Ponzi 4: Former GE Chief Jack Welch says obsession with short-term profits, share price gains was “Dumb Idea”

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"Ponzi 4: Former GE Chief Jack Welch says obsession with short-term profits, share price gains was “Dumb Idea”"

File this one under “now they tell us” or maybe “the former drug kingpin says crack is not healthy for you.” The Financial Times reports the shocking not-quite-deathbed conversion:

Jack Welch, who is regarded as father of the “shareholder value” movement, has said the obsession with short-term profits and share price gains that has dominated the corporate world for over 20 years was “a dumb idea”….

“On the face of it, shareholder value is the dumbest idea in the world,” he said. “Shareholder value is a result, not a strategy … your main constituencies are your employees, your customers and your products.”

Uhh,”your products,” Jack? Still, an amazing statement and 2 out of 3 aren’t bad.

I realize this is not the same as Jack denouncing the whole system as a Ponzi scheme (see “Is the global economy a Ponzi scheme, are we all Bernie Madoffs, and what comes next? Part 1). It’s not like he said “your main constituencies are your employees, your customers and the next generation.”

But escaping the Ponzi scheme requires a massive national and global investment in the trifecta of energy efficiency, cogeneration, and renewable energy (see “An introduction to the core climate solutions“). And that requires companies to make investments maximizing long-term profits and minimizing lifecycle costs — not maximizing short term profits and minimizing first costs.

Having spent a decade working with leading businesses on greenhouse gas mitigation strategy, helping (many of) them to adopt energy efficiency, renewable energy, and cogeneration technologies, I can attest that the single biggest reason senior company executives and corporate energy managers turned down even highly profitable investments was the companies’ obsession with short-term profits. A four- to five-year payback is, for instance, typical for a major energy efficiency upgrade and/or an onsite combined heat and power system, which can cut energy bills 25% to 50% (see the hundred case studies in my 1999 book, Cool Companies: How the Best Businesses Boost Profits and Productivity by Cutting. Greenhouse Gas Emissions).

Now that is a simple return of some 20% to 25% per year — comparable to or even higher than most of the other kinds of investments companies make. And that high return comes with a far lower risk than any of those other investments. And that high return also often come with productivity gains, as I and others have documented at length.

But it requires making a capital expenditure now (or increasing debt to borrow the money for the retrofit), to reduce operating expenses for the next 10 to 20 years. That hurts short-term profits and shareholder value — at least in the Welch-created world of now, now, now.

So perhaps Welch’s statement might be the first crack in the short-term-profit fa§ade. Here are more excerpts from this amazing story:

In an interview for the Financial Times‘ series on the future of capitalism, the former General Electric chief said the emphasis by executives and investors on shareholder value since he spelt it out in a speech in 1981 was misplaced.

Mr Welch, whose stellar record in his two decades at GE helped make shareholder value popular, said that it was wrong for managers and investors to set consistent earnings growth and steady share price increases as their overarching goal.

Mr Welch spoke at the weekend, before Thursday’s news that GE, which he left in 2001, had been downgraded by Standard & Poor’s, losing the pristine triple A rating it had held since 1956.

Mr Welch’s comments on shareholder value come as the credit crisis and the global economic slowdown have caused a radical rethinking of many of the corporate and financial beliefs that held sway over the past few decades….

The birth of the shareholder value movement is commonly traced to a speech Mr Welch gave at New York’s Pierre hotel in 1981, shortly after taking the helm at GE.

In the speech, entitled “Growing Fast in a Slow-Growth Economy,” Mr Welch outlined his beliefs in selling underperforming businesses and aggressively cutting costs in order to deliver consistent profit rises that would outstrip global economic growth.

GE, he told analysts then, “will be the locomotive pulling the GNP, not the caboose following it,” according to reports of the speech.

Mr Welch said last week he never meant to suggest that setting, and meeting, profit expectations quarter after quarter in an effort to boost a company’s share price should be the main goal of corporate executives.

“It is a dumb idea,” he said. “The idea that shareholder value is a strategy is insane. It is the product of your combined efforts – from the management to the employees”.

However, GE’s success under Mr Welch – during his tenure, the conglomerate’s market capitalisation rose from $13bn to $400bn while profits grew tenfold to almost $14 billion – prompted many executives to place greater emphasis on shareholder value. Many fund managers also backed concept because they are judged on a quarterly basis.

Sadly, most businesses today still haven’t done what the best businesses did on energy efficiency and cogen in the 1990s. And yes I realize that most companies don’t feel they have the money to make such investments right now.

