70-452

General Electric Company

By: Sachin Malhotra
Was Jack Welch’s
compensation
reasonable???
 Is Welch Underpaid???
 When Jack Welch became General Electric's CEO
in 1981, the stock market judged the company to
be worth about $14 billion.
 Today, GE is worth nearly $500 billion
 What's a CEO worth for providing the brains and
leadership to turn a $14 billion corporation into
one worth $500 billion?
 How about paying just a measly one-half of a
percent of the increase in value?
 If that were the case, Welch's total compensation
would have come to nearly $2.5 billion, instead of
the few hundred million that he actually received.
 Is Welch Overpaid???
 On December 20, 1996, GE, with the approval of its board of
directors, and Welch executed an "employment and post-
retirement consulting agreement" (the "Agreement"). The
Agreement required Welch to continue to serve as chairman and
CEO until December 31, 2000, and, during his retirement, to
provide consulting services and advice to GE when and as
requested by the company's CEO. In exchange for these services,
he was to receive a retainer at the beginning of each year equal to
five-days pay (at his daily salary rate existing upon retirement)
and a daily fee for each additional day of service. Under the
Agreement, however, Welch's principal benefits were non-
monetary. With respect to those benefits, the Agreement stated:

"In addition, the Company shall provide Welch, for the remainder
of his life, continued access to Company facilities and services
comparable to those provided to him prior to his retirement,
including access to Company aircraft, cars, office, apartments, and
financial planning services."
 What It All Meant?
Welch retired on September 30, 2001. In his first year of retirement, Welch
received approximately $2.5 million in benefits under the Agreement,
which included the following:
 access to GE aircraft for unlimited personal use and for business travel;
 exclusive use of a furnished New York City apartment that, according to
GE, in 2003, had a rental value of approximately $50,000 a month and a
resale value in excess of $11 million;
 unrestricted access to a chauffeured limousine driven by professionals
trained in security measures;
 a leased Mercedes Benz;
 office space in both New York City and in Connecticut;
 the services of professional estate and tax advisors;
 the services of a personal assistant;
 communications systems and networks at Welch's homes, including
television, fax, phone and computer systems, with technical support;
 bodyguard security for various speaking engagements, including a book
tour to promote his autobiography Jack: Straight from the Gut; and
 installation of a security system in one of Welch's homes and continued
maintenance of security systems GE previously installed in three of
Welch's other homes.

Approximately $1.2 million of the total cost of these benefits was

attributable to Welch's use of GE aircraft.
So Was Jack Welch over or
underpaid?

DEFINITELY
OVERPAID!!!!
Where does the money come to
pay for executive
compensation?
The money comes from
b) the operating income

c) non-operating income

d) the current assets (such as

cash)
e) Capital assets (corporate jets)
 Whose money is it?
The money belongs to the
shareholders.
Who manages the money?
The money is managed by the
compensation committee appointed by
the board of directors.
How else can this money be used?
 Reinvest in company and profitable
operations
 Distribution as bonus to employees
 Advertising to attract more investors
 To improve stockholders relations
with the board of directors
 To cover under-allocated costs
 GE-Welch Scenario

 Interested Parties: GE
corporation(Board of Directors and
the compensation committee),
stakeholders and Jack Welch.
Who Benefits and Who Gets Harmed?
 The main purpose of the executive
compensation is to align the interests of
the agents (the executives) with the
principals (the shareholders).
 [better pay = better performance]
 -4
Objectives of Management
Compensation
McDonald’s
McDonald’s rewards
rewards managers
managers
for
for these
these critical
critical success
success factors.
factors.

Quality
 Quality
Service
 Service
Cleanliness
 Cleanliness
Value
 Value
Earnings
 Earnings
Growth
 Growth in
in sales
sales
 Then What Goes Wrong?
 Excessive compensation, however,
leads to corruption (creative accounting
methods, e.g. Enron)
 Hence, with the innocent intention to
benefit the shareholders, executive
compensation harms the stakeholders
and the corporation as a whole.
 Should companies disclose
compensensation paid
 Where does the money comes from?
 the shareholders
 Would you not like to know what is
happening with your money?
 So why shouldn’t the shareholders!!!
 The company has a social
responsibility to disclose any
information that can potentially
affect the decision of the investors.
 Should the SEC alter the rules
 SEC rules for corporations are
equivalent to the laws of the nation
 GE had an obligation to fully disclose
Welch's retirement benefits.
 http://www.sec.gov/litigation/admin/34-5

