Thursday, October 27, 2011

Income Inequality in America - The 1 percent control 17 percent

The Congressional Budget Office (CBO) has released its study that examined the distribution of real household incomes of Americans and how that distribution changed or dispersed over the period from 1979 to 2007.  The study, entitled "Trends in the Distribution of Household Income Between 1979 and 2007" was undertaken at the request of the Chairman of the Senate Committee on Finance and looks at the distribution of household incomes before and after government taxes and breaks income down into its components including wages, capital income and business income (i.e. farms, partnerships etcetera).  Since the authors of the study used Census Bureau data, they could not go back past 1979 since income measures prior to that time were less consistent.  Let's get right into the study.

The CBO found that, over the past 30 years, both mean and median real (corrected for inflation) after-tax household incomes have risen as shown on this graph:

That should surprise no one.  Real mean income rose by 62 percent between 1979 and 2007 and median income (half of all households have more or less household income than the median) rose by 35 percent.  Since mean (or average) income can be influenced greatly by very high income households, the growing gap between median and mean suggests that households with incomes well above the median were growing more rapidly.  The uneven growth in after-tax income can also be explained by a rapid rise in income for the highest income households, very modest income growth for the middle 60 percent of the population and a very small increase in income for the bottom 20 percent of Americans. 

Here is a graph showing the cumulative growth in average after-tax income for the entire population divided into percentiles:

Note that the shaded areas represent economic recessions.  This graph shows that the distribution of household income in the United States became increasingly dispersed, that is, the share of income going to higher income households increased whereas the share of income to lower income households decreased.  This dispersion has risen pretty much continuously since 1979 with the exception of periods of recession.  Let's break the income groups down:

1.) Top 1 percent: After-tax real household income for the top 1 percent of Americans rose by 275 percent over the three decades.  Note that the incomes for the top 1 percent are quite volatile when compared to times of recession; during the recession in 2001, incomes dropped markedly but regained all of their losses and rose by more than 85 percent between 2002 and 2007. 

2.) Middle 60 percent (or 21st to 80th percentile): After-tax real household income grew by 37 percent between 1979 and 2007 with a very slow and steady rise over the entire period.

3.) Lowest 20 percent (1st to 20th percentiles or lowest quintile): After-tax real household income grew by only 18 percent over the three decade period with a large drop following the 1980 and 1981 to 1982 recessions where income dropped and did not recover until 1995.

Note as well that even the top quintile (81st to 99th percentile) of earners did not see a large increase in household income during the three decade period noting an increase of roughly 60 percent, well below what was experienced by the top 1 percent.

All of this adds up to a shift in the share of income received by each of the population groups.  The total share of after-tax income received by the 1 percent doubled over the three decade period, rising from 8 percent of the total to 17 percent of the total.  The share received by the highest quintile (excluding the 1 percent) rose only slightly from 35 to 36 percent.  The share received by the 60 percent "middle Americans" fell by 7 percentage points from 50 percent to 42 percent.  The share of after-tax income received by the lowest quintile fell from 7 percent to 5 percent over the three decade period.  Looking back, in 1979, the top 1 percent received roughly the same share of income as the lowest quintile; by 2007, the top 1 percent received that same share of income as the lowest two income quintiles combined (the lowest 40 percent of the population).  Here is a graph showing the changing share of the nation's income over the three decade period for each of the income groups discussed above:

As I discussed in a previous posting, the Gini index can be used to measure this phenomenon.  The Gini index is based on the relationship between the share of income and the share of population and has a range of values between 0 and 1.  Where the Gini index is 1, one household would receive all of the country's income.  Where the Gini index is 0, all of the households in a country would have equal incomes.  Where the Gini index increases over time, it is showing that household incomes are becoming increasingly unequal.  In the case of the United States, the Gini index was 0.479 in 1979; this rose to 0.590 in 2007 with the greatest increases in inequality between the years 2002 and 2005.  This means that 55 percent of America's income would have to be redistributed for perfect income equality.  The authors of the paper feel that this change is, in large part, related to the volatile nature of income from capital gains.  That said, income from capital gains tends to be greatest in high income households (think CEOs and their stock options).  Here is a graph showing that the highest income households (the smallest portion of the population) have the most fun collecting capital gains from the stock market:

Please note that the line of equality shows what the distribution of capital gains would be among the population if all income groups had equal incomes.  In the years between 2002 and 2007, more than 80 percent of the increase in the Gini index was derived from increases in income sourced from capital gains.