But the Obama administration and Congress are working hard to help underwrite part of those investments with tax credits and loans — and incentivizing the utility industry to do the same by pushing smarter regulations (see “Waxman puts utility decoupling in the stimulus“).

So I expect a real resurgence in corporate energy investments over the next few years.

Note to self: Perhaps it is time to reprint some of the case studies I published a decade ago.

h/t HuffPost

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24 Responses to Ponzi 4: Former GE Chief Jack Welch says obsession with short-term profits, share price gains was “Dumb Idea”

  1. More active business and investment leaders need to chime in here. Welch in his retired status may be given a “pass” because he views this now from 30,000 feet. This is key to allowing businesses to invest for the medium and long-term, not to eviscerate their fixed capital investments and investments in people to make their balance sheets look better on a quarter-by-quarter basis.

    Carbon pricing policies will not work without businesses taking at least a medium if not a long-term view. So we need more reformed Jack Welches coming out of the woodwork.

  2. tidal says:

    Joe, I have enormous regard for you, but this post is kind of wonky.

    Corporations are always going to have a duty to maximize shareholder value. Almost certainly that will always be their primary mission, albeit balanced and constrained by certain interests of their other constituencies.

    It’s fair to argue that maximizing LONG-TERM shareholder value needs to supersede short-term tricks, but it’s not valid to suggest that they need to focus on, say, employees’ welfare, as their key metric.

    Anyway, to your point about the madness of short-term focus, you and your readers might enjoy this “Onion”-like blurb: Wall Street Rejects Short-Term Thinking, Embraces Shorter-Term Thinking Excerpt: “Ten minutes ago I had lost all I ever worked for, but now I know that my money is secure in a powerful and revitalized economy that could last all of an hour.”

  3. Corporations are always going to have a duty to maximize shareholder value.

    Does that come before or after maximizing their value to their nation and their planet?

  4. Dano says:

    What he forgot to say was that he and his corporate buddies blew up this bubble so they could profit from it. Other than that, I credulously believe his every word, because I play his stock and one day I’m going to be rrrrRRRRICH!!! because of it!!!

    Best,

    D

  5. tidal says:

    Thomas, yeah, they have other constituencies, and like I said, they need to balance shareholder-value maximization with other competing interests and constraints. But to think that the modern corporation is going to start operating from an “employees-first” or “environment-first” frame of reference is naive.

    I am deeply concerned about the environment and the failures of capitalism as it exists today to cost in externalities, etc., etc. But to start suggesting that the corporation is not duty bound to its shareholders to maximize long-term wealth just marginalizes this kind of criticism.

    If you are a shareholder of a company, do you want them to put your interests behind those of their suppliers, for instance? They have to balance off competing interests, but management and directors must look to create value for shareholders.

  6. they need to balance shareholder-value maximization with other competing interests and constraints.

    Er … no, they don’t. What they need to do is put their planet and their nations before their shareholder needs. What is so hard to understand about that?

  7. Joe says:

    I am a wonk — that’s “KNOW” backwards for the uninitiated :)

    When Jack Welch walks back on short-term profits and shareholder value, that’s news, I think.

    But given the massive wealth destruction of the past 12 months, where total U.S. wealth (narrowly defined) is now back at 1997 levels — I think we have every right to ask whether the Welch strategy ever made sense, Especially because of its anti-environmental implications.

  8. Tidal,
    A focus on quarter by quarter shareholder value can diminish long-term shareholder value. In the 1980s and after, shareholders became increasingly focused on the next quarter rather than building the corporations capacity to deliver value over the long term. We need to extend the timeframe for creating value for shareholders and for other constituencies, otherwise we will not see much of the climate-friendly investment we need until it is too late.

    Another tack is for corporations to opt into a “B” corporation model where their obligations were more evenly distributed among stakeholders.

    http://www.bcorporation.net/why

  9. tidal says:

    Thomas, Joe, if their goal was to put the planet’s need ahead of shareholders’ needs, why wouldn’t every corporation simply liquidate all its assets and give the money to the Sierra Club? That would certainly put the environment ahead of shareholders’ interest, no? Creating shareholder value will always be the first priority of the corporation, subject to the various constraints. If you think that solving things is going to come from magically telling corporations in a market-based economy to internally adopt another mission, you are dreaming. The solution has to come from the outside in terms of regs or incentives to make them incorporate their full costs of doing business, long-term consequences, etc.

