Immelt Stock Option Conditions – Real or Illusory Governance?

On one level, the recent action of General Electric in adding performance related conditions to the vesting of stock options recently granted to its CEO (GE Realigns Immelt’s Incentives, Barrons, 4/19/2011) would seem to reflect improvement in its governance. Tying CEO options to company performance can not be a bad thing for shareholders, so long as the performance criteria are not illusory and do not encourage aggressive accounting or a short term focus. The four year horizon for these criteria seems to make them meaningful.

However, on another level, these criteria beg the questions of what they really do for shareholders and whether they provide sufficient incentives to avoid the near-death experience caused by GE Capital in 2008-   i.e. are they an exemplar of good governance? In particular, the requirement that GE’s return on equity meet or exceed that of the S&P 500, by definition is a reward for mediocre performance. Immelt is paid a substantial salary and bonus for “base” performance, so it is unclear why simply meeting this minimum benchmark should warrant additional recognition. As a small GE shareholder desiring good performance, I see no reason why it should.

As to the industrial cash flow criterion, it is unclear what it means. If it embodies a substantial improvement over recent performance in any meaningful respect, it may be laudable. The raw number tells us little about its significance. Putting the focus on performance of GE’s industrial businesses is both good and bad. Good because the recent experience of GE Capital indicates that management previously focused too much on it, but bad because there is still a mess to clean up at Capital and management should be evaluated in part on how it does so.

Furthermore, the exclusion of “the effect of unusual events” warrants inquiry. It is management’s job to be proactive and guard against inevitable unusual events to the extent feasible and not to be excused from responsibility for disastrous performance simply because it results from something which is said to be “unusual”. We can all agree that some things, such as a 9-11 type attack, can not be ‘managed around’, but the same should not be said for economic cyclicality such as the housing meltdown. Management needs to acknowledge its responsibility for maintaining a capital structure and business model that will survive a ‘rainy day’.

Most fundamentally, this action is based upon the premise that Immelt will be in his position in all events for the next four years. Especially if GE’s performance lags that of the S&P 500 for such time, the board should be seriously considering whether he is the right man for the job at all. Simply denying him the benefit of his options while keeping him in place in the face of performance that is less than mediocre is a curious approach.

The author has argued on this site and elsewhere that tweaking management pay is not a sufficient response to poor performance at systemically important firms, and that more fundamental matters need to be addressed in order to improve governance. This is a good illustration of why this is the case.