As Goes General Motors
As of today, General Motors’ market capitalization (the combined value of its shares) is about $16.5 billion. In 2005 alone, GM lost $10.6 billion and by all accounts the losses continue. The positive value of the stock reflects a chance that the company will turn around not an indication that it has. Even so, the company can for some time continue to suffer losses at this or higher levels and still not default on any of its loans. All it need do is borrow from Peter to pay Paul, and GM is doing just that.
In late June, the automaker announced that it would refinance $5.6 billion in loans, a move it described as a "positive action toward additional financial flexibility." This action is "positive," no doubt, for GM managers, employees, and shareholders, each of whom would like to buy time for a reversal of fortune. But no such reversal is guaranteed, or even likely, and thus not every corporate constituent is pleased by the company’s new liquidity. The new loans are secured by collateral that gives the holders priority over GM’s unsecured bonds. Should the company continue its losses and default on its new obligations before it pays off the bonds, the bondholders will be left with little or nothing to collect. In anticipation of such an event, both Standard & Poor’s and Moody’s investor services cut the credit rating of GM bonds, which were already classified as junk. So while GM may consider the refinancing a positive step, the news is not necessarily good.
The General Motors response is straightforward. It has done all it can to survive. It has not only refinanced some of its loans, it has also moved to reduce its workforce and assembly capacity, with the goal of increased efficiency. It has contributed to worker buyouts at Delphi, its largest supplier, in an attempt to prevent labor strife there that could cripple GM production, and it has asked its own workers for concessions. It will introduce new car lines and announced plans to restructure the way it markets its brands. Most recently, it said that it will consider a joint enterprise with competitors Renault and Nissan, a step recommended by GM shareholder Kirk Kerkorian. What more can GM do?
That General Motors may have taken every reasonable step to assure its survival does not imply that it has taken the right steps. Perhaps GM should not attempt to survive. The company’s financial losses have not been visited upon it randomly. Rather the losses have been earned the old fashioned way, through the manufacture of expensive, unpopular products. Of the $10.6 billion in 2005 red ink, $3.4 billion was operating loss, which reflects not debt burden but real resources consumed in excess of revenues received. This is not a problem that can be fixed with new loans. The planned overhaul at General Motors might restore profitability, but given the stiff competition, it might not. GM’s market share—though roughly a quarter of U.S. new vehicles—has fallen and continues to fall. Perhaps the best course for General Motors, then, is to give up any attempt to continue in its current form.
The company might instead voluntarily file a Chapter 11 bankruptcy petition, which would free it from debt payments and permit a rational disposition of its assets. GM’s profitable brands could be retained or sold to competitors, who could also stand behind warranty commitments and assure the availability of parts for current models. The rest of the company would be liquidated piecemeal. Workers would suffer, but fewer might lose their jobs than will be the case if GM holds out until the last penny is spent, when there may be nothing left for anyone to salvage.
Voluntary bankruptcy may seem anathema to corporate management, but almost all corporate bankruptcy cases are voluntary. That is, managers do eventually accept the inevitable and one would expect that the GM managers ultimately will as well. The question is whether they have already waited too long.
They would not be alone if they have. In a just-completed study of large U.S. corporate bankruptcies, Vedran Capkun, Larry Weiss, and I found that in recent years financially distressed companies have waited longer than in the past to file. Thus, by the time today’s financially distressed firms enter bankruptcy they are more heavily indebted than in the past and have burned through more value that might have been rescued with an earlier petition.
Ironically, the likely cause of this change is the greater role creditors now play in the bankruptcy process, formerly dictated by a firm’s management. Creditors are now tough on managers and shareholders once a firm enters bankruptcy, with liquidation a far more common outcome than in the past. As a result, today, few firms that have failed as businesses as well as financially are allowed to reorganize in Chapter 11 and continue as before. The result may be greater returns for creditors from the assets available when a firm enters bankruptcy, but the tougher landing for management and equity has increased management’s incentive to stay out of bankruptcy in the hope of a turnaround, even against all odds and at great cost.
There is an apparent dilemma, then. Leniency yields losses as a result of the bankruptcy process while stricture yields losses in anticipation of that process. There is a solution. The law, or creditors by contract, might make it more difficult for financially distressed firms to stay out of bankruptcy. This could be accomplished if new loans were not permitted to have seniority over (or earlier maturity than) the loans they replaced. Had GM, for example, been unable to refinance its debt with secured loans, refinance would have been unattractive to the lenders, who, like holders of GM’s unsecured bonds, would be left in the unenviable position of general creditor. The lenders, in turn, might have offered new funds only on terms so unfavorable to General Motors that refinance would not be a viable source of liquidity. Bankruptcy might then have been swift and for the better.