Why did income inequality grow over the past three decades?  The authors of the paper note that the technological changes of the past 30 years have necessitated the hiring of an increasingly skilled labour force which demanded higher wages.  Hourly wages for higher income workers rose at a faster rate than those for lower income, less skilled labourers.  While that is an interesting observation, the greatest portion of the most highly skilled workers reside in the top quintile, not the top 1 percent.  That tends to be the habitat of those who dwell in the corner offices on the top floor of Corporate America's headquarters.  As shown in this graph from our friends at the Institute for Policy Studies, the compensation packages for America's CEOs have risen at a rate that far exceeds the rate of income growth for their workers:

Keep in mind that in the 1970s, very few CEOs made 30 times more than their average worker.  That phenomenon definitely explains at least some of the increase in inequality.  The same could be said for many of America's non-CEO executives who have also been increasingly well compensated for their efforts.  One need look no further than the proxy statements for many American corporations to see just how out of line named executive officer compensation has become.  For example, think of the compensation paid to bank executive teams just prior to the Great Recession; multi-million bonuses and extremely rich stock options were far from a rare commodity on Wall Street.  In fact, executives, managers, supervisors and financial professionals accounted for 60 percent of the increase in income accruing to the top 1 percent between 1979 and 2005!

I think that's enough for this posting.  It is no wonder that there is growing anger across America.  What we suspected all along is, in fact, true.  Those of us who break a sweat while we work are, in large part, working to enrich the elite of America.  Unfortunately, it is the elite that have Washington's ear and they seem to be listening.

Tuesday, October 25, 2011

America's Best Paid Chief Executive Officer

With all of the recent attention that the so-called "one percent" are receiving in the mainstream media, I thought that I would take a more in depth look at the most "one percent" of them all, at least according to Forbes and their 2011 list of America's highest paid CEOs.  When looking through the list, it truly is amazing how well paid some of our corporate leaders are, including the gentleman at the top of Forbes list, one John Hammergren, CEO of McKesson Pharmaceuticals.

You might be asking yourself John Who of What?  I asked myself the very same question.  Here I was expecting a Bill Gates type or the CEO of a major, multi-national oil company but I was dead wrong.  McKesson, a health care company headquartered in San Francisco, employs more than 32,000 people across America and around the globe.  They are America's oldest and largest health care services company with their corporate roots going back more than 175 years and they currently ring in at number 15 on the Fortune 500 list.  They are the largest pharmaceutical distributor in North America and, on a daily basis, they distribute one-third of the medicines used in the United States.  As America's leading health care IT company, they are responsible for the development and installation of electronic health care systems that eliminate the need for paper records and provide software that helps physicians in diagnosis and treatment of patients.  The company's system is installed in more than 70 percent of the nation's hospitals with more than 200 beds.

Let's start by taking a look at how well their stock has done over the past 5 years:

McKesson's stock performance has not been too shabby; 5 years ago they were trading at about $50 per share.  The stock is currently trading in a range between $70 and $75 and hit a 52 week high of $87.32 and a 52 week low of $60.39.  It is trading at a P/E multiple of 15.8 and paying a dividend of 80 cents per share (about a 1 percent yield).  It took a hit back in the fall of 2008 and spring of 2009, dropping to just over $30 per share but, then again, whose stock didn't take a massive haircut during that period?

Over the past five years, the company's annual revenues increased from $93 billion to $112 billion (compound annual growth rate of 4.8 percent) and earnings per share increased from $2.89 to $4.86 (compound annual growth rate of 13.9 percent).  Over the same time period, quarterly dividends have increased from 6 cents per share to 20 cents per share.  The company is currently sitting on $3.6 billion in cash and cash equivalents.

