Marko Jukic, in a Twitter threat flagged by reader dk, advances a theory that is neat, plausible, and wrong. He correctly points out how the installation of CEOs coming out of finance at storied companies like Boeing, Intel, and Sony, directly led to them adopting policies that were destructive to these companies.
However, he goes wide of the mark in saying that the replacement of engineer CEOs across Corporate America with finance/MBA CEOs was the cause of their decline. While that is true in the highly visible examples he cites, the trend to financialization was well underway by the time he depicts as a turning point, the early 2000s. And its lead implementer was engineer Jack Welch at General Electric, who from the mid-1980s onward was touted as the pinnacle of modern management. By the early 1990s, over 40% of GE’s profit came from its financial service arm. McKinsey was making bank on selling its manufacturing clients to beef up in financial services just like General Electric.1 One vogue well underway by then was that major multinational started running their treasury operations as a profit center, which too often led to unhappy outcomes. 2
A second ginormous driver of the trend to financialization was the rise and stunning success of the raiders of the 1980s, rebranded multiple times (levaraged buyout, then private equity, which admittedly includes other strategies but leveraged buyouts still account for the majority of expenditures). The 1980s deals consisted overwhelmingly of financial engineering plays. At that time, there were plenty of over-diversified, undervalued conglomerates. The vogue in American business then was also to have fat corporate centers, and that was even more true for these companies. These deals were exercises in financial engineering. The hard part was the nearly always hostile takeover. Even after paying a merger premium, the buyers could break up the company and sell the parts for more than the value of the former whole. This process didn’t break down until the buyout artists, in the later 1980s, bought more and more marginal companies with more and more pricey debt. The leveraged buyout debt losses were masked by the much larger saving & loan crisis. It didn’t hurt that big foreign banks were major customers for the LBO loans, making the mess for US regulators smaller than it would otherwise have been.
Despite the LBO crash, a cadre of academics, with Harvard’s Michael Jensen, flogged the idea, first promulgated by Milton Friedman in a poorly reasoned New York Times op ed, that companies should be run to promote shareholder interests above all others. That flies in the face of their legal status, as residual claimants after all other obligations have been satisfied. Although I cannot prove a negative, I have read quite a few guides for directors of corporate boards produced by big building law firms, concentrating on Delaware, which despite Elon Musk’s hissies, is a corporate-friendly jurisdiction. I found not a single mention of prioritizing shareholder value as a board duty. The implicit prime directive instead was “Don’t go bankrupt”.
Jensen later recanted his position having seen the damage it did. But too many people benefited from this ideology for it to go away.
Let’s return to Jack Welch as a case study in how running a company for short-term results started well before the era of financiers and MBAs becoming prevalent as CEOs. One reason Welch was lionized was the supposedly miraculous tightness of GE corporate controls, enabling them to hit their forecasted earnings like clockwork. For such a sprawling company, with exposures in many currencies, that should instead have been seen as a Madoff-adjacent indicator of accounting funny business, even if it was not fraud per se. GE played lots of games with its finance arm to achieve these results, such as additions to and releases from loss reserves and the timing of the recognition of sales from their large venture capital portfolio. From a 2021 post:
My harsh take on Jack Welch isn’t just due to his destructive expansion into financial services and his cultivation of “CEO as celebrity” which was extremely successful for him and General Electric during his tenure but long-term destructive to management practice in the US. It is also that Welch’s success as a manager has been exaggerated, but it will be well nigh impossible to ascertain to what degree due to the cheerleading and a code of omerta among departing execs. One colleague who worked under Reg Jones and later under Welch, and turned around a manufacturer that remains a top player in its niche, has said that Welch ran on Jones’ brand fumes. And some of his touted practices, such as Six Sigma, were all PR.
Jack Welch and General Electric were lucky enough to ride the great financial markets boom, triggered by a long-term secular trend of declining interest rates. Welch also inherited a superbly run company at a time when America was still a manufacturing powerhouse, despite Japan and Germany making inroads.
Admittedly, General Electric, like many American manufacturers, was in the financing business by virtue of lending to buyers. But it had greatly expanded its role by the late 1980, to the degree that it took big hits from LBO lending (I knew the ex-McKinsey partner who ran its workouts. He had two conference rooms, one that he named “Triage” and the other “Don Quixote”.)
But even as of the early 1990s, GE Capital was celebrated for accounting for 40% of General Electric’s activities, doing everything from venture capital to private label credit cards to credit guarantees. And General Electric got the best of both worlds. It avoided the taint of being seen as a stodgy old economy manufacturer; by the time Jack Welch left, in 2000, it was classified in the Fortune 500 as a diversified financial firm. Yet got to borrow at industrial AAA rates, which were more favorable than any bank or insurer rated AAA.
