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Guest Post: Rewarding Failure
Submitted by Thomas Ryan, CEO of Doddsville Investments
Every day we hear about proposed caps on CEO pay, and new regulations to make sure companies are not rewarded for failure. Nowhere is failure being more greatly rewarded than in the United States bankruptcy system. R.H. Donnelley, one of the largest yellow page companies in America, declared bankruptcy earlier this year. The Company had over $500,000,000 of cash on hand when it declared bankruptcy and has generated positive cash from operations every month since declaring bankruptcy. R.H. Donnelley had no debt coming due in 2009, and received an unqualified opinion, a clean bill of health, from KPMG during its audit. The Company is projected to make hundreds of millions of dollars in cash from operations in 2009 and will have an estimated EBITDA of $1 billion dollars. This information is all publicly available in R.H. Donnelley’s SEC and bankruptcy filings.
Why did R.H. Donnelley fail when shareholders were against the bankruptcy? There is one simple reason: The CEO will make more money bankrupting the company than keeping it alive. It takes a year or more for shareholders to elect new board members who in turn elect the CEO. As a result, when the CEO and board of a company feel threatened they may lose their jobs; they can wipe out current equity at any time regardless of the company’s financial condition by declaring bankruptcy. David Swanson, R.H. Donnelley’s CEO, cut a deal with bondholders to keep his job and have management acquire a 10% stake of the Company when it emerges from bankruptcy. Management had approximately 1% of the shares before bankruptcy. Equity was destroyed before the shareholders could have the CEO or the board members removed. The Company has wiped out six billion dollars of debt through the bankruptcy process and significantly lowered its debt service payments. A conservative valuation puts Management’s 10% stake at a couple hundred million dollars. The stake could be worth considerably more if the economy recovers over the next few years. I believe this is a clear breach of management’s fiduciary duty to stockholders.
This bankruptcy certainly did not need to happen. The debt markets, which were locked up for the better part of two years, have thawed in the last few months. The company generated over $100 million of cash flow in the latest quarter according to the latest 10-Q and could have used this money to pay down debt. There were dozens of other options besides bankruptcy that would have protected the interest of equity, but none of these other options would catapult David Swanson into the legions of the super rich. The worst part is that the U.S. Bankruptcy Court and the U.S. Trustee allowed this to travesty to occur. The watchdogs are allowing this to happen, and encouraging corporate behavior that is harmful to all Americans.
This is not to say the Company did not have problems. R.H. Donnelley had a lot of debt because of a slew of acquisitions it made over the last decade. David Swanson orchestrated the acquisitions and the board of directors, Barry Williams, Edwina Woodbury, Thayer Bigelow, Robert Kamerschen, Alan Schultz, Michael Connors, Ronald Rittenmeyer, David Veit, Thomas Reddin and Nancy Cooper, approved of the Company’s business strategy and acquisition binge. The problems that the Company had were the direct result of inept management. Management should be removed as a consequence of poor decision-making, not rewarded and supported by U.S. bankruptcy courts. The current corporate governance system rewards failure. R.H. Donnelley sold a billion dollars in bonds last year and made only one interest payment before voluntarily defaulting on its debt. One can only wonder what would happen if a homeowner walked away from their mortgage after one payment. Would the homeowner be rewarded in the same manner? The Company’s actions not only negatively impacted the equity holders and bond holders, but also Company employees who put in years of sacrifice to make the Company a success and the retirees counting on a pension. Many stockholders were also the Company’s employees and retirees. These people were doubly hurt by the bankruptcy. The CEO and board of directors must be removed upon the failure of a company rather than be rewarded with hundreds of millions of dollars. This is what happens when banking institutions are taken over by the FDIC, and it should be what happens when any public company fails. Management must be held accountable for its actions.
There are three major problems with allowing a company that is still able to service its debt and generate positive cash flow to voluntarily enter bankruptcy. The first is the tremendous human cost to all the workers; retirees and investors who had believed their contracts would be honored. The second problem is that allowing solvent companies to declare bankruptcy raises the cost of capital for all companies. If a company that can pay its debt is allowed to enter bankruptcy, then investors will require a higher interest rate due to the increased risk of all companies defaulting. This will make it harder for companies to undertake new projects and reduce corporate profits. Fewer projects will be profitable for companies, and hiring will suffer as a result. It will mean fewer jobs in America. Finally, it will create a major incentive for other companies to follow suit. If one major company is allowed to file bankruptcy, that company has a tremendous cost advantage over its competitors. The company can under-price the competition and win new business. The companies that declared bankruptcy will be able to earn more money than competitors. Companies unencumbered by debt and legacy costs will use these earnings to expand. This will force other companies in the industry to declare bankruptcy to compete. This will harm all stakeholders and further reduce the returns for investors like pension funds, endowments, insurance companies, banks and individuals. It will again cause the cost of capital to rise further for all companies, and further reduce employment.
