The Substack blog MD&A, written by the pseudonymous “Philo,” published a posting earlier this week entitled “Intellectual Laziness.” It concerns General Electric — the one-time “bluest of the blue chips” — and its fall from grace.
The story is told through references to two books: William Cohan’s Power Failure: The Rise and Fall of An American Icon, about GE, and Winning Now, Winning Later by David Cote, who had been passed over for the top job at GE before becoming CEO at Honeywell.
General Electric
Philo summarizes the reverence that was given to GE. For much of two decades it was “the most valuable company in America” and was regularly ranked as “the most admired company in the world.” And Jack Welch was at the helm, at the top of the heap of celebrated CEOs:
Jack Welch had most of the traits we typically associate with a great executive. He was incredibly smart (earning his PhD in chemical engineering in only three years), he was demanding of his subordinates, and he worked tirelessly. He had deep operating experience, he was willing to buck convention, and he produced quantifiable results. He was charismatic, ambitious, and a world-class marketer and publicist.
The total package. But here’s the last sentence from that description by Philo:
And yet, he will forever be remembered as the father of the biggest corporate disaster in American history.
The posting offers example after example of the errors that were made by Welch and by his successor Jeff Immelt, grouped into three categories: poor operating discipline, problems at GE Capital (the engine of the firm’s apparent success and also the source of most of its accounting strategems), and poor capital allocation, which Philo describes as “GE’s biggest problem”:
Jack Welch was public in his distaste for stock buybacks, preferring to use cash for acquisitions instead. GE’s track record demonstrates why investors so often prefer buybacks, and are particularly loathe to allow companies to invest outside their core business: managers are high on ego and low on investment expertise.
At almost eight hundred pages, Cohan’s book covered the story in detail — and he interviewed a wide range of sources, including Welch, Immelt, and other top managers (as well as “critics, counterparties, and journalists”). But, for Philo, the book
doesn’t really offer an overarching theory of why GE failed. Power Failure lists many different things that went wrong at GE — bad management, bad acquisitions, bad incentives, bad accounting, bad luck — but almost all companies suffer from some of these issues without running into a GE-scale disaster.
David Cote at Honeywell
That “overarching theory” came courtesy of David Cote. Philo termed Cote’s book about his tenure at Honeywell to be “fairly standard for the business advice genre,” but he was struck by the opening vignette in it, in which Cote summarizes an early business review of the Honeywell Aerospace unit:
We sat down in a conference room so that team members could present their strategic plan to me. A copy of the plan had been placed on the table facing each seat. Flipping through mine, I saw that it was thick — maybe 150 pages long, full of charts and tables. Uh oh, I thought, not good. I had found so far at Honeywell that executives and managers often made presentations far longer than necessary, overwhelming audience members with facts, figures, and commentary to preempt sharp, critical questioning.
Cote was to discover that it was part of a pattern:
Lacking any drive to think deeply about their businesses, and unchallenged by leadership to do so, teams held meetings that were essentially useless, their presentations clogged up with feel-good jargon, meaningless numbers, and analytic frameworks whose chief purpose was to hide faulty logic and make the business look good. When you did a bit of digging, you found that most executives didn’t understand their businesses very well, or even at all.
Intellectual laziness
This pattern was not unique to Honeywell. As summarized by Philo:
Cote defines this as intellectual laziness. It is the tendency of organizations to “juke the stats” and lie to themselves instead of diagnosing and solving root problems.
Importantly, “what intellectual laziness is not”:
It is not actual sloth. People are working hard, just not directed in a way that creates value. . . . It is not necessarily fraudulent or illegal in any way. Yes, the organization is being dishonest with itself, but it is fundamentally a form of mismanagement rather than willful deception. . . . It is not stupidity or incompetence, either. In this example, the Aerospace team had the capability to identify and solve root problems, but they had just never been forced to do so by senior management. They were doing stupid things, but not because they were stupid; they were just responding to the culture and incentives in place.
In contrast:
Cote preaches that managers should instead strive for intellectual rigor, to probe deeply to identify and confront root problems and think creatively and rigorously to find solutions. He argues that “leadership [is], at its core, an intellectual activity.” In his framework, leadership is almost entirely about picking the right direction for the organization and getting the team to move in that direction.
Which brings us back to GE. One of the stories in Cohan’s book is when Comcast bought NBCUniversal from GE and Steve Burke took over as CEO:
Burke quickly concluded that NBC had been terribly managed under GE and the culture was abysmal. . . . [Burke] quickly ascertained . . . that the incentive at NBCU wasn’t to make money. “The game here was to keep GE, to keep Connecticut, happy,” he said. “So the game then became telling a story, as opposed to running businesses, and the incentives were to do that.”
And there was one behavior prized above all at headquarters.
Earnings management
Welch was known for the incredibly smooth and growing earnings stream that he could produce, “the art of making reported earnings grow consistently each quarter, even as the underlying business produces volatile results.” Investors worshipped Welch for delivering that pattern of earnings, but the mandate within the company to produce the façade was a cultural rot that led to its downfall:
According to Power Failure, almost every time GE made a major decision that destroyed shareholder value, the obsession with manipulating earnings was front and center in the thought process.
No attention to shareholder value, just “earnings, earnings, earnings,” an all-too-common path for companies, supported by sell-side analysts and buy-side acolytes. Beyond that:
Even putting aside the obsession with reported earnings, GE’s culture seems to have been generally lacking in intellectual rigor. GE’s strategies were supported by narratives that sounded compelling at a superficial level, but fell apart under any kind of scrutiny.
There’s a lot of that going around.
Business theater
Philo draws some conclusions for those evaluating businesses. One is that CEOs should not be judged based only upon their outstanding strengths, as they often are, but in light of their weaknesses, since “intellectually lazy managers are eventually doomed to produce bad results, no matter how hard they work or how exceptionally smart they are.” Therefore, it is “important to identify underrated managers” and avoid overrated ones.
Many of them “are able to assemble a narrative that sounds convincing to a layman, peppered with vanity metrics and impenetrable business-speak”:
However, the narrative is usually all form and no substance, pure business theater. It leans heavily on rhetorical tricks: accounting chicanery employed to meet previously announced financial targets might be rationalized as “exceptional dedication to meeting our public commitments.”
It is through intellectual rigor — the willingness to ask tough questions and not fall for the rhetorical tricks — that you can crack the narrative and get at the underlying reality:
The goal of an analyst is to become knowledgeable enough to “separate the bluffers from the doers,” to borrow a phrase from Shelby Davis.
This is true in every corner of the investment ecosystem, for analysts studying companies, portfolio managers grilling analysts, allocators and advisory firms vetting asset managers, and on and on. Outsiders face a whole host of hurdles in trying to understand what is happening, but quality research involves getting beyond the play being presented on the stage to understand the nature of the actors and how they perform when no one is looking.
Please read the posting, which provides much more detail. You can see the archives of other postings from Philo or subscribe to the Substack here.
Published: July 8, 2023
To comment, please send an email to editor@investmentecosystem.com. Comments are for the editor and are not viewable by readers.