The enormous GE Capital operations gave Welch more luster than he deserved a second way: they enabled General Electric to play earnings games, so they alway met their quarterly guidance to the penny. Admittedly, GE Capital unwisely continued its expansion after Welch left, in the low interest rate dot-bomb era, including increasing its leverage level and re-entering the subprime mortgage business in 2004.
Let’s turn to more evidence of how financialization and short-termism were established features of Corporate America well before that trend was reinforced by engineers being turfed out of CEO posts. In 2005, the Conference Board Review published our piece, The Incredible Shrinking Corporation. In that, we described how public companies had become so fixated on short-term earnings that McKinsey consultants complained to me that they were unwilling to make investments even with a less than one-year payback, because there would still nearer-term quarter costs. Similarly, the trend against investing had become so pronounce that across all American business, corporations were engaged in the unnatural behavior of net saving in an expansion. That means they were slow motion liquidating.
Mind you, that is not to minimize the importance of Jukic’s finding, that companies in the early 2000s had gone so whole-hog on milking rather than growing that they put spreadsheeters and PowerPoint jockeys in charge. And his tweetstorm does include fully warranted indignation:
You would think that a company in the process of being murdered by its own CEO would see worse financial performance and lower stock valuations by investors, but in fact murdering a company seems to greatly increase profits and excite investor enthusiasm to unheard-of heights.
The apparent conclusion—uncomfortable if not unthinkable for free marketeers—is that MBA/finance thinking and decision-making is not just not helpful but actively hostile and destructive to running a successful, functional company.
How could that be? Well, if you accept there are such things as trade-offs between short-term profit vs. long-term viability, in the examples above we see MBA/finance dogma ruthlessly maximizing those trade-offs in favor of short-term profit. Including killing the company!
But this change in leadership fashion was an intensification of a process long underway, as opposed to something new. However, differences in degree can be differences in kind. A question for another day is whether the destruction of Intel and Boeing, both not merely iconic but so important to the US that they would not be allowed to fail, amounts to looting, as defined by George Akerloff and Paul Romer, in their classic paper, Looting: The Economic Underworld of Bankruptcy for Profit:
Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society’s expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations
Mind you, neither Boeing nor Intel are likely to be on a trajectory to default. But that in no small measure may wind up being due to them getting government support before things get to that point.
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1 The apotheosis of that trend, of course, was Enron, which under McKinsey’s tender guidance went from being primarily an energy producer to what McKinsey praised as an asset-light trading operation. The executive singularly responsible for leading Enron to ruin, Jeff Skilling, was COO, not CEO, and had originally studied engineering before switching to a business major. Its CEO and chairman, Ken Lay, did not have an MBA but was not an engineer either. He was an economist whose rise though the energy industry appears to have rested on regulatory expertise.
2 I had an odd client assignment in the early 1990s, where I had been engaged by a derivatives firm to help advise a new client, a Fortune 500 company, that had just hemorrhaged losses on foreign exchange trades. My immediate client, a partner at the derivatives traders, was actually not exactly keen to be trying to help the corporate client: “This stuff is really dangerous. You have to know what you are doing not to blow yourself up.” This engagement came shortly before the famed Proctor & Gamble case, where tape recordings of Bankers Trust derivatives salesmen revealed them to be gloating over their ease of deceiving and screwing customers.
All things considered, yes (in discrete circumstances) an engineering CEO is better than not.
But let’s not kid ourselves, engineer CEOs are not a panacea—look at Alan Mullally. Great product manager/engineer at Boeing, awful (IMO) CEO of Ford.
Even engineer CEOs will be spitting into the wind given shareholder demands, short-termism, and inheriting a corporate bureaucracy that, like a supertanker, is difficult to turn around on a dime.
being a good engineer CEO sounds like purgatory—seeing everything wrong, but unable to change everything barring incredible force of will.
You are right that engineers often do make mistakes too and are not some cure all solution, but the problem is less their major as much as what you note – shareholder demands.
Engineering CEOs can’t overcome greed. The problem is that the Western elite are greedy. If a long-term CEO were to come, the shareholders in their desire for profit would remove that CEO and install someone that was able to deliver short term profits.
The upper middle class and especially the rich, which own the stocks want returns without any obligation to society nor any long term investment. There’s a reason why capital spending and research spending is not the priority it used to be.
The executives are just a reflection of their greed. They want to make a fast buck on their stock holdings, the future of company, the working class, and the nation be dammed.
