September 11: Management Quality

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Administrative

Books Syllabus Articles Teams If you weren’t here a week ago Who is here?

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Two Perspectives on Quality of Management

Slow and Steady, Boring, Shy Have to Make Change Fast and

Tell Everyone How Great You Are

But First, Does it Matter?

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Methodology

Analysis of Fortune’s America’s Most Admired Companies (AMAC) 1985-2000– Correlations run on change in mean scores and

changes in financial measures (sales, profits, and earnings per share.

– Volatility of perceived management quality tested between two time periods: 1985-1994 and 1995-2000.

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Historical Data: Alcoa

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1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Alcoa Survey Average

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Reputation and Financial Performance: Alcoa

EPSOverall rep

Mgmt qual

Prod qual

Fin sound

Invest value

Asset Use Innov

Dvlp/keep People

Comm/Env

Change in EPS 1.0000 0.6862 0.7088 0.3668 0.5741 0.5203 0.6975 0.4394 0.6495 0.5994Correlated with Overall Reputation 0.6862 1.0000 0.8039 0.7256 0.8286 0.8461 0.9005 0.8664 0.9520 0.6877Correlated with ManagementQuality 0.7088 0.8039 1.0000 0.5209 0.5650 0.6264 0.6736 0.5706 0.8340 0.4862Correlated with Product Quality 0.3668 0.7256 0.5209 1.0000 0.3713 0.3681 0.6818 0.7419 0.6896 0.5841Correlated with financial soundness 0.5741 0.8286 0.5650 0.3713 1.0000 0.9556 0.6480 0.6669 0.7635 0.4705Correlated with investment value 0.5203 0.8461 0.6264 0.3681 0.9556 1.0000 0.6343 0.6926 0.8353 0.4388Correlated with asset use

0.6975 0.9005 0.6736 0.6818 0.6480 0.6343 1.0000 0.8669 0.8232 0.5910Correlated with innovativeness 0.4394 0.8664 0.5706 0.7419 0.6669 0.6926 0.8669 1.0000 0.7879 0.4425Correlated with people

0.6495 0.9520 0.8340 0.6896 0.7635 0.8353 0.8232 0.7879 1.0000 0.5595

0.5994 0.6877 0.4862 0.5841 0.4705 0.4388 0.5910 0.4425 0.5595 1.0000Correlated with comm/environ

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Historical Data: Fruit of the Loom

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1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Fruit of the Loom Survey Average

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Reputation and Financial Performance: Fruit of the Loom

Profits Overall repMgmt qual

Prod qual

Fin sound

Invest value

Asset Use Innov

Dvlp/keep People

Comm/Env

Change in Profits 1.0000 0.6714 0.7420 0.4185 0.5990 0.5608 0.5807 0.6158 0.3918 0.3436Correlated with Overall Reputation 0.6714 1.0000 0.9653 0.6876 0.9538 0.9493 0.9220 0.7613 0.8709 0.8786Correlated with ManagementQuality 0.7420 0.9653 1.0000 0.6422 0.9081 0.9257 0.8405 0.7848 0.8704 0.7548Correlated with Product Quality 0.4185 0.6876 0.6422 1.0000 0.4978 0.6788 0.5232 0.6948 0.5283 0.5719Correlated with financial soundness 0.5990 0.9538 0.9081 0.4978 1.0000 0.8926 0.9428 0.6236 0.8039 0.8677Correlated with investment value 0.5608 0.9493 0.9257 0.6788 0.8926 1.0000 0.8691 0.6892 0.7800 0.7807Correlated with asset use

0.5807 0.9220 0.8405 0.5232 0.9428 0.8691 1.0000 0.5296 0.7184 0.9134Correlated with innovativeness 0.6158 0.7613 0.7848 0.6948 0.6236 0.6892 0.5296 1.0000 0.6764 0.5064Correlated with people

0.3918 0.8709 0.8704 0.5283 0.8039 0.7800 0.7184 0.6764 1.0000 0.7413

0.3436 0.8786 0.7548 0.5719 0.8677 0.7807 0.9134 0.5064 0.7413 1.0000Correlated with comm/environ

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Historical Data: Airlines

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1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Airlines Cmp Survey Average

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Reputation and Financial Performance: Airline Industry

