The issue of unionism at General Motors is long since settled. We have achieved workable relations with all of the unions representing our employees.
Chapter 22 - Incentive Compensation
The General Motors Bonus Plan has been since 1918 an integral part of our management philosophy and organization, and, I believe, an essential element in the progress of the corporation. Our management policy, as the 1942 annual report formally stated it, "has evolved from the belief that the most effective results and the maximum progress and stability of the business are achieved by placing its executives in the same relative position, so far as possible, that they would occupy if they were conducting a business on their own account. This provides opportunity for accomplishment through the exercise of individual initiative, and opportunity for economic progress commensurate with performance. In that way managerial talent is attracted to and retained by the Corporation."
The Bonus Plan and the policy of decentralization are related, since decentralization gives executives the opportunity for accomplishment, and the Bonus Plan makes it possible for each executive to earn a reward commensurate with his own performance, and so gives him an incentive to put forth his best effort at all times.
Although the General Motors Bonus Plan was first adopted on August 27, 1918, its fundamental principles have never changed— that the interests of the corporation and its stockholders are best served by making key employees partners in the corporation's prosperity, and that each individual should be rewarded in proportion to his contribution to the profit of his own division and of the corporation as a whole. We have made alterations, of course, from time to time; for example, in 1957 the incentive program was expanded to include a stock-option plan for a group of top executives. At the present time, bonuses may be awarded out of net earnings only if the corporation has earned more than 6 per cent on its net capital employed. The maximum annual credit to the bonus reserve is limited to 12 per cent of the net earnings after taxes and after the 6 per cent return, and in its discretion the Bonus and Salary Committee may determine to credit less than the maximum. For 1962, some 14,000 employees were awarded bonuses totaling $94,102,089 in General Motors stock and cash. In addition, contingent credits under the stock-option plan amounted to $7,337,239. These amounts, together with $3,550,085 applicable to the separate bonus plans of four overseas manufacturing subsidiaries, were distributed out of a credit to the reserve of $105 million for 1962, which was $38 million less than the maximum permitted under the plan.
But while bonus awards depend on profits, the bonus system is not a profit-sharing plan. It does not entitle any employee to any regular share in the earnings of the corporation or any of its divisions. The Bonus and Salary Committee may—and sometimes does —award less than the maximum sum available for bonus payments. More important, each man must earn the right to be considered for a bonus award each year by his own effort. Since his effort is judged each year, his bonus award may fluctuate widely from year to year— if, indeed, he receives one every year. The knowledge that his contribution to the corporation is weighed periodically, and a price put on it, acts as an incentive for each executive at all times.
The Bonus Plan has also had an important effect in creating an identity of interest between management and shareholders by creating an owner-management group: in most cases, bonus awards have been made partly or wholly in General Motors stock. As a result, General Motors has always had a top management group with a heavy stock interest in the corporation—heavy, that is, from the standpoint of the executives' total personal assets, if not from the standpoint of the corporation's total stock outstanding. Since the bulk of their own assets usually consists of General Motors stock, General Motors executives are more conscious of the identity between their interests and those of the shareholders than they would be if they were professional managers only.
But the Bonus Plan has done more than stimulate and reward individual effort per se; when the plan was first started, it made a tremendous contribution in encouraging executives to relate their own individual effort to the welfare of the whole corporation. Indeed, the Bonus Plan played almost as big a role as our system of co-ordination in making decentralization work effectively. O. E. Hunt observed in a letter to me:
Decentralization provided the opportunity; [the incentive compensation] . . . provided the stimulation; jointly they made the top level executives in the Corporation a cooperatively constructive group without destroying individual ambition and initiative.
Before we had the Bonus Plan in operation throughout the corporation, one of the obstacles to integrating the various decentralized divisions was the fact that key executives had little incentive to think in terms of the welfare of the whole corporation. On the contrary, the general managers were encouraged to think primarily of their own division's profits. Under the incentive system in operation before 1918, a small number of division managers had contracts providing them with a stated share in the profits of their own divisions, irrespective of how much the corporation as a whole earned. Inevitably, this system exaggerated the self-interest of each division at the expense of the interests of the corporation itself. It was even possible for a division manager to act contrary to the interests of the corporation in his effort to maximize his own division's profits.
The Bonus Plan established the concept of corporate profit in place of divisional profits, which only incidentally added up to the corporation's net income. Suitably, it provided for bonuses to be paid to employees "who have contributed to its [General Motors'] success in a special degree by their inventions, ability, industry, loyalty or exceptional service." At first total bonus awards were limited to 10 per cent of the net earnings after taxes and after a 6 per cent return. In 1918 more than 2000 employees received bonus awards, and in 1919 and 1920, more than 6000. In 1921, when the recession and inventory liquidation cut profits sharply, no bonus was awarded under the plan.
