Venture capitalist Chamath Palihapitiya has recently made headlines with his strongly worded beliefs that the government should not bail out large corporations that are facing bankruptcy as a result of the recent economic slowdown.
The argument being pushed by these companies is that if they are allowed to fail, there will be great broader economic damage from the resulting layoffs, so a bailout for the company is a bailout for the employee. Palihapitiya doesn’t buy this, and in an interview with CNBC, he explains why he is so skeptical.
Who is being bailed out?
Palihapitiya says that bankruptcy does not punish the employees:
“This is the lie that’s been promoted by Wall Street. When a company fails it does not fire its employees. It goes through a packaged bankruptcy. The people who have the pensions inside those companies - 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 of debt, or the folks that own the equity - those are the rules of the game, because these are the people who purport to be the most sophisticated investors in the world.”
I wholeheartedly agree with this position, and I think that every value investor should agree with it as well. What is the point of doing due diligence on a company, figuring out the strength of its balance sheet, assessing its management and their ability to prepare for unforeseen shocks and carrying out all the other necessary checks and research if the government is going to ride to the aid of every mismanaged big corporation out there? If anything, this creates a perverse incentive for investors to seek out the most short term orientated companies, because they know that the government guarantee will always be there. This is a classic example of moral hazard.
Moreover, as Palihapitiya pointed out, the companies that would be bailed out are the very same companies that spent trillions of dollars (in aggregate) on stock buybacks and dividends. Executives should only return money to shareholders when they are unable to redeploy it efficiently inside the business - that’s Corporate Finance 101. Clearly it would have been beneficial for corporations like Boeing (BA, Financial) and American Airlines (AAL, Financial) to build up a cash buffer that would have protected them against an exogenous shock. It would have been in the interest of a company like IBM (IBM, Financial) to redeploy capital to counteract its falling revenues.
But rather than doing any of these things, management teams across the country chose to buy back shares at increasingly inflated levels (profiting nicely in the process from their own stock options), and are now begging for the government to bail them out. The people who made the worst decisions, putting their companies at the most risk, are the ones who stand to benefit the most. This should not be allowed to happen, and if it does, the investing world will be turned on its head.
Disclosure: The author owns no stocks mentioned.
Read more here:
- A Brief History of Junk Bonds, Part 2
- Black Monday 1987: Why Investors Should Be Wary of Automated Selling Strategies
- Seth Klarman: Why It Is So Hard to Have a Long-Term Perspective
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