John Hammergren, age 52, has been at the helm of McKesson since 2001 where he currently holds the positions of Chairman, President and Chief Executive Officer.  He gained extensive experience in the health care field after graduating with a BA in Business Administration from the University of Minnesota and and MBA from Xavier University.

Back to the subject of this post.  As source material for Mr. Hammergren's compensation package, I'm using McKesson's Proxy Statement for July 2011 Annual Meeting.  Let's start by looking at Mr. Hammergren's share ownership:

The 1.6 million shares include those that may be acquired by exercising of stock options or vesting of RSUs within 60 days of May 31, 2011 (1,006,000 shares) and those controlled by family members living in the same household, family trusts or an independent trust (590,257 shares).  At the recent trading price of $73 per share, Mr. Hammergren's shares are worth  a cool $116,820,440.  According to McKesson's Stock Ownership Policy, Mr. Hammergren must own a minimum of 10 times his base salary ($16,800,000) worth of stock as a gesture toward shareholders showing that he's "in it like the rest of us". Not to worry folks, his actual stock ownership multiple is in the 77 times range.

Now, let's look at Mr. Hammergren's overall compensation package for the last three years:

Note his rather small salary of $1,664,615?  While that seems like what most of us would make in the better part of a lifetime, it is a rather insignificant part of his overall compensation package coming in at around 3.6 percent of the total.  Why, you ask?  Because forms of income other than salary receive preferential tax treatment.  Interestingly enough, according to the McKesson Proxy Report "... Section 162(m) of the Internal Revenue Code generally provides that publicly held corporations may not deduct in any taxable year specified compensation in excess of $1,000,000 paid to the CEO and the next three most highly compensated executive officers, excluding the chief financial officer. However, performance-based compensation in excess of $1,000,000 is deductible if specified criteria are met, including stockholder approval of the materials terms of applicable plans.".  It certainly looks like stockholders approved!

It's always interesting to look at the exact items that are included in the "All Other Compensation" column.  In Mr. Hammergren's case, in fiscal 2011, the company paid $16,935 for financial counseling services including tax preparation, $231,743 for installation of home security, personal use of corporate aircraft and the incremental cost of personal use of a company car and driver.  Mr. Hammergren must be quite concerned about his personal security; he was reimbursed for spending $122,177 for the installation and monitoring of home security devices (noting that this amount is not that much below what an average American home costs!).  As well, he accrued $100,560 worth of personal use of the company aircraft and $9,006 worth of company car and driver.  Let's not forget his expenditure of $7,562 to attend the annual Board retreat and two annual employee award programs with his spouse.

For fiscal 2011, depending on corporate performance, Mr. Hammergren stands to make between $1,260,000 and $6,000,000 on his Management Incentive Plan (MIP) should the company exceed a predetermined earnings per share threshold.  In addition, should the company's profitability exceed a predetermined threshold over the next three years, he stands to make up to an additional $8,100,000 on his Long Term Incentive Plan (LTIP).  In addition, he received 402,000 options with an exercise price of $67.81 and up to 285,700 Performance Restricted Stock Units worth a total of $19.5 million should everything work out as shown here:

So far, Mr. Hammergren's compensation package is certainly not out of the norm for those that have reached the lofty levels of the 0.1 percenters.  But (and it's a big but), we haven't yet looked at the options that he exercised in the fiscal year ending March 31, 2011.  Here is a screen capture showing the gross take from exercising both his stock options and his stock awards:

Yup, that's right.  He made $112,121,910 by exercising 3,353,666 options and another, rather paltry sum of $6,552,247 for vesting another 94,050 stock awards or RSUs (Restricted Stock Units).  That's a total of $118,647,157 just on his stock holdings alone!  And, despite that, this is how many unvested stock options he still has remaining just in case you were concerned that he was out of vested options:

The remainder of Mr. Hammergren's unvested options are worth an additional $62 million and change!  See, I told you that there was no reason for concern.

