From Satyajit Das’s “The Age of Stagnation” aka “A Banquet of Consequences”[1]:
General Motors (GM), once a symbol of America’s industrial might, is now a token of the problems of entitlement programs. Shaped by chairman Alfred P. Sloan, who ironically was indifferent to cars, GM once produced more vehicles than all its competitors combined. In 1955, the company made unprecedented profits of US$1 billion. In the apocryphal words of the chief executive, Charlie “Eugene” Wilson, what was good for America was good for GM, and probably vice versa.
Between the late 1940s and the 1960s, GM and the United Automobile Workers, led by Walter Reuther, negotiated increased employee benefits. These included guaranteed wage increases ties to increases in the cost of living and to improved productivity, more paid vacations, pension benefits (adjusted for government-sponsored Social Security entitlements), disability benefits, and medical benefits for both workers and retirees. GM provided job security, guaranteeing payments to supplement unemployment benefits for workers made idle by plant shutdowns, In 1973, the United Automobile Workers negotiated the infamous thirty-and-out arrangements, enabling any employees with thirty years’ service to retire with full pension and healthcare benefits.
The steel, railroad, and airline industries negotiated similar arrangements for their workforces. By the late 1960s, around 45-50 percent of US workers were entitled to company pensions.
With demand buoyant, GM wanted to avoid labour unrest and lengthy disruptive strikes that would reduce profits. The firm reasoned that higher costs could easily be passed on to buyers. In the 1970s and 1980s , a weaker GM continued to increase benefits, preferring deferred payments to immediate cost increases so as to remain competitive, and obtaining agreement to changed work practices. Critics expressed concern about these future obligations, questioning whether companies could finance the payments. A young management consultant, Peter Drucker, doubted that a company could forecast its ability to meet such obligations decade into the future.[2]
Fast forward to 2017, to another bastion of America’s industrial might, General Electric (GE), whose CEO, Jeffrey Immelt, is set to depart on August 1. Immelt leaves the company with a massive pension obligation — an estimated $31-billion shortfall between pension assets and future liabilities — which will be the proverbial ball and chain around the neck of Immelt’s successor, John Flannery. But we don’t have to feel sorry for Flannery, executives have the ability to exercise real options in their favour to the detriment of the stakeholders who put in years of service at companies, only to see their pension assets mismanaged by the fiduciaries entrusted to oversee them, and by the short term myopia of maximizing shareholder value.
Think of this, GE undertook a $50 billion share buyback plan during the latter stages of Immelt’s tenure. According to Factset General Electric bought back $21 billion in stock over the trailing twelve months ending fiscal Q3 2016, which helped reduce its shares outstanding by a massive 12.5% over that period. Rather than the lavish expenditures on share buybacks, General Electric could have spent a portion of those funds on reducing its pension shortfall and embark on de-risking the strategic allocation of its defined benefit pension plan portfolio. But instead, the binary decision tree outcome was squarely skewed in favour of short term gains so that executives, compensated heavily by their vested equity holdings, would benefit. Who cares a wit for the 231,000 retirees and families and approximately 242,000 current and former workers?[3] This behavior is in keeping with the narrative that all economic gains are going to those at the top of the corporate food chain (see economist Gabriel Zucman‘s chart below). The state of ethics is such that those at the top who are compensated by equity will vote in favour of their enrichment, and they can kick the can of future obligations down the road so that it becomes someone else’s problem.
Do I have an axe to grind against GE? No at all. For full disclosure I am a shareholder and my holdings of the company’s stock are modest and account for a small percentage of my RRSP. I am long the stock because of the long term view that it will be a major player in the Industrial IoT. As Nick Srnicek states in his book, “Technology after Capitalism” also know as “Platform Capitalism“:
The competition here is ultimately over the ability to build the monopolistic platform for manufacturing: ‘It’s winner takes all,’ says GE’s chief digital officer. Predix and Mindsphere both already offer infrastructural services (cloud-based computing), development tools, and applications for managing the industrial internet (i.e. and app store for factories). Rather than companies developing their own software to manage the internal internet, these platforms license out the tools needed. Expertise is necessary, for instance, in order to cope with the massive amounts of data that will be produced and to develop new analytical tools for things like time series data and geographical data. GE’s liquid natural gas business alone is already collecting as many data as Facebook and requires a series of specialised tools to manage the influx of data.
But will GE learn from GM’s mistakes? GM was forced to file for Chapter 11 reorganization in 2009, this was the biggest industrial bankruptcy in history and forced concessions from the UAW with respect to retiree healthcare entitlements and compensation. Closer to home, and on a significantly smaller scale, the Sears Canada debacle illustrates how the pension problem won’t go away. Sears Canada’s $266.8-million deficit in its defined benefit pension plan had meant special monthly payment of $3.7 million in order to raise its funded ratio. Those special payments will be suspended, and the lawyer representing Sears Canada retirees had an expected response:
“The process that Sears Canada is following offers no protection for the retirees’ pension losses, and Sears Canada now also seeks to cut off retiree health and life insurance benefits,” said Andrew J. Hatnay, Partner at Koskie Minsky LLP. “This is a totally unacceptable situation for Sears retirees who earned their pensions and benefits during their employment service for the company.” [4]
The issues touched upon here concern the private sector, but the situation in the public sector is worse, particularly in the US system where the under funding for municipalities and states amounts to $1.3 trillion. It is high time for companies to reflect and reassess their positions surrounding future entitlement to their current and retired employees. Low discount rates for unfunded liabilities won’t go away — the cycle of central bank tightening which is all the rage amongst the financial press will make way for looser monetary policy once the business cycle turns to lower growth and eventually a recession. Moreover, the return assumptions of pension planse —Calpers cut its expected return on assets to 7%— remain too high.
We need to adjust our collective thinking on retirement age and what retirement actually entails. Japan of today is our future in the West tomorrow. There will be people working longer, and people working in their golden years. Defined Benefit plans are going the way of the dodo in the private sector but stories of entitlement debacles won’t disappear as quickly. This is a problem with no easy solution; there is no silver bullet.
[1] The phrase “Sooner or later everyone sits down to a banquet of consequences” is attributed to Robert Louis Stevenson. Das’s book “A Banquet of Consequences” was renamed “The Age of Stagnation” for the North American market.
[2] Peter Drucker, “The Mirage of Pensions,” Harper’s Monthly, February 1950.
[3] Michael Hiltzik, GE spent lavishly on shareholders, shortchanged pensions and still landed in a deep hole , LA Times, June 16, 2017.
[4]‘ Totally unacceptable’: Sears Canada looks to suspend employee retirement benefits in restructure
Arijit Banik 