Opinion: Rethinking ‘Shareholders First'

digital
Credit: Adrian825/iStock

The recent passing of former GE CEO Jack Welch may represent more than the loss of the icon named Manager of the Century by Fortune magazine in 1999. It may also symbolize the passing of an era in capitalism—“shareholders first”—that Welch did so much to promulgate. What does this have to do with today’s aerospace industry? Plenty, as it turns out.

Before the “shareholders first” mantra took hold in the 1990s, publicly traded companies considered four stakeholders in allocating capital: customers, local communities, employees and suppliers, and shareholders.

Before Welch took over in 1981, GE publicly stated it valued workers and research labs before shareholders. After 20 years of relentless focus on productivity, cost-cutting and shedding more than 100,000 jobs, GE’s market capitalization skyrocketed from $12 billion to an astounding $410 billion. Much of this profit growth was driven by financial services rather than traditional manufacturing.

Encouraged by the late economist Milton Friedman and success stories such as GE, aerospace executives began to adopt “shareholders first” in the 1990s. McDonnell Douglas famously embraced this philosophy and focused on quarterly earnings while refusing to invest in new civil aircraft. Its CEO, Harry Stonecipher, eventually took the leadership helm at Boeing. Responding to the perception that he was only interested in making money, he responded, “You’re right, I am.” 

 

Employees were the first casualty, with unions weakened and raises curtailed. For example, until recently, Honeywell International imposed mandatory unpaid leave on its employees—while it was making 20% margins. As employees lost pace, so did local communities. In the early 2000s, the number of employees in low-wage countries became a key performance indicator. New aerospace clusters in places such as China, Eastern Europe and Mexico followed suit. The blind push to leverage labor-arbitrage has ebbed in recent years, but the compact of secure employment was violated, and employee morale suffered.

A decade later, suppliers became the target of OEM supply chain cost-reduction initiatives with double-digit price reduction demands, longer payment terms, aftermarket royalty payments and other concessions. Market capitalization shifted from suppliers to the OEMs, while the lower tiers of the supply chain were bled of working capital. Today, many subtier suppliers are fragile, and their ability to invest in the future—let alone ride out a crisis like the 737 MAX production shutdown—is diminished compared to a decade ago.

What about customers? On the one hand, brutal competition between Airbus and Boeing held jetliner prices relatively flat over the past 15 years. On the other hand, customer satisfaction in the aftermarket and customer support is suffering. In last year’s AeroDynamic Advisory/Aviation Week Network customer satisfaction survey, just one out of 41 OEMs received a positive net promoter score from airlines.

The manifestation of the “shareholders first” philosophy is very negative for a long-cycle industry like aerospace, which faces enormous challenges—including sustainable development—that will require large sums of R&D. Boeing, for example, spent an average of $12.8 billion in share buybacks and dividends in 2018 and 2019, while averaging just $2.2 billion in R&D. This is not just a Boeing problem; it is a corporate America problem. In 2018, share buybacks and dividends for the S&P 500 were an astounding 109% of net income, according to The Wall Street Journal. This disparity points to another issue: Companies are taking on debt to fund shareholder generosity. This is not sustainable in the long run and leaves no capital to invest in customers, suppliers, employees or local communities. 

Contrast this behavior with OEM customer Delta Air Lines, which earned $6.5 billion in 2019. It shared $1.6 billion (16.7%) of that with employees—a record amount for a U.S. company. This translates into improved employee morale and in turn improved customer satisfaction, higher yields and growing market share.

Don’t get me wrong. I am a pro-business, free-trade capitalist who depends on increasing stock prices to fund his retirement. Making money and rewarding shareholders is a good thing. However, our long-cycle, innovation-driven industry is clearly out of balance. 

“Shareholders first” needs to be replaced by a more balanced version of capitalism if the aerospace industry is to thrive in the long run. The change must originate not only from aerospace leaders, including the new CEOs of Airbus and Boeing, but also from the boards that evaluate them and set priorities.

Kevin Michaels

Contributing columnist Kevin Michaels is managing director of AeroDynamic Advisory in Ann Arbor, Michigan.

Comments

5 Comments
It's not just a killer of big business, it's bad for any business unless you're in private equity and are looking to cash out in a short cycle. It's why the existing privately held, family owned companies, (Johnson's Wax, Henkel, Heaven Hill Brands, etc.) look at long-term sustainability and that means "Not making short term decisions to jack up stock price". Even publicly traded companies like Berkshire Hathaway look at long term ownership as much as short-term gain. Warren Buffet's decision to own and manage BNSF for the next 100 years. It used to be that shareholders gained their value from dividends, which reflected solid performance. When stock price, not dividend became the driver, we have the Boeing situation as a result. GM and GE both are shadows of their former self as they tried to cut themselves to higher stock prices. German companies (or at least what my experience of living there 20 years ago showed me) have to prime directives: Shareholder Value AND employment for the German Society. As a result, during the Great Recession, instead of laying off workers as the first knee-jerk reaction, they put people on shortened work weeks and trained them on new technologies. When the economy picked back up, they didn't miss a beat. We did.
A closer evaluation would yield the real management process as "CEO first", today's shareholders second. A good stock analyst will predict "sell by" dates, using expected future market share loss, with corresponding profitability loss to evolving competitors that have taken the long view.

Boeing's product problems are throughout most of the business, starting with the fiascos at Commercial Air, as well as Military Air, Commercial Space, and Space Launch.

For all of the Jack Welch aficionados, his financial services focus almost killed the company in 2008-2010. jack's approach worked well for him, but note the damage two of his three disciples did to Boeing and to Home Depot and Chrysler.

Maybe there will be a CEO at Boeing someday that will realize that it's the customers and products that determine long term success.
This column is squarely on point. Boeing's experience shows that "shareholders first" is not in the best interest of shareholders, customers, or the industry. Southwest is (or used to be) Exhibit A for the proposition that putting employees and customers first is good business.
Who do you think you are kidding. This has always been a business. Not only do the fiduciary officers know who puts the money in their pay check but they are not allowed to be human beings. The "Uniform Commercial Code" requires them to act "Solely and Exclusively in the Best Interest of the Stockholders". The united states chamber of commerce wrote that law and saw to that it was embedded in to law, and the devil take the hind most.
Who do you think you are kidding. This has always been a business. Not only do the fiduciary officers know who puts the money in their pay check but they are not allowed to be human beings. The "Uniform Commercial Code" requires them to act "Solely and Exclusively in the Best Interest of the Stockholders". The united states chamber of commerce wrote that law and saw to that it was embedded in to law, and the devil take the hind most.