True North Blog

A great American institution has died. Mark June 1, 2009 as the tragic end of the General Motors as a viable entity. Like a grade B movie wending toward its inevitable conclusion, thirty years of management insularity and incompetence at General Motors led to Monday’s bankruptcy filing.

GM will emerge from bankruptcy in some form, but it will never again be the king of the road that once produced one out of every two automobiles on American highways.

Italian philosopher Nicolo Machiavelli once advised his followers, “Never waste the opportunities offered by a good crisis.” For three decades General Motors management refused to face the reality that its autos were not competitive with foreign vehicles. This led to steady loss of market share, triggering a series of crises. The latter were always treated as short-term events to get through, rather than as opportunities to transform the company. Rather than acknowledge its mistakes, management preferred to blame external factors and hope that halfway measures, passage of time, or government protection could solve its problems.

Avoiding reality never works. At the outset of a crisis, leaders have many options they can deploy to address their problems. Like the early spotting of a cancer tumor in one’s body, early action to surgically remove the problem can enable the body to get healthy once again.  Over time, the options narrow or wither away. Then management is forced to ask someone else to save it.
 
In GM’s case, that “someone” has always been the U.S. government. By failing to take decisive action, GM management saw its options narrow to one: asking the U.S. government to save it. When in trouble, GM executives boarded their company planes to lobby the U.S. government to bail the company out.

Past efforts included imposing import quotas on foreign-made vehicles, fighting against safety improvements such as seat belts and air bags, delaying federally-mandated increases in fuel efficiency, or lobbying the government to take over its health care benefits. GM had powerful allies in these campaigns, including the United Auto Workers and Michigan politicians.

For a poignant example, recall 1981 when GM management convinced the U.S. government to restrict imports of Japanese-made vehicles to prevent them from taking market share. Rather than seizing on this golden opportunity to recapture share and invest in more competitive cars, GM used the reprieve to raise prices and restore flagging profit margins. When import quotas were removed, GM was even less competitive with foreign-made vehicles. Its market share continued to decline from its 1970s peak of 51 percent of the American market to only 19 percent today, as GM ceded share to the Japanese, Germans and other foreign producers.

Six months ago fast action by the GM board could have saved the company.  Last December I proposed a plan to save GM by splitting it into two companies, a dramatically down-sized but healthy GM and one to be liquidated (See wsj.com, 12.15.2009: “Bill George: A Plan to Save GM”). The latter company would have contained fifty years of obligations that GM could no longer fulfill. But management once again wasted this crisis, and the inexorable march to Monday’s bankruptcy continued unabated.

Anyone who ever doubted the importance of leadership in a crisis should compare the fates of General Motors under CEO Rick Waggoner and Ford under CEO Alan Mulally. Mulally was recruited from Boeing by the Ford board in 2006, becoming the first outsider to lead either GM or Ford.

Three months after joining the company, Mulally announced that Ford would mortgage all its assets for $23.6 billion in loans to finance an overhaul of the company.  Mulally claimed the loans would give Ford “a cushion to protect for a recession or other unexpected event.” Mulally’s actions saved the company, avoiding the requirement for government bailouts. Today Ford is operating as an independent company, focusing on upgrading its fleet and endorsing President Obama’s proposed fuel efficiency and emission standards.

Thanks to Stephen Rattner, who became Obama’s auto czar in March, General Motors’ long march to bankruptcy has been relatively orderly. He removed Waggoner and promoted Fritz Henderson to CEO and named Kent Kresa as board chair. Rattner has negotiated evenly handedly with the unions, bondholders, and other claimants to prepare for a quick trip through the bankruptcy courts. However, if GM management had taken control of its destiny last fall by splitting out the healthy parts, it could have avoided bankruptcy altogether.

Now begins the agony of finally breaking GM into pieces, shedding unnecessary employees and entire brands, and salvaging whatever is still viable.  Meanwhile, GM’s loyal customers are likely to switch to Fords or made-in-the-USA foreign brands and find them to their liking.

The lessons from this tragedy are all too evident: leaders are paid to build healthy enterprises by facing reality and using crises to strengthen their competitive position. Three decades of GM leaders failed this basic test, and millions of lives are being negatively impacted.

Maybe there’s a silver lining in the global economic meltdown after all. I believe all the economic misery, financial disasters, and millions of lost jobs will produce a new generation of leaders who are battle-tested in crisis and ready to get the global economy pointed in a healthier long-term direction.

Having learned the lessons of this crisis, these new leaders will think differently than their predecessors about how to build great institutions. As President Obama said during the presidential campaign, “I don’t want just to get us out of Iraq. We need to change the mentality that got us there in the first place.” The same lessons applies to healing our economic ills: We need to change the mentality that got us there in the first place.”

This global meltdown wasn’t caused by subprime mortgages, credit default swaps, or even excessive greed. These are only symptoms of the real problem. The root cause of this crisis was failed leadership.
Many leaders in the Baby Boomer generation did not comport themselves well in the years leading up to the crisis. They bought into the mantra of maximizing short-term shareholder value, and got stunning rewards for financial transactions that ultimately destroyed more wealth than they produced. As Jack Welch said recently, “Shareholder value as a strategy is the dumbest idea in the world. Shareholder value is a result, not a strategy. … Your main constituencies are your employees, your customers, and your products.”