We know that the future of Social Security payments is not exactly looking secure in this time of $14.8 trillion debts and $1.2 trillion deficits with no end in sight.  I want to assure you that you should not lose one minute's sleep worrying about Mr. Hammergren's pension.  Here's the pension that 15 years of service have built up:

For your illumination, that's nearly 6 times the pension benefit amount that his nearest fellow named executive officer, Paul Julian, Executive Vice President and Group President, has accrued over 14 years of service.  In 2011 alone, the actuarial value of Mr. Hammergren's pension increased by $13,458,402!  McKesson's executive pensions can be collected at age 62 or when years of service total 15 and their age reaches 55.  Only three years to go, Mr. Hammergren, and then it's all day golfing, skiing and sailing!

Suffice it to say that Mr. Hammergren's total compensation for 2011 certainly is eye-opening.  His total compensation for fiscal 2011 is in the $150 million range.  Using that number and the United States Census Bureau's median household income number for 2009 of $50,221, Mr. Hammergren makes as much as 2980 "average" American families.  While I'm certain that Mr. Hammergren runs McKesson very professionally and has led it through years of growth, one has to question whether his services really have the monetary value of the services that are rendered by nearly three thousand American families.  I'll leave that up to you, however, from my perspective, it is no wonder that there is anger in the streets of America.

Monday, October 24, 2011

The Federal Reserve: A Bunch of Old, White, Male Bankers

The United States Government Accountability Office recently released a report entitled "Federal Reserve Bank Governance - Opportunities Exist to Broaden Director Recruitment Efforts and Increase Transparency".  This report was undertaken to study the composition of those who govern the 12 Federal Reserve Banks, in particular how the Bank's boards of directors involve themselves in activities that are related to supervision and regulation.  The study looked at the composition of the boards and whether they are diverse in both gender and race and whether the Bank's policies identify possible issues of conflict of interest between board members and industry.  The study looked at the composition of FRB boards for the years from 2006 to 2010, during the lead up to the Great Recession, during the Recession itself and during its aftermath.  For the purposes of this posting, I will be examining the gender and racial/ethnic composition of the various boards and will leave the GAO's examination of potential conflicts of interest for another posting for the sake of relative brevity.

Let's open with a map of the Federal Reserve Districts:

As background information, the Federal Reserve Act requires each of the 12 regional Federal Reserve Banks be governed by a nine member board with three Class A directors elected by the member commercial banks within the region to represent their interests, three Class B directors elected by member banks to represent the public and three Class C directors that are appointed by the Federal Reserve Board to represent the public.  See how nice the Federal Reserve is?  A full two-thirds of their Federal Reserve Banks' boards consist of members that, at first glance, appear to represent the sweaty masses!

Federal Reserve Bank directors have three main functions; they participate in the formation of national monetary and credit policies by providing input on their local economic conditions to the Reserve Bank President, they oversee the management of the Reserve Bank and the act as a link between the Federal Reserve Bank and the community.  It is so heartwarming to see that they are such a community-minded group!

Let's take a brief look at a few examples of just who it is that sits on the Federal Reserve Bank boards representing the public followed by their class of directorship where available:

Boston: John Fish, CEO, Suffolk Construction Company Inc (Class B)
Boston: Henri Termeer, Chairman, President and CEO Genzyme (Class C)

St. Louis: William E. Chappel, President and CEO, The First National Bank
St. Louis: Robert G. Jones, President and CEO, Old National Bancorp

Dallas: Herb Kelleher, Executive Chairman Emeritus, Southwest Airlines (Class C)
Dallas: Joe Kim King, CEO, Brady National Bank (Class A)

San Francisco: Blake W. Nordstrom, President, Nordstrom Inc. (Class B)
San Francisco:  Betsy Lawer, Vice Chair, First National Bank Alaska (Class A)

In looking through the lists for the members of the boards, there certainly do not appear to be too many of America's 99 percent represented, rather, it is a rather interesting collection of the who's who of America's corporate and banking elite.  This, despite the fact that according to the Federal Reserve Act, Class B and C directors are supposed to be elected with due consideration for balance between the interests of agriculture, commerce, industry, labour, services and consumers.  Here's a table showing the requirements for the selection of Federal Reserve Bank directors:

Before we discuss the detailed composition of the Federal Reserve Bank boards, let's look at racial and ethnic diversity in the United States. Between the years 2000 and 2010, the Asian population in the United States grew by the greatest amount of all racial groups and now accounts for about 5 percent of the total (14.7 million people).  The white population grew the slowest over the decade and accounts for 72 percent of the total (223.6 million people).  The African-American population accounts for 13 percent of the total (38.9 million people).  Over the decade, the Hispanic population grew by 43 percent to reach 16 percent of the total (50.5 million people).  With these statistics in mind, let's now take a look at the actual composition of Federal Reserve Bank boards.