Jack Welch is just a reflection of their desires. The rich never wanted the New Deal that emerged from the aftermath of WW2. They always wanted to have a very unequal relationship with the working class. Again, the Jack Welch method was the vehicle for that objective, alongside the Powell Memo.
The fundamental problem is that our elite are just a horribly greedy group of people. Their collective desires are what set policy, and the corporations are a world in their image.
Not at all sure Jack would have pulled this off without riding on the reputation of GE as a brand. Goose, golden eggs – read something about that as a child.
And to this day people are constantly posting about corps having “a duty to their shareholders” to justify every single thing.
This goes far beyond the CEO level, it is all the way down to middle level management and below. The technical folks are at the bottom of the totem pole in all decision making. They are ignored even for topics such as reliability, resiliency, risk,… Of course, the marching orders come from the top but the people who go along with these marching orders get the promotions and get their voice heard.
It feels more like the death of the engineer.
“The technical folks are at the bottom of the totem pole in all decision making. They are ignored even for topics such as reliability, resiliency, risk…”
One way to tell if this is happening at a company: lots of hires of people with the word “strategy” in their job title, while execution of ideas and processes suffer. The companies often want to outsource the execution.
Also, look out for companies that are hiring but most of the job openings are for an executive assistant of some sort.
Yes and we all know how promotions work: The people most amenable to the people making the decisions to promote get promoted.
file this all under: People Like Simple Stories
Jack Welch affected some regret during his ridiculously lucrative retirement (here and here) at what he did to GE. The Man Who Broke Capitalism is in my view a good treatment of his evisceration of the exemplar of American capitalism, not that capitalism has not always been “broke” in the long term. Those of us of a certain age remember GE as the American company.
Not just financier CEOs, it is also sales weasel CEOs.
I know that Carly Fioria was an MBA (UM College Park and something from MIT Sloan) she was a sales weasel, not a finance person.
One need only look at her disastrous tenure at Lucent, where she allowed (more likely encouraged) wide spread fraud in sales, and her even more disastrous tenure as HP’s CEO to see its effects, and her errors stemmed from her sales perspective, not a finance one.
Something else I would add, and Fiorina is a classic example of this, when a company that is doing pretty well (HP) decides that it needs to juice its market cap by picking someone from outside of the company as a CEO, it frequently flops.
I was loyal HP customer with HP41C and HP laser printers like HPIIIP and HPIV but after that no longer
HP should have merged printers with Kodak and kept CompaQ independent
Missing a word:
both not merely iconic but so important to the that
The problem is that the Western elite are greedy.
The executives are just a reflection of their greed. They want to make a fast buck on their stock holdings, the future of company, the working class, and the nation be dammed.
Jack Welch is just a reflection of their desires. The rich never wanted the New Deal that emerged from the aftermath of WW2. They always wanted to have a very unequal relationship with the working class. Again, the Jack Welch method was the vehicle for that objective, alongside the Powell Memo.
Fixing, thanks!
Here is a corporate character even the Daily Mail can love:
https://www.dailymail.co.uk/news/article-13755095/Steward-Health-hospitals-Ralph-la-Torre.html
Short-termer: Check.
Financialization: Check.
Going broke for profit: Check.
Here’s Maureen Tkacik’s story on this scam, from a week ago.
I’ve been watching the wheels fall off in American corporations since the 1980s, and have had a ring-side seat at times watching the follies. The whole pipeline from youth to CEO is messed up in this country. We have all the wrong heroes. Chief among the criteria for recognition is attaining money, but a public pulpit with credentials from a recognized institution are a close second. If you don’t rise to those lofty heights then virtue signaling will get you social acceptance, either by prostrating yourself as a lib or wrapping yourself in a flag as a con. Any demonstration of intelligence is forbidden unless properly filtered through these merits. Is it any wonder that our CEOs, when drawn from our citizenry, leave much to be desired? There is no better achievement for a person in our country than achieving vast riches, preferably with a whiff of rule breaking. Being a CEO puts you in prime position.
What is omitted by our system is highlighted by the priorities in other countries. China in particular. Political office is attained only by strenuous effort and passing difficult exams. They also start in schools, but with better priorities. From this Guardian article:
Empires decay slowly, but they become dangerous as the decrepitude takes over. I think some politicians take pride in our increasing malevolence, but what we are really doing is encouraging the rest of the world–vassals aside–to protect themselves from the final paroxysms. The problem is not that we are evil; the problem is that we have run out of ideas and refuse to search for more. Our corporations and their leadership are just a reflection of our broader society and its faltered vision.
