How Immelt Turned GE Into a Basket Case

Political Calculations February 17, 2011

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.

That worked all the way up until the bubble for easy profits to be made through investment activity in the U.S. popped in 2008 and the investment climate turned nasty. Through 2009, GE Capital's share of GE's total revenues had dropped to 32.6%, while the division's share of total segment profits plunged to 12.1%.

Soon after the bubble popped, mounting losses from GE Capital's lending activity caused GE's earnings to plunge, with share prices following as the market adapted to the loss of value resulting from the consequences of Immelt's too-long misplaced focus on generating "easy" profits through investment activity. Ultimately, even Jeffrey Immelt's compensation followed suit as the company's declining situation forced him to decline bonuses and as the value of his stock awards has fallen. (Note: Immelt's has continued to receive his annual base salary of $3.3 million.)

But that's not all. GE's fiscal situation deteriorated so much in 2008 that it required massive bailouts from the federal government to stay afloat. Beyond that, GE has moved to scavenge itself to raise cash, seeking to sell off several highly-valued business divisions to competitors, sometimes at significant losses.

Even the kinds of business that GE now pursues are perhaps best characterized by their likelihood to receive either special protection from competitors or subsidies from the federal government, relying on close connections to politicians rather than real competitive ability to win new business. For example, in December 2010, GE announced that it would invest in developing high-speed rail technologies. On 8 February 2011, Vice-President Joseph Biden announced that the U.S. government would spend over $53 billion over six years to build high speed rail systems and infrastructure in the U.S.

That $53 billion should really be considered yet another bailout for GE, as the company's high-profile entry into the field combined with the newly announced government subsidy program would seem to be designed to guarantee the company a portion of the revenue to be provided from the federally-funded boondoggle at the expense of competitors, not to mention more economic, efficient and effective methods of transportation for people between cities (aka "every other form of transportation").

Real companies that aren't basket cases don't pursue business strategies whose success hinges on government mandates, protections and subsidies, much less that rely upon fulfilling the outdated visions of dimwitted politicians and bureaucrats. Instead, they focus on improving the profitability of what they do so that both their shareholders and their customers are happy, which is what creates real value for everybody involved.

That kind of focus just happens to be what GE has been missing from its top leader now for more than a decade. Which perhaps may be what Immelt was really trying to confess to the company's shareholders in describing recent times at GE as "The Decade from Hell".

Disclosure: Ironman, as your ecomagination might already tell you, holds no position in GE.

Labels: business, management

- posted by Ironman at 4:27 AM | Permalink | Share | | << Home Unexpectedly Intriguing!

About Political Calculations

blog advertising is good for you Welcome to the blogosphere's toolchest! Here, unlike other blogs dedicated to analyzing current events, we create easy-to-use, simple tools to do the math related to them so you can get in on the action too! If you would like to learn more about these tools, or if you would like to contribute ideas to develop for this blog, please e-mail us at: ironman at politicalcalculations.com Thanks in advance!

Recent Posts

The New Obama Spending Future Correlating the Price of Gas and the Unemployment ... The Strangest Foods Served On Sticks How Many Kids Should You Have? From Economic Crisis to Statistical Adjustment How Much Is That in Gold? The Transformation of Student Loans Into Taxes 1.2 Million Americans Quit Seeking Work Since Nove... A Look in the GDP Crystal Ball The Educated and the Unemployed

U.S. GDP Temperature Gauge

Political Calculations' U.S. GDP Temperature Gauge provides a means to quickly evaluate the growth rate of the U.S. economy against the backdrop of how the economy has performed since 1980, with the "temperature" color spectrum ranging from a recessionary "cold" (purple) through an expansionary "hot" (red).

The GDP Temperature Gauge presents both the annualized GDP growth rate as reported by the U.S. Bureau of Economic Analysis reports for a one-quarter period and also as averaged over a two quarter period, which smooths out the volatility seen in the one-quarter data and provides a better indication of the relative strength of the U.S. economy over time.