The first major modification of the Bonus Plan was made in 1922, when bonus awards were resumed. The minimum return on capital that had to be earned before any bonus provision could be made was raised from 6 to 7 per cent, after taxes. It stayed at that level until 1947, when the minimum return on capital was reduced to 5 per cent and the per cent of net earnings after taxes available for bonus above the minimum return was increased to 12 per cent. In 1962 the minimum return on capital was increased to 6 per cent.
The 1922 revisions also related the employee's level of responsibility to his eligibility for bonuses. Since the simplest measure of an employee's level of responsibility is his salary, eligibility for the bonus was set on that basis: for several years, beginning with 1922, the minimum salary for bonus eligibility was $5000 per year. As a result of this change we awarded a total of only 550 bonuses in 1922.
Managers Securities Company
Another important change was made in November 1923 with the establishment of the Managers Securities Company. Managers Securities Company was set up, essentially, in order to give our top executives an opportunity to increase their ownership interest in General Motors. We had in mind that this would provide added incentive. A block of stock, made available by the du Pont Company, was in effect purchased by the executives selected for participation in the plan at the then market price. Through their participation in the Managers Securities Plan, the executives made a partial payment for the stock in cash at the outset, and agreed to pay the balance by applying their participation in supplemental compensation for a number of years in the future. This meant that, if the business was successful, they would be in a position to become substantial owners of stock. Those who benefited by this plan are indebted to Pierre S. du Pont and John J. Raskob, who arranged that General Motors stock be made available for that purpose, and to Donaldson Brown, who developed a highly effective plan for creating a reality out of an opportunity. Here are the essentials of the plan worked out by Mr. Brown.
Managers Securities Company was organized with an authorized capital stock of $33.8 million di
vided as follows: $28.8 million of 7 per cent cumulative nonvoting convertible preferred stock; $4 million of Class A stock with a par value of $100; $1 million of Class B stock with a par value of $25.
On formation Managers Securities Company bought a block of General Motors Securities Company stock, which was the equivalent of 2,250,000 shares of General Motors common stock. General Motors Securities Company was a holding company for du Pont's ownership in General Motors stock. The purchase by Managers Securities Company represented a 30 per cent participation in General Motors Securities Company.
The reason du Pont was willing to sell at the market a 30 per cent interest in its entire holding of General Motors stock was twofold. First, du Pont believed firmly that it was thereby creating a partnership relationship between General Motors' management and itself. It was convinced that the resulting incentive to General Motors' executives would be reflected in increased dividends and would enhance the value of the stock, thereby compensating du Pont through the increased value of its remaining interest. Second, du Pont sold because the stock in question was an extra investment originally acquired under duress, so to speak, in connection with the financial adjustment of Mr. Durant's affairs. These circumstances led Pierre S. du Pont to request Mr. Brown to consider possible avenues through which du Pont's objectives might be effected.
Managers Securities Company paid General Motors Securities Company $15 per share for the 2,250,000 shares, or an aggregate purchase price of $33,750,000. This purchase was financed by paying for same with $28,800,000 par value 7 per cent convertible preferred stock and the balance in cash to the extent of $4,950,000. Managers Securities Company obtained the cash by selling its entire Class A and Class B stock to General Motors Corporation for the aggregate sum of $5 million. General Motors undertook to pay to Managers Securities Company an amount equal to 5 per cent of the net earnings after taxes of the corporation less 7 per cent on capital employed during each year. This payment was equivalent to one half the aggregate bonus fund for each year. The agreement was to last eight years, beginning with 1923 and ending with 1930.
General Motors further agreed that, should the contract payment to Managers Securities Company in any year come to less than $2 million, then General Motors would make up the difference in the form of an unsecured loan, to Managers Securities Company, bearing interest at 6 per cent. (Payments under this provision were in fact made in both 1923 and 1924.)
General Motors in turn resold Class A and Class B stock to about eighty of its top executives by an allotment based upon recommendations submitted by me to a special committee appointed by the board of directors of General Motors. Employees paid $100 cash for each share of Class A stock and $25 for each share of Class B stock, the same price that General Motors had paid Managers Securities.
In general, the number of shares allotted depended upon the executive's position with the corporation. I personally visited every executive who appeared to qualify under the plan, and discussed his situation with a view to determining whether he wished to join the plan and whether he could afford to pay cash for his allotment. I tried, in general terms, to limit the investment on the part of each executive to an amount no greater than his annual salary. Not all the shares of Managers Securities Company were originally allotted. A block was set aside for future allotments; first, to executives who might later qualify, and second, to supplement an executive's holdings in the event that his responsibilities increased.
General Motors held an irrevocable option to repurchase all or part of any executive's holdings should he resign, or should his position or performance in the corporation change. In order to maintain participation in the Managers Securities Company on a current basis, an annual review was required of the performance of each executive in the Managers Securities Plan to determine whether his participation was out of line compared with other executives, including those not in the plan. Where the discrepancies were significant I could recommend an additional allotment of unused Managers Securities Company stock or an award out of the half of the bonus that did not flow to Managers Securities Company.
Here is how the plan worked.