These leaders found they could not keep this game going, no matter how much risk they took, and it all came crashing down. Some knew their activities weren’t sustainable, but they kept dancing faster and faster until the music stopped. In so doing, they let self-interest trump their responsibility to create lasting value and destroyed great institutions in the process.

We need a new generation of leaders who have learned the lessons of this crisis the hard way-–by being in the midst of it. These leaders will bring a new mentality to building lasting value through innovation and growth that creates sustainable wealth in the global economy. Their rewards will be for performance, not just for transactions. This economic crisis is providing the best training ground to develop a new generation of leaders. MBA programs don’t teach you how. Crisis-simulation exercises are just that-–simulations, not the real thing.

Leaders who never get tested until they reach the top may be unable to cope with a crisis. Some buckle under the pressure. Others become immobilized. Still others make big mistakes, but learn from them to become better leaders the next time around.

As a new 27-year-old general manager of Litton Microwave Cooking, I encountered my first major crisis when the FDA threatened to pull our only product, microwave ovens, off the market. We learned a painful lesson about the importance of adhering to proposed government safety standards, lessons that proved highly beneficial in my years as CEO of Medtronic.

An old English proverb says, “A smooth sea never made a skilled mariner.” Managing a stable business is a lot easier than leading it through a crisis. Growth periods don’t test your intestinal fortitude like a crisis does, nor do they determine whether you will stay on track in the heat of battle.  As in war, crises tests leaders to their limits because the outcome is rarely predictable. They not only have to use all their wisdom to guide their organizations through it, but must dig deep inside themselves to find the courage to keep going forward. As GE’s Jeff Immelt said about a crisis he faced earlier in his career, “Leadership is a long journey into your own soul.”

Some great leaders are already emerging from this crisis. Goldman Sachs’ Lloyd Blankfein, on whose board of directors I serve, and JP Morgan’s Jamie Dimon have proven their leadership not only in guiding their firms through the crisis, but by showing the way toward sustainable capital markets.

In the corporate world IBM’s (IBM)Sam Palmisano, Avon’s Andrea Jung, Xerox’s Anne Mulcahy, Novartis’ Dan Vasella, PepsiCo’s (PEP) Indra Nooyi, and Immelt are demonstrating the kind of visionary leadership that will reshape the U.S. economy. Behind them are young leaders stepping up to the top roles, like 43-year-olds Andrew Witte of pharmaceutical giant GSK and Kasper Rorstad of German chemical maker Henkel.

Robert F. Kennedy once said, “Few will have the greatness to bend history itself. But each of us can work to change a small portion of events, and in the total of all these acts will be written the history of this generation.” Just as the “greatest generation” did in World War II, this new generation of leaders is learning leadership lessons they will use the rest of their lives. It’s time to let them take over leadership and focus their organizations on pressing problems that have been festering for a decade. By concentrating on health care, education, energy and the environment, and job creation through innovation, creativity and entrepreneurship, they will build a sustainable global economy while making the world a better place for all its citizens.

As they do so, they will write the history of this generation.

When the public furor over AIG’s $165 million in bonuses was unleashed this past week, did the politicians and former CEOs involved in this never-ending fiasco acknowledge their responsibilities? Not in the slightest.  Instead, they stepped aside and watched AIG’s new CEO, Ed Liddy, twist in the wind. 

Only President Obama, reflecting the outrage ordinary citizens felt about the bonuses, was willing to say, “I’ll take responsibility. . . It is appropriate when you’re in charge to make sure stuff doesn’t happen like this.”

Where were Treasury Secretary Tim Geithner, Federal Reserve Chairman Ben Bernanke, Senator Chris Dodd, and former AIG CEOs Hank Greenberg and Martin Sullivan?  All of them were missing-in-action, running for cover, and unwilling to take any responsibility for the fiasco they helped to create.  Only the recently-appointed Liddy – who is working ninety hours a week for $1.00 per year – is willing to take the heat.  For those who are outraged over CEO compensation, Liddy earns $0.0002 per hour to take this abuse.

He doesn’t deserve it.  Ed Liddy is a good man, trying to salvage an impossible situation. He has nothing to gain and a lot to lose in terms of his stellar reputation.  “Six months ago I came out of retirement to help my country,” said the 63-year-old Liddy, who guided Allstate Insurance to great success as its CEO.

When the bankruptcy of Lehman precipitated the financial crisis, Paulson, Bernanke and Geithner worked as a triumvirate to keep AIG from a similar fate.  Reluctantly, they agreed that the U.S. government would inject $80 billion into AIG. In exchange, Paulson demanded that the government receive 80 percent ownership of AIG and the right to replace then-CEO Robert Willumstad with a new leader.

