Why Ron Johnson is paying for the privilege of running J.C. Penney

June 15, 2011: 5:00 AM ET

The head of Apple's retail strategy, Ron Johnson, is putting skin in the game at his new position as CEO of J.C. Penney.

By Jennifer Reingold, senior editor

FORTUNE -- He could have had any job he wanted. Or he could have stayed at Apple, where he was sitting on $50 million of restricted stock -- and, should the company continue its record of innovation, untold millions more in the future.

But instead, Ron Johnson, senior vice president and creator of Apple's retail stores strategy, is taking the CEO job at J.C. Penney (JCP), a middle-class, middling-performance department store chain -- and paying for the privilege of doing so.

Why? In part, it's because Johnson, who started his career at Mervyn's (later bought by Target (TGT)) and moved up the ranks there before leaving for Apple (AAPL) in 2000, has always dreamed of running a retail company. But there's another reason, too: In addition to being made whole on his Apple stock with $50 million in J.C. Penney restricted stock, a $1.5 million salary, and a target incentive bonus of nearly $1.9 million, Johnson is actually investing another $50 million in stock warrants for 7.26 million shares -- a cost of $6.89 per share. He can't sell them for at least six years, and if the stock is at or below $29.92 at that point, he loses his $50 million.

On the other hand, the upside is dramatic: If the stock doubles from today to $60, he'll earn over $385 million -- in addition to the huge sums he would gain on his restricted stock and other pay. What's more, because the warrants are an investment rather than compensation, Johnson will be eligible for capital gains tax treatment instead of the ordinary income tax rate. And Johnson is already ahead -- J.C. Penney shares shot up 17.5% on Tuesday to $35.37.

It's the ultimate skin-in-the-game move, says Pershing Square Capital Management's Bill Ackman, who owns 16.5% of the company (and, with JCP's market cap rising $1.2 billion on the investment, had quite a lovely afternoon). "Ron's large investment in the company demonstrates his confidence in the value he can deliver while aligning his interests with shareholders," said a pleased-as-punch Ackman, reached at a café in Rome, Italy on Tuesday evening. "If the stock stays flat, he loses his investment; if he creates shareholder value on a sustained basis, he has the potential to make a fortune."

It's not the first time a Pershing Square investment has used the warrant as a lure for top talent. Last November, Ackman proposed almost the identical structure when David Weinreb became the CEO of The Howard Hughes Corporation (HHC), an outgrowth of real estate company General Growth, (Pershing owns 14% of Howard Hughes).

It's not uncommon to see such arrangements in the private equity world, but this is new territory for public companies, particularly vaunted old brand names like J.C. Penney. The downside for shareholders? The nearly 4% dilution from Johnson's investment and the restricted stock. The upside? Well, if Johnson lives up to his reputation as a retail genius of unparalleled talent, they may not much care about anything else.

"The market says the guy we hired is worth $1.2 billion," says Ackman. "The market is wrong; he's worth way more than that."

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