Asymmetrical Information

Wouldn't that also be the case for individual bankruptcy then? And if so, why are we making it more difficult for people to go bankrupt if they need to? Why don't we have basic financing classes (like we have had home-ec and shop)? Where people are taught the system and how it works so that they aren't led astray or bamboozled into ruining their credit rating before they even realize what it is that they're doing?

At least with businesses you have some idea of the economic concepts in which you operate.

Just a nitpick: Bankruptcy law lets creditors know up front what the process of reorganization will be. The terms of the reorganization presumably will vary case by case.

Semiotic Pirate:

There's a fine line that must be walked in either case. You want to make it doable, so that companies don't have to liquidate (not sure what the individual version of that is -- debtor's prison?). At the same time, you don't want to make it too easy, given that it imposes costs on your creditors (and raises costs to everyone if it is too easy).

Those who supported the recent tightening of the individual bankruptcy standards presumably believed that it had become too easy for people to discharge their debts. Time will tell whether or not that was the right decision.

Is it reasonable to continue with the existing management following a Chapter 11 bankruptcy? In almost all cases, management had something to do with the problems of the company.

One could argue that Chapter 11 should require the replacement of the entire senior management layer of the company, or at a minimum the Chairman, CEO, and CFO. The problem with this, of course, is that it would make it difficult to attract senior execs to a company that was in serious trouble. Still, is it reasonable to leave the same people in charge?

David Foster,

'Require' of whom? Who should appoint new management? The current one, which screwed up so badly, or the directors, who also failed in their oversight? Or maybe the shareholders should form a popular hiring committee?

If you let the current management go, there isn't really much of anyone left who can be required to do anything.

That's besides the problems of finding people who will want to manage a bankrupt company, and the small chances that an effective team of outsiders can be put together.

But the fact of bankruptcy is made more likely by the existence of bankruptcy laws and limited liability, both of which invite imprudent business decisions.

Joe...In a Chapter 11 bankruptcy, the existing shareholders are typically wiped out (or nearly so) and new stock is issued to bondholders and other creditors. They would be the ones to select the new management.

I'm not sure it would be all that difficult to find executives to run a company which was already in the Chapter 11 process, if it had good business fundamentals...the debt overhang is eliminated, and any stock or options grants will probably be on favorable terms. The "continuity" issue may or may not be a real problem...in some cases, the problem is that there has been too *much* continuity.

David,

Fair enough. There might still be a problem in implementing such a requirement. The law would have to specify who is considered senior management (and perhaps how long they have to have been with the company in order to be subject to the law). This would be hugely inflexible. You could let a judge decide, but does it make sense for a jurist (or anyone) to start apportioning blame between managers for a business failure?

We should not equate corporate bankruptcy with personal bankruptcy. A better comparison is with an individual losing his or her job. If you don't do your job well, you get fired, and the boss finds someone else to do it. If a corporation doesn't do its job well, it gets fired, and the public finds someone else to do it.

The judge in a personal bankruptcy must consider the survival of the individual. This should not be the case in a corporate bankruptcy. It is ultimately in the best interests of the public to fire a failed corporation.

I work for a corporation that went into chapter 11 a couple of years ago. How it finally worked out was that one company (call them Angels, Inc.) bought out all of our liabilities (at a considerable discount, no doubt), canceled out the existing stock certificates, traded most of the bonds and other debts for new stock, and replaced top management by promoting from below. The old management also held most of the stock; I think they got a few cents per share to go away(the IPO a few years earlier was at $12). Business conditions are still pretty darned tough, but we're rid of the over-ambitious idiots that spent us into bankruptcy and of the excessive debt payments they plunged us into. Not sure yet whether they've just been replaced by new idiots...

Anyone undeservedly hurt here? Maybe the employees that plunged their savings into company stock right after the IPO, when it briefly surged to $16 before it began a long steady decline to penny prices, or maybe they just paid the price for stupidity. I recalled all the inanities I'd seen issuing from headquarters, and hung onto my money.

Now, this might not be the typical chapter 11. We've got customers that know it would be very difficult and take a very long time to get another source for our products - so much so that, if "Angels, Inc." hadn't shown up, they'd probably have been trying to buy the manufacturing plants. And that's probably why "Angels, Inc." thought a rescue would be worthwhile. Since "Angels, Inc." bought out or reached an agreement with every other stakeholder, I suppose the judge's final decree discharging the bankruptcy just rubberstamped their arrangements.

