How about a #MeToo movement for executive compensation?
No joke. Corporate America has abused shareholders for too long. They have made a mockery of fairness, taste and responsible capitalism.
They have no more idea of proper incentives than Harvey Weinstein had of employee relations.
Their unceasing grabbing of tens of millions of other people’s (their shareholders’) money bespeaks a single phrase: the arrogance of power. They need a reset.
General Electric brought this to mind — the company that just, and for the second time in a year, replaced its CEO. It hired Lawrence Culp, a former CEO of Danaher, as chief executive. Without blushing, GE awarded Culp a contract that could be worth $300 million over the next four years. If that number doesn’t shock you, you have been spending too much time reading the business pages.
Wall Street has nothing but cheers for Culp’s contract. Much of his compensation will be tied to the performance of the stock. CNBC’s Jim Cramer said, “It’s the best performance-oriented contract I’ve ever seen.”
But history is replete with companies that rewarded CEOs for achieving short- and medium-term goals and that didn’t, in the long term, realize gains for investors. GE is a prime example.
The 126-year-old General Electric was once a company your grandparents knew; it made lightbulbs, consumer appliances and plastics.
In the 1980s and ’90s, a CEO named Jack Welch expanded into broadcast, defense electronics and financial services. Welch was fawned over by security analysts for seemingly making his numbers every quarter. He was lauded for managing earnings, a euphemism for gaming the numbers so he could hit performance targets.
Welch retired wealthy. But it turned out that pursuing a series of short-term managerial goals was not a ticket to enduring prosperity for GE. In finance in particular, quarterly results bore little relation to the long tails of liability or to the intrinsic value of the underlying assets.
Welch’s successor, Jeffrey R. Immelt, was left to clean up the mess. Immelt frenetically traded businesses, doubling down on fossil fuels, selling NBC, buying and later selling water filtration, getting into a predictive (and risky) health-care venture, and dumping most of GE’s assets in finance.
The old businesses were always one that didn’t fit. The new ones all had great potential and fit some strategic plan. Along the way, GE promised that Immelt would be paid only for performance — as shareholders prospered, too.
What GE really did was reward Immelt for a series of near-term goals without respect to whether GE’s value increased in the long run. Which it didn’t.
A year ago, Immelt was retired ahead of schedule. During his 16 years, GE shares (including dividends) returned a pitiable 1 percent annually, while the Standard & Poor’s 500-stock index rose 7 percent a year.
While compiling that abysmal record, Immelt collected hundreds of millions of dollars — $91 million in 2014-2016 alone. He exited with deferred shares and benefits worth an estimated $100 million, to help with the rent I guess.
John Flannery, the in-house promotion who succeeded Immelt, sold (or planned to sell) numerous businesses acquired by his predecessors and intended to focus on industrial units such as power turbines and jet aircraft engines. The dealmaking shuffle was to continue.
I said at the time that GE subscribed to a pervasive myth that acquisitions are accretive. Whether the buyer or seller will look good in hindsight may not be known for many years.
Consider the deal that set the pieces in motion for Flannery’s ouster. Just over four years ago, Immelt announced a huge acquisition to buy the gas and steam turbine business of the French company Alstom. Wall Street hailed the deal, which closed in 2015. TheStreet called the Alstom purchase GE’s “Best Deal in a Century.” Jim Cramer — yes, that one — said, “The acquisition is a brilliant one.”
Immelt’s pitch was that Alstom was a strategic fit that would give GE scale in power turbines, enable it to supply a world hungry for power capacity, and lead to significant savings and synergies.
The honey in the deal was that GE’s margins in power were more than double Alstom’s; just by bringing Alstom’s margins to GE’s level, it would reap huge incremental profits.
But nothing worked as planned. Gas power turbines faced surging competition from renewables. Demand plunged even as capacity grew.
“We used to ask, ‘When is renewable going to blow up demand for turbines?’ ” says Nick Heymann, an analyst at William Blair. The answer was always way in the future. But the timeline for wind and solar to get to cost parity with gas collapsed. Gas turbines still had an advantage; wind and solar power are expensive to back up and store (the sun doesn’t shine, nor does the wind blow, evenly or all the time). But the timeline for reducing the cost of temporarily storing power collapsed as well.
The bottom line is that GE paid $13 billion for assets that, within a few short years, were seriously impaired. Rather than rising, GE’s margins in power have suffered a haircut. Finally, GE took a $23 billion charge on Alstom and other assets — the last straw for Flannery’s board.
Flannery wasn’t to blame for most of what went wrong. In addition to Alstom, he had to add $15 billion in reserves to GE’s legacy health-care reinsurance business because of falling interest rates and rising health-care costs. He had to borrow billions to shore up GE’s massively underfunded pension. Those problems predated him.
Flannery also reversed an Immelt policy of booking turbine upgrades for which GE wouldn’t receive payment for years to come. In other words, Flannery stopped trying to dress up the numbers, which caused his reported numbers to suffer.
The point is that just as decisions made by Welch came home to roost under Immelt, so it took several years, or more, to properly appraise mistakes by Immelt. That’s why bonus packages that reward CEOs for doing deals, or for any short-term results, are an insult to genuine capitalism. They are a form of socialism — an extraction of owner profits by the executive suite.
Since GE’s announcement of its management change, the company’s stock has rallied. Culp has had a good fortnight. But his contract is party to the same short-term thinking that led GE astray.
No manager or board is expected to have a crystal ball. Mistakes happen, and acquisitions (despite what they say when deals are hatched) are notoriously hard to forecast.
Therefore, CEO pay ought to be geared to the very long term, after the results are in. A decade is reasonable. And compensation at the top ought to be proportionate to pay elsewhere — reflecting that CEOs are human, not some breed of infallible superstars.
Dangling options over short-term periods creates the worst of incentives. Effectively, managers are paid to bet the ranch in the hope of becoming the next Bill Gates, knowing if the present cycle doesn’t pan out, the next one may.
Moreover, the pay for just doing the job is absurdly inflated. GE says Culp’s pay is “at risk.” What they mean is that even if the stock doesn’t appreciate, Culp can “only” earn, over four years, $85 million, dependent on meeting performance targets that GE says are challenging.* It the stock rises 50 percent, he collects $127 million. If it rises 150 percent, he makes precisely $297 million.
Think about that. When Culp was hired, GE stock was at $11.28. A 150 percent rise would take it to $28.20. That is just few pennies above its level when Flannery’s appointment was announced. In other words, having paid Immelt hundreds of millions to risk the franchise, with the damage fully reflected only during Flannery’s subsequent tenure, GE would then pay hundreds of millions more to return to par, that is, to a zero net gain for the shareholders. It’s a funny way to pay for performance.
General Electric may not learn from its experience, but the rest of us can. It’s time for a reset on executive pay.
*This story was updated to reflect GE’s view that Culp’s pay-related performance targets are “challenging.”