What is a government to do when a company faces a near-death situation? In almost all cases, the right answer is to let the company go under: It is not the job of a government to prevent companies from dying. Indeed, creative destruction is central to the proper functioning of capitalism. Capitalism without failure is socialism for the rich.
But sometimes, the cost-benefit ratios can look startling. Sometimes, the disruption to the economy that comes from the death of a company can be rather large. Let's look at three stories.
- In July 2009, the US government chose to put $50 billion into the
auto maker General Motors (GM) as part
rescue, which included wiping out the existing shareholders and
embarking on a complex restructuring of the firm. The old GM died
GM got back to profitability this year. Seventeen months later, in 17 November, GM got back on its feet with an IPO which raised $23.1 billion. How impressive! See this story by Michael J. de la Merced and Bill Vlasic in the New York Times. This IPO was at $33. With this IPO, the US Treasury got down from 61% ownership to 26% ownership, so this IPO was the re-privatisation of GM. From here, if the US Treasury is able to sell its remaining 0.5 billion shares at $53 a share in the future, it will fully recoup the $50 billion that went into the rescue (ignoring time value of money).
- On 7 January 2009, Satyam announced that a lot of money was missing
from their balance sheet. In the aftermath of this crisis, the
government put Deepak Parekh, Kiran Karnik, Tarun Das, and three
others in charge. Read this interview
of Deepak Parekh with Tamal Bandyopadhyay in Mint, and this
post by John Elliott.
The new board put the firm up for sale. It was bought by Tech Mahindra. A collapse of the firm was averted; the employees and customers largely stayed in place.
- When UTI got into trouble, I was opposed to government intervention. But by and large, I think the intervention worked well. US-64 unitholders did suffer losses: half of the gap between the NAV and market value was paid by the unitholders and half by the government. And the follow-through was excellent. The staff quality that MoF was able to muster on the problem was outstanding. The UTI Act was repealed, and UTI was turned into an ordinary company. `Bad UTI' was separated out by `Good UTI'. The ownership was modified including the recent work of bringing in T. Rowe Price as a shareholder. All in all, the exchequer did well when selling off the shares in SUUTI. Privatisation hasn't yet come about, but where we are is progress.
When is it right for a government to go in?
Should the US government have gone into GM? There was a fair amount of criticism of the Obama administration for the decision. There was concern that they were doing this owing to pressure from trade unions. But the outcomes have been quite nice, so (at least ex post) it looks like a good call.
In the case of Satyam, the existing shareholders were not expropriated. It can be argued that the failure of the firm was not their fault. But by that argument, many firm failures in India in the future will justify government intervention since most public shareholders are fairly powerless when the inside shareholders have over 50% shares. In his interview, Deepak Parekh says Had it happened to a consumer finance company or a small, or even big, manufacturing company, the government would not have come out and superseded the board. The normal procedures for bankruptcy and liquidation would have taken place.. I am not sure how the future will work out.
The problem of execution capability
Satyam, GM and UTI are success stories in that the government packed a mean punch in the execution. In particular, in Satyam's case, I had simply not expected that such a nice outcome could be achieved by the government. We should really admire the teams that worked on these problems.
But can we count on such high quality execution on such problems in the future? Our success in the Satyam or UTI stories should not be generalised to the view that in the future such high quality execution will always come about.
The exit strategy
The really amazing feature of the GM story is the clarity and commitment of the government in getting out of `Government Motors' by doing a privatisation just 17 months after going in. All too often, government interventions turn into nationalisation and then you're stuck with a public sector company for a long time, with all the usual politics of the privatisation.
In the deep past, numerous weak companies have been nationalised in the decades of Indian socialism (e.g. National Textile Company) and generally the outcomes have been bad.
A particularly attractive feature of the Satyam story is that no government money was involved. The presence of government money makes things much harder. In India, all too often, it's easy to ask for government money and it's easy to get it. And if the government had got shares in Satyam, it's not easy to see how they would have got out of it.
Similarly, a nice feature of the UTI story is that in the end, the UTI Act was repealed, and UTI is on course for turning into a normal financial firm. Government intervention in the rescue did not yield an ossified PSU.
At the same time, while Satyam and UTI are good stories in terms of the exit path, we cannot generalise too much from this given the fact that GOI is at a standstill on privatisation. In general, we have to assume that what is purchased is never sold, which puts a crimp on a vast array of situations where government intervention might be evaluated.
When most firms approach death, the decent thing to do is to let the firm die. We must rejoice in the extent to which Indian capitalism is able to bring about a steady pace of firm death. Building a good quality bankruptcy mechanism will increase the class of firms where resolution is handled in a routine and humdrum way, without the possibility of a special intervention. (Note that going through the bankruptcy process was an integral part of the GM story).
When a potential intervention situation arises, six questions need to be asked:
- Are the negative externalities of firm death really that onerous?
- Can government intervention be envisaged without requiring money?
- Are the Union ministers involved in the problem known for being smart and clean?
- Can a top quality team be put together which will work on a time-bound project starting from intervention until exit? Does this team combine competence with cleanness?
- Do we see an exit strategy through which, within a short time, the firm will be fully out of government hands?
- Are we very sure that in the end, we will endup imposing no costs upon the government?
Ex post, these questions worked out well for GM, UTI and Satyam.