Monday, February 21, 2011

How General Electric Became a Basket Case (GE)

From Political Calculations:
In the 1980s and 1990s, General Electric (NYSE: GE) was led by one of the most influential corporate chiefs in American history: Jack Welch.

Throughout his tenure, Welch maintained a tight focus on improving the profitability of each of GE's business divisions. His goal was that GE would either be the most profitable or the second-most profitable company among all competitors in each of its business segments. To that end, he earned the nickname "Neutron Jack" for how he dealt with the poorest performing divisions and managers within the conglomerate, as he stopped money-losing operations by exiting non-profitable businesses either by closing divisions or selling them and by firing the lowest performing 10% of the company's managers each year.

By the time he retired from GE's CEO position two decades later, GE had been transformed from a bloated conglomerate into one of the most successful and profitable companies in the world. Its manufacturing and technology-oriented businesses had grown to become industry leaders and the company's expansion into the financial industry had also been enormously successful, for which Welch was enormously well compensated.

And that's when GE's fortunes permanently changed for the worse, although it would be years before anyone would realize it. Because Jack Welch's successor, Jeffrey Immelt, couldn't compete his way out of a wet paper bag to real success by comparison.

To understand why, we'll need to consider the findings of new academic research into CEO compensation.
Here, Partha Mohanram and Sudhakar Balachandran had asked the question "Are CEOs Compensated for Value Destroying Growth in Earnings?" To answer the question, they tapped the Execucomp database, which tracks the compensation of business executives at some 1500 publicly-traded companies.
What they found is that corporate boards too often reward CEOs too generously for generating the wrong kind of growth from the perspective of creating real shareholder value. Here, many CEOs are effectively being overcompensated by focusing on generating "easy" profits through investment-related growth at the expense of improving the real profitability of their business operations.

Over time, the incentives for higher compensation leads executives to favor investment-related activities too strongly over working to achieve the more organically-generated growth that results from improving their business' real profitability. That leads to substantial losses of shareholder value when the investment climate turns stormy.

In a nutshell, that's what has happened to GE under Jeffrey Immelt's tenure. The financial arm of the company, GE Capital, grew to dominate all its other business segments, as this single division grew to represent 39.5% of GE's total revenues and 42.1% of its total segment profits by 2007....MORE
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