In the entire history of corporations, has there ever been one whose CEO said something like the following to his shareholders?
Your company is in a declining industry. Your company is currently profitable and will remain profitable for some time. But eventually, the forces that are causing the decline of the industry will catch up with it. While we could attempt to keep the company alive by trying to make a new product or catering to a different market, we have determined that it would be exceedingly difficult to do so, and attempting it would be a waste of your money. Your interests would be much better served by liquidating the assets of the company in an orderly fashion and returning your money to you. This we will do over a period of 10-15 years. Our employee strength will decrease over time, we will make every attempt to provide for a reasonable career transition for all of them. While they are at it, our employees will be judged, not by how much they contribute to the growth of the company, but by how well they manage its decline.
I hope you see what I am getting at. I know that many companies go bankrupt. When bankruptcy is inevitable, experts in liquidating the company and stripping its assets take over. I am not referring to that. I am looking for an example where a company planned its own orderly retirement over a period of time.
Take the example of music companies or a newspaper in the US. They are facing adverse market conditions. They are declining. But why should they fight so hard against it, rather than accept the situation and that their companies will decline over a period?
One objection to my suggestion could be that in these cases, while the market for CDs and for news papers has declined, there is still a market for music and for news. That is a fair point, and many companies would do well to try to explore the market. But the law of probability tells me that there will be some companies which, because of the way they are structured, will never be able to adapt to the changed conditions. Statistically, of so many companies, there should be at least one company with an enlightened CEO who manages to convince his shareholders that they are better off with a planned decline.
After all, companies do go bankrupt. Autopsies of most of those companies will reveal mismanagement or incorrect choices that could have staved off the ruin. But surely, there ought to be one or two cases where the autopsy will reveal that nothing at all could have been done about the decline, and the company would have done well to plan its closure than fight desperately against it?
It is puzzling to me why people plan their retirements much better than companies do. A person has emotional investment in himself. He cannot bail out of that. Employees of a company, on the other hand, have life outside their company. A CEO who manages the decline of his company well should still be able to find a job elsewhere with this on his resume?
I am not sure if much academic work has been done on this subject. Of course, I know of the BCG matrix, which talks of managing declining companies as part of a portfolio, but do we have anything else?
Very true. I guess most CEOs are full of themselves.
ladies and gents, there is a bomb in this building but we know for a fact that it will not blow immediately. our best estimates are that it will happen in 2 hours time which is sufficient for us make an orderly exit.
what happens next? 🙂
After raising the the most obvious objection to your case, you say…
“But the law of probability tells me that there will be some companies which, because of the way they are structured, will never be able to adapt to the changed conditions.”
That seems a little bit of a stretch. I would think a shareholder remains a shareholder because he thinks a turnaround is possible. We are all hoping for turnarounds, else we would make the sell decision ourselves; Not wait for the CEO acknowledgment.
Ajit, there are many problems with your analogy.
Losing your job after 5 years is quite different from losing your life in 2 hours. Staying on in a building with a bomb in it provides no obvious advantages, while staying in a declining company with a planned decline will still give you a salary and valuable experience which you can use while interviewing for your next job. And the most important problem is that orderly evacuations do happen, even though they are rare. The scenario I have mentioned has never happened, as far as I know.
Swami, your objection would be valid if no further value can be obtained from the company. I am talking of a scenario where it will continue to make profits for the next few years. Surely, there will be some value from the dividends and from the orderly liquidation of the company piece by piece?
Doesn’t the orderly liquidation usually happen after a takeover or other buyout? I think private equity deals are meant for this – buying companies in brutally competitive industries out from public shareholders who expect better returns.
A CEO who asks a Private Equity firm to buy out the public shareholders would probably not get as much media attention/ hype as a CEO who bitterly fights corporate raiders and gets immortalised as a Teldar Paper/ New England Wire and Cable.
I think Brealey-Myers did give an example of a company which performed a management buyout and then did exactly what a corporate raider would have done – I can’t recall it offhand though.
But why would anyone rule out a turnaround in that case? Particularly since you are talking medium-long term…
I think my main objection is to your line of argument that the way the company is structured – somehow will render the company incapable of taking a turn for the better.
And I am not sure what the law of probability is doing here. In a new market with a host of hungry startups then, the law of probability should tell you that some of those will fall by the wayside as the market matures. But none of them will be willing to accept they’ll be the ones who’ll fall. More importantly, neither would you (the analyst) be able to pick any with any sort of conviction.
As you can see, I am searching for the point you are trying to make.
Ravi,
The minute a CEO declares her company to be in a terminal decline, the first thing that will happen is all its creditors(banks) will want out. Apart from being senior to shareholders, bank loans to companies are priced only for default risk, so banks will opt out first leading to financial distress and eventual bankruptcy. The CEO may tell everybody about continuing profits – but why should the creditors believe you? Thus, creditors do have an incentive to back out before a bankruptcy and do so quickly before they may get screwed in the bankruptcy courts. Same goes for any customers that owe the company money. They have an incentive to not pay you back if they believe you will end up in bankruptcy anyways. The company’s vendors will also stop supplying since they will believe that the company may end up owing them money and they won’t get paid. Hence, the variety of stakeholders that surround this company will not believe the CEO’s assertion that the company will continue to generate cash.
