By Kurt Lieberman, CEO, Magni Global Asset Management
Back in a 1970 essay, Milton Friedman, the acclaimed economist, wrote an essay for The New York Times. In it he argued that a company has responsibility only to its shareholders. Today this definition of a company is called the Shareholder Theory.
In August of 2019, the era of shareholder value as a singular objective likely came to an end. The Business Round Table broadened the definition of a company to include managing across stakeholder relationships.
The almost half-century is long enough to take stock of the era, whether it is over or not. Perhaps no individual symbolized the era more than Jack Welch. He became CEO of GE in 1981. He followed a series of transformative CEOs who had created an important company, though the best was yet to come. During 20 years with Welch at the helm, GE increased in value from $12 billion to $410 billion.
While the shareholder value increased, the other stakeholders were not considered as important. At one point, GE was shedding workers so fast that Mr. Welch received the nickname “Neutron Jack” as the people were gone, but the buildings remained.
When the time came to choose a successor, Welch selected to compete for the CEO role three of the best business leaders in the company’s heralded leadership program: Jeffrey Immelt, Robert Nardelli, and James McNerny. As you probably know, Jeffrey Immelt won the competition and succeeded Jack Welch in 2001. GE has struggled since the transition. In 2017 the company announced that Immelt would retire as CEO.
By 2018 the valuation of the company had dropped to the point that is was removed from the Dow Jones Industrial Average. The institution that Jack Welch had built into the most valuable company in the world was now too small for the prestigious U.S. index of companies.
My guess is that if Milton Friedman were alive today, he would make sure that we understand his view on value. He would have said that value needs to be maintained over time. When he was alive, the word “sustainable” was not used regarding businesses. I believe he would like the concept of sustainable value.
One could say that 20 years during which value creation far exceeded almost all large companies is sustainable. I submit that sustainability needs to include leadership transitions. By that definition, the value creation was not sustainable. Jack’s “lightning in a bottle” did not survive.
Some of the issues that daunted Immelt had been building over time and were known at the time of the transition. Others arose during Immelt’s tenure as CEO. While Immelt clearly was unable to resolve these issues, it will take more time for business historians to assess the extent to which Immelt made the situation worse.
Perhaps Jack Welch chose the wrong person. He had three of the best and most high-potential executives competing for the job. The two who lost the competition left GE with the announcement of Immelt and were recruited to new jobs immediately.
What can we learn from the post-GE experiences of the two who lost the succession race? If one of them had tremendous success, then the wrong person probably was chosen. However, if neither were successes, then perhaps the shareholder value model is not sustainable.
Alternative 1: Robert Nardelli
Robert Nardelli had the nickname “Little Jack” while at GE. Soon after Immelt’s selection, Nardelli left to become Home Depot’s new CEO, despite having no retail experience. He attempted a dramatic overhaul of the company using methods from GE. Relentless cost cutting replaced the entrepreneurial culture of innovation. While sales and profits rose, turnover of experienced store staff increased, and the quality of customer service deteriorated, thus enabling Home Depot’s primary competitor to increase its market share. Applying the shareholder model to Home Depot provided a tactical boost in financial performance, but it was not sustainable. Nardelli and the board reached mutual agreement for him to resign at the beginning of 2007.
Later in 2007, Nardelli was recruited by Cerberus Capital Management to run Chrysler, which it had just purchased. Soon after that, the Great Financial Crisis started. Chrysler filed for bankruptcy on April 30, 2009.
During 2010, Nardelli became the head of Freedom Group, a gun manufacturer. Within 18 months, Nardelli stepped down as CEO.
Alternative 2: James McNerny
James NcNerny has a blue-chip pedigree: degrees from both Yale and Harvard, brand management at Proctor & Gamble, and consulting experience at McKinsey & Co. During 19 years at GE, he rose in the ranks of the company.
Soon after losing the succession race, 3M hired him as CEO. His four-year stint was more successful than Nardelli’s time at Home Depot. The board hired him to reinvigorate growth in the company. He made significant changes and was popular with the workforce. Like Nardelli, he too applied the GE playbook. While earnings improved, capital spending dropped 65% and the research & development budget dropped 25%. Growth was not reinvigorated. In 2005, George Buckley assumed the role of CEO at 3M.
McNerny was hired by Boeing as CEO that same year. For the next ten years he ran the company. In 2015 he retired with an internal candidate, Dennis Mullenburg, succeeding him. During McNerny’s tenure the company achieved record profits, though it was during the longest aviation boom in history. Separately, there was significant discontent among workers, especially union workers.
Immelt, Nardelli, and McNerny rose through the GE management program. All three learned the GE playbook. In one way or another, all three used the playbook throughout their careers. All three made significant changes and delivered near-term profits. None of the three achieved the primary change required by the companies they led. The companies were in a similar or worse situation by the end of their respective tenures as CEO.
Of the three, McNerny appears to have done the best job. At 3M, he delivered profits and was popular, though growth was not reinvigorated. At Boeing, he delivered profits and was unpopular, though he did not fix the deteriorating governance and did not demonstrate the ability to move the company in a better direction. Even if Welch had chosen McNerny, GE likely would not have continued its success. As those in Responsible Finance already know, the era of shareholder value is not sustainable.