Paulson immediately reached out to Liddy as the only person in the country with the leadership and knowledge to turn AIG around.  Not only did he have a successful track record, he was known for his integrity and ability to straighten out very complex financial matters.  Having retired just months before, Liddy was embarking on a new career in private equity management, while serving on the boards of Boeing, Goldman Sachs, and Kroger.

Ed Libby isn’t charismatic or flashy, but he is as honest, practical and solid as anyone I know.  His Chicago roots and Midwestern values shine through every minute. I came to admire him as a colleague on the Goldman board, where he did an outstanding job as chair of the audit committee. 

Shortly after he retired from Allstate, Liddy and I talked about what was next in his career.  Becoming CEO of another insurance company was the last thing on his mind.  Only Paulson’s persuasive powers and the opportunity to serve his country caused Liddy to take on the thankless task of bailing out AIG.  While he didn’t know the specifics of AIG’s problems, Liddy sensed what deep trouble AIG was in after decades of its loosely run conglomerate culture and the under-pricing of risk.

On a day’s notice he left his home in Chicago, rented a modest apartment in New York, and threw himself into this enormous task.  He immediately felt the public’s wrath for a company meeting held at a California spa, but that was nothing compared to the abuse he is taking now.

The architect of AIG was Maurice “Hank” Greenberg, who was chairman and CEO of AIG for 37 years from 1968 to 2005. Greenberg managed AIG’s 165 businesses for growth and short-term profitability instead of financial soundness and solid risk-management – the hallmarks of Allstate under Liddy. In 2005 a major accounting scandal forced Greenberg to resign. He was replaced by his longtime colleague, Martin Sullivan, who lasted less than three years until the AIG board brought in retired Citigroup executive Robert Willumstad last June to keep AIG from imploding.  

Neither Greenberg nor Sullivan has taken any responsibility for the multitude of messes that led to AIG’s downfall. Greenberg even has had the audacity to suggest that all these problems came about after he retired and that he would like to take over the company once again.  The truth is that Greenberg has clear responsibility for the culture of AIG that led to these problems.

In response to the public outrage over the bonus payments, the politicians are having a field day, while avoiding any responsibility themselves.  Until confronted by a reporter, Senator Chris Dodd disclaimed the fact that the incentive provisions of the stimulus bill which he authored included an exemption for any arrangements made prior to February 11, 2009.

Clearly, this problem should have been handled much better in the first place.  The general public is justifiably outraged over compensation payouts for executives in companies that American taxpayers have to bail out. The leaders’ job is to own their mistakes, not to duck their responsibilities and focus the blame on the one person who can turn AIG around.

Next time around Ed Liddy may think twice about taking a $1 per year job to serve his country.

Virtually every American institution is facing major crises these days, from declining businesses to evaporating financial portfolios.  To get out of these crises, authentic leaders must step forward and lead their organizations through them.

The current crisis was not caused by subprime mortgages, credit default swaps, or failed economic policies.  The root cause is failed leadership. New laws, regulations, and economic bailouts won’t heal wounds created by leadership failures. They can only be solved by new leaders with the wisdom and skill to put their organizations on the right long-term course.  

Here are seven lessons for leaders charged with leading their organizations through a crisis:

Lesson #1: “Leaders must face reality.” Reality starts with the person in charge.  Leaders need to look themselves in the mirror and recognize their role in creating the problems.  Then they should gather their teams together and gain agreement about the root causes. Widespread recognition of reality is the crucial step before problems can be solved.  Attempting to find short-term fixes that address the symptoms of the crisis only ensures the organization will wind up back in the same predicament. 
    
In order to understand the real reasons for the crisis, everyone on the leadership team must be willing to tell the whole truth.  As J.P. Morgan CEO Jamie Dimon says, “It’s not sufficient to have one person on your team who is a truth teller. Everyone on the team must be candid in sharing the entire truth, no matter how painful it is.”  How else can we solve problems if we don’t know acknowledge their existence?

Lesson #2: “No matter how bad things are, they will get worse.” Faced with bad news, many leaders cannot believe that things could really be so grim.  Consequently, they try to convince the bearers of bad news that things aren’t so bad, and swift action can make problems go away. 

This causes leaders to undershoot the mark in terms of corrective actions.  As a consequence, they wind up taking a series of steps, none of which is powerful enough to correct the downward spiral.  It is far better for leaders to anticipate the worst and get out of in front of it.  If they restructure their cost base for the worst case, they can get their organization healthy for the turnaround when it comes and take advantage of opportunities that present themselves.

Lesson #3: “Build a mountain of cash, and get to the highest hill.”  In good times leaders worry more about earnings per share and revenue growth than they do about their balance sheets.  In a crisis, cash is king.  Forget about EPS and all those stock market measures.  The question is, “Does your organization have sufficient cash to survive the most dire circumstances?”

In the recent financial crisis, Citigroup it ignored the risks inherent in its investments in order to generate fee-based income to prop up 2007 earnings.  When the markets turned, Citigroup found itself out of cash and was forced to turn to the federal government to save it from bankruptcy.  In contrast, Goldman Sachs anticipated the difficult times built up its cash reserves.   When the markets got really bad, Goldman had adequate cash reserves to weather the storm.

