In the late 1980s, General Electric Company (GE), whose CEO at the time was Jack Welch, acquired Kidder Peabody, an investment banking firm founded in 1824. In 1991, Kidder hired a bond trader named Joseph Jett. Jett’s job was trading STRIPS, which are securities linked to U.S. Treasury bonds.
The trades work as follows. Assume you own a 20-year Treasury bond with a face value of $1,000 and an interest rate of 12 percent, payable semiannually. This bond entitles you to 40 payments (20 years × 2 payments per year) of $60 (= $1,000 × 12% × 1/2). For various reasons, some companies and individuals want the payment stream to follow a different pattern. It is possible to convert the single bond described above into 41 separate zero-coupon bonds. (A zero-coupon bond is one without an explicit interest rate and no payments before maturity.) The resulting bonds are called STRIPS (Separate Trading of Interest and Principal of Securities). The reverse transaction––converting separate bonds into a coupon bond—is referred to as a RECON, or reconstitution of the security.
This transaction has been compared to going to the bank and changing a dollar bill for four quarters. This transaction was done with the Federal Reserve Bank (Fed). Kidder made money on the business through fees and trading profits associated with the inventory of bonds it kept for transactions. As you might expect, there should be no profit in the transaction with the Fed.
Although at first he struggled in his job, Jett was soon generating enormous profits and earning large bonuses. He was able to do this because of an error in the internal Kidder accounting system that recorded the transaction improperly. Because the error would eventually correct itself (as the interest payment date approached), Jett was forced to trade larger and larger volumes. At the time this was discovered, approximately 95 percent of Jett’s trades were with the Fed.
Jett earned a bonus of $2 million in 1992 and $9 million in 1993, in addition to being named Kidder’s “Employee of the Year.” In 1994, Jett was generating in one month the profit he earned for the entire year in 1992 and Kidder executives began to investigate. Jett was fi red in April 1994 and GE was forced to take a $350 million pretax charge against earnings.

Required
a. Suppose you were Jett and you realized the accounting system used to record your performance was flawed. What steps would you take?
b. Suppose that you are unable to convince your superiors that the accounting system is flawed (in other words, that it encourages individual actions not in the best interests of the company). What should you do?
c. In his autobiography, Jack: Straight from the Gut , Jack Welch discusses the Kidder case and the differences between the GE and Kidder environments with respect to bonuses:
Frankly, the bonus numbers knocked us off our pins when we saw them. At the time, GE’s total bonus pool was just under $100 million for the year for a company making $4 billion in profit.
Kidder’s bonus pool was actually higher––at $140 million––for a company that was earning only one-twentieth of our income.
How might the different business environments and industries lead to such a large difference in the amount of contingent-based (bonus) compensation?
d. In the same autobiography, Welch compares the cultures of the two companies (page 225): The response of our business leaders to the crisis [the write-down of $350 million] was typical of the GE culture. Even though the books had closed on the quarter, many immediately offered to pitch in to cover the Kidder gap. Some said they could find an extra $10 million, $20 million, and even $30 million from their businesses to offset the surprise. Though it was too late, their willingness to help was a dramtic contrast to the excuses I had been hearing from the Kidder people.
(1) What does Welch mean when he says that GE’s business leaders offered to help by finding an extra $10 million, $20 million, and even $30 million to offset the surprise?
(2) What would be alternative uses of the extra $10 (or $20 or $30) million in those businesses?
(3) Would such help be ethical?