    This is a quixotic and fringe quest. Our time is better spent getting meaningful carbon prices, etc., rather than trying to convert the modern corporation into a quasi-charity operation.

  10. I wish someone would focus on specific re-regulation that would finally drop this market to its bottom and restore confidence. Re-regulation will cause a market tantrum, a final political protest sell off. Let it happen. Final capitulation by childish masters of the universe will signal a solid bottom.

    What is needed in terms of re-regulation? 5 cent uptick rule, Glass Steagall, transparent accounting, margin requirements for hedge funds, enforcement of insider trading and market manipulation laws.

    How can any progress on climate happen without restoration of economic confidence?

    http://amazngdrx.blogharbor.com/blog/_archives/2009/3/11/4119281.html

  11. Len Ornstein says:

    Joe’s :

    “that requires companies to make investments maximizing long-term profits and minimizing lifecycle costs — not maximizing short term profits and minimizing first costs”

    IS THE MESSAGE THAT MUST BE USED TO REDEFINE THE FREE MARKET!

    Then there would LESS FREQUENTLY be conflicts between such capitalism and the needs of humanity and the planet.

  12. tidal says:

    By the way, Gus Speth’s The Bridge at the Edge of the World: Capitalism, the Environment, and Crossing from Crisis to Sustainability came out in paperback this week. He examines a lot of these issues further.

  13. Thomas, Joe, if their goal was to put the planet’s need ahead of shareholders’ needs, why wouldn’t every corporation simply liquidate all its assets and give the money to the Sierra Club?

    Because that would not be in their shareholders, the planet’s or their nation’s best interests.

    That would certainly put the environment ahead of shareholders’ interest, no?

    No it would not. Do you have anything cogent to say at all here?

    Our time is better spent getting meaningful carbon prices, etc., rather than trying to convert the modern corporation into a quasi-charity operation.

    Where did I say that? You said that. You have some predispositions and preconceived notions of what I said and what it means which I do not hold.

    Let me reiterate, corporations need to put the needs of their nation and their planet first and second, if they wish to survive.

    It’s simple Darwinism. How do you think organisms evolve?

  14. Maarten says:

    A corporation is in the business of serving customers. Thus, customer value comes first, within ecological and societal constraints (tranlated into laws), when these are met, investors are willing to provide capital.

  15. nsrig says:

    It seems to me that if we all plunged headfirst into global action geared towards energy efficiency, and environmental repair that profits and economic stability would be an unexpected by-product. There are a few examples availabe of individuals doing whats right because its right, and coming out of it suprised they made a profit. ( I cant recall specifically so if someone wants to provide a case, or tell me I’m wrong, please do!) I’ll go out on a limb here and say that profiteering and greed are essentially their own enemies, the current financial crisis as an example. Imagine if 50 years ago the president would have taken heed of the warnings about climate change that arrived at his desk and pushed America towards sustainability, we would all have a quality of life that would make modern day america look like a third world counrty. Well 50 years down the line and thats 20/20 hindsight. But the same logic applies to us now since where in the same situation, we just have better technology and science. With sustainability in our grasp will we reach for it? or ark ‘god’ why he didn’t make a remote control for this sort of thing? In fifty years will my grandson be saying the same thing as me? or celebrating our generation for facing the truth and doing somehting about it?

  16. nsrig says:

    I just had this thought reading more comments: What he have here is a newly born global state that is essentially a toddler growing too big for its diapers and unwilling to give up its bottle.

    Its time for us to stop pooping in our pants (the environment)

    and to give up our bottle (the economy)

    I know that for most people the idea of a world without money is an impossible idea, because I am constantly suggesting, and discussing it. Peoples minds immediatley reel when presented with the idea of a world without money. How could someone possible wake up in the morning and go out in the world to persue development without the incentive of a cash reward? It is a thought as foreign to us today as thinking there is no god would have been centuries ago. And the two have one important thing in common, they are both a figment of our imagination.

  17. David B. Benson says:

    Co-operatives still exist in some settings. So do employee owned corporations.

  18. Thus, customer value comes first, within ecological and societal constraints (tranlated into laws),

    Perhaps corporations need to understand the value of laws then, and the customers need to write laws with value to their nation and their planet.

    Oh, I get it, America has a fundamental ‘values’ problem, which reaches into all levels of their activities, from government to corporations to the street.

  19. paulm says:

    What kind of ponzi scheme is this…print your own money to pay interest with it?

    Time to buy gold. Quick look on the markets – lots of others are thinking that too. Ouch.

