The Tyranny of the Shareholders

by: Felix Salmon December 03, 2008 | about stocks: AIG / F / GM    
Felix Salmon

Felix Salmon

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What does AIG have in common with the auto industry? Beyond bailouts, of course. One answer is that public shareholders are really part of the problem, rather than part of the solution.

In a publicly-listed company, management works, first and foremost, for shareholders. At AIG, the incentives are even more skewed: the CEO, Edward Liddy, is working for $1 a year -- plus a large slug of equity.

And so we end up with a situation where Liddy wants yet another AIG bailout, this one to reduce the amount of interest that the company is paying to the government, leaving more money for shareholders. It's similar to GM's protestations that bankruptcy is not an option -- but management would say that, because they work for shareholders, and shareholders would get wiped out under any bankruptcy proceedings.

The problem is that these companies are insolvent, and shareholders should be wiped out, sooner rather than later. But because they're still hanging on by their fingertips, they're refusing to accede to the inevitable. The value of their shares is minuscule, but because they control the management of these multi-billion-dollar companies, they're a massive obstacle to any sensible reorganization.

At AIG, Treasury is at least the single largest shareholder, and should tell Liddy to shut up: His job is to manage the company, and if he doesn't want to do that for $1 a year, he should resign, or renegotiate his contract. His job should not be to try to maximize the value of the rump equity held by himself and other shareholders: This is just another situation where minority shareholders really don't have much in the way of rights, and have to go along with whatever the majority shareholder wants -- even if the majority shareholder is getting lots of interest on preferred stock investments and the minority shareholders aren't.

At GM, Congress should provide financing within a Chapter 11 bankruptcy, and get the shareholders out of the way that way. Once it's already in Chapter 11, management can hardly continue to say that bankruptcy is not an option. And shareholders won't have a significant seat at the table any more, which will reduce the number of stakeholders who need to be placated.

The WSJ reports:

In the past several days, congressional representatives have met with bankers and bankruptcy experts to discuss the possibility of a so-called prearranged bankruptcy for either GM or Chrysler, these people said.
One idea that emerged from the talks would have the U.S. government put up as much as $40 billion to fund reorganizations under bankruptcy for GM and Chrysler, these people said.

Let's do it, and end the tyranny of the shareholders, and of the managers who work for them.

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This article has 15 comments:

  •  
    Dec 03 12:34 PM
    Don't be so short-sighted, Felix. The issue is that 80% of consumers surveyed stated they would not buy a vehicle from an automaker in bankruptcy. So, Chapter 11, pre-packaged or not, would likely culminate in a Chapter 7 liquidation. The collapse of the domestic industry would follow with a cost to the taxpayers of hundreds of billions of dollars.
    Reply | Link to Comment
  •  
    Dec 03 12:41 PM
    Isn't the real issue that a bankruptcy of the Big 3 automakers would leave the UAW with nothing to do? Their political friends in Congress will keep that from happening, that's for sure.
    Reply | Link to Comment
  •  
    Dec 03 01:01 PM
    There is a big difference between insolvency and illiquidity. AIG is illiquid, not insolvant. In addition, take a look at the bigger picture. It is in everybody's interest to have these large companies survive and thrive because the benefit the country as well as supplying jobs. The shareholders have already lost their shirts. Buy the stock and benefit yourself if you don't like what the govt is doing. If you can't beat them, join them. AIG needs a new deal.
    Reply | Link to Comment
  •  
    Dec 03 01:02 PM
    Are you Mr. Jimmy from the Stones tune, "You can't always get what you want?"


    On Dec 03 12:34 PM Mister Jimmy wrote:

    > Don't be so short-sighted, Felix. The issue is that 80% of consumers
    > surveyed stated they would not buy a vehicle from an automaker in
    > bankruptcy. So, Chapter 11, pre-packaged or not, would likely culminate
    > in a Chapter 7 liquidation. The collapse of the domestic industry
    > would follow with a cost to the taxpayers of hundreds of billions
    > of dollars.
    Reply | Link to Comment
  •  
    Dec 03 02:16 PM
    Let's not forget that American banking and industry was wrecked because executives compensated in stock options made decisions with short term benefits but long term costs and risks.

    With the banks, it was easy, but risky, money on mortgages and credit default swaps. With the big 3, it was ending strikes so that profits could be made in the next quarter, while unpayable pension and healthcare liabilities piled up. This short-term incentive mentality has afflicted all of American business, and turned executives and boards into little more than pump-and-dump insiders.

    Executives should be well compensated in cash only, so that their incentive is to do well in the long run and actually be around in 15 years still drawing that salary.
    Reply | Link to Comment
  •  
    Dec 03 03:10 PM
    Tyranny of the shareholders, eh?

    So who should be in control, the workers?

    I knew socialism was coming back, but I didn't expect to see it here.