Lesson #4: “Get the world off your shoulders.”  In a crisis, many leaders act like Atlas, carrying the weight of the world on their shoulders.  They go into isolation, and think they can solve the problem themselves.  In reality, leaders must have the help of all their people to devise solutions and to implement them.  This means bringing people into their confidence, asking them for help and ideas, and gaining their commitment to painful corrective actions.

Lesson #5: “Before asking others to sacrifice, first volunteer yourself.”  If there are sacrifices to be made – and there will be – then the leaders should step up and make the greatest sacrifices themselves.  Crises are the real tests of leaders’ True North.  Everyone is watching to see what the leaders do.  Will they stay true to their values?  Will they bow to external pressures, or confront the crisis in a straight-forward manner?  Will they be seduced by short-term rewards, or will they make near-term sacrifices in order to fix the long-term situation? 
 
Lesson #6: “Never waste a good crisis.”  This piece of advice comes from Benjamin Netanyahu, the next prime minister of Israel.  When things are going well, people resist major changes or try to get by with minor adaptations. A crisis provides the leader with the platform to get things done that were required anyway and offers the sense of urgency to accelerate their implementation.

Lesson #7: “Be aggressive in the marketplace.”  This may sound counter-intuitive, but a crisis offers the best opportunity to change the game in your favor, with new products or services to gain market share.  Many people look at a crisis as something to get through, until they can go back to business as usual.  But “business as usual” never returns because markets are irrevocably changed.  Why not create the changes that move the market in your favor, instead of waiting and reacting to the changes as they take place?

Bill’s bottom line: In a crisis we learn who the real leaders are, and whether they have the wherewithal to stay on the course of their True North.

We have a transformative new leader in the White House, but Congressional leadership is playing the same old games as the economy seeks deeper into recession.  And the unemployment lines grow . . . and grow . . . and grow.

President Obama understands the urgency and severity of our economic problems, but Congressional leadership does not.  Democratic leaders Nancy Pelosi and Harry Reid are using the stimulus package to rewrite social policy, while Republican leaders John Boehner and Mitch McConnell push the same tax cuts that led to this fiscal crisis.

This recession is going to be longer and deeper than anyone acknowledges, but it won’t be corrected by tax cuts or social programs.  There are three ways to pull the U.S. economy out of the ditch: 1) jobs, 2) jobs, and 3) jobs.

As bad as job losses were in December and January, they are getting a lot worse.  Corporate leaders are recognizing they urgently have to make deep payroll cuts, or wind up in bankruptcy. With General Motors’ car sales down 49% in January, the ripple effects on auto suppliers and dealers are just beginning. At Davos last week, I talked with one steel mogul, who told me that with factories running at 60 percent of capacity, he was forced to lay off nearly 50,000 workers.

By the time GM’s leaders return to Washington on February 17, its $13 billion December subsidy will have vanished in a river of red ink.  That river isn’t yet close to reaching its crest. To Americans who just lost their jobs, or fear they are next to go, that five-year-old car doesn’t look so bad any more.

Meanwhile, retail sales are imploding.  During January, elite stores like Saks Fifth Avenue had virtually their entire merchandise on sale at 50 per cent or more off.  Even so, same store sales declined 24 per cent. How long can that go on without massive store closings and huge layoffs?  We’ll soon have so many empty store fronts in overbuilt malls that their owners may turn them into fitness facilities.  As corporate travel and conferences get, airlines, hotels, and restaurants will surely feel the pinch.

How do we get the economy moving again?  It won’t be with government-guaranteed 4.5 percent 30-year fixed-rate mortgages or $10,000 subsidies for new car purchases.  The recently unemployed aren’t going to buy new homes or new autos.

President Obama’s Job #1 is use the stimulus package to create jobs.  Not to change social policy, like Speaker Pelosi wants to do.  Not to reform tax policy like House Minority Leader Boehner is demanding.  And certainly not with “Buy American” clauses to appease labor unions. Foreign leaders at Davos were clear that this will set off global trade wars and lead to further job losses as major exporters like Boeing and Apple find overseas markets closed.

President Obama should ask his budget director to determine how many jobs each line item in the stimulus bill will create, list them in descending order, and draw a line when spending gets to $800 billion.  Then forget about everything else – all the pork and all the unnecessary tax cuts. Then he should insist on an “up or down” vote, and challenge liberals and conservatives to abandon their orthodox ideology and act in America’s best interests.

Part of the problem is that business leaders who create jobs do not have a seat at President Obama’s table.  Thus far, not a single business leader is part of the Obama team. The president has only held two brief meetings with a politically-correct cross-section of business leaders that provide good “photo ops.”

Here’s what happens when business leaders do get involved. IBM CEO Sam Palmisano led an initiative to build the nationwide IT and broadband network. Verified studies show this will create one million new jobs for a $30 billion investment, not counting employment created by innovative companies building on this network.  Unlike new roads that create jobs for two years, this investment offers sustainable jobs for twenty years.

Whatever happened to the millions of high-paying jobs in energy, environment, health care and information technology President Obama promised during his campaign? Our future lies in innovation, creativity, entrepreneurship and new company formation. 

