To Bail Or Not To Bail? Let’s Talk Government Intervention

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Last week Chamath Palihapitiya, CEO of venture capital firm Social Capital, made headlines with his divisive comments on the current state of capitalism and government’s role in propping up “zombie companies that deserve to fail”.

When asked in the viral interview if airlines in particular should be allowed to fail, Chamath responded in the affirmative and proceeded to defend this philosophy that has garnered significant media attention:

“When you look at it, this is a lie that’s been purported by Wall Street. When a company fails, it does not fire employees it goes through a packaged bankruptcy…the employees of these companies end up owning more of the company. The people that get wiped out are the speculators that own the unsecured tranches or the folks that own the equity. And by the way, those are the rules of the game. That’s right. These are the people that purport to be the most sophisticated investors in the world. They deserve to get wiped out.”

Chamath outlines how CEOs and board members have enriched themselves by “playing games” to manipulate earnings per share (one of the common metrics tied to management incentive compensation) through stock buybacks and increased dividends. His belief is that companies should have been saving for a rainy day and investing in R&D, rather than solely enriching executives and shareholders. In looking at the data, airlines are some of the best (or worst) examples of Chamath’s theory in action. Over the last 10 years US airlines spent over 96% of free cash flow on buybacks.

So, have airlines done anything wrong? The long-prevailing theory of economics from Milton Friedman has supported that increasing shareholder value is the primary function of a corporation. If airlines had amassed huge war chests of savings to weather the five sigma event and the fallout we are currently experiencing, shareholders would have clamored for the board to use the cash to reward them. Or alternatively, in more modern stakeholder economic theory, excess cash could have been used to raise wages and improve benefits for employees. Regardless of which camp received the benefit, airlines would have been ill-prepared for the current situation; can we expect corporations to hoard cash in order to weather all black-swan events at the expense of both shareholders and stakeholders? Given that airlines have focused primarily on increasing value to shareholders, should the tax dollars of Main Street be used to prop them up, to the primary benefit of large institutions, hedge funds, and the wealthy individuals behind them?

Leon Cooperman, founder of the multi-billion dollar hedge fund Omega Advisors, has publicly disagreed with Chamath’s views. He instead believes government will ultimately be on the hook for the unemployment that will ensue should airlines fail and interest-bearing loans would provide returns while keeping workers employed. While this opinion is fair, is Leon not the very shareholder whose interests are best served by this circle of shareholder enrichment and government bailout, the very person Chamath is warning will distort the message to Main Street in service of his own interests? Or, is it indeed logical that government do everything in its power to keep the public employed, even if it encourages companies to keep repeating the same mistakes?

Given Chamath is an impact-minded investor, one question that remains is which side of this issue do other impact-minded investors fall? On one hand, government bailouts have enabled companies to enrich shareholders without consequence, further widening the wealth gap and holding down wages. But on the other hand, it seems likely that contrary to Chamath’s beliefs, many airline workers would lose their jobs should the government fail to intervene, as evidenced by the 2002 bankruptcy of American Airlines in which 7,000 employees were laid off. Should we bail out the wealthy to save the working class? Just one more time?

Jake Greenwald, Business Development

The latest proposal of the airline bailout plan could make the federal government the largest shareholder of American Airlines at 3%. The government could also own up to 2.3% of United and 1% of Delta through warrants equal to 10% of the loan amount. The proposed package, currently awaiting ratification from airline companies, includes $25 billion in government grants and a further $25 billion in loans, of which 30% would require repayment.

RepRisk is a Zurich-based business intelligence company that analyzes corporate ESG integration to improve engagement and identify risks. Could such a tool be levered by government to better determine whether a corporation is deserving of federal assistance? If one company needs a bailout because all excess cash went to shareholders vs. another which invested heavily in its employees and R&D, in addition to shareholders, should the latter receive preferential assistance? Perhaps by rewarding more well-rounded corporate responsibility, over time companies would be incentivized to think less quarter to quarter and more in terms of long run health.

All the Devils Are Here by Bethany McLean and Joe Nocera is a great read that reveals much of the political maneuvering and backroom dealings in 2008 that went into determining which banks were bailed out and which were left to fail.

This newsletter is intended solely for informational purposes, and should not be construed as investment/trading advice and are not meant to be a solicitation or recommendation to buy, sell, or hold any securities mentioned. Any reproduction or distribution of this document, in whole or in part, or the disclosure of its contents, without the prior written consent of Flat World Partners is prohibited

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