Recession Probability Track

Political Calculations' Recession Probability Track shows the probability that the U.S. economy will be in recession 12 months from the indicated date (shown in red) while revealing the probability trend over the past four years.

Previously, the probability of recession peaked at 50% on 4 April 2007, which means that March-April 2008 was the most likely period in which the NBER would have found the U.S. to be in recession.

As it happens, they almost did. The NBER instead chose December 2007 as the beginning month of the most recent recession (we had found a 46% probability for a recession beginning in that month!)

On the Moneyed Midways

Political Calculations is also the online home of On the Moneyed Midways (aka OMM), a review of the best posts contributed to the week's best business and money-related blog carnivals, which we ran as a regular weekly feature for the five years from 2006 through 2010.

The link below will take you to the running index containing our most recent back issues (you can easily navigate the index to find older editions.)

OMM's Most Recent Editions - with links to our older editions!

Site Data

This site is primarily powered by:

Visitors since December 6, 2004:

var site="sm7politicalcalculations"

CSS Validation

RSS Site Feed

JavaScript

The tools on this site are built using JavaScript. If you would like to learn more, one of the best free resources on the web is available at W3Schools.com.

Other Cool Resources

ZunZun - Exceptional regression analysis tool. Wolfram Integrator - Solve integrals. Do calculus! Create a Graph - Easy-to-use basic graph-making tool. Many Eyes - Data visualization extraordinaire! Wolfram Alpha - Computational knowledge engine. Khan Academy - Math & science video mini-lectures!

Archives December 2004 January 2005 February 2005 March 2005 April 2005 May 2005 June 2005 July 2005 August 2005 September 2005 October 2005 November 2005 December 2005 January 2006 February 2006 March 2006 April 2006 May 2006 June 2006 July 2006 August 2006 September 2006 October 2006 November 2006 December 2006 January 2007 February 2007 March 2007 April 2007 May 2007 June 2007 July 2007 August 2007 September 2007 October 2007 November 2007 December 2007 January 2008 February 2008 March 2008 April 2008 May 2008 June 2008 July 2008 August 2008 September 2008 October 2008 November 2008 December 2008 January 2009 February 2009 March 2009 April 2009 May 2009 June 2009 July 2009 August 2009 September 2009 October 2009 November 2009 December 2009 January 2010 February 2010 March 2010 April 2010 May 2010 June 2010 July 2010 August 2010 September 2010 October 2010 November 2010 December 2010 January 2011 February 2011 if (location.href.indexOf("archive")!=-1) document.write("Current Posts");

Bloodhoundblog Budgets Are Sexy Cafe Hayek Carpe Diem Cheap, Healthy, Good Copywriting Tips Core77 Coyote Blog Craig Harper Darwin's Finance Digerati Life, The Division of Labour Dough Roller, The Eclectecon Econlog Economics Roundtable EconomicsUK Entrepreneurial Mind Environmental Economics Escape from Cubicle Nation Execupundit FiscalGeek Fortify Your Oasis Get Rich Slowly Gongol Good Financial Cents HR Bartender Hot Air i4cp Productivity Innocent Bystanders Innovation and Growth Instapundit Intangible Economy I've Paid Twice for This Already Joanne Jacobs Kaus Files Len Penzo dot Com Mahalanobis Making Ripples Market Power Mechonomics Mighty Bargain Hunter Monevator Money Blue Book My Dollar Plan New Economist Newmark's Door Nina Simosko Physorg Private Sector Development Radio Equalizer Real Clear Politics Richard Fernandez Roger L. Simon SCSU Scholars Science and Money Skeptical Optimist Sound Politics SOX First Speculist, The Sports Economist, The squawkfox Three Star Leadership Tim Worstall Tough Money Love Townhall Trusted Advisor Uncommon Misperceptions voluntaryXchange WILLisms Winterspeak

Market Links

Big Picture, The CXO Advisory Group Disciplined Approach to Investing Dividend Guy, The Doug Short Evidence Investing Fat Pitch Financials FX Investment Strategies

How Immelt Turned GE Into a Basket Case

Related Articles