Our greatest competitive advantage is entrepreneurs like Larry Page of Google and Arthur Levinson of Genentech that create innovative products and services to develop new markets and dominate them globally.  With venture capital dried up for entrepreneurs ready to found breakthrough companies, the Obama administration could create a “fund of funds” to get them started in proving their ideas, and use long-term capital gains policies to bring the financiers back to the table. 

Let’s refocus the stimulus package on putting Americans back to work so we can rebuild a sustainable, long-term economy.

In spite of the gloom about the economy I witnessed at this week’s World Economic Forum in Davos, hope was in the air about a new era of global collaboration resulting from President Barack Obama’s inauguration. After a decade of declining respect for American leadership, the time is ripe to get the U.S. back on the track of economic growth, well-run government, and world respect.

In his inaugural address, President Obama called on all Americans to serve their country—a clear message that applies directly to business leaders. In spite of the pro-business orientation of the Bush Administration, every industry and sector has been harmed by the failure to create a fiscally sound, sustainable economy.

As business leaders, we must accept our share of responsibility for this state of affairs. We let self-interest, greed, and instant gratification take precedence over the country’s long-term needs. Our failure to provide visionary leadership cost us the trust of the people we serve—our customers, employees and fellow citizens.

President Obama expressed genuine anger over Wall Street bonuses and excessive executive compensation, especially for those taking government money. Calling this “the height of irresponsibility,” the President’s words stung, but were well deserved. Either corporate board members bring this situation under control or we will abdicate our responsibilities to the government.
As President Obama has moved quickly to fill key government posts with a highly competent group of leaders, it is noteworthy that not a single business leader has been named to a key position, not even Commerce or Treasury Secretary. As a result, business does not have a place at the table.

This does not mean the voice of business is unwelcome. The President has indicated he wants inputs from business leaders, as he received on the stimulus package this past week. But we cannot sit back and wait for the government to propose solutions and then commission our lobbyists to work behind the scenes to shoot them down.

Business leaders need to step up and propose solutions that benefit the entire country. Either we get engaged, or we’ll suffer unintended consequences from well-intentioned new programs that don’t work in the real world.

Here’s a short list of areas where business leaders should contribute to the nation’s long-term problems:

Health care. Health care is back on the national agenda. With escalating costs, declining availability, and mixed quality outcomes, employers have been hurt by the absence of sound national policy. The solution is not to take health care away from our employees or to get the federal government to take these problems over. Instead, we should support President Obama’s proposal to make health care available to all Americans through the combination of private and public insurance pools.

We need to contribute to creating more efficient and affordable health care, while engaging our employees to take responsibility for living healthy lives. This means supporting an aggressive public health program, supplemented by employer and community initiatives, to cause people to improve their health through regular exercise, nutritional diets, and stress-reduction programs. People with chronic disease should be offered integrated healing plans that combine evidence-based care paths with lifestyle improvements.

Energy and the Environment. The decline in oil prices from $147 to $41 per barrel shouldn’t make us complacent about the severity of the energy crisis. Near-term, the best opportunity to reduce dependence on foreign oil is through a massive efficiency program. Increased fuel efficiency and emission reductions for vehicles should be combined with a national initiative to drive efficiency improvements throughout industry and homes. Meanwhile, we need to create cost-effective sources of renewable energy through technology breakthroughs and the formation of startup companies developing innovative solutions.

Financial Services. Business contributed to the current economic crisis by advocating that institutions like hedge funds and instruments like credit default swaps go unregulated and operate without transparency. Lack of “fair value” accounting has shut down the credit markets because no one knows how to value these instruments. Leaders of financial institutions should advocate for full transparency, fair value accounting, and sound regulation in order to restore healthy financial markets.

Innovation. Innovation and entrepreneurship are America’s competitive advantages in the global world. Saving jobs that are no longer viable will never restore a sound, sustainable economy. Instead, we need to leverage our strengths by creating new companies and high tech jobs enabling America to dominate high-tech fields while exporting our products and services.

Education. American education is rapidly devolving into a two-tier system that cannot provide enough well-trained employees for the technology age. Nor is it providing an adequate supply of scientists and engineers to compete with India and China. Business should support innovative solutions to K-12 education like Teach For America and expanded grants for engineering and science students.

President Obama’s new administration is working to create long-term solutions to all these problems. It’s time for business leaders to get behind them with our own initiatives that will restore the U.S. economy to sustainable growth and world leadership.

As former WalMart CEO Lee Scott said in a recent interview in The New York Times, “Businesses have a responsibility to society…There is no conflict between delivering value to shareholders and helping society solve bigger societal problems.”

Credit the board of Citigroup for facing reality by splitting the company in two.  It is a tragedy that General Motors’ leadership won’t make a similar move. Both need to recognize that the conglomerate approach to creating shareholder value does not work.