EPSOverall rep

Mgmt qual

Prod qual

Fin sound

Invest value

Asset Use Innov

Dvlp/keep People

Comm/Env

Change in EPS 1.0000 0.8415 0.9057 0.8737 0.6776 0.8658 0.6473 0.9373 0.8835 0.8891Correlated with Overall Reputation 0.8415 1.0000 0.9771 0.8915 0.8851 0.9809 0.9313 0.9733 0.9613 0.8317Correlated with ManagementQuality 0.9057 0.9771 1.0000 0.8324 0.8469 0.9438 0.8689 0.9638 0.9167 0.8656Correlated with Product Quality 0.8737 0.8915 0.8324 1.0000 0.8151 0.8571 0.7429 0.8719 0.9783 0.5699Correlated with financial soundness 0.6776 0.8851 0.8469 0.8151 1.0000 0.8647 0.8735 0.7600 0.8608 0.5573Correlated with investment value 0.8658 0.9809 0.9438 0.8571 0.8647 1.0000 0.9464 0.9596 0.9432 0.7901Correlated with asset use

0.6473 0.9313 0.8689 0.7429 0.8735 0.9464 1.0000 0.8649 0.8422 0.7874Correlated with innovativeness 0.9373 0.9733 0.9638 0.8719 0.7600 0.9596 0.8649 1.0000 0.9439 0.8723Correlated with people

0.8835 0.9613 0.9167 0.9783 0.8608 0.9432 0.8422 0.9439 1.0000 0.6886

0.8891 0.8317 0.8656 0.5699 0.5573 0.7901 0.7874 0.8723 0.6886 1.0000Correlated with comm/environ

Level 5 Leadership

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Five Levels

Level 1: Highly Capable Individual – good work, skills, knowledge

Level 2: Contributing Team Member – makes the team better through individual efforts

Level 3: Competent Manager – organizes people and resources

Level 4: Effective Leader – creates commitment and vigorous pursuit of a higher set of performance standards

Level 5: Executive – builds enduring greatness

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Collins – Level Five Leadership

Lincoln vs. Caesar Bush vs. Clinton? Self-effacing, quiet, reserved, shy Professional will & personal humility Bill Gates vs. the Millionaire Next Door

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Professional Will

Ambition is the Institution Burn the Boats: there is no other option Focus on the long-term health of the institution,

not the short-term gains Set up successors well Value system is focused on the greatness of the

organization If Lincoln had only wanted peace, not a great

nation, would we be the same today?

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Personal Humility

Press not important, shuns public adulation Usually from inside – not an outside savior Looks at the mirror, not out the window Apportion credit to others, apportion

responsibility to themselves Inspires through determination, not charisma Boring

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First Who, Then What

Right People on the Bus, Then Start Driving Who Before What: The Right People are

Everything Not a Genius with A Thousand Helpers Vigorous Debate Not How Much You Pay, But Who You Pay Rigorous, not Ruthless

– When in doubt, don’t hire– Make change fast– Best people on best opportunities

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A Nation of Grinders – NY Times Magazine

In America, you are rewarded if you:– Get an education

– Get married and stay married

– Work hard

– Mixed-up – no class consumption

““You Got Six Months To You Got Six Months To Make Your CEO Look Great”Make Your CEO Look Great”

““You Got Six Months To You Got Six Months To Make Your CEO Look Great”Make Your CEO Look Great”

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Key Points

Reputation = $$$$Management Quality = Reputation

Management Quality is more important than everPerceptions of Management Quality are

changing faster than ever

Bottom Line:You have six months from a management change to start communicating value or it is over in a year

and a half

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Importance of Management

Executives and analysts SAY that management quality is the most important factor when evaluating a company.

Stated Importance

Quality of management 9.3

Product/service quality 8.8

Employees 8.5

Investment value 8.2

Financial position 8.0

Innovativeness 7.8

Asset use 7.9

Comm./Envir. Resp. 6.5

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Today…

The relationship between management quality and overall reputation (both change in and mean scores) has also grown stronger.

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Importance of Management(Overall Reputation and Management Quality Correlated With One Another)

Correlation Coefficient 1985-1994

Correlation Coefficient 1995-2000

Fruit of the Loom .9516 .9961

Liz Claiborne .8470 .8792

Boeing .8772 .9514

UST .9602 .9887

Coca Cola .6810 .9373

Apparel Companies .9012 .9862

Aerospace Companies .9369 .9485

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Today…

Perceived management quality has become more volatile.

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Importance of Management

The average rate of change has doubled. The change from 1999 to 2000 was the

biggest ever – 4%.

Management Quality

1985-1995 1996-2000

Average rate of change 1% 2%

Average point change .06 .11

Judgment Day Comes Faster Than Ever Among Those Who Buy Your Stock

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Methodology

1000 interviews conducted with the general public February 8, 2001 – February 11, 2001.

Identified individual investors were asked subsequent questions related to the performance of a Fortune 500 CEO.

Individual investors are defined as people who own stocks.