    ;-)
    Reply | Link to Comment
  •  
    Dec 03 03:12 PM
    Tyranny of the shareholders?
    What are you smoking?(Pass it on, don't be a bogart)
    It's the COMPLACENCY of the shareholders that have gotten us into this mess. And when I say shareholders, I mean the mutual funds and index funds that stand by while impotent management run companies into the ground.
    I think the whole idea of index funds has been a giant failure because they have no incentive to monitor management through the board of directors. We have all been fed a line of bull that no portfolio manager can outperform the index over time so invest in index funds that are no check on management at all. I bet Bernie Ebbers loved that idea!
    And look at all the other mutual fund companies who have failed to adequately price the risk into the strategies that the companies they invested in undertook(namely BSC,GS, MS, LEH, JPM).
    Had they taken a more realistic approach to the risk these outfits took on when they expanded their leverage ratios, shares of such companies would not have been bid up to such unreasonable heights. Management, in turn, would not have profited so handsomely from their stock options and then, maybe way back when, the whole idea of overleverage would have been put to bed and prudence would have reigned.
    But , no, portfolio managers are like the blind leading the blind. Taken by the nose by securities analysts from the same brokerage firms, they are led down the primrose path and are told all is well, keep buying lest the next guy outperform you. Chase the earnings, forget the risk. Do any of these guys bother to read a 10-k anymore?
    What has happened to security analysis and portfolio management in this country?
    What has happened to the idea that people should keep a reputation(that isn't a bad one)?
    Reply | Link to Comment
  •  
    Dec 03 04:22 PM
    Any deals (or renegotiation) that would make AIG's financial more attrative is a better situation for the Govt. in the long run. AIG will be able to attract more private equity investment, retain on the value of the assets that it will be selling (on it own terms) and the Govt. would get their money back faster. The Govt. needs a "viable" AIG for it to get paid back.
    Reply | Link to Comment
  •  
    Dec 03 11:39 PM
    If democratic senate/congress is foolish enough to waste our tax on bailing out dying an industry that is not competitive in US due to UAW and its hubrious managers, you can be sure that in 2 years there will be republican senate/congress. UAW is smaller than tax payer base, Pelosi. Govt should consider bailing broad US tax payers out instead of garnering favor of UAW. Taxpayer way or highway.

    And Pelosi, don't waste your breath trying to explain something you have zero idea on. You can not afford to undermine incoming registration and yourself in this dire time.

    Here are my suggestions.

    1. Let PBGC take care of UAW members pension and healthcare. All other failed business do, and UAW members are just as guilty of failure as the managers.

    2. Remove current managers with innovative/reputable outsiders who will in turn boost industry morale, develop better product/brand and keep parts manufacturers in shape (You know the part company managers are old line Big 3 managers. Some of them needs to go, also.)

    3. Set up bankruptcy remote entity to service warantee, or let US Govt guarantee it. And let the news media repeat the mantra; "US Treasury guarantees your GM/Ford/Chrysler warantee for 10yr/120,000 miles."

    After implementing these ideas, ever patriotic US customer base will buy from uncle Sam's GM and Chrysler (and I never bought a US car, yet if these changes come, I will to support my country by buying GM)

    I bet if UAW members start to take GM and Ford equity as its 401 k and wasges, that would boost the stock and lower borrowing cost. UAW leader Gelfinwhatever guy avoided answering this question today. What a joke!

    I really wish that new administration and regislative branch will be bold enough to do something for voters, out of line with their political interest. That is why we voted for Mr. Audacity of Hope, were it not?
    Reply | Link to Comment
  •  
    Dec 04 12:50 AM
    Yes, lets bail out the taxpayers and the productive, honest, working people, not the failed businesses, unions that forced contracts on management to pay people to do nothing (Job Bank idea), and other non-productive rat-hole expenditures. This just mires our economy in mediocrity.
    Reply | Link to Comment
  •  
    Dec 04 01:23 PM
    I thought it fascinating that the WSJ recently saw fit to allow Maurice "Hank" Greenberg to plead in an editorial column that AIG was being badly treated by TARP and the Fed. It says a lot about why the WSJ does good journalism but its editorial policy is garbage. AIG was not an insurance company so much as an off-shore and unregulated bookie and the complexity of its dealings were quite reminiscent of the thieves running Enron. Very similar methodology, in my opinion. The rest of it of course, is the well-documented divorce between management and the interest of individual shareholders and the failure of institutional investors to object to excessive executive compensation or hold management accountable.
    Reply | Link to Comment
  •  
    Dec 04 01:50 PM
    first WSJ could go out of business & the world would go on.second nobody considers the shareholders.i doubt if they are ever mentioned in the selfserving boardrooms or by the lying ceo's.they should be called suckerholders.
    Reply | Link to Comment
  •  
    Dec 04 04:54 PM
    I TAKE IT YOUR NOT A SHAREHOLDER
    Reply | Link to Comment
  •  
    Dec 05 01:52 PM
    Where do you get your information? How is AIG insolvent? You really need to check your facts before you are allowed to print. Here is a word for you, libel!
    Reply | Link to Comment
  •  
    Dec 05 01:57 PM
    Berekely Bob: Please astound us all and inform us how AIG is like Enron? Sheep like you make me laugh. You can be led astray by pundits on capitoal hill and in the media who don't know the first thing about AIG or how business works in the real world. AIG had a liquidity crisis caused by the overnight failure of Lehman's. They needed a bridge loan, instead the Gov't bend them over a barrel and took 80% of the company, something that has not happened to other company's such as Citi. All AIG is asking is for the Gov't to relinquinsh the shares it stole without shareholder approval so that the company can raise capital and pay back the taxpayers!
    Reply | Link to Comment
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