What GE’s board could have done differently – Robert Pozen

MIT Sloan Senior Lecturer Robert Pozen

MIT Sloan Senior Lecturer Robert Pozen

From Harvard Business Review

During Jeff Immelt’s tenure as CEO of General Electric, from 2001 until 2017, the company’s stock price fell by over 30%, a decline of roughly $150 billion in shareholder value. Since Immelt’s departure, GE’s stock is down another 30%, as its new CEO, John Flannery, has struggled to cope with the cash flow drain from years of problematic acquisitions, divestitures, and buybacks. Because of these dubious decisions, GE’s ratio of debt to earnings has soared from 1.5 in 2013 to 3.7 in early 2018, according to Moody’s.

So, during GE’s long and steep decline, where was the company’s board of directors? Composed almost entirely of independent directors, it was a distinguished and diversified group of former top executives and other leaders with relevant experience. In my view, however, the structure and processes of the GE board were poorly designed for effectively overseeing Immelt and his management team. There were three problems in particular:

During most of Immelt’s tenure, the GE board was much too large, with 18 directors. The average size of U.S. public company boards is 11 members, with most boards having between eight and 14. Smaller boards are significantly correlated with better stock performance — 8% to 10% higher, according to a GMI study.

Why? After studying meetings of various sizes, researchers have concluded that the optimal number of participants is seven or eight — small enough for good discussions, but large enough for a diversity of opinions. Sociologists observe that many participants in large meetings engage in “social loafing”: Because of the large size, they do not feel responsible to contribute, and instead are content to rely on others to carry things forward.

Fortunately, in December of 2017 GE’s board downsized from 18 members to 12.

GE’s board had another major structural defect: It lacked a finance committee. Before 2018, it had the three standard board committees — governance, compensation, and audit — plus a technology and risk committee to cover important areas such as product risk, cyber security, and technological innovation.

As I have explained elsewhere, a finance committee is critical for a board in complex public companies like GE, which are involved in a broad range of retirement plans, stock buybacks, and large acquisitions. Since the Sarbanes–Oxley Act in 2002, audit committees do not have enough time to carry out their prescribed list of detailed duties as well as to deal effectively with these broader issues of capital allocation.

If the GE board had had a finance committee, the board might have done a better job of overseeing the design and funding of its retirement plans. When Jack Welch stepped down as CEO in 2001, GE’s defined benefit (DB) plan was sitting on a surplus of $14.6 billion. By the end of 2017, this pension surplus had turned into a pension deficit of almost $29 billion. GE has by far the largest pension deficit of all companies in the S&P 500 — over 50% higher than Lockheed Martin or General Motors.

By 2000 most US public companies had closed off their DB plans and made substantial contributions to shore them up. But GE was late in freezing its DB plan and failed to adequately fund it. These are the types of mistakes that an effective finance committee should have been able to prevent.

Instead, the GE board approved a massive series of poorly timed buybacks and acquisitions, all of which should have been carefully vetted by a finance committee. GE’s pension deficit exploded between 2010 and 2016, as the company spent $40 billion on stock buybacks in a futile effort to boost its stock price. Similarly, the company overpaid for several problematic purchases — for example, $9.5 billion in 2015 for Alstom’s business of making coal-fired turbines for power plants.

At the same time, GE’s independent directors put no limits on the amount of GE stock held by employees in its 401(k) plan. Over one-third of this plan’s assets are invested in GE shares, which are used by the company to match employee contributions. This over concentration in employer stock undermines the benefits of a diversified portfolio in a 401(k) plan, where participants bear the entire risk of sub par investment performance.

Robert C. Pozen is currently a Senior Lecturer at MIT Sloan School of Management and a Senior Fellow at the Brookings Institution.

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