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Time Allotted to New CEO

24% 23%

9% 5% 6% 7% 9%

0%

20%

40%

60%

80%

100%

6 months orless

6 months -1 year

1 - 1 1/2years

1 1/2 - 2years

2 - 3 years + 3 years Never makejudgments

Average = 17 months

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Compared to 10 Years Ago…

2%

10%

13%

37%

39%

0% 20% 40% 60% 80% 100%

Didn't make 10years ago

Don't know

Longer

About the same

Shorter

Three times more say shorter than longer

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Still…

CEOs are American Icons!

Who Wants To Be A CEO (Anymore)?

An Investment Community Perspective

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Methodology

Brief Telephone Interviews with Targeted Audience Conducted in January & February 2001 Market Conditions

– January 31, 2001• Dow Jones Industrial Average Close: 10,887.36• NASDAQ Composite Index Close: 2,772.73

– As of 3/16/01• Dow Jones Industrial Average Close: 9,827.64• NASDAQ Composite Index: 1,890.74

– Percent Change• Dow Jones Industrial Average: -9.73%• NASDAQ Composite Index: -31.81%

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A Cross Section of Top US Financial Institutions

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In your opinion, what is a reasonable timeframe (in months) for a new CEO to significantly increase shareholder value?

According to the Investment Community, new CEO’s have, on average, 14.5 months to increase shareholder value

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Is that time frame shorter, longer or the same as your time frame say, 10 years ago?

85% of participants surveyed feel that this is a shorter time period than 10 years ago

Nearly half believe this time is 1-3 years shorter than 10 years ago

“More immediate results are required…Wall Street and analysts are more involved

in management choice today.”

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CEO Turnover

In the 1990s, a third of CEOs appointed at 450 major corporations lasted three years or less

One in four companies went through three or more CEOs

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Recent CEO Tenures

Jill Barad, Mattel– 37 Months

John McDonough, Newell Rubbermaid– 35 Months

M. Douglas Ivester, Coca-Cola– 28 Months

Robert Knowling, Covad– 28 Months

Michael Hawley, Gillette– 17 Months

Durk Jager, Procter & Gamble– 17 Months

Lloyd Ward, Maytag– 15 Months

Richard Thoman, Xerox– 13 Months

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“Why is everyone mad at me?” –CEO

Earnings performance Share price Litigation/Crisis Compensation/Golden

Parachute issues

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Are CEOs generally worth the compensation they receive in salary and options?

Fully one-third of the participants do NOT believe that CEO’s are generally worth the compensation they receive in salary and options

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CEO Compensation

Top 10 CEO’s by Total Compensation (1999)• Salary Plus Bonus, and Long-term Comp.

– CHARLES WANG - COMPUTER ASSOC. INTL. = $655.4 Million– L. DENNIS KOZLOWSKI - TYCO INTL. = $170.0 Million– DAVID POTTRUCK - CHARLES SCHWAB = $127.9 Million– JOHN CHAMBERS - CISCO SYSTEMS = $121.7 Million– STEPHEN CASE - AMERICA ONLINE = $117.1 Million– LOUIS GERSTNER – IBM = $102.3 Million– JACK WELCH - GENERAL ELECTRIC = $93.1 Million– SANFORD WEILL – CITIGROUP = $90.2 Million– PETER KARMANOS JR. – COMPUWARE = $87.5 Million– REUBEN MARK -COLGATE-PALMOLIVE = $85.3 Million

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CEO Compensation: A Widening Gap

1989: $1.2M– 45 times the blue-collar wage

1999: $12.4M– 475 times the blue-collar wage

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Should exiting CEOs be paid the “golden parachutes” they receive in salary and severance?

NO!

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Should exiting CEOs be paid the “golden parachutes” they receive in salary and severance?

Three out of four participants feel that exiting CEOs should NOT be paid these “golden parachutes”

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Is a troubled company better off appointing an insider or an outsider as CEO?

Three quarters feel that it is better to appoint an outsider as CEO of a troubled company to bring in a “Fresh Perspective”

Current Environment– 80% of CEOs are still hired from the inside

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Would you want to be the CEO of a Fortune 1000 company today?

Nearly two-thirds would NOT like the title of CEO on their office door or parking space

OfficeOfficeCEO’sCEO’s

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Professional Heartburn

“It is bad enough being an analyst!”

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My Doctor Said…

CommunicateCommunicate

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Conclusions

Reputation has a measurable financial value Management quality drives reputation Perceived management quality is more

important than ever

You’ve got six months; or your CEO has no more than a year and a half.

Presentation Guidelines Redux

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Guidelines

Each Team Member Has a Role Have a Team Leader Use Any AV Approach that works for you One-page handout – should include:

– Team members– Key question(s)– What you propose

Three Steps:– What you are going to say– Say it– What you just said

An Example of An “A” Team Presentation

Fall 2002

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Any guesses as to what this is?