Thanks for this post. I hadn’t seen the Guardian piece, really interesting.
I’m fairly certain Yves meant “short-termism” but I really like “shart-termism”.
Fixing, but maybe that can become a coinage down the road….
“One colleague who worked under Reg Jones and later under Welch, and turned around a manufacturer that remains a top player in its niche, has said that Welch ran on Jones’ brand fumes. And some of his touted practices, such as Six Sigma, were all PR.”
The way Jack Welsh and then Jeff Immelt after him (he had a video with his family and dog that he showed to the company to show what a regular guy he was) and the implementation of Six Sigma (a process to improve the manufacture of large glass vacuum tubes to reduce failures (old style room hogs of TV and CRTs on every desk) and I think it was Motorola that started it…JW and JI ripped it off and applied it to their Financial Services and Investing – What a clown show – my project was to show how multiple ‘black belt’ projects emanating out of one department would result in savings totaling more than twice the departments entire budget…. they did not find the humor – the whole Six-Sigma/Black belt was used by less than competent individuals to shame their way up the ranks while leaving behind a gigantic heap of crap that the true knowledgeable cleaned it up. On top of it, some of the best people I knew professionally were booted, to be replaced by these back stabbing blind climbers(BSBC). I personally witnessed outside vendors trying to pawn my designs, as their own patents, to our purchasing department where two of these (BSBC) had previously booted one of the best and invited me to a meeting and, where the outside sales touted their patent and our purchasing department felt that a 10% premium would be worth it (kickback is what it was), Fortunately, through my broad based ties to the professional community at the time, I invited inside counsel to attend with me for something fun that he might find enjoyable and if he didn’t I would buy lunch and if he did like it – he would buy me lunch. He did buy me lunch a number of times after that.
Glass-Steagall was repealed in 1999 and the corporate honcho called a group of us together to inform us a the new financial possibilities – she started by asking if anyone new what had changed that affected the financial services industry – I was the only one raised their hand and answered that question buy stating the original intention and why needed the Glass Steagall act and that it was repealed – She kind of didn’t like the fact that an underling like me would know that sort of thing.
Intentional or unintentional mis-implementation of project management has always been an area of great loss. IMHO
Six Sigma Belts are credentialism. Six Sigma is trying to be Japanese!
W Edwards Deming’s TQM attempted to drive work culture and demanded more than lip services. It was based on statistical analysis and then demanded critical thinking. The emphasis was system failure, not special case rabbit holes.
Root cause, was fairly new when TQM was popularized.
One of the canned “sheets” was close to failure effects analysis developed for aviation design for safety, and maintenance repair optimization.
Made it hard because neither engineers nor finance type seem to worry how the customer cares for their broken product.
IOW Six Sigma and TQM are hard sell for both techies and finance types.
BTW, Deming worked to old age trying to get US companies to do quality, he had introduced statistical process control to Japan during occupation and reconstruction. He hit a passion in Japan, not touched in U.S.
System engineers are a rare breed, DoD has tried to explain it for decades and still buys things like F-35
“Six Sigma Belts are credentialism…”
Quite an interesting analysis. Thank you.
Reg Jones was born in 1917 in Stoke-on-Trent. You do not get more grounded than that !
Welch was a con artist and Immelt was like Welch HBS and Jones was Wharton
Frankly Wall Street rewards bosses that turn their manufacturing businesses into banks and punishes those that don‘t just as The City destroyed ICI and real businesses like GEC or Rowntree or BREL or Pilkingtons
Wasn’t Welch an engineer though? Chemical Engineer?
There’s too much praise for engineers. I studied engineering for me degree at university and engineers are also very often just AWFUL, one dimensional people as well.
Don’t lionize them.
That was precisely the point of mentioning Welch, that the trend to financialization had started before the rise of finance/MBA CEOs.
And I not idealize them. That was Jukic.
Youright. And not not a bachelors, he had a PhD in chemical engineering. But it sounds like he wasn’t much of an engineer as he threatened to quit after a year due to a raise he didn’t like. And sounds like he quickly went into management: “In 1963 (he eas hired in 1960), an explosion blew the roof off the factory under Welch’s management, and he was almost fired.”
My uncle was a vice-president at Chrysler during the 60’s and 70s. He remembers when Lester Lum Colbert was replaced as CEO by Lynn Townsend. “Tex” Colbert had an engineering background, and had an understanding of the engineering culture at Chrysler. Townsend was an accountant, and he plunged Chrysler into several bad financial investments while overseeing the crapification of Chrysler products. Financializing a manufacturing enterprise has a longer history than one would suspect.