The root cause of Citigroup’s and GM’s problems– and of our current economic crisis – is the mantra of “maximizing shareholder value,” which led to an incessant focus on short-term gains. Any company that focuses primarily on short-term shareholder value will eventually destroy itself. When entire industries do so – as we have witnessed with financial service institutions and U.S. auto makers – they can drag the entire country into a deep recession.

After ten years of trying to implement former CEO Sandy Weill’s vision of turning Citigroup into a financial supermarket, its board finally acknowledged this strategy has been a colossal failure. To survive, Citigroup is returning to its roots in commercial banking, recreating the former Citicorp, the healthy bank composed of its retail and commercial banking arms, private banking, and investment banking. The second company, Citigroup Holdings, will contain its “non core” assets, including its subprime and illiquid mortgage-related assets that eventually will be spun off or liquidated.

Citigroup never integrated its far-flung units, nor did it provide its employees with an integrated information system enabling one unit to expand financial relationships with customers of other units.  Even worse, the Citigroup board never looked at firm-wide risk, assuming erroneously that the diversity of its businesses would offset the risks.  By 2007, Citigroup was so desperate to generate profits through short-term fees that it totally underpriced risk, leading to the bad investments that forced the U.S. government to provide $45 billion in bail out funds and guarantee $306 billion in bad loans.

At least Citigroup had the wisdom to recognize the music stopped some time ago.  General Motors continues on its merry dance, as its management fiddles while the company implodes.  Its board refuses to save the company by following Citigroup’s lead and splitting GM in two – a viable core business of Chevrolet, Buick and Cadillac and a holding company for all its other assets, which would be spun off or liquidated. Unless GM moves quickly, it will face with an uncontrolled liquidation of its entire business, and America will lose its one-time icon of industrial preeminence.

In spite of the Bush administration’s “Christmas bailout,” the new Obama team is unlikely to continue financing GM’s losses, just to preserve jobs that are no longer viable. Asking American taxpayers to provide GM employees with 100% health care coverage tax-free, while 47 million Americans have no health care at all, doesn’t pass the smell test.

The lesson of Citigroup and GM is that the conglomerate corporate structure, so popular in the days of ITT, Litton, and Textron, simply doesn’t work.  Customers don’t care if the parent company has a full range of offerings. They only want to know if the specific product or service they are buying is superior to competitive offerings.  As GM and Citi learned the hard way, any company that cannot provide customers with superior products and services is steadily going out of business.

In 1969 I joined Litton Industries, one of the model conglomerates of its era, and saw first-hand the flaws inherent in the conglomerate structure.  Litton had just acquired Stouffer Foods because Litton Chairman Tex Thornton dreamt of marketing the company’s new consumer microwave ovens with Stouffer’s frozen foods. The problem was that Stouffer’s tin foil containers wouldn’t work in a microwave – and so few households had microwave ovens that Stouffer management couldn’t justify redesigning its packaging.
For all the promises of “synergies” between conglomerate units, the real attraction for companies like Litton, Citigroup, and GM is the flexibility of creative financial engineering. That’s what enabled Litton to produce fifty-five consecutive quarters of earnings increases – the epitome of the “shareholder value maximization.” When the myth of Litton’s ever-increasing earnings machine was exposed, its stock dropped from $130 to $3 per share, and never fully recovered. 

The only way to create sustainable shareholder value is through the long-term creation of superior products and services that serve customers.  This is what motivates employees to peak performance, generates customer loyalty and market share gains, sustains profit growth, and provides funding for the next generation of products and services.

Creating sustainable growth in shareholder value requires a laser-sharp commitment to being the best in the world in your field.  That’s why focused competitors like Google, Genentech, ExxonMobil, Medtronic, Goldman Sachs, Intel, and Starbucks have sustained success for so many years, and created so much long-term value. 

To restore the vitality of our capitalistic model, our leaders need to acknowledge the flaws in short-term value creation and get back to creating sustainable shareholder value. This is the only way the U.S. economy will be restored to sustainable growth.

It is time for General Motors’ board to fulfill its fiduciary duty.  GM management has failed to create a viable turnaround plan.  The U.S. Senate has refused to bail it out.  So the board is the only entity left that can save the company before it gets forced into bankruptcy.  Isn’t this the board’s duty anyway?

Neither bailouts nor bankruptcy are viable courses of action.  The $18 million that GM requested in its most recent bailout, on top of “the innovation R&D bailout” passed by Congress in October, is just a down payment on many more to come. Eventually, taxpayers and even the new administration will get fed up with chasing a downward spiral, especially when it means asking Americans who have no health care coverage to pick up 100% of the health care tab for GM employees.

In spite of many calls to let GM go bankrupt from Congress and elsewhere, the GM board is correct in its assessment that American consumers won’t want to buy their automobiles from a bankrupt company.

So why doesn’t the GM board do the obvious: dramatically downsize the company to make it viable?  The only way GM can survive is to consolidate around three brands – Chevrolet cars and trucks, Buick and Cadillac, and sell off or shut down the rest of the company.  

