Managing GM

The WSJ reports: Jerome York is on the board, GM may have cut its dividend as York’s boss Kerkorian wants, GM is considering a sale of GMAC (one reason why ML CEO O'Neal resigned from the GM's board), and the rising price of insuring GM’s debt on the credit default swap market has GM lurching perilously close to insolvency.

GM might save itself by selling GMAC, which is probably worth more standalone than saddled with GM’s credit rating. The question is, what then? One scenario is that GM uses the cash to undertake a restructuring, but it’s not clear (at least to me) what that might entail.

Another scenario is that GM pours the cash from a GMAC sale down the rathole – that is, keeping its horrendously expensive job bank going. Of course equity holders wouldn’t like this. One wonders how much of GM’s current stock price, and what’s left of its credit rating, is a bet that GM won’t do that – and therefore whether shareholders and creditors will lose faith in the company if they see this scenario unfolding.

Amid all this, there is the question whether the GM board has any duty to take a particular course of action. More specifically, is GM in some “zone of insolvency” that would require the board to start managing the company in the interests of creditors? That might entail specific obligations to refrain from fraudulent conveyances, which theoretically could include continued dividends to shareholders. But those rules give the board has a lot of leeway in valuing the company and its prospects.

Another theoretical possibility is that the board has a “fiduciary duty” to manage the company for the creditors, which again might include cutting the dividend, as well as not making long-shot restructuring bets that might pay off for the shareholders but that might harm creditors. If the board is thinking along those line, it ought to look at my article with Kelli Alces, Directors’ Duties in Failing Firms. For all the rhetoric in the cases about duties to creditors in the cases, we find that the cases do not actually hold in favor of such a duty.

The GM situation is a good example of why. Consider the imponderables such a duty might present to directors. How would the directors be able to determine whether the company had entered the “zone”? What would the board have to do to properly balance the various interests? Precisely which actions would be deemed to breach duties to creditors? A decision not to declare bankruptcy? Particular kinds of restructuring? Which creditors must the board watch out for? Bondholders, or the workers in GM’s job bank?

It is to protect directors faced with such decisions that we have the business judgment rule. The fact that the decisions only get harder in the “zone” is a good reason for not suspending the rule by requiring the board to make particular tradeoffs at this point.

If GM does go into bankruptcy, what then? Probably Ford will follow. As the WSJ reports this morning, “[t]he trade follows the logic that car companies are like airlines: If one files for Chapter 11, others do so to keep their cost structures in sync and for leverage in labor negotiations.” That’s a cheery scenario – yet another US industry under interminable court protection. Do they shoot auto companies?

Is GM considering bankruptcy? One question here is whether the board has a duty to tell us what its thoughts are. One might think, if investors absolutely have to know the details of what executives are getting paid and why, surely they need to know about something as important as this. Given the really big ramifications to investors, creditors, and even Ford investors, isn’t even a minor shift in the board's thinking material?

The problem is that shifts in thinking are more subtle and variable than discrete events. And there would be real costs if a disclosure about bankruptcy plans caused a loss of faith by suppliers, customers and others that actually did tip the company into bankruptcy.

So it would seem that disclosure, like the other tricky decisions discussed above, should be a matter of business judgment. Of course, disclosure generally is not a matter of business judgment under the federal securities laws. And while investors get the benefit of nondisclosures that help the company in the long run, the managers of the firm might pay the costs if they get it wrong.

It must not be particularly pleasant to be a GM director or manager these days.  You couldn't pay me to do the job.  And the way things are going in compensation land, you won't be able to pay them, either.

Comments

[Robert Schwartz]

GM should have filed a couple of years ago. It may be too late now. Cutting the dividend in half is the sort of political compromise that has been killing them for years. The truth is that they have to stop the dividend sooner rather than later. They cannot survive the Chapter 11 without cash.

Political problems. One too many labels to market, badge engineered cars, too many dealers and a union contract they cannot afford. Just starters.