In the period between 2006 and 2010, minorities and women accounted for a rather small portion of the overall Federal Reserve Bank membership.  In 2006, minorities comprised only 13 of 108 directorships (12 percent) and that had not improved by much in 2010 when minorities comprised only 15 of the 108 directorships (14 percent).  Here is a graphic showing the race and ethnic composition of the Federal Reserve Bank directorships from 2006 to 2010:

Over the 5 year period, women didn't fare all that well either with 39 female directors out of a total of 202 (19.3 percent), well below their proportion in the overall population.  In 2010, Federal Reserve Bank directors consisted of 78 white men, 15 white women, 12 minority men and 3 minority women.  Here is a figure showing the representation women and men on the Federal Reserve Bank boards over the period from 2006 to 2010:

When looking at the annual bar graphs, note that the gender situation is actually getting worse as the five year period passes with fewer women receiving one of the much coveted directorships for reasons that I will outline later.

Here is a graphic showing a more detailed look at the gender and race breakdown for each of the 12 Federal Reserve Bank branches:

As mentioned earlier in this posting, Federal Reserve Bank directors are supposed to reflect a broad industrial background.  Unfortunately, that is not the case.  More than half of the 2010 directors have experience in the finance industry.  Here is a graphic showing the over-representation of directors with connections to the finance industry, a ratio that is far in excess of their representation in the American economy as a whole:

As well, almost all of the Federal Reserve Bank directors serve on the boards of other for-profit corporations, universities and non-profit organizations, hardly a phenomenon shared with the general public.  Federal Reserve Bank officials stated that, in practice, they generally focussed their search for directors on senior executives, mainly CEOs and presidents.  In fact, in 2010, 72 of the 108 directors were either the CEO or president of their company with at least 23 being employed by Fortune 500 companies.  When asked whether board diversity would be increased if non-executives were included, the authors of the study were told that "...having senior executives on the board of directors helps elevate the stature of the board.  In addition, they said that the individuals working at the top of their organization may have a broader view of how their industry is being affected by the economy...".  Apparently, the 1 percent really do have us under their thumbs!

Surprisingly, compensation for directors is rather poor compared to the private sector; perhaps the power they wield is compensation enough.  The per diem for directors ranges from $100 to $300 depending on their position and head office directors receive annual retainers ranging from $2000 to $5000 again, depending on their position.  The Fed maintains that they are competing with the private sector for the relatively rare female and minority directors which makes it difficult for them to reduce the imbalance on their boards.  More's the pity for all of us, particularly since the Fed has backed itself into a corner by wishing only to recruit among America's white, male, corporate elite.

Perhaps the American economy is stuck in limbo largely because the policies used by the Federal Reserve stem from the great and imaginative minds of the powers that already control the U.S. financial industry, the same minds that largely were responsible for the issues that led directly to America's near collapse.  Perhaps the Fed's decision-making processes would be different if the diversity of their directors was more closely aligned with diversity in the country that they are supposed to represent.  One thing is quite apparent, whatever the current system, it is not working for reasons that may well be a reflection of the single-mindedness of America's white, male, banking elite.  

Apparently, we are caught in one gigantic case of clusterthink and we can't get out!  To complete the story, in a future posting, I'll take a look just how inbred the commercial banks and Federal Reserve Banks are and the implications for conflicts of interest among Federal Reserve Bank directors.

