GM

Yesterday GM announced that it was filing for bankruptcy protection. For the past 50 years, GM has watched (as in seeing and not reacting to) its market share decline from over 50% to less than 25%. A significant cause of this decline was GM's lack of creativity and innovation in the market for smaller, more efficient cars, effectively ceding that market to foreign carmakers. GM instead focused on producing larger vehicles, in recent years almost exclusively on light (categorical, not descriptive) trucks and SUVs. GM made a lot of money on these larger vehicles and seemed to be content focusing on those categories. This might have been a defendable business strategy were it not for its reliance on cheap oil. However, anyone who understands that the petroleum supply is finite and that global demand for energy is accelerating has known for years that the price of oil would eventually skyrocket unless we transitioned to renewable energy sources. I'm certain this fact didn't escape Smith or Wagoner, yet they apparently did little to prepare for it. Why not? Some may say that they were short-sighted, dense, lazy, or even evil. On its face, this lack of preparation for the inevitable seems to be irrational.

The key to understanding why high gas prices and the current financial crisis caught GM with it proverbial pants down lies in understanding that the long-term success of a company and the incentives of its leader(s) are often not properly aligned. This is true of every public company for which the chief executive owns a diminutive percentage of the company and derives most of his/her compensation in performance-based cash or stock option bonuses.* In this case, the executive often chooses to focus on maximizing profits for the current year or even quarter, for many reasons, including:

1. The executive makes a lot of money if the company beats certain quarterly profit targets.
2. Increasing profit for the current period is often easier to do than focusing on longer-term initiatives.
3. Even though maximizing current period profits is often done at the expensive of subsequent periods, the executive is willing to push that problem forward hoping to make it up later.
4. Turnover at top executive positions is very high at many large, public companies. Therefore there is less incentive to focus on long-term strategy since the executive would likely be solving someone else's problems.

Given these dynamics, it does not seem surprising that the navigation performed at the top level in these companies seems to result in a path that is unintelligible when viewed across longer time horizons.

This all being said, I don't necessarily have an easy solution. Top jobs in these companies are hard and stressful, and tend to burn out even the hardest-nosed executives. It would be difficult to provide a performance-based pay structure that rewards long-term performance of the company if the executive weren't going to be around long enough to see if the strategies pay off, and at the very least you would need to still provide short-term performance based bonuses too. Short-term performance is still important as long as you are not stealing $10 from tomorrow to make $1 today. And if you provide significant short-term performance incentives you run the risk that the executive decides to maximize those and forego the longer-term ones.

Thoughts? How do we fix this?

*In fact, in certain circumstances with companies in crisis, the most lucrative outcome for a CEO would be termination, in which case the economic interests of the company and its CEO have not only diverged, but are in direct competition.