Note that the CEO’s message in this case isn’t relevant at all. The shareholders are probably in only because they believe that the break up value of the company is greater than what they have currently. The scenario that Ajit described is not far fetched, in fact it is exactly what should happen.
Mikey –
I don’t think banks panic quite as much as people in a bomb-infested building. And they also decide on whether the company will continue to generate cash based on financial statements more than what the CEO says.
In an ideal situation, they would realise it before the CEO does, and start cutting back their lending before a CEO ever makes an announcement.
Ravi –
another thing which is especially applicable in India is that few companies/ groups are in only one industry or product. So they can happily use the BCG matrix and gradually unwind the dogs while pleasing the shareholders with the shooting stars.
Aadisht, with regard to your yesterday’s comment… are you talking of orderly liquidation or orderly decline? The distinction is important because my guess is that managing a decline is much more psychologically draining than managing a liquidation… It is one thing to actively liquidate a company over a year or two. It is one thing to slowly liquidate it over many years, while still running parts of it at a profit. Even though at first glance it looks like it will provide an adequate career to people, I think that when it comes down to it, it won’t.
Swami, the thing is, yes, most startups that are running think they will succeed even if they won’t. But some time or the other many find that they won’t succeed, and when they find that out, the only thing to do is close down. So by definition, you won’t find any startup that is still running and thinks it will fail. But a profitable company that sees its own end 5 or 10 years down the line does not have to close down immediately.
Mikey, apart from Aadisht’s reply, one other point is that a profitable, but declining company will not need that many loans. It will be generating cash from its profits and from the liquidation of its assets. Working capital loans, yes. But that will not be very difficult to find.
I am not an expert or an MBA person, but isn’t the decline factored into downside risks gradually over time?
Isn’t that a logical thing to do — rather than declare it, since it assumes the probability on the upside is 0?
Ravi,
All financial statements are backward looking, as in how they have done in the past. The CEO’s statement here is basically forward looking. As a creditor, I would worry more about what lies ahead if I want to be paid back. Maybe not panic right away – but banks will have to ask questions. The point is this can quickly descend into panic, if any one of junior lenders wants to bail out. Junior lenders would act first because they would have lesser control over the company’s assets in case of financial distress. All it needs is one person to cry “wolf”.
A very recent example of this in the U.S. was with mortgage lender, Countrywide Financial, which ended up getting bought out by Bank of America (one of Countrywide creditors), pre-empting a bankruptcy. It really is a classic case, with Countrywide’s customers defaulting, regulators demanding interest rate freeze and other creditors unwilling to lend, despite the CEO’s protestations to the contrary. BofA didn’t panic, only because it had the option of buying Countrywide out – but how many creditors are as strong as BofA?
Aadisht,
Agree with you on buyouts. However, not all buyouts are liquidations. Generally speaking, Private Equity buyers give the management incentives to sell out (shares, options) and stick with the company after taking it private. Thus, it works to management’s benefit to sell out rather than allow for an orderly decline.
Any CEO who makes such a statement would be removed for being incompetent. There are many instances of companies who are in a decline, but to state that it is in a permanant decline and to do nothing about it is simply wrong.
There are many things that a CEO can do. He can choose a different business for his company, e.g. Intel switched to microprecessers from memories in the mid 80’s. He can decide that a part of a business is not viable for him to run and can downsize or sell off that part. Then the company continues to operate as a smaller unit. These are just off the top of my head. A CEO has better resources and can come up with better ideas.
You dont simply give up.
I agree with Mikey. What this CEO is saying is, not only is the industry in a decline, but this company’s growth rate is also going to be negative.
Now as a shareholder, if I believe him, why should I continue to hold the stock when I know there is no scope of capital appreciation ? The only thing that is still attractive about this company is its cash flows. As it declines, it will continue to throw off cash. Which it will not invest anywhere.
Who will like this scenario best? A private equity guy. So if a CEO makes a statement like this, he is basically laying out the red carpet for a P/E guy to come and buy him out.
Enlightened CEO? Shareholder’s interest? NOT!
If a person is facing death, and an escape seems improbable, he doesn’t call up his relatives and friends and asks them to prepare for a funeral. He tries to fight it. Because struggle is the essence of life.
Similarly, a company facing a probable bankruptcy still looks at avenues to rescue itself, its employees, its shareholders, its creditors, etc. Even if it were to go down, it won’t go down without a fight, without an effort.
rishi, I think you are right in that any CEO who does so would be removed, but I still think that he should not. I agree that in the overwhelming majority of cases it is always worth putting up a fight. But there will be some case where putting up a fight will turn out to be the wrong and irresponsible thing to do with your shareholders’ money. In that case, it makes much more sense to make arrangements to systematically return their money over a period of time. To the extent the market makes it difficult for a CEO to accept this case, the market must be doing wrong.
Lekhni, the reason why a shareholder will hold the share is that he will get good returns when the company is liquidated. Money is money.
Amit, the difference between a company facing decline and a person facing death is huge. I have already answere your point above, in the ticking timebomb scenario.
That is my point exactly. If someone is unable or unwilling to deal with change he should be and will be removed.
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I dont think that it is possible to return any money to shareholders in such cases. What the company can give to their shareholders is only the dividend. The share price is generally a multiple of 15-25 times the dividend.
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If a shareholder thinks that a company will not survive a downturn, he should sell off the share and not continue to be a shareholder in that company.
>I dont think that it is possible to return any money to shareholders
It is. The company can buy back shares.