Wednesday, October 19, 2011

China's Impact on its Neighbours and What Lies Ahead for Asia

The IMF recently released its latest prognostication for Asia's economy and things are not particularly looking great.  The world's economic engine is looking like it might be starting to show evidence of "Euro Influenza" as the impact of Eurozone debt and banking issues spill over into Asia.  Here's a brief summary of what the IMF predicts in its Regional Economic Outlook for Asia and the Pacific.  I'll also post a bit of information from the Outlook showing how big China's impact is on the world's economy and how a slowdown there would impact its neighbours and the rest of the world.

The IMF opens by noting that the world economic recovery is much more sluggish than it appeared to be back in the spring of 2011, particularly because of the eruption of Eurozone financial turbulence.  Economic growth from advanced economies is weak and is unlikely to improve; this will most likely lead to decreasing external demand for goods produced in the Asia-Pacific region.  Despite the drop in external demand, internal demand is expected to remain robust which will lead to both an increase in both credit and inflation in the area.  Internal demand has been resilient largely because of increased employment and gains in real wages, the complete opposite to what is being experienced in Europe and the United States.  In the Asia-Pacific, the conflict between a potential economic slowdown because of dropping exports and an increase in inflation as a result of high domestic demand means that Asian central bankers are walking a very fine line between over-tightening and not tightening enough.  Here is a look at the year-over-year change in inflation rates since January 2011 for selected Asian countries:

On a year-over-year basis, inflation increased from 4.6 percent in January to 5.5 percent throughout the entire region due to both increases in commodity prices and the pressures of increased demand for goods.  Inflation remains above central bank targets in Vietnam, Korea, Hong Kong and China.  Contrary to this, Japan is still mired in deflation with negative core inflation when food and fuel are excluded.  Here's a rather cool graph showing which countries are within their inflation targets by month with the red months showing that inflationary pressures are above target and rising and which are not:

The IMF has changed its growth forecast for the region since its last report in April.  Growth for 2011 is expected to be 6.5 percent (down 0.5 percent from their previous prognostication) and for 2012 is expected to be 6.75 percent (down 0.25 percent).  Growth levels of this magnitude would be positively amazing for the world's advanced economies where many nations are on the cusp of seeing economic contraction.  The drop in economic growth in the Asia-Pacific region is almost exclusively related to a drop in exports to the world's advanced economies where the IMF's economic forecast shows declining growth levels.  Here is a chart showing the IMF's latest Asian growth projections by country:

Taking a closer look at the economic giants of the area we note that China is still expecting growth of 9.0 percent in 2012, Taiwan is expecting 5.0 percent , Korea is expecting 4.4 percent and India is expecting 7.5 percent growth.  On the downside, Japan is expecting growth of only 2.3 percent following a contraction of 0.5 percent this year and Australia is expecting growth of only 3.3 percent following 1.8 percent growth this year.  With this economic dichotomy, if Asia's central banks raise interest rates too much, they risk either pushing their weaker local economies into a slowdown or increasing the value of their local currency which will make their exports even more expensive to consuming nations.  Oh what a tangled web!

Despite the very high growth levels in many Asian nations, their stock markets have not been immune from the "Eurozone Influenza" which struck with a vengeance during the summer.  Here is a look at how three of the Asian markets responded to the multi-country debt debacle:

1.) Nikkei 225 Index:

2.) Shanghai Composite Index:

3.) Hang Seng Index:

Stock markets throughout the Asia-Pacific noted declines that paralleled those seen in advanced nations in August and September.  This demonstrates that there is no safe place to hide from the "Eurozone Influenza" and from the after-effects of the United States debt near-default.  You may try to run, but you definitely cannot hide!

Now, let's change gears and take a closer look the impact that China's economy has on the rest of the world and on its neighbours.

Let's start by looking at China's inflation.  This graph shows you how volatile consumer price inflation has been in China (blue line) over the past five years when compared to the rest of Asia (green line):

Inflation in China spills into the surrounding nations (and from there into the rest of the world) with a one percentage point increase in China's inflation that is related to supply and demand shock leading to a 0.25 percent increase in the rest of the Asia-Pacific. Because China is the dominant importer of many of the world's commodities, in particular metals, the impact of their demand on the world's supply and price reaches far.  Here's a graph showing how much of the world's total imports of certain commodities are imported by China noting that the country is not yet impacting the world's food supply and demand equation:

In 2009, China consumed 65 percent of the world's imports of iron ore and 53 percent of the world's soybeans, nearly doubling since 2000.  China has been the world's largest consumer of iron ore since 1992 and produces 47 percent of the world's steel.  In total, China imports 29 percent of the world's total imports of all metals and 13 percent of the world's imports of all raw materials.