We should not equate corporate bankruptcy with personal bankruptcy. A better comparison is with an individual losing his or her job. If you don't do your job well, you get fired, and the boss finds someone else to do it. If a corporation doesn't do its job well, it gets fired, and the public finds someone else to do it.

Errr not quite. If the corporation owes you money you're basically screwed when it goes bankrupt just as you are if an individual owes you money and declares bankruptcy.

The judge in a personal bankruptcy must consider the survival of the individual. This should not be the case in a corporate bankruptcy. It is ultimately in the best interests of the public to fire a failed corporation.

The 'public' does not own the corporation. The corporation is owned by stockholders who would like to either liquidate the company and receive the value of its assets or allow it to continue operations and generate income. The corporation owes creditors who want to get paid. The judge weighs everyone's interests but the creditors get more consideration because of their status under bankruptcy law. In some cases it is in everyone's interest for the company to continue since that way it has the best possible shot at paying back the most creditors...other times it is more logical to just break it in pieces and sell it off.

Boonton,

Re; "If the corporation owes you money you're basically screwed when it goes bankrupt just as you are if an individual owes you money and declares bankruptcy."

Define "screwed". Losing money on a business deal and being left homeless due to personal bankruptcy are hardly the same thing. Certainly a corporate bankruptcy may lead to individual bankruptcy. In which case, the individual will be protected under the latter and there is no need to protect individuals under the former. To do is to halt necessary creative destruction, the result of which is stagnation. This is a far greater danger to the public than the loss of any particular enterprise - no matter how big.

Re; "The judge weighs everyone's interests but the creditors get more consideration because of their status under bankruptcy law."

Which is as it should be. My only concern is when the government steps in to prop up what should be a failed enterprise. It is politically expedient to appear to protect the interests of those who will be injured in the failure of a large enterprise, but it is not in the public's long term best interests, which are best served by the creation of a more efficient enterprise.

A better comparison is with an individual losing his or her job. If you don't do your job well, you get fired, and the boss finds someone else to do it. If a corporation doesn't do its job well, it gets fired, and the public finds someone else to do it.

Well, yes, except that instead of firing one specific person for that specific person's faults, you're firing a whole bunch of people for the faults of (most likely) a small subset.

"Firing" a company doesn't happen in bankruptcy court; it happens when people choose different companies, or choose to do without, because of the company's incompetence. Bankruptcy court comes when the company can't find enough people to hire it.

Which, by some coincidence, is a lot like what happens when a person can't find a job that pays well enought for the lifestyle the person has.

So personal bankruptcy and corporate bankruptcy are more like each other than we thought.

Jeff,

Re; "...except that instead of firing one specific person for that specific person's faults, you're firing a whole bunch of people for the faults of (most likely) a small subset.

The public can and often does fire an enterprise in situations where there is no fault at all. Times change. More efficient methods arise. The basic cause of UAL's problems is not something they did wrong, but competition with new efficient competitors which keep them from raising prices. So too with GM and Ford. Creative destruction happens - and must happen.

What will happen when UAL finally does go under? Demand for air travel is high. Investment capital is available. UAL's assets and workers will be available for a reasonable price. My guess is that UAL will be replaced by several smaller airlines operating along the lines of Southwest. Most of the workers will be reemployed, though probably not at the union wages they have become accustomed to. UAL investors will learn that bigger is not always better. Prices for air travel will rise. This is good - a viable enterprise has to charge a price which returns a profit. Some will decide they would rather telecommunicate than fly. This is also good - it will drive improvements in telecommunications. For the public, service will improve and flying will become a less miserable experience.

The folks on the "save United!" bandwagon seem to be worried about what would happen if _all_ the major airlines ceased operations. What they're ignoring is the fact that one major airline going out of business would _improve_ the climate for its competitors. The market for premium air seats is massively oversupplied right now, so it's no real surprise that nobody's making any money in it.

Of course, the crippling effects of the unions won't go away with a major carrier's shutdown, nor will the mostly-unique airline problems caused by the extraordinarily high ratio of fixed costs to marginal costs and the perverse pricing incentives that creates. But one less competitor in the market means many fewer planes flying half-empty, and thus a lot more flights with a fighting chance of profitability.

The availability of Chapter 11 bankruptcy is a good thing...most businesses have a better chance of paying off their debts by continuing to operate under a restructuring agreement than by selling off their assets at fire sale prices, throwing everybody out of work, and turning over every cent they can scrape together today.

But there's a big difference between a legal remedy available to any insolvent business and special treatment for one big company that's perceived as "too important to fail".

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