How GE and Jeff Immelt Are Failing to Reinvigorate the U.S. Economy
How are recent financial reforms by the U.S. Congress likely to lead to bigger CEO paychecks?
May 3, 2011
The Great Recession and its jobless recovery have focused attention, once again, on outsized top executive pay. In 2005 to 2007, in the run-up to the financial crisis, the total annual compensation of the 500 highest paid corporate executives in the United States averaged over $26 million, of which 53% were gains from exercising stock options. With the stock market down in 2008 and 2009, executive pay fell as well: The top 500 averaged “only” $16.6 million in 2008 and $13.9 million in 2009. Preliminary data indicate that, along with the stock market, executive pay rebounded in 2010, rising by about 27%.
Driven by stock-based compensation and the belief that corporations should be run to “maximize shareholder value,” exorbitant executive pay has been with us since the 1980s. There are three forces that drive listed stock prices, and hence the stock-based compensation of executives. The first is innovation: a company’s stock price rises because it actually has been successful in generating higher quality, lower cost products. The second is speculation: gamblers enter the stock market, betting on the strength and length of the upward momentum of stock prices before the bubble bursts. The third is manipulation: corporate insiders allocate corporate resources to boost stock prices.
Unfortunately, over the past decade, manipulation has become a prime driver of stock-price increases, with large-scale stock repurchases as the favorite tool. From 2000 through 2009, S&P 500 companies — which account for about 75% of the market capitalization of all U.S. publicly listed corporations — spent more than $2.5 trillion on stock buybacks. Stunningly, that amount is equal to 58% of their net income. The average buybacks per company more than quadrupled from less than $300 million in 2003 to over $1.2 billion in 2007, before falling to around $700 million in 2008 and $300 million in 2009. That number rebounded to $600 million in 2010, and is on pace to total at least $700 million in 2011.
Why are stock buybacks such a great way to give a manipulative boost to stock prices? Because they can be used to enable corporate executives to meet Wall Street’s quarterly earnings targets. In the process, these executives pump up their own stock-based remuneration — at least hinting at a major conflict of interest, if not anything outright illegal. Supported by repurchases, executive pay for the years 2004 to 2007 was three times higher in real dollars than it was in 1992 to 1995.
But in terms of developing the productive capabilities required for future global competition, the news is actually much worse. Buybacks come at the expense of investment in industrial innovation and sustainable employment opportunities in the U.S. economy. The manipulation of the stock market through buybacks, the explosion of executive pay and the disappearance of middle-class American jobs all go hand in hand.
It is therefore with considerable skepticism that one has to regard the “Say-on-Pay” provision in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. This provision gives public shareholders the right to express their opinion to corporate management on issues related to executive compensation. A case in point is the recent announcement of the Say-on-Pay modification of the conditions under which Jeffrey Immelt, CEO of General Electric, can receive stock options awarded to him in 2010. Acting on the advice of Institutional Investor Services, Mr. Immelt will now get 50% of his 2010 option awards if GE’s total shareholder return (dividend yield plus stock-price yield) is equal to or better than the return of the S&P 500 Index for the years 2011-2014. Under the modification, Mr. Immelt will receive the other 50% of those options if GE’s industrial businesses generate operating cash totaling at least $55 billion in 2011-2014.
While these performance conditions look tough to hasty onlookers, they are butter soft to any real analyst. The total shareholder return requirement effectively says that Mr. Immelt can get half the options if GE is just an average performer among the S&P 500 companies.
The larger question, however, is what will drive the S&P 500 Index average over the next four years. If the quadrupling of stock repurchases by S&P 500 companies from 2003 to 2007 is a guide, we can expect that the next four years will witness a massive manipulation of the market through an escalation of buyback activity. GE participated fully in the 2003-2007 buyback mania, increasing its repurchases from $1.2 billion in 2003 to $14.9 billion in 2007. Over the decade 2000-2009, GE expended almost $52 billion on stock buybacks — seventh-highest among all U.S. corporations, and equal to 59% of its net income and double its R&D spending. The Say-on-Pay shareholder-return performance condition is a license for Mr. Immelt to manipulate GE’s stock price to gain his stock option awards.
Furthermore, the second Say-on-Pay performance condition — that over the next four years GE must generate at least $55 billion from its industrial businesses, as distinct from GE Capital Services — creates the impression that shareholders want Mr. Immelt to invest in real productive assets. Indeed, upon being named chair of President Obama’s new Council on Jobs and Competitiveness last January, Mr. Immelt declared in a Washington Post op-ed that “there is nothing inevitable about America ‘s declining manufacturing competitiveness if we work together to reverse it.”
But does the target of $55 billion in cash from operations of GE’s industrial businesses over the next four years imply an expansion of GE’s investments in its non-financial businesses? To the contrary. The fact is that over the past four years GE’s cash from industrial operating activities was almost $73 billion. In reality, this Say-on-Pay performance condition will reward Mr. Immelt with stock options for bringing about a 25% reduction — repeat: reduction! — in GE’s industrial businesses. So much for working together to reverse the nation’s declining manufacturing competitiveness.
If Congress had understood what drives executive pay in the United States, it would have recognized that the granting of Say-on-Pay rights to public shareholders in the Dodd-Frank reform is part of the problem, not the solution. Through a combination of stock options and stock buybacks, Say-on-Pay provisions reinforce an alignment between the incentives of top executives and the interests of public shareholders that has been undermining investment in America’s future.
If we want financial reform that will serve to limit executive pay and encourage investment in innovation and job creation, a crucial first step would be to ban stock buybacks by large corporations such as GE on the grounds that they are nothing but a manipulation of the stock market.
Stock buybacks come at the expense of investment in industrial innovation and sustainable employment opportunities in the U.S. economy.
From 2000 to 2009, GE expended almost $52 billion on stock buybacks — double the amount it spent on R&D.
GE's CEO can get his stock options by bringing about a 25% reduction in the company's industrial businesses. So much for working together to reverse the nation's declining manufacturing competitiveness.
Professor of economics, University of Massachusetts Lowell William Lazonick is an economics professor at the University of Massachusetts Lowell, and co-founder and president of the Academic-Industry Research Network (theAIRnet). Mr. Lazonick is also affiliated with the University of Bordeaux and University of Ljubljana, where he is engaged in collaborative research on finance, innovation, and growth, […]