The Tyranny of the Shareholders

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.

Update: Some great comments below. Apparently boards do start having fiduciary obligations to non-shareholders when a company enters the "zone of insolvency". (But hasn’t GM been there for many years now?) And dWj comes up with a wonderfully wonky slogan: "You want moral hazard, give control of a company to a class of people who are longer vega than they are the value of the company." There’s a line to whip out at your next dinner party.