Posted Dec 13, 2008 by Bill George |
Filed in: Business
It is time for General Motors´ board to fulfill its fiduciary duty. GM management has failed to create a viable turnaround plan. The U.S. Senate has refused to bail it out. So the board is the only entity left that can save the company before it gets forced into bankruptcy. Isn´t this the board´s duty anyway?
Neither bailouts nor bankruptcy are viable courses of action. The $18 million that GM requested in its most recent bailout, on top of "the innovation R&D bailout" passed by Congress in October, is just a down payment on many more to come. Eventually, taxpayers and even the new administration will get fed up with chasing a downward spiral, especially when it means asking Americans who have no health care coverage to pick up 100% of the health care tab for GM employees.
In spite of many calls to let GM go bankrupt from Congress and elsewhere, the GM board is correct in its assessment that American consumers won´t want to buy their automobiles from a bankrupt company.
So why doesn´t the GM board do the obvious: dramatically downsize the company to make it viable? The only way GM can survive is to consolidate around three brands - Chevrolet cars and trucks, Buick and Cadillac, and sell off or shut down the rest of the company.
The fastest and most efficient way to get this done is to split GM into two companies, a healthy GM and one to be liquidated. The healthy GM would take the aforementioned brands, a limited number of factories operating at greater than 80 per cent of capacity, and a select number of healthy dealerships. Employment agreements would be renegotiated to get wages and benefits competitive with the North American plants of the Japanese and German producers, along with a more flexible set of work rules. This includes getting employees to pay up 20-25% of the cost of their health care, like all other Americans do.
The new GM would embark on a massive new product development program to make its automobiles competitive in engineering, features, fuel efficiency and styling. Management would commit to a fleet average of 40 miles per gallon by 2016 and 50 MPG by 2020, with a mix of lighter vehicles, efficiency improvements, hybrids, and electric cars like the Chevy Volt. Management should aggressively attempt to move buyers from former GM brands like Pontiac and Saturn to its remaining brands.
To lead this new company, GM needs new management, much like the team of Louis Gerstner and Jerry York that restored IBM to health. The best candidate for CEO is Carlos Ghosn, who has achieved remarkable success at both Renault and Nissan. A new headquarters location should be established - somewhere like Dallas or Atlanta - with a very small corporate staff. Finally, the company should be governed by a new board of directors.
The remaining GM, which includes the existing board, management, headquarters building and staff, the rest of the factories, jobs bank, retirees, and dealers, would be liquidated. This would likely mean that U.S. government would be forced to pick up some of the pension and health care obligations of the retirees, and renegotiate agreements with creditors, suppliers and the unions.
This solution is neither elegant nor easy, but it is the only way to save General Motors. In this way the GM board can fulfill its fiduciary responsibilities, not only to the remaining shareholders, but to the creditors, dealers, customers, employees, and suppliers that have a vested interest in the company.
The "divide and conquer" approach is far better than the partial nationalization of the company that will occur under continuing government bailouts, or forcing the company into a bankruptcy from which it may never emerge.
This post was co-authored with Malcolm Salter, the James J. Hill Professor Emeritus at Harvard Business School.
Enron's demise in 2001 and the collapse of some of our most prominent financial institutions this fall share a common root cause: a shocking breakdown in corporate governance resulting from the endorsement of perverse financial incentives by directors, coupled with ineffective monitoring of firm-wide risk.
As Warren Buffett has said, "Executive compensation is the acid test of corporate governance." Financial incentives determine what objectives an organization pursues, and they drive the way managers conduct a business.
Enron's board ratified a cocktail of financial incentives and compensation contracts that promoted reckless gambling with shareholder money. Its bonus system, in particular, gave new business developers and commodity traders many incentives to inflate estimates of future profitability in order to pocket annual bonuses before the actual performance of multi-year transactions was known.
Lacking the recapture of bonus payments for unprofitable contracts, executives had little accountability in deploying shareholder capital. Finally, short-term quantitative criteria displaced qualitative measures of executive performance. The result was overcompensation, outsized risk-taking, and supreme overconfidence.
In the current subprime crisis, mortgage bankers and some commercial bankers utilized similar incentives to achieve short-term gains. Mortgage brokers, for example, were paid on commission with no economic penalty for writing poorly performing home loans. The mortgage bankers earned fees for packaging home loans as multi-layered collateralized loan obligations to investors, yet they bore no liability for the credit quality of these complex securities.
The result of these perverse incentives was as predictable for these bankers as it was at Enron: excessive risk-taking was rewarded to achieve short-term gains. Executives received outsized cash bonuses for closing deals and selling securities without evidence of future profitability. All this encouraged deception and carelessness in the management of firm-wide risk.
The history of Enron and the unfolding story of the current banking crisis suggest important lessons for boards in designing executive compensation programs:
Awarding performance bonuses based on estimated future cash flows and profits eliminates accountability and invites employees to maximize short-term pecuniary goals while risking the company's viability.
Failing to include provisions for rescinding bonuses if companies revise their past performance creates perverse incentives for executives and promotes gaming behavior.
Awarding stock grants without extended holding periods enables executives to benefit from short-term stock price fluctuations, putting corporate insiders in conflict with ordinary shareholders.
Like the Enron board, directors at Lehman, UBS, Wachovia, Washington Mutual, Citigroup, and Fannie Mae failed to understand how compensation systems drove behavior, thereby creating the conditions that led to their failures. Directors at these firms failed to detect and deter the inevitable gambling that resulted from their compensation plans.
Were these boards incompetent, uninformed, or simply intimidated by powerful CEOs? The answer is not entirely clear. Whatever the reason, the outcome was the same: they failed in their fiduciary duty to govern.
