Wednesday, December 3, 2008

Should we keep the Big Three on life support?

Sometimes it is best to let the patient die. At least if the patient is a company. A company can be resurrected, and enjoy a new life no longer stricken by the debilitating weaknesses that left it lingering at death’s door. Weaknesses like encumbering labor agreements, pension liabilities and health care obligations.

The pleas of the Big Three are those of the management and of the equity holders they represent. They do not have much interest in the hereafter. They would have the company cling to life by the last thread, keep it on life support for as long as it is offered, even make a devil’s bargain to trade the possibilities in its second estate for more time, however impaired, in the current one. Management and the equity holders will not share in the corporation’s afterlife. If it dies, they are gone, no matter how bright the prospects are for the company in its resurrected state.

Thus the equity holders can end up on the wrong side of one of economics’ most prickly conundrums, the agency problem. Usually this problem pits the managers of the firm against the owners; i.e. do the managers of a firm have interests that are aligned with the owners of that firm? In the current crisis the agency problem is: do the equity holders act in the best interest of the firm as a robust, competitive going concern? Do they have an interest in the long-term prospects of the firm, which is our point of interest if we are the government making the bail out decision?

If the answer means pulling the plug, then of course they do not. They will bleed the cash flow to have the firm stay afloat, exert their will to live to the detriment of the future prospects of the firm in a reorganized form. And they will be urged on by those with an interest in the encumbrances that weigh the companies down now, but that will be excised postmortem.

What is surprising in this death drama is that here, in the non-ethereal plain of corporations, we get to observe the passage into the after-life. We get to know the better world where these firms are heading. For example, we can look at what happens to airlines. It seems one airline or another goes into Chapter 11 every few years, and yet they hardly miss a flight. We don’t worry that the planes will start to fall out of the sky; if you didn’t read the papers you might not even know what happened. It is almost a part of the business plan. An airline starts off with the advantages of a new fleet and a low cost work force. Over time the fleet ages, the labor force works its way up the pay scale, the union rules clog the arteries, and costs finally squeeze the life out of the margins. So the airline goes into Chapter 11 and starts the process over.

As Congress deliberates on the Big Three, it should recognize the agency problem it faces with management. And it should look to case studies of reorganizations to weigh the shackles that bind the companies in the current sphere with their prospects in the hereafter.

There is life after death.