Friday, November 19, 2010

Governments riding in to rescue firms

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.

Three examples

GM
In July 2009, the US government chose to put $50 billion into the auto maker General Motors (GM) as part of complex rescue, which included wiping out the existing shareholders and embarking on a complex restructuring of the firm. The old GM died there.
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).
Satyam
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 blog 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.
UTI
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 The UTI Act was repealed, and UTI was turned into an ordinary company.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.

To summarise

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:

  1. Are the negative externalities of firm death really that onerous?
  2. Can government intervention be envisaged without requiring money?
  3. Are the Union ministers involved in the problem known for being smart and clean?
  4. 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?
  5. Do we see an exit strategy through which, within a short time, the firm will be fully out of government hands?
  6. 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.

9 comments:

  1. The Satyam bailout has not been smooth sailing by any means. The fact that it continues to exist as part of a merged entity belies the fact that there have indeed been customer defections (though the company says it has won much new business), and the company remains under sustained pricing pressure because perception of the company continues to be tainted. Which means it has had to offer its services at deep discounts to rivals such as infosys or TCS in order to retain clients, who seem to continually defer signing contracts until after the company reports results because of persistent worries that it is financially unstable.

    Clearly over time a lot of those problems will be overcome, many companies have recovered from financial scandal, but I am not so sure I agree with the notion that successful government bailouts which ultimately allow companies to recover from what was very bad decision making by management does anything but produce moral hazard.

    It reinforces the notion of too big to fail which will perpetuate poor risk taking. Frankly India would have survived fairly easily had Satyam been allowed to fail. A Stayam failure though perhaps relatively large in magnitude could hardly be defined as being an event which would have produced economic catastrophe, so I don't see why the government felt the need to get involved. As far as UTI is concerned, my perception is the entire banking industry in India is underwritten by the Indian government anyway. Indian banking operation of international banks included. I can't see any bank in India with a wide depositor base ever being allowed to fail, though smaller co-operatives have been allowed too, though that is just my perception.

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  2. @becreative. A government bailout of a business or industry should only ever occur if failing to act would result in economic catastrophe, e.g a total and utter meltdown in the wider economy. Frankly even then as far as I concerned I am a little dubious of the notion.

    Governments should provide regulatory frameworks which encourage business to develop and grow, they should not be used as a means by which tax payer money is used to resuscitate and prop up dying business whose management made questionable decisions or perpetrated fraud. It sets a terrible precedent and sends all the wrong signals to managers, investors and employees and actually suggesting it is a viable option to maintain employment of a single company and its suppliers is anti-competitive and some what protectionist. If you look at Japanese or Korean auto makers in the General Motors example, none of those auto makers went to their governments seeking assistance (at least not that I know of, I may well be wrong), despite facing the same economic conditions in their largest markets.

    If a government engages in a policy of bailing out and resuscitating large company's whenever the need arises, it sends as a signal to a number of participants in the economy that excessive risk taking, or bad management and judgement is not an existential threat, so long as one's balance sheet and employment base is large enough.

    The success of the General Motors IPO, which is touted by Mr. Obama as a win for his economic policy, is really a symbol of a lack of consequences for very large company's, a luxury which is not afforded to smaller company's or individuals (welfare payments aside) granted the Americans bailed it out at a time when uncertainty was at its highest in recent memory, and it has to be said in general the Americans are fairly good about allowing large company's to fail, e.g. Enron.

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  3. I don't think questions 2 and 6 can be answered favorably (as yet) for the GM case.

    GM has been allowed to get the benefit of old tax losses ($45B) contrary to bankruptcy law.

    While I do not know the details, the bankruptcy code for GM creditors was also messed with. There may well be a cost to pay for these in future, explicit and implicit.

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  4. The Satyam was an IT giant as a 7300 crore firm with 53000 employees at that time.The most important things were its reputation and clients.If it was not considered by government that time,the country's image will be suffering.The government took adorable steps which are paid off.

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  5. Is there no sense of moral hazard here? And you just speak of an instance where GM actually got back on its feet, but what of Chrysler which has been bailed twice (Reagan era and Obama era now), but yet it continues to be chronically ill and should have been finished a long time ago - so going by that count what is to stop GM from going the Chrysler way soon..also another thing, just mere financial wizardry can perhaps show the people that a company has recovered but the original direction of the company still remains the same - GM is headed to a cliff and until there is a drastic change in culture and management nothing really is going to change - watch this space...GM will go under once again.

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  6. Ajay,

    You are overstating the joys of the GM intervention.

    The nutty benefits of workers of GM were not scaled back -- as they would have been by a private equity fund that might have done the deal -- since the Democratic administration is beholden to the unions.

    GM is not yet really viable - they can't compete with car production in India. There may well be another fatal accident.

    It's true, the government staved off the collapse and the government got its money back. But (a) If the government had done nothing, this would have reinforced market discipline - maybe the most important good thing that you can do for the US automobile ecosystem is a dose of creative destruction and (b) The government did not do as a private equity fund would have (though maybe it's unreasonable to ever ask a government to behave in a commercial setting with the brainpower and clarity of a private player).

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  7. Ford, Toyota, Honda, Volkswagen, et al...have all the reason to complain here. Unlike the financial firms which had cross-holdings of various toxic assets as a result of which any one of the large finance cos going down under would have threatened bankruptcy for others, there was no such problem affecting the global auto industry.

    Had GM gone down under, it would not have put Toyota and others out of the market. Infact there were huge market share gains to be had for the likes of Ford, Toyota, & Honda....really huge gains!

    Where GM was reckless with its expenses and investments, these companies made business decisions sensible enough for them to survive a scary downturn.

    And yet, ironically, post Govt intervention an inefficient company like GM comes out of bankruptcy, reports a large profit (thanks to a recovery, bankruptcy induced cuts, tax breaks, etc.) and trades at a market cap that is same as its nearest competitor - FORD.

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  8. In continuation of the previous comment, a 7th test should be: "Is the contractual negotiation of a rescue of the kind that a private equity fund would enter into?"

    GM fails this test and I think Satyam fails it also.

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  9. Though it is not the job of a government to prevent companies that are dying but still, if we think of the 53000 employees and also the Satyam played as an It giant with 7300 firm. I feel the government has done the right job.

    And I totally agree with what Anonymous said...

    "GM fails this test and I think Satyam fails it also".

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