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Could an effective finance committee have averted GE’s woes?

One of America's biggest brands recently lost its place in the Dow Jones Industrial Average but GE's decline has been a long and protracted one. From 2001 to 2017, under the tenure of CEO Jeff Immelt, its stock price fell by 30 per cent, or around $150 billion. And since Immelt's departure in January 2017, the stock price has fallen a further 30 per cent. In May it announced it would sell off its healthcare division and sell a 62.5 per cent stake in the oil company Baker Hughes, while this week it announced the reduction of its German workforce by about a third as part of its plan to refocus on fewer key divisions. In the past five years, GE has accrued debt and its ratio of debt to earnings has soared from 1.5 in 2013 to 3.7 in early 2018. In a nutshell, GE is not in good financial shape.

Much has been said and written about the company's slow decline and, fairly or not, Immelt has taken much of the blame – in particular for his bad capital allocation decisions during a series of mis-judged acquisitions and divestitures. A recent article in the Harvard Business Review (HBR) offers some interesting perspectives on how the fall could have been cushioned, if not completely averted, by better financial and audit oversight, and why financial executives within the company should have been appointed to play a more prominent role in steering the decisions for the conglomerate.

Writing in HBR, Robert C. Pozen, of MIT Sloan and the Brookings Institution, asks what GE's board could have done differently. He puts forward three suggestions:

  • The board was too big and for much of Immelt's time as CEO, it had 18 directors, even though studies suggest that smaller boards, ideally with around 8-14 members, are more effective. In December 2017, GE downsized its board to 12.
  • The board didn't have a finance committee – Pozen calls this “another major structural defect”. He writes that a finance committee is critical for a board in complex public companies like GE. This led to serious mistakes in managing the company's pension scheme. GE was slower than most US public companies in freezing its defined benefit (DB) plan and Pozen adds that, by 2017, GE had “by far the largest pension deficit of all companies in the S&P 500”. Pozen notes that GE's board has now appointed a finance committee.
  • The board's audit committee wasn't vigilant and the company has been investigated by the SEC for its revenue recognition practices, in which GE was found to have reported “materially false and misleading results in its financial statements”, including reporting inflated sales figures and the mis-application of cash flow accounting to interest-rate swaps. The role of external auditor KPMG was also criticised by the SEC and further accounting problems have arisen, which are also being investigated by the SEC.

Pozen concludes that GE's board “should have been much more proactive in questioning his [Immelt's] massive allocation of capital to acquisitions and buybacks and in probing the company’s accounting practices”. It seems almost unbelievable that the GE board was without a finance committee for such a prolonged (and financially-complex) time. Pozen has called for public companies to appoint finance committees as a matter of course. 

But his HBR article really underscores the role of both the finance committee and the audit committee in maintaining standards of accountability, transparency and responsibility. They are seen as two bulwarks against undue influence from the commercial and management considerations of the board and CEO. As one commenter below the article says, the lack of financial responsibility and accountability shown by GE's board during the 2001-2017 period does seem like a case of hubris and perhaps comparisons can be drawn with the Theranos case, too. The finance committee, CFO and financial executives have an important part to play in counter-balancing powerful CEOs and ensuring that correct financial transparency and investor interests are protected.

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