pay. It had become a flashpoint with the rank-and-file, and
they feared it would alienate the work force for good.

Arpey and his aides explained how variable pay worked, how little the execs actually received, and how union members themselves had rejected more incentive pay in their contracts. And Arpey also told them, defiantly, that they didn’t get to play in that sandbox.

In a narrow sense, he was right; the board alone sets executive pay, without input from the unions. But on the big picture, Arpey couldn’t have been more wrong. He lost his employees over it and, ultimately, the company.

Mitchell Schnurman is an award-winning business columnist for the Fort Worth Star-Telegram.