Do corporate bonds lash CEOs into leanness - or not?
Briefly, it looked as if Kirk Kerkorian, in his attempted buy-out of Chrysler, was going to revive single-handedly the buccaneering days of the 1980s when stocks and shares were replaced by bonds - many of which, if not all, well deserved the epithet junk.
Wall Street's feeding frenzy culminated in the RJR Nabisco buy-out, which was notorious more for its size and the repletion of sharks surrounding it than for the principles behind it. Realising the hidden value of assets and forcing management efficiencies were excuses sufficient unto the day, even though it was plain that principal, not principles, was the main concern of the fixers. For several years since then, the Street has had the slightly shamefaced and penitent air of a chief executive caught with a junior receptionist during a well lubricated office party.
In the end, the corporate bloodbath clotted mostly because of recession, possibly even exacerbated by the leveraged buy-out frenzy. It could also be argued that, like the Vikings, the looters had to allow their victims a few uninterrupted harvests before returning for more booty.
Chrysler learnt its lessons and became highly efficient and competitive. It swam against the ebbing tide of short-termism by building up reserves against the possibility of another recession. Some one third of its value was invested in this corporate Keynesian attempt to counter the business cycle.
Enter Kirk Kerkorian with his buy-out proposal, looking not unlike Dr 'Death' Kervorkian with his self-help suicide kit. Just as in the good old days, Kerkorian's chosen instrument was a major bond issue, although emblazoned on his banner was the need for shareholders to benefit immediately from that cash reserve. We have no reason to doubt his concern for shareholders since - like his ally Lee Iacocca - he himself was a major stockholder, who stood to gain handsomely from the price hike that followed the announcement of his seemingly abortive plan.
Michael Jensen, of Harvard Business School, makes the mortal analogies even closer. He supports the Kerkorian-Iacocca bid on the grounds that it was Chrysler's near death experience ten years ago that made it so efficient now. In his models, lean and hungry companies are dangerous to their rivals while well-cushioned ones are dangerous to themselves - they slink too much.
'We have an enormous amount of evidence that a corporation with a large amount of cash floating in the bath tub eliminates any incentive for it to stay lean and mean. For example, they'll make expensive labour settlements,' says Jensen. He adds that any company with a triple A bond rating is teetering on the verge of disaster from the complacency that a cash cushion and low debt give it.
But to whose benefit is the buy-out? One might assume that shareholders should benefit from having a cash reserve, assuring the safety and value of their investment. Jensen is convinced that, almost whatever happens, however, the main beneficiary will be what he calls the Imperial CEO. 'In the US, no-one has any interest in the company except the - management - and they act as if they were bondholders. On most boards shareholders are the least represented group,' he says, 'apart from labour, of course.'
This is accurate, but heretical. In the US, the heartland of aggressive corporate capitalism, captains of industry have always scorned the continental European notion of 'stakeholders', which gives local communities, staff, suppliers, customers and other interested parties a legitimate say in the running of a company. In the US and elsewhere, companies are by law corporations of entrepreneurial shareholders, who democratically run their investments to maximise their collective profits. In reality, of course, everyone knows that the average shareholder has about as much say in corporate governance as a North Korean voter has in choosing the Politburo.
As for bondholders, after buying their bonds, the next point of leverage is in bankruptcy, which is a consummation that they will devoutly wish to miss. Shareholders can be awkward. They can buy or sell at any time, and thus are, in a sense, being continuously polled on what they think of management's performance. CEOs derive a large part of their income from stock options, so what's good for them is also, incidentally, and occasionally, good for the shareholders. But when a company is financed by 80 per cent debt, who will the board listen to then - shareholders or bondholders? The answer is that they will probably be even more deaf to both.
The Internal Revenue Service in the US has given significant positive assistance to this shift in corporate governance. Since a company is theoretically a collective of shareholders, it naturally taxes their dividends - they are the profits. If a bank buys bonds, then its interest payments are tax deductible for the company, because they represent a cost of business rather than a profits distribution.
In grosser economic terms, it could be said that the banks and other bondholders just take their profits out of the company in a different way. However, one difference is that the shares appreciate if profits are reinvested and kept in the company, whereas bondholders' only gain is from interest payments which take resources out of the company.
Despite Michael Jensen's celebrations, one is led to speculate that American taxpayers - including shareholders - are subsidising the subversion of shareholder democracy, the spread of short-termism, and so the destruction of the 'American way' and the country's economy.
Its effects on motherhood and apple pie have yet to be calculated..