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1. I recently sent this letter to General Electric. Perhaps you may find this of interest.

2. If you think you have found an Earnings Power Chart company and want to share with the rest of us, send me a note and I will run the numbers through my model.

3. Seasons greetings to all and best wishes for health and happiness in 2005.

4. Special thanks to Meddler for creating this board several months ago. Shine on!


December 16, 2004

Mr. Ralph S. Larsen
Chair, Management Development and Compensation
General Electric Company
3135 Easton Turnpike
Fairfield, CT 06828

Dear Mr. Larsen:

Does the world's most valuable company need to improve its executive compensation plan?

I ask this question after the Wall Street Journal suggests that General Electric is paying rich sums for its acquisitions ("Heard on the Street," Dec. 2). To wit:

· Nov. 23 - $1.2 billion for Ionics (ex. assumed debt), or 48% more than the water treatment company's pre-announcement market value

· Nov. 15 - $1.4 billion for Edwards Systems Technology, or 40% more than analysts thought the fire-and-security unit was worth

· March 15 - $900 million for InVision Technologies, or 22% more than the bomb detection maker's stock price before the announcement

· October 2003 - 800 pence a share for Amersham, or 45 percent more than the diagnostic imaging firm's pre-announcement stock price

As a part-owner of GE, I hope this activity boosts intrinsic value. But most acquisitions do not benefit stockholders, research shows. A common reason for disappointment is because the buyer overpays for expected revenue gains and cost savings that never materialize.

Time will tell whether these deals make sense. What we know today, however, is that GE's intangibles as a percentage of stockholders' equity is going up.* At year-end 1995, soft assets were 39% of book value; as of Sept. 30, that figure had climbed to 80%. The higher this ratio, the sketchier a firm's corporate net worth. In GE's case, if this trend persists we won't have any tangible book left in a few years!

General Electric Corp.-Intangibles as a percentage of stockholders' equity
12/95 12/96 12/97 12/98 12/99 12/00 12/01 12/02 12/03 9/04
39% 51% 56% 61% 61% 54% 64% 72% 69% 80%
Source: Reuters

I cite your recent acquisitions and growth in intangibles to highlight an aspect of compensation that needs fixing. CEO Jeffrey R. Immelt will receive 125,000 performance share units if "operating cash flow, adjusted to exclude the effect of unusual events, increases an average of 10% or more per year during the five-year period from 2003 through 2007." These PSU's vest at the end of 2007, and each unit is convertible into one GE share. These stock-equivalents are cancelled if operating cash flow falls short of the target growth rate. (Mr. Immelt also receives another 125,000 PSU's if total shareowner return beats the S&P 500 during this period.)

"Linking 50% of Mr. Immelt's 2003 equity award directly to the company's cash generation performance," states the latest proxy, "underscores GE's commitment to strong operating discipline, our triple-A rating and the GE dividend."

Incentives that promote cash flow growth make sense, of course. Still, you can improve upon the September 2003 Executive Compensation Action instituted by your predecessor. Specifically,

1. What is an 'unusual' event? Another 9/11? A series of natural disasters? How about a recession?

Proposal: Delete 'unusual' so that Mr. Immelt is in the same boat, figuratively speaking, as GE's 670,000 other stockholders.

2. This plan is all-or-nothing. If operating cash flow goes up an average of 10.0% a year, then Mr. Immelt gets his bonus. But what if cash from operations rises, say, 9.99% a year? Then what? Alternately, suppose operating cash flow climbs faster than the target rate? Shouldn't Mr. Immelt get more than his scheduled allotment? (This criticism also applies to the 'shareowner return' portion of the bonus plan.)

Proposal: Use a graduated scale to link performance with PSU's. This discourages "swing for the fence" behavior if Mr. Immelt knows the company is behind schedule, or from playing lots of golf if actual results are ahead of schedule.

3. Finally, the benchmark. Operating cash flow ignores the opportunity cost of stockholders' equity (a real, albeit noncash, expense). Also, operating cash flow can be increased by cutting spending on R&D, advertising, and employee education (but at a long-term cost). In addition, this metric omits capital spending (fixed assets wear out, however). The most vexing limitation, however, is the omission of payments for acquisitions. Under the current plan, Mr. Immelt benefits from the added cash flow that acquisitions contribute, but the investment to generate that incremental growth is ignored.

To illustrate, suppose you offered $2.2 billion for Ionics, rather than $1.2 billion. This additional use of cash does not appear in operating cash flow; instead, it is reported in the investing section of your cash flow statement. Stockholders pay a price, however, as the extra billion dollars could have reduced your loan balance, increased the dividend, or repurchased more stock.

Proposal: Use a 50-50 mix of free cash flow and net return on capital. The advantage of free cash flow is that it expenses cash outlays for capital spending and acquisitions. Meanwhile, net return on capital accounts for acquisition premiums, recognizes that stockholders' equity is a costly resource, and matches sales with R&D and other market-building initiatives.

Last year GE began expensing stock options, lengthened stock ownership requirements, and instituted a holding period for option grants. Your Board deserves a salute for these corporate governance improvements.

Nevertheless, the bonus plan needs a little more work. First, to protect Mr. Immelt from even a whiff of suspicion that he is buying other companies for personal enrichment. Second, to protect GE stockholders from executive decisions that punch holes in the balance sheet and cause marginal returns on capital to fall. And third, to protect stockholders of other companies that look to GE for a "best practices" solution for aligning the interests of managers and owners.

Thank you for your consideration.


Hewitt Heiserman Jr.
Author, It's Earnings That Count (McGraw-Hill, 2004)

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