Looking even further into the problem of China's growing demand for commodities, the IMF calculates that a one percentage point increase in China's output may raise commodity price inflation by about 5 percent!  Now that's what I call an economic powerhouse!

China's ASEAN neighbours have been big suppliers of exports to China with commodities including iron ore, petroleum and rubber which have replaced exports of information technology.  This increase in commodity exports is expected to continue for the foreseeable future as China ramps up its construction of social housing projects.  Here is a graph showing how much exports to China from its neighbours have grown over the past three years, in some cases doubling in value:

Should China's economy slow down in a meaningful way, the impact on its commodity-rich neighbours would be widespread, leading to a slowdown in their economies.

With this information in mind, it is interesting to see the issues facing the world's new economic powerhouse.  With China reporting its lowest economic expansion since 2009 for the third quarter of this year, a deceleration in their economic growth pattern seems to be in place.  While growth is still a robust 9.1 percent, it is at its weakest level since the second quarter of 2009 when it hit a low of 8.1 percent.  While growth levels of this magnitude are unheard of among OECD nations, the impact of China's economy on the rest of the world cannot be denied, most particularly on its Asian neighbours.  Should China's economy continue to slow, the "Asian Influenza 2011 Variant" could create further nightmares for central bankers and other policy makers throughout the Eurozone and America who are already struggling to keep their economies above water.  Apparently we really do have most of our eggs in a single basket.  Three cheers for globalization! 

Thursday, October 13, 2011

Jeffrey Immelt and how the one percent lives

Now that it looks like the Obama jobs plan is circling the porcelain bowl and with it, his “tax the rich” plan, I thought perhaps it was time to take a look at the compensation package for an American that is playing a big role in putting America back to work.  This is even more pertinent after his recent appearance on 60 Minutes, particularly in light of his quote "I want you to root for me."

Jeffrey Immelt, age 55, was appointed as CEO of General Electric in September of 2001.  He was appointed by President Obama as a member of his President's Economic Recovery Advisory Board and in January 2011, he was appointed as the Chairman of Obama's Council on Jobs and Competitiveness where he is otherwise known as Obama's “Jobs Czar”.

To put things into perspective, let's look at just how well GE stock has done since Mr. Immelt landed in the corner office:

A share that was trading in the $40 range when he took the reins has had a pretty good haircut with shares down to $16 and change, a drop of roughly 60 percent.  GE hit a record high of nearly $60 back in September 2000 in it’s pre-Immelt days and it's been a pretty steady downhill ride from there.  If I was a shareholder, I'd certainly be none too pleased with GE's performance.

Now let's look at the important stuff.  How much has Mr. Immelt been compensated for this downhill ride?  For my source material, I'm using GE's Notice of 2011 Annual Meeting and Proxy Statement.

Let's start with his salary.  Here's what he made in 2010:

Note the difference between his total compensation of $21,428,765 and his total realized compensation of a mere $5,845,124?  The difference is defined as "...Total compensation, as determined under applicable SEC rules, minus (2) the aggregate grant date fair value of 2010 stock option awards (as reflected in the Option Awards column), minus (3) the year-over-year change in pension value and nonqualified deferred compensation earnings (as reflected in the Change in Pension Value and Nonqualified Deferred Compensation Earnings column), and plus (4) the value realized in 2010 from the vesting of RSUs or PSUs before payment of any applicable withholding taxes and brokerage commissions (as reflected in the 2010 Option Exercises and Stock Vested table on page 38), including the value realized from the payment of any dividend equivalents. In addition, Total Realized Compensation reflects any bonus actually paid in 2010, whereas Total compensation under the SEC rules reflects any bonus earned for 2010."  Got it?

