Monday, April 17, 2006

Management Compensation

Thoughts on corporate management and their rewards from a long-time business associate of FalkerInvestments.

I read with interest the comments of the FI customer regarding your posting of March 31 about GM. I agree with his/her observation about the need for a complete management change. I would take it a step further and say that both management and directors should be changed.

As an investor I am inundated at this time of year with annual reports and stockholder meeting agenda. Most of these request shareholders voting in favor of the adoption of some new or updated management or director incentive stock or compensation plan. In some instances, the proxy materials include proposals by shareholders which would limit either form of incentive compensation (cash or shares) if the company doesn’t meet certain criteria. These proposals are almost always recommended to be voted AGAINST by the directors. The corporate mentality seems to be to continue to provide more rewards for less performance. When you read the proxy and annual report materials and observe the compensation levels these executives and directors are receiving, it is mind-boggeling in light of their performance. Further, there is no incentive for them to change.

It is with this continuing frustration in mind that I read with joy the report in today’s Wall Street Journal of Coca Cola Company’s plan to require that earnings targets be met in order for their directors to receive any compensation. Immediately the naysayers have said that this is a bad idea. They claim it is dangerous to tie directors compensation to EPS because of the temptation to mis-state earnings in order to receive compensation. They also claim that people from academia and the non-profit sector will be less willing to serve as directors if their compensation is not assured. If that is the case, then so be it.

I agree that Coke’s approach is not a final and complete solution to the problem. But it is a great start. If we continue to pay executives and directors millions of dollars for substandard performance, our businesses and the economy will continue to wallow in mediocrity. Congratulations to CocaCola Company for exhibiting some courage and attempting to break the mold to achieve better things. More companies should do the same.

Thursday, April 06, 2006

GM and Ford Prescription

The following post about the auto industry was submitted by a client of FalkerInvestments.

The biggest difference between GM/Ford and Toyota/Honda is their mentality toward suppliers. GM and Ford look to their job regarding suppliers as a purchasing mentality. How can we purchase parts for less? Toyota and Honda have, in contrast, an engineering mentality. How can we together come up with better designs and methods?

Toyota and Honda have reputations for severe pressure on their suppliers to reduce costs, and both customer and supplier then benefit. This has the result of getting more cost out, as well as better designs and stronger suppliers. Compare the amount of warranty claims, recalls, launches on time, and customer loyalty, just to look at what the public sees. Review the kind of help that Toyota and Honda give to their supplier base vs. what GM and Ford do. When I was working for a GM supplier and GM "help" was arriving, it was greeted with dread. GM would pick the best opportunity to save money, do a kaizen class, calculate some (highly questionable) savings, often with a large capital requirement, then extrapolate the findings over the whole plant and demand those "savings" as a price reduction. In contrast, Toyota suppliers generally greet Toyota's help gladly, because both sides benefit.

Why do GM and Ford keep doing this, when the results of the purchasing mentality are so destructive and the results of the engineering mentality so beneficial? The answer is: they want quick fixes, and price reductions are quicker. And the suppliers don't trust them to actually share information (because they've had their suggestions/ideas given to other suppliers who offer lower prices). I believe it will take a total management shakeup. I'm talking an entirely new team, not just Rick Wagoner and Bo Anderson, which will deal with reality as it is and change the incentive and reward systems in place. Plus, I believe they will need the time--and the clout--that the bankruptcy process provides. Yes, that would be disastrous for the public to buy a car unsure about warranty, dealer support and resale value. So much of both companies probably would have to be sold off, allowing the public to buy a car without worrying about the future.

I do not see either Ford or GM being able to change their cultures fast enough to reverse their downward trend. All of the wage cuts and plant closures are to deal with the past problems, and they don’t deal with making the future different. Having a lower-paid (disgruntled) workforce doesn’t sound like a recipe for developing the kind of thinking workforce that Toyota has, with hundreds of thousands of suggestions a year—from Americans. For a different future, they need to have a different present. It won’t happen without a totally different management—and that is more than Kirk Kerkorian can deliver.

-FI Client