The fastest and most efficient way to get this done is to split GM into two companies, a healthy GM and one to be liquidated.  The healthy GM would take the aforementioned brands, a limited number of factories operating at greater than 80 per cent of capacity, and a select number of healthy dealerships.  Employment agreements would be renegotiated to get wages and benefits competitive with the North American plants of the Japanese and German producers, along with a more flexible set of work rules. This includes getting employees to pay up 20-25% of the cost of their health care, like all other Americans do.

The new GM would embark on a massive new product development program to make its automobiles competitive in engineering, features, fuel efficiency and styling. Management would commit to a fleet average of 40 miles per gallon by 2016 and 50 MPG by 2020, with a mix of lighter vehicles, efficiency improvements, hybrids, and electric cars like the Chevy Volt. Management should aggressively attempt to move buyers from former GM brands like Pontiac and Saturn to its remaining brands.

To lead this new company, GM needs new management, much like the team of Louis Gerstner and Jerry York that restored IBM to health. The best candidate for CEO is Carlos Ghosn, who has achieved remarkable success at both Renault and Nissan.  A new headquarters location should be established – somewhere like Dallas or Atlanta – with a very small corporate staff.  Finally, the company should be governed by a new board of directors.

The remaining GM, which includes the existing board, management, headquarters building and staff, the rest of the factories, jobs bank, retirees, and dealers, would be liquidated.  This would likely mean that U.S. government would be forced to pick up some of the pension and health care obligations of the retirees, and renegotiate agreements with creditors, suppliers and the unions.

This solution is neither elegant nor easy, but it is the only way to save General Motors.  In this way the GM board can fulfill its fiduciary responsibilities, not only to the remaining shareholders, but to the creditors, dealers, customers, employees, and suppliers that have a vested interest in the company.

The “divide and conquer” approach is far better than the partial nationalization of the company that will occur under continuing government bailouts, or forcing the company into a bankruptcy from which it may never emerge.

This post was co-authored with Malcolm Salter, the James J. Hill Professor Emeritus at Harvard Business School.

Enron’s demise in 2001 and the collapse of some of our most prominent financial institutions this fall share a common root cause: a shocking breakdown in corporate governance resulting from the endorsement of perverse financial incentives by directors, coupled with ineffective monitoring of firm-wide risk.

As Warren Buffett has said, “Executive compensation is the acid test of corporate governance.” Financial incentives determine what objectives an organization pursues, and they drive the way managers conduct a business.

Enron’s board ratified a cocktail of financial incentives and compensation contracts that promoted reckless gambling with shareholder money. Its bonus system, in particular, gave new business developers and commodity traders many incentives to inflate estimates of future profitability in order to pocket annual bonuses before the actual performance of multi-year transactions was known.

Lacking the recapture of bonus payments for unprofitable contracts, executives had little accountability in deploying shareholder capital. Finally, short-term quantitative criteria displaced qualitative measures of executive performance. The result was overcompensation, outsized risk-taking, and supreme overconfidence.

In the current subprime crisis, mortgage bankers and some commercial bankers utilized similar incentives to achieve short-term gains. Mortgage brokers, for example, were paid on commission with no economic penalty for writing poorly performing home loans. The mortgage bankers earned fees for packaging home loans as multi-layered collateralized loan obligations to investors, yet they bore no liability for the credit quality of these complex securities.

The result of these perverse incentives was as predictable for these bankers as it was at Enron: excessive risk-taking was rewarded to achieve short-term gains. Executives received outsized cash bonuses for closing deals and selling securities without evidence of future profitability. All this encouraged deception and carelessness in the management of firm-wide risk.

The history of Enron and the unfolding story of the current banking crisis suggest important lessons for boards in designing executive compensation programs:

Awarding performance bonuses based on estimated future cash flows and profits eliminates accountability and invites employees to maximize short-term pecuniary goals while risking the company’s viability.

Failing to include provisions for rescinding bonuses if companies revise their past performance creates perverse incentives for executives and promotes gaming behavior.

Awarding stock grants without extended holding periods enables executives to benefit from short-term stock price fluctuations, putting corporate insiders in conflict with ordinary shareholders.

Like the Enron board, directors at Lehman, UBS, Wachovia, Washington Mutual, Citigroup, and Fannie Mae failed to understand how compensation systems drove behavior, thereby creating the conditions that led to their failures. Directors at these firms failed to detect and deter the inevitable gambling that resulted from their compensation plans.

Were these boards incompetent, uninformed, or simply intimidated by powerful CEOs? The answer is not entirely clear. Whatever the reason, the outcome was the same: they failed in their fiduciary duty to govern.

If self-governance is to be preserved as a principal of corporate law, several improvements are required to protect against future breakdowns in board governance. Public companies should select only directors who have the time to serve effectively. Commensurate with that time and increased levels of director liability, director compensation should be increased, based on long-term performance of the firm.

Directors should be required to put more of their wealth at risk through investments in company shares so that their interests align with shareholder interests. Holding periods of restricted stock and stock options awarded to directors should be ten years or until retirement. In the event of a corporate failure, directors should be forced to sacrifice their earnings since they joined the board.

Finally, the roles of board governance and management must be clearly delineated and separated from each other. According to a study by Spencer Stuart, 95% of the S&P 500 companies currently have “lead” or presiding directors that coordinate the work of all independent directors, up from 36% in 2003.

