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Thursday, October 13, 2005

Financial Times: The Danger of Rewriting Chapter 11

This is an interesting perspective on bankruptcy law. The quotes, "How irresponsible of a company that goes into Chapter 11 to be in dire financial straits at the time" and "...managers in Chapter 11 ... can get richer by persuading the hourly-paid workers to become poorer" set the tone:

John Gapper: The danger of rewriting Chapter 11, Financial Times: Steve Miller, chief executive of Delphi, was in New York this Monday to explain why he was putting the Michigan automotive parts supplier into Chapter 11 bankruptcy. “We are broke,” he said, holding his hands in the air. “I am sorry to be the one delivering that message.” Mr Miller did not look very sorry. In fact, he seemed like someone whose bargaining position with his employees had just become a lot stronger. Instead of having to wheedle unions into accepting cuts in pay and benefits for Delphi’s 34,000 hourly-paid US workers, he can threaten them with the company defaulting on its defined-benefit pension plan. Nor is Delphi broke. It may have lost $600m (€499m) in the first half of the year, but it has plenty of cash to tide it through the two years that it could be in Chapter 11. ... As Mr Miller also observed, Delphi’s bankruptcy is “well-financed, well-organised and well-planned”. He disdainfully compared Delphi’s approach with the “disgrace and embarrassment” of Collins & Aikman, a parts supplier that went bankrupt in May amid a liquidity crisis and asked customers to pay more to maintain production. How irresponsible of a company that goes into Chapter 11 to be in dire financial straits at the time.

Organised labour, meet organised capital. Chapter 11 of the Bankruptcy Code used to be regarded as a bizarre US arrangement allowing a troubled company’s managers to stay at the helm and restructure instead of being kicked out by the creditors. Eastern Airlines went into Chapter 11 in 1989 and remained there for two years losing money before collapsing. These days, ... Chapter 11 has become a device for reasserting management fiat over workers with the backing of bankers. Financiers have forced steel industry employees who were used to being highly paid to accept lower wages and fewer benefits. Delphi’s Chapter 11 filing suggests Detroit’s workers and retirees are next in line. ... David Skeel, a University of Pennsylvania law professor, says ... managers are given very large financial incentives to act rapidly and to take tough decisions. Delphi, like most Chapter 11 filers, had negotiated so-called “debtor in possession” (Dip) finance from Wall Street before it went to court. ... The covenants on such loans tend to be structured to give managers sufficient time to negotiate a restructuring but to discourage them from hanging around.

Even more pertinently, managers in Chapter 11 cases have their eyes on the prize of cash and equity bonuses if they can work the company into shape speedily without it having to be broken up. Delphi plans to award up to $87m in bonuses and 10 per cent of equity in a new company to its 600 most senior managers. They can get richer by persuading the hourly-paid workers to become poorer. Thus Chapter 11, which used to enable the managers of companies in difficulty to avoid both their creditors and hard decisions, has become fearsomely effective. ... All of this carries a price. They say you should not visit a sausage factory if you like eating sausages and in this case the ingredients being ground up for profits are health and (perhaps) pension rights. It does not take a union activist to be disturbed by the prospect of Delphi workers losing benefits that they dedicated their lives to gaining by working there. The stark contrast between workers’ losses and managers’ gains was one reason for changes to Chapter 11 in the bankruptcy reforms that come into effect next week. The new law bars companies from paying managers Chapter 11 bonuses and limits the time during which they have the sole right to propose a restructuring plan. ... Like many political interventions..., the reason for the changes is understandable but the danger of unintended consequences is considerable. The law reduces both the carrots given to managers and the sticks they can wield without putting much in their place. If managers have less incentive to sort out the financial problems of US rust-belt industries, who will take on the job? There is little sign of Washington doing so. Efforts to reform ... the Pension Benefit Guaranty Corporation – the federal safety net for underfunded schemes – are now stuck in Congress. Politicians tend to be happier handing out subsidies to companies than imposing rules that will upset potential voters. ... The spectacle of Delphi’s “well-financed, well-organised and well-planned” Chapter 11 filing is strange but it at least promises action. The alternative is to let the industry’s problems fester and its companies drift into, well, bankruptcy.

A lot about this article surprises me. For instance, it seems to say that Delphi is not in serious trouble and bankruptcy is a being used as a way to restructure and to force labor to accept lower wages and reduced benefits. I don't see how creating a financial incentive for managers to lower wages and benefits necessarily improves efficiency instead of creating a distortion.

    Posted by on Thursday, October 13, 2005 at 01:50 AM in Economics, Health Care, Income Distribution, Regulation, Unemployment | Permalink  TrackBack (0)  Comments (17)


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