– Monthly pension to amount to 80% of last salary – Six cars and seven drivers– 34 office workers– 12-bedroom mansion– Three cooks – 2 housekeepers– 9 Security Men– Gym– Swimming pool– Sauna – Medical care for him and his family– Pay for trips inside Kenya and abroad– State Funeral upon death

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Golden Parachute:

A clause in an executive's employment contract specifying that he/she will receive large benefits in the event that the company is acquired and the executive's employment is terminated. These benefits can take the form of severance pay, a bonus, stock options, or a combination thereof.

http://www.investorwords.com/cgi-bin/getword.cgi?2201

CEO Compensation

Brought to you by:

Karen Dwyer

Jerry Roenbeck

Jonathan Gaynor

Tarshia Griffin

Valerie Pitchford

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Argument for Large CEO Compensation

Attract top management Promote loyalty Motivate long-term financial gain Parachutes deter takeovers Promote stability

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Studies show:– CEO’s no more likely than average paid

employees to stay based on the salary/benefits

– Huge compensation packages do not ensure loyalty

– Stock options can be ineffective– Takeovers still occurring– Zero Cost Collaring

Not So!

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Let’s Look at the Stats

Average US CEO – salary over $2M Average CEO makes 17x the average

American CEO’s of major corporations make 85x the

average American

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Let’s Look at the Stats

CEO Compensation– Up 212% in the past decade

Compared to the– Factory workers’ up 54%

– Engineers up 73%

– Teacher up 95%

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Let’s Look at the Stats

CEO payment outdoing inflation– Satisfactory workers’ pay up 4.7%

– Outstanding workers’ pay up 7.7%

– ½ Fortune 500 made large cuts yet CEO pay surged

1979-89– Family take home up 9%

– Income of the richest 1% (31% CEO) up 31%

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Example 1

Jack Welch– 81,000 layoffs in the first 5 years as CEO– 993 acquisitions– Apr 4, 1981

• Market Capital up $402.4B• Revenue $21B

– 20 years later• Market Capital up 5000%• Revenue $129.9B

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Example 1 (cont’d)

Jack Welch Perks– $80K/mo apartment in Manhattan

– $127K/mo in living expenses

– $3.5M/yr use 737 Boeing

– Courtside Knicks tickets

– U.S. Open tickets

– Country Club

– Restaurant Bills

– Security

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Business Health

Executive Compensation packages contain Perverse Incentives that Hurt Business– Why? Incentives to boost stock price and

earnings reports hurt firms in the long run

– How? Downsizing, Demoralization, Reduced LT investment and inflated accounting

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Business Health

Downsizing: cuts in manpower increase short term profits, but ultimately hurt output

Demotivation: Fear of downsizing leads to lower productivity while employees not cut are overloaded with work

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Business Health

Reduced Long Term Investment: Cuts in long term investments like Research and development & training reduce expenses but prevent growth

Fraudulent Accounting: Accounting rules and reports are “bent” aggressively by executives to inflate earnings, but can destroy the firm’s credibility or worse

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It's Clean Up Time

Self governance New York Stock Exchange Sarbanes-Oxley Act

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Awareness

“Enron – itis” has increased public awareness of CEO compensation packages.

How can public awareness have a hand in diminishing these “golden parachutes”?– Be informed about CEO contracts.

• Visit, www.thecorporatelibrary.com/ceos

– Use your knowledge to support organizations and politicians that want to fight the same battle

Where is the discussion headed?

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Will closer scrutiny of corporations be effective?

Media coverage places pressure on large corporations to respond to the scrutiny

Statistics made available give the public a point of comparison in terms of their own financial security

The recently unemployed (nearly 4200 from Enron and 17,000 from Worldcom) will demand justice

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What reform options look promising?

Grant stock with restrictions on its future sale instead of granting options

Emphasize long-term rewards for long-term success

Penalize executives who fail to reach success, as opposed to heavily compensating them

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What reform options look promising?

Monitor the role of business funds in political campaigning

Reform pension laws to stop over exposure to one stock

Prevent a company from investing its pension funds in its own stock

Create higher standards of transparency and disclosure in the audit profession

See for yourself– http://news.bbc.co.uk/1/hi/business/1854642.stm– www.corpwatch.org

QUESTIONS?

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Questions for Discussion

Does Level 5 Leadership Make Sense? Does it fly in the face of what we often think makes the best CEO?

If you were to run an “American” business, how would Collins’ principles apply? What would be American about it?

How does the Collins model compare to the CEO-star model implied by the “hurry-up and communicate” presentation? Who’s right?

What is more American? What is not? If the face of 9/11, who is a great leader?