The non-executive chair, or lead director, provides an independent voice when recruiting new directors, approving board meeting agendas, asking for information on firm-wide risks, evaluating CEO performance, creating a process for CEO succession. He also organizes the independent directors in the event of a unexpected issue, such as a takeover bid, resignation of the CEO, or fiscal crisis. Without clear separation of board governance and corporate management, the entire corporation may be put at risk.

If directors fail to provide clear oversight of executive compensation and risk-taking, they may abdicate their fiduciary responsibilities to groups of dissident shareholders and, ultimately, to the government. The Enron case resulted in the rushed passage of Sarbanes-Oxley legislation, a process that took just 31 days and considered only limited input from the business community. Unless boards of directors act immediately to adhere to their fiduciary responsibilities, this could happen again in 2009.

In our opinion, this would not be in the best interests of free-market capitalism and the growth of the U.S. economy, but it may happen unless boards take their responsibilities very seriously.

Many people want to save General Motors (GM), but no one seems willing to do what is required to make it competitive.

GM is like an aging heart-failure patient, suffering from decades of physical abuse and nearing the end.  The medical team has two difficult choices: keep the patient alive on life support, or perform radical surgery with a heart transplant.

A $25 billion bailout for GM, Ford (F), and Chrysler is akin to putting them on life support to stay alive until the money runs out. But it won’t make them competitive. 

GM’s problems have developed over the last 50 years under a series of financially-oriented CEOs.  Instead of staring down the unions and risking a strike, they agreed to expensive employee and retiree health-care programs, generous pensions, a jobs bank, and inflexible work rules that rendered GM non-competitive.

As serious as these problems are, GM’s bigget issue is that it isn’t making cars the American people want to buy, unless enticed with huge discounts and 0% financing.  Over the last four decades GM management watched its share of the U.S. market decline from 53% to 20%. Management repeatedly cut costs, but never deeply enough to get competitive. 

Meanwhile, GM lobbyists opposed most fuel-efficiency standard and safety improvements, from miles/gallon improvements to seat belts to catalytic converters to air bags. Yet when GM started losing share, its management lobbied Washington for limiting imports of foreign autos through increased tariffs, only to waste its opportunities by increasing prices and profits instead of investing in competitive products. 

In fairness to current CEO Richard Waggoner, he inherited these problems from his predecessors. He is taking incremental steps to improve, but isn’t thinking boldly enough about the drastic actions required to fix them. 

The debate in Washington has been framed in stark terms – bail out General Motors or let the company go bankrupt.  The Michigan delegation claims the latter option is untenable to the nation – and I agree that it is – but a quick fix that doesn’t make GM competitive is equally unappealing .

There is better option, but first the executives, unions, and politicians need to face these realities:

1. With high employee costs and inflexible work rules, GM is not competitive with the North American factories of the Japanese and German producers.
2. GM cannot afford the overhead for seven brands, many of them “look-alikes,” and the advertising, dealers, and service networks to sustain them.
3. GM’s products need a massive overhaul to become competitive in fuel efficiency, air pollution, engineering excellence, consumer features, and styling.
4. GM needs new leadership and a new culture.
                  

Here’s my radical proposal for a heart transplant to save General Motors:

1. Divide GM into two companies, the first composed of Chevrolet (including trucks), Buick, and Cadillac. 
2. Install new management, move the headquarters to a new location, and create an empowering culture for all employees.  
3. Negotiate new employee agreements with wages and benefits competitive to those of foreign producers’ U.S. factories (around $44 per hour compared to GM’s current level of $73),  including health plans and pensions comparable to its foreign competitors.
4. Retain only GM’s most productive American and foreign factories—those that operate at greater than 80% of capacity.
5. Embark on an aggressive new-product development program to make its autos fully competitive in engineering, features, and styling within five years.
6. Commit to fleet average of 38 MPG by 2016 and 48 MPG by 2020, competitive with European standards, with a mix of hybrids, electric cars, lighter vehicles, and efficiency improvements.
7. Re-charter the dealer network for these three brands with fewer, healthier dealers.
8. Establish a viable capital structure enabling this company to operate with sound cash balances and a reasonable debt-to-equity structure.

The second company would retain the remaining brands, employee agreements, factories, and dealers.  Management would proceed to liquidate the company, on terms that reasonably protect employee rights, dealer rights, and creditor rights, comparable to what a bankruptcy court might offer.  When this process exceeds GM’s residual balance sheet, the federal government would fund the balance on a one-time basis.

Who could pull off this radical plan?  For starters, the President should appoint an “auto czar” to guide these changes.  For CEO of the first company, an experienced auto executive should be recruited from outside Detroit, someone like Carlos Ghosn, CEO of Renault. The current GM management would lead the second company.

Such radical surgery would be difficult and expensive in the short-term, but it is the only way to make American automobiles competitive for the future. Creating a viable company is a far better solution than letting GM go bankrupt, or facing the slow death of going on “life support” from American taxpayers.