The annual payments by General Motors Corporation to Managers Securities Company, which were 5 per cent of the net earnings after taxes of General Motors less 7 per cent on the capital employed, were credited to Class A surplus for the benefit of the Class A stock. Dividends received on the General Motors stock owned by Managers Securities Company (through General Motors Securities Company) were credited to Class B surplus along with all other income of Managers Securities. Dividends on the outstanding 7 per cent preferred stock of Managers Securities were paid out of Class B surplus.
The Managers Securities Company was obligated each year to retire 7 per cent preferred stock in an amount equivalent to all its income after taxes and expenses and after deducting an amount equal to the dividends paid on the preferred stock. Managers Securities Company could also pay dividends on its Class A and Class B stock—not in excess, however, of 7 per cent per annum on such paid-in capital ($5 million) and the surplus earned thereon —provided that all cumulative dividends on the 7 per cent convertible preferred stock were paid.
As a result of the success attained by General Motors during the period after 1923, the Managers Securities Company plan was successful beyond the most optimistic expectation. As I have pointed out, this was a period of remarkable accomplishment for General Motors. Significantly, the over-all automobile market did not show much growth during the period—as a matter of fact, it remained at a level of around four million cars and trucks annually in the period 1923 through 1928. But General Motors sales more than doubled over this period and our share of the market increased from less than 20 per cent in 1923 to over 40 per cent in 1928. This, of course, resulted in a rapid increase in earnings and with it increased payments to the Managers Securities Company representing the supplemental compensation of the participants. The preferred stock was completely retired by April 1927 and so the total assets of the company were held exclusively, and without encumbrance, for the benefit of the Class A and Class B stock with their respective surplus accounts.
The expansion of the earnings of General Motors Corporation not only permitted the retirement of the 7 per cent preferred stock of Managers Securities, but also enhanced the market value of General Motors stock. This, together with the increased dividends on the General Motors stock, resulted in such a high value for Managers Securities Company stock that it could no longer be offered to executives who had been advanced to top management after the plan had been started. In consequence, the contemplated period of eight years was reduced to seven years, and ended with the year 1929 instead of 1930. The purpose of this was to facilitate the organization of General Motors Management Corporation— which was designed to carry on the general concept of the Managers Securities Company for another seven years, with a broadened executive participation commensurate with the increased size of the business.
I have already stated that the Managers Securities Company plan was successful beyond the most optimistic expectation. Perhaps that can best be demonstrated by stating the results in terms of each $1000 of stock purchased in Managers Securities Company Class A and Class B stock in December 1923. At that time such an investment represented in effect a partial payment on 450 shares of General Motors no par value common stock, with a then market value of $15 a share, and the executive had agreed to apply his future bonus participation to pay off the balance due. Over the next seven years, the applicable share of the contract payments made to the company by General Motors totaled $9800 on such an investment. These represented amounts which the executive would have received as bonus during the period and in effect constituted additional investments in the company, increasing each $1000 of original investment to a total of $10,800.
During the period from 1923 to 1930, the applicable 450-share equity had, through exchanges, stock dividends, and additional purchases by Managers Securities, increased to 902
shares. After General Motors made the last contract payment to Managers Securities on April 15, 1930, the resulting total investment represented an unencumbered claim on 902 shares of General Motors $10 par value common stock. Expressed another way, by that time the total of $10,800, represented by a $1000 original investment and the $9800 applicable share of supplemental compensation, had in effect purchased 902 shares of General Motors $10 par value common stock. As a result of the appreciation in the market value of General Motors common stock during the interim period, the 902 shares had a value of $52,375 per share, or a total market value of $47,232. Taking into account the redemption of a portion of the investment for $2050 in 1927 and 1928 and dividend income of $11,936 received over the period, the final value growing out of the total $10,800 invested was $61,218.
The Managers Securities Company Plan rewarded the General Motors Corporation and its shareholders as handsomely as it rewarded the participating executives. The success of the plan reflected the success of General Motors between 1923 and 1929, and I am confident that this success was due in part to the fact that Managers Securities Company created a top management team with a heavy personal stake in the success of the corporation as a whole. Managers Securities Company was certainly a great individual financial incentive. But as Walter S. Carpenter, Jr., of the du Pont Company has written me, it also supported the enterprise as a whole and led to greater co-operation. Mr. Carpenter said:
The importance of Managers Securities Company was that it created in these many individuals ... an urgent and continuing desire to make a success of the whole as distinguished from their previous parochial and separate interests . . .
You know, perhaps as well as anyone, that the design of that so-called financial mechanism was such that the benefits of the earnings of the corporation as a whole were pyramided in a form to give a tremendous leverage upon the individual's participation in the results. That is now so old and has been used so much that we accept it now as more or less a matter of course. We must recognize that in that form and at that time it was quite new and in that way contributed enormously to the drive and determination ... to make the corporation as a whole a success. This, of course, in turn facilitated the development of cooperation and correlation and interdependence, all of which later played such an important part in the success of that corporation.
My Years With General Motors Page 50