To Mr. Immelt's credit, and despite the fact that the executive team met or exceeded the performance objectives set by the Board of GE for fiscal 2010, his base salary has not increased since April 2005.  That said, in 2010 he did graciously accept the kind offer of a $4,000,000 cash bonus, the first time that he's accepted a bonus since his last one in 2007.  How big was that bonus?  A rather cool $5,800,000, enough to feed a town of Americans for a good long time!  Oh yeah, before I forget, Mr. Immelt also accepted a special grant of 2,000,000 stock options in March 2010.  On the downside (and there is always a downside), in February 2011, the Board saw fit to cancel all of the performance share units (PSUs) that were granted to Mr. Immelt in 2006 because the cash from GE's operations did not grow by an average of 10 percent per year over the 5 year period from 2006 to 2010 and total shareholder return had not met or exceeded that of the S&P 500 over the same period.  Poor fella.  You’ve got to feel for a down-and-outer, don’t you?

Because Mr. Immelt is so positive about GE's future, he went so far as to purchase over 870,000 GE shares on the open market in the past 10 years.  To further show shareholders that he's in it up to his knees just like the rest his us, he has not sold a single share, PSU or vested stock option since he became CEO.  Atta boy Jeffrey!  You're just one of the guys.  Although, on second thought, perhaps its because the stock has been dropping for the past 10 years, could it?

Here's a summary of Mr. Immelt's compensation for the past 3 years:

Despite the lack of a raise, note that Mr. Immelt's total compensation package rose by 116 percent from 2010, a raise that is just a tad more than the average American saw last year.

One item that I found particularly interesting in the Proxy Statement was Mr. Immelt's "Other Compensation".  Here it is:

Notice - no contributions to life insurance but a tiny $8575 to the Employee Savings Plan, the company's contribution of up to 3.5 percent of Mr. Immelt's annual salary to his 401(k).  It's the other rather larger number that I found interesting.  Was it an interest free loan to buy stock or something similar?  Wrong on all counts.  Here's what it was:

Yup, he spent $381,234 using the "company bus" for "personal flight activity".  This includes such items as a portion of ongoing maintenance and repairs, fuel, travel expenses for the flight crew etcetera but does not include the cost of exterior paint, interior refurbishment and inspections.  Having accrued $381,234 in personal use of GE's aircraft, it's no wonder he didn't need to lease a car like 3 other members of his executive team.  Why sully yourself in highway gridlock when you can fly the friendly skies!

Now let's take a look at his Incentive Plan Awards:

Mr. Immelt was granted 2,000,000 shares at an exercise price of $16.11 on March 4th, 2010.  In three years, 50 percent of these options vest followed by the remainder on the fifth anniversary of issuance.  Further, he was granted a Non-Equity Incentive Plan Award between $2,475,000 and $6,600,000 based on whether or not the company meets its performance targets.

Here is a summary of Mr. Immelt's outstanding Equity Awards:

Notice that other than his most recent options, Mr. Immelt is WELL out of the money on the remainder.  From the charts at the beginning of this posting, it looks very unlikely that many of his options will be worth a great deal unless GE does a 180 degree turnabout.

Last, let's take a look at Mr. Immelt's pension plan:

Over his 28 plus year history with GE, Mr. Immelt has accumulated just under $38,000,000 in pension benefits.  In another 5 years, Mr. Immelt can retire with full pension benefits.  I would imagine that he will never really need to actually collect his Social Security benefits but one never knows what expenses one might have in one's post retirement years, does one?

It's most reassuring to see that Mr. Immelt is just another one of "us".  I'd like to close with another quote from 60 Minutes when he was confronted by Ms. Stahl about GE's rather low level of pay for its newly hired employees:

 "We have a range. When we go out and recruit, let's say hire 1,000 people at between $15 and $17 an hour, we get 50,000 applicants. So I think you've gotta start somewhere and ...but we want to hire more people..."

Mr. Immelt, thanks for reassuring us that you really want to hire Americans no matter how much it costs GE.  As you requested, we’re all rooting for you! 

Oh, and by the way, your personal use of the corporate wings would have paid the annual salary for 11 new employees working a 40 hour week at $16 an hour.