If self-governance is to be preserved as a principal of corporate law, several improvements are required to protect against future breakdowns in board governance. Public companies should select only directors who have the time to serve effectively. Commensurate with that time and increased levels of director liability, director compensation should be increased, based on long-term performance of the firm.
Directors should be required to put more of their wealth at risk through investments in company shares so that their interests align with shareholder interests. Holding periods of restricted stock and stock options awarded to directors should be ten years or until retirement. In the event of a corporate failure, directors should be forced to sacrifice their earnings since they joined the board.
Finally, the roles of board governance and management must be clearly delineated and separated from each other. According to a study by Spencer Stuart, 95% of the S&P 500 companies currently have "lead" or presiding directors that coordinate the work of all independent directors, up from 36% in 2003.
The non-executive chair, or lead director, provides an independent voice when recruiting new directors, approving board meeting agendas, asking for information on firm-wide risks, evaluating CEO performance, creating a process for CEO succession. He also organizes the independent directors in the event of a unexpected issue, such as a takeover bid, resignation of the CEO, or fiscal crisis. Without clear separation of board governance and corporate management, the entire corporation may be put at risk.
If directors fail to provide clear oversight of executive compensation and risk-taking, they may abdicate their fiduciary responsibilities to groups of dissident shareholders and, ultimately, to the government. The Enron case resulted in the rushed passage of Sarbanes-Oxley legislation, a process that took just 31 days and considered only limited input from the business community. Unless boards of directors act immediately to adhere to their fiduciary responsibilities, this could happen again in 2009.
In our opinion, this would not be in the best interests of free-market capitalism and the growth of the U.S. economy, but it may happen unless boards take their responsibilities very seriously.
Many people want to save General Motors (GM), but no one seems willing to do what is required to make it competitive.
GM is like an aging heart-failure patient, suffering from decades of physical abuse and nearing the end. The medical team has two difficult choices: keep the patient alive on life support, or perform radical surgery with a heart transplant.
A $25 billion bailout for GM, Ford (F), and Chrysler is akin to putting them on life support to stay alive until the money runs out. But it won´t make them competitive.
GM´s problems have developed over the last 50 years under a series of financially-oriented CEOs. Instead of staring down the unions and risking a strike, they agreed to expensive employee and retiree health-care programs, generous pensions, a jobs bank, and inflexible work rules that rendered GM non-competitive.
As serious as these problems are, GM´s bigget issue is that it isn´t making cars the American people want to buy, unless enticed with huge discounts and 0% financing. Over the last four decades GM management watched its share of the U.S. market decline from 53% to 20%. Management repeatedly cut costs, but never deeply enough to get competitive.
Meanwhile, GM lobbyists opposed most fuel-efficiency standard and safety improvements, from miles/gallon improvements to seat belts to catalytic converters to air bags. Yet when GM started losing share, its management lobbied Washington for limiting imports of foreign autos through increased tariffs, only to waste its opportunities by increasing prices and profits instead of investing in competitive products.
In fairness to current CEO Richard Waggoner, he inherited these problems from his predecessors. He is taking incremental steps to improve, but isn't thinking boldly enough about the drastic actions required to fix them.
The debate in Washington has been framed in stark terms - bail out General Motors or let the company go bankrupt. The Michigan delegation claims the latter option is untenable to the nation - and I agree that it is - but a quick fix that doesn´t make GM competitive is equally unappealing .
There is better option, but first the executives, unions, and politicians need to face these realities:
- With high employee costs and inflexible work rules, GM is not competitive with the North American factories of the Japanese and German producers.
- GM cannot afford the overhead for seven brands, many of them "look-alikes," and the advertising, dealers, and service networks to sustain them.
- GM´s products need a massive overhaul to become competitive in fuel efficiency, air pollution, engineering excellence, consumer features, and styling.
- GM needs new leadership and a new culture.
Here´s my radical proposal for a heart transplant to save General Motors:
- Divide GM into two companies, the first composed of Chevrolet (including trucks), Buick, and Cadillac.
- Install new management, move the headquarters to a new location, and create an empowering culture for all employees.
- Negotiate new employee agreements with wages and benefits competitive to those of foreign producers´ U.S. factories (around $44 per hour compared to GM's current level of $73), including health plans and pensions comparable to its foreign competitors.
- Retain only GM´s most productive American and foreign factories-those that operate at greater than 80% of capacity.
- Embark on an aggressive new-product development program to make its autos fully competitive in engineering, features, and styling within five years.
- Commit to fleet average of 38 MPG by 2016 and 48 MPG by 2020, competitive with European standards, with a mix of hybrids, electric cars, lighter vehicles, and efficiency improvements.
- Re-charter the dealer network for these three brands with fewer, healthier dealers.
- Establish a viable capital structure enabling this company to operate with sound cash balances and a reasonable debt-to-equity structure.
The second company would retain the remaining brands, employee agreements, factories, and dealers. Management would proceed to liquidate the company, on terms that reasonably protect employee rights, dealer rights, and creditor rights, comparable to what a bankruptcy court might offer. When this process exceeds GM´s residual balance sheet, the federal government would fund the balance on a one-time basis.
Who could pull off this radical plan? For starters, the President should appoint an "auto czar" to guide these changes. For CEO of the first company, an experienced auto executive should be recruited from outside Detroit, someone like Carlos Ghosn, CEO of Renault. The current GM management would lead the second company.
Such radical surgery would be difficult and expensive in the short-term, but it is the only way to make American automobiles competitive for the future. Creating a viable company is a far better solution than letting GM go bankrupt, or facing the slow death of going on "life support" from American taxpayers.