Phil, Both Tom Watson and Tom Jr were Sales oriented CEOs. Not Engineering and not FInancial. The colossus was built by Sales and destroyed by a series of Bureaucrats (Learson, the Watsons’ last choice, handed off rather than taking the lead). The Financialization started with Gerstner. They’ve done a great job. Sad.
The great Norm Bartzak de-mystified ‚Neutron Jack‘ in a course called ACFR and stripped GE voluminous accounts into each piece of artful chicanery. He had been an SEC consultant at some stage and was excellence embodied.
Siemens did income-smoothing in the days of German reserve accounting
As for Engineers – Wall Street pays for them to program much more than GE or GM or Boeing pays as engineers
China has hbf highest annual output of Engineers followed by Russia followed by Iran
The Arab world has huge output of engineers without work which generates frustration and well- educated terrorist personnel – go look how many „terrorists“ are professionals
There is huge need for engineers but it is a question of paying them to do what they are trained for – Germany scours Central Europe for engineers as it fails to train them or pay properly
The same reason we have so many H1-Bs.
I read an article about the 2008 financial meltdown that talked about physicists losing their jobs in the nuclear industry and being hired by Wall Street. They came up with the product that had bad loans bundled with good loans and sold to to buyers like Icelandic pension funds. They had used math to calculate that the products were safe. But the fatal flaw was that their formulas were based on real estate prices never going down more than 25%. But the period of giving bad loans to people who couldn’t afford them because they could be bundled with good loans led to a surge in real estate prices that ultimatley caused prices in some areas to decline more than 25%.
Behind the rise of corporate short-termism and looting are the Reagan tax cuts and withdrawal from anti-trust enforcement. As a result, there was more loot to be had without immediately endangering survival.
I worked at a large fund complex during the Welch period. We managed a large investment portfolio for them. Every quarter we would receive a call instructing us as to how much capital gain we should realize so they could book it into income.
Let’s not leave the fully complicit, enabling and lazy actors on Wall Street. Few analysts do, or want to do, the work to see what is really going on in a company’s financial statements. Again, with GE both GE Capital and the GE insurance companies and their own SEC filings. I read them every period — I knew of few who did, or if they did understood what they were saying.
What was clearly evident is that Welch an his CFOs were consuming the balance sheets of those companies in both depleting reserves and eating up the unrealized capital gains. He was also driving them to grow above their natural rate of growth, which in property casualty reinsurance is not only dumb, but highly risky. So by the time he was retiring anyone who wasn’t looking the other way knew that in his financial engineering he had hollowed the company out.
As you point out above, we can look across industrial corporations that played the same games; e.g., GM – Ally, Boeing, etc.
I wonder if part of the probem in current times is the fact that Boards are full of bean counters representing private equity and finacial investors of all types. Look at Boeing or Intel. In Boeing no board memeber can fly a plane and until recently no one knew anything about design or manufacturing. It is not much better in Intel. Any surprise that their corporate culture sucks, products are worse and worse and they are becoming black holes for investors?
Greed and looting come from engineers as much as MBA’s. I’m not a finance type at all, but I’m a student of history. The late Kevin Phillips discussed the history in his 2006 tome Wealth and Democracy. In my view the corporate looting phenomenon got its start 75 years ago when U.S. industry had zero competition thanks to the other industrial nations having been bombed into rubble by a war waged against civilians as much as armies.
U.S. industry got to be lazy for a couple of decades until Germany and Japan came roaring back as industrial powerhouses. By the early 1970’s American industrialists chafed at Progressive and New Deal antitrust and transparency rules “stifling” their ability to compete. At just this moment the combination of Great Society/Vietnam War spending, Nixon untethering from gold, and women entering the workforce en masse thanks to the Pill triggered a massive wage and price inflation. I can remember getting 16 percent interest on a CD.
Workers and their wages became the enemy; greed and looting became the virtuous way to screw the proles. Then in the early 1980’s, Ronald Reagan’s Iran-Contra shenanigans brought about the notion of elite impunity. Can it be a coincidence that Michael Milken and Charles Keating arose from the same self-regarding preen-in-the-mirror Southern California culture as Reagan?
Clinton cast the schnookery die by joining Gingrich in a deregulation race-to-the-bottom while CEO’s rushed to compete with newly-minted post-Soviet Russian oligarchs for the trappings of wealth. The American billionaire caste shot up from about 60 in 1992 to close to 800 today.
The company I work for used to be run by people who used to do the work themselves. It is now run by people who don’t understand the work we do. And they have built an enormous empire of people who have nothing to do with the work we do.