 Research\ge trial.doc
 Design of an
Executive Compensation
Contract
Types of Executive
Compensation
Base Salary and Bonus
The base salary is usually determined through
the benchmarking method.
Current bonus - based on current performance.
This is the most common form of the bonus.
Deferred bonus - earned currently but not paid
for two or more years.
Types of Executive Compensation
(continued)
Stock Option
Executive stock options—the most common
form of market-oriented incentive pay.
Stock options give the executive of the firm the
incentive to manage the firm.
Stock options are believed to align managers’
goals with shareholders’ goals.
Stock options have asymmetric (unbalanced)
incentives
Stock Option
Stock Options
• Stock and Accounting
option’s favorable tax treatment for both
the executive and the company
• Accounting cost and economic cost
• FAS 123(R)
 Salary--a fixed payment
Types of Executive
 Bonus--based upon the achievement of
Compensation
performance goals
 Perks--special benefits for employees, such as
club membership, medical and life insurance,
company pension, etc.
 Equity-based rewards - stock options and
stock grants.
Types of Executive
Compensation
Base Salary and Bonus
The base salary is usually determined through
the benchmarking method.
Current bonus - based on current performance.
This is the most common form of the bonus.
Deferred bonus - earned currently but not paid
for two or more years.
Types of Executive Compensation
(continued)
Stock Option
Executive stock options—the most common
form of market-oriented incentive pay.
Stock options give the executive of the firm the
incentive to manage the firm.
Stock options are believed to align managers’
goals with shareholders’ goals.
Stock options have asymmetric (unbalanced)
incentives
Stock Option
Stock Options
• Stock and Accounting
option’s favorable tax treatment for both
the executive and the company
• Accounting cost and economic cost
• FAS 123(R)
Types of Executive Compensation
(continued)
Stock Grants
Another form of long-term incentive
compensation. Two types:
• Restricted stock does not have asymmetric
incentives
• Performance shares can be viewed as
bonuses for past realized performance.
 Salary--a fixed payment
Types of Executive
 Bonus--based upon the achievement of
Compensation
performance goals
 Perks--special benefits for employees, such as
club membership, medical and life insurance,
company pension, etc.
 Equity-based rewards - stock options and
stock grants.
Types of Executive
Compensation
Base Salary and Bonus
The base salary is usually determined through
the benchmarking method.
Current bonus - based on current performance.
This is the most common form of the bonus.
Deferred bonus - earned currently but not paid
for two or more years.
Types of Executive Compensation
(continued)
Stock Option
Executive stock options—the most common
form of market-oriented incentive pay.
Stock options give the executive of the firm the
incentive to manage the firm.
Stock options are believed to align managers’
goals with shareholders’ goals.
Stock options have asymmetric (unbalanced)
incentives
Stock Option
Stock Options
• Stock and Accounting
option’s favorable tax treatment for both
the executive and the company
• Accounting cost and economic cost
• FAS 123(R)
Types of Executive Compensation
(continued)
Stock Grants
Another form of long-term incentive
compensation. Two types:
• Restricted stock does not have asymmetric
incentives
• Performance shares can be viewed as
bonuses for past realized performance.
Potential “Incentive” Problems with
Incentive-based Compensation
Problems with Accounting-Based
Forego costly research and development that
Incentives
might be beneficial to the firm
Accounting profits may be manipulated
CEOs may place too much focus on
manipulating short-term earnings
 Salary--a fixed payment
Types of Executive
 Bonus--based upon the achievement of
Compensation
performance goals
 Perks--special benefits for employees, such as
club membership, medical and life insurance,
company pension, etc.
 Equity-based rewards - stock options and
stock grants.
Types of Executive
Compensation
Base Salary and Bonus

The base salary is usually determined through

the benchmarking method.
Current bonus - based on current performance.
This is the most common form of the bonus.
Deferred bonus - earned currently but not paid
for two or more years.
Types of Executive Compensation
(continued)
Stock Option
Executive stock options—the most common
form of market-oriented incentive pay.
Stock options give the executive of the firm the
incentive to manage the firm.
Stock options are believed to align managers’
goals with shareholders’ goals.
Stock options have asymmetric (unbalanced)
incentives
Stock Option
Stock Options and Accounting

• Stock option’s favorable tax treatment for both

the executive and the company
• Accounting cost and economic cost
• FAS 123(R)
Types of Executive Compensation
(continued)
Stock Grants
Another form of long-term incentive
compensation. Two types:
• Restricted stock does not have asymmetric
incentives
• Performance shares can be viewed as
bonuses for past realized performance.
Potential “Incentive” Problems with
Incentive-based Compensation
Problems with Accounting-Based
Incentives
Forego costly research and development that
might be beneficial to the firm
Accounting profits may be manipulated
CEOs may place too much focus on
manipulating short-term earnings
Problems with Stock Option
Incentives
CEOs might forego increasing dividends in favor of
using the cash to try to increase the stock price
CEOs have a tendency to pick a higher risk business
strategy
Stock options may be too far underwater (below
exercise price) to motivate the manager effectively.
CEOs may try manipulate stock price movements to
match the time horizons of their stock options
Stock prices are affected not just by company
performance but also by other factors beyond its
control