Wonkblog | Analysis
June 16, 2017 at 12:36 PM
With Jeffrey R. Immelt gone from General Electric, pundits are urging GE to reexamine, as the New York Times put it, its "core mission." Not to be outdone, the Wall Street Journal sees the chance to "freshen up shareholder returns."
And John Flannery, the new chief executive, hardly needs encouragement. Flannery, a finance specialist with broad corporate experience in his 30 years at GE, promptly emphasized that he will review the company's portfolio of businesses "with a sense of urgency," which is Wall Street talk for deciding which ones to dump.
If that were not enough, Nelson Peltz, who runs a so-called activist investment fund, has made it clear that he is impatient with GE's disappointing quarterly earnings and lagging stock. Peltz, after all, has owned GE for two years — not a long time in the annals of a 125-year-old corporation, but a lifetime on Wall Street.
If GE embarks on a plan to sell divisions, it will satisfy short-term investors, but it will be playing into two of Wall Street's central myths. The first is that dealmaking is an accretive activity — one that "creates value" for anyone other than investment bankers and lawyers. It should be obvious that any deal has a buyer as well as a seller. To the extent that certain GE businesses are unattractive, the price they command also will be unattractive.
If GE gets a good deal, the buyers — perforce — get a bad one. Who ends up better off will not be known for years. Even then, a verdict will depend on difficult calculations: How did the cash received match up against the cash flow GE would have enjoyed had it retained the business sold?
If Flannery takes a knife to his portfolio, you can bet it will be described as a strategic plan to "focus" GE on businesses that "fit." But it is not hard to find examples of seemingly well-wrought strategic visions that, ultimately, did not deliver the expected returns.
GE has just been through such an experience. Immelt, who took over in 2001 after the deal-happy reign of Jack Welch, carefully sold businesses that did not seem central to GE's mission, notably its NBC network and other media units and most of its sprawling financial empire, to focus on industrial businesses. GE's latest proxy, in justifying Immelt's $21 million pay package, boasts that he "strengthened & simplified the portfolio." But over Immelt's tenure, which began just days before the Sept. 11 terrorist attacks, GE's shares (including dividends) rose a mere 21 percent, compared with 207 percent for the Standard & Poor's 500-stock index.
Immelt is not necessarily to blame for this. The simple fact is that dealmaking and other forms of financial engineering cannot manufacture results (at least beyond the short term). Over the long term, earnings will depend on market conditions for jet aircraft engines, power turbines, hospital equipment and GE's other businesses. And these are almost entirely beyond the chief executive's control.
Comes now the second myth — that of the omnipotent chief executive. Welch, Immelt's predecessor, was feted on Wall Street for his supposed ability to "manage" quarterly earnings and deliver consistently higher stock prices.
But life is the territory of the unexpected. No corporate wizard — even at GE — can insulate shareholders from the vicissitudes of recessions and of shifting business performance. And soon after Welch retired, the magical quarterly earnings growth — and the stock price gains — stopped.
The bill for the myth of the chief executive actually was paid twice — once by investors beguiled into a false sense of security and, once by shareholders who have footed absurd levels of CEO pay.
Across Corporate America, a chief executive's compensation is determined not in relation to what other mortals at the company earn, but only on a scale with the pay of other CEOs, as if they were truly a breed apart, irreplaceable except by one of their own.
As the author Steven Clifford has pointed out, this is patently untrue. There is no generic "market" for chief executives. Only 2 percent have been CEOs at other companies. Far more common is what happened at GE, which simply promoted Flannery up the ranks.
But chief executives, and the hired shills who design their pay packages, have sold boards on the notion that CEOs, like some rare hothouse flower, are both uniquely talented and temperamentally fragile, and thus in need of far more motivation than the average worker. Immelt, for instance, was rewarded with seven-figure sums in each of the following categories: salary, bonus, stock options, a separate form of equity known as "performance shares," still another incentive dubbed "long-term performance award," a pension and, just in case anything was omitted, "other."
Such bizarrely complex and over-the-top packages are routine. They are the reason chief executives in the United States earn hundreds of times more than the average worker.
Corporate proxy statements regularly assert that such packages "align" the CEO's results with those of the shareholder. But shareholders at GE know better. Despite his subpar returns, Immelt pocketed $91 million over the past three years alone.
The myth of the superhero chief executive does tangible harm by encouraging strategies that are overly focused on short-term metrics. Even to think about raising the stock to a certain level is deeply flawed, because doing so benefits only the shareholders who sell. Because business is ongoing, chief executives who are long-term stewards will worry about the business and let the stock take care of itself.
Corporate boards should get over the fantasy of CEO superheroes. Until this week, Flannery was a well-regarded executive. It would be foolish to think — simply because he has moved to the corner office — that he can be anything more.
Lowenstein is a financial journalist and author of six books, including "America's Bank: The Epic Struggle to Create the Federal Reserve."