    China ‘Worried’ Over Safety of U.S. Debt, Wen Says
    http://www.bloomberg.com/apps/news?pid=20601087&sid=a6KTPb8k2koY&refer=home

    “We have lent a huge amount of money to the United States,” Wen said at a press briefing in Beijing today after the annual meeting of the legislature. “Of course we are concerned about the safety of our assets. To be honest, I am a little bit worried. I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets.”

  20. Laurie Dougherty says:

    I worked for GE at Appliance Park in Louisville, KY in the 1970s and 1980s (when I wasn’t laid off). Appliance Park went from 23,000 employees in 1974 to about 6,000 in 1991 when I left GE for good and moved back to Massachusetts. (Now the appliance division is on the market from what I’ve heard.) They called Jack Welch “Neutron Jack” in those days: like a neutron bomb that eliminates the people but leaves the buildings standing.

    Jack Welch’s enlightenment is far too little and far too late. What he said has been said about him for decades. I remember someone showing me an article about him cutting back on R&D, something about eating the seed corn. I said things like this in an op-ed in the Louisville paper in the late 1980s and in a few articles I wrote for small progressive magazines based on my GE experiences.

    Forget about Jack Welch being misunderstood. The pursuit of short term profit was exactly how he ran the company. Welch demanded that each sector of the company be #1 or #2 in market share in its product lines (or be sold off or shut down) and that the company’s quarterly earnings increase at 1.5 to 2.0 percent faster than GDP growth.

    Just a year or so ago, I went to a Q & A session Welch gave at MIT (he has been teaching a course there too.) I couldn’t even get into the hall, had to watch on a screen in an overflow area. The place was packed with starry-eyed students. I couldn’t stand to stay for all of it, but I did hear the moderator ask him about the GE Ecomagination program started by his successor Jeffrey Immelt. the Welch said something to the effect that the company sees that some people want green products so this is another way to make money. (Let’s all forget about the dozens of Superfund sites, PCBs in the Hudson and Housatonic Rivers, resistance to energy efficient appliance standards, and resistance to eliminating CFCs back in the days of the Montreal Protocol). Short term profit was all that Jack Welch was about.

    Love your blog, Joe. Sorry my first comment here is a rant but I see “Jack Welch” and rant is what I gotta do.

  21. Pangolin says:

    If only there were some way that corporate CEO’s and boards couldn’t collect their pay until ten or fifteen years had passed. Something like a very delayed stock option that couldn’t be traded. Where would GM be today if fifteen years ago the CEO’s knew they had to keep the company solid in a peak oil environment to get paid? What if GE CEO’s thought they would have to pay toxic cleanup costs out of pocket?

    I think corporations need a thin wire tied around the boards genetic reserves and a short leash tied to it. I just don’t know how to construct that legally.

  22. Charlie says:

    The real problem that businesses (or individuals for that matter) have making investments in energy savings projects is not that they are short-sighted or criminal – the real problem is that the price of energy fails to account for the externalities associated with the use of fossil fuels and other non-renewable resources. Once this problem is solved (we can debate how this should be done) companies will quickly make begin to make rational investment decisions that will align the interests of the shareholders and the environment.

  23. I applaud Laurie Dougherty for her illuminating comment.

    The generation of yuppies Neutron Jack inspired to junk their companies to boost their bonuses still runs things. The “downsized” employees are victims of greedy managers and greedy lawyers, who have made health care and tort liability so expensive that the smart thing is to dump US employees.

    We need to ask why there is a short-term perspective. The pressure is bonuses or contingent fees or commissions payable immediately based on a percentage of deals done (remember Enron? remember the S&L crash?). No matter how bad the deals are. Bonuses should be in a special class of non-transferable stock, payable to their retirement plan. Let them reap what they sow.

  24. Jim Bullis says:

    Corporations are creatures of law and there is no morality involved if it is not included in that law. So the moral responsibility has to fall to government. That is us. After that, the responsibility is indeed to the shareholders. Whatever else we might expect is extralegal dreaming. There are legal sharks waiting to pounce on any corporation doing otherwise.

    Long term profits were sacrificed for short term profits when Jack started selling off all the business lines that were not at least number 2 in their field. I contend that his actions greatly damaged a national resource, which otherwise might have continued to be a great investment for shareholders on a long term basis, as it had been for many years.

    Not only did he damage his core company, he went on to get into loan sharking so he could more conveniently present growth of short term profits.

    So why is Jack given the opportunity to speak? I would consider sending him to keep Madoff company. A lot of GE shareholders might agree.