Congress needs to address corporate governance immediately to make sure the failures of the last few years are not repeated. Bankrupting a company should be a last resort for a company, not a winning Powerball ticket for the CEO. The current system is not only encouraging risky behavior; it is actually encouraging corporations to default on their debt. The human cost is too high to allow this to continue. We must act now to make sure failure is no longer rewarded in bankruptcy.
Sincerely,
Thomas Ryan
CEO Doddsville Investments
Largest Shareholder of R. H. Donnelley
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Wow, just wow. Thank you for sharing this. I honestly did not think that was possible.
Wall + firing squad + CEO = Justice
30' of boiled 3/4" hemp rope + gravity = Justice
Un-fucking-believable! Great post Mr. Ryan.
I wonder -- is there no recourse? I think the former shareholders ought to file a class action lawsuit, with Doddsville Investments as lead plaintiffs. I got the feng shui figured out; David Swanson can share a cell with Ken Lewis.
I think some of this might be unintended consequences from the Chrysler secured bond holder fucking the Obama Admin blessed.
I suspect some company BODs/CEOs are feeling a bit more bold now-a-days. I mean, can the President bless the Chrysler screwing and then push back against a similar scam? Maybe, maybe not.
I don't really understand all the legal ramifications of the Chrysler "thing" so I might just be talking off the top of my head. But something tells me they are related.
It's the Wild Wild West out there these days.
Good point, this is all a slippery slope into serfdom. Did you hear Barney Frank's support for taxing every trade transaction? Now, not only will you be potentially anally raped for holding equity (see: Doddsville Investments); you'll be guarenteed a raping for trading it. Capital gains need not apply.
It seems the solution to every problem these days is K-Y jelly.
Touche.
As K-Y Jelly is one of the byproducts of petroleum, your theory has sufficiently explained the new highs in Oil prices.
As K-Y Jelly is one of the byproducts of petroleum, your theory has sufficiently explained the new highs in Oil prices.
LOL spit-my-coffee-at-the-computer-screen tears-in-my-eye funny shit.
K-Y by the barrel. Hilarious.
Yep, I have an acquaintance who works at Donnelley and the bankruptcy was planned to eliminate X in order to leave time to come back and achieve Y.
Third world isn't quite as third world, anymore. Better to bribe then to be subjected to our arbitrary property "law".
- The first thing we do, let's kill all the lawyers (I know it doesn't apply, but it's fun to say).
I pledge allegiance to the Banana Republic of the United States of America.
Sounds rather catchy, doesn't it. Sadly, we're more than halfway there. We just don't want to admit it.
Banana-rama... since Government Sachs is cornholing us with one...
A bit off-topic, I personally prefer The United Vassal States of China, but that one is still a few years off, when the bills are due.
Welcome to the new Amerika Tom,the rule's have changed(sorry no memo cc)
the bankrupcy laws are way too lax .. in aust directors and/or ceo's are banned from holding positions for at least 5 years
I have some trouble taking this post seriously. The writer is the self admitted largest shareholder of a company that even the rating agencies understood was going to go bankrupt months before the event. The company's major business is printing phone books. Not exactly a growth business, we can all admit, and heavily dependent on advertising. $1 billion of EBITDA in 2009 on $12 billion of debt still makes the equity worthless.
Assuming the writer acquired the stock before the BK, one would hope that his investors question his own fiduciary responsibilities. Assuming he bought the stock after the filing, he must hope that he has a case in BK court. How many equity holders get a spot in reorg committees? Not many, and therefore the same conclusion as the first sentence.
How is this not an egregious example of dangerously incompetent decision making? Why isn't ZH ripping this guy apart? It seems terribly irresponsible, even if his existential point is interesting.
I am not a BK specialist, so if someone has better info, or if the poster has an explanation, I am all ears.
I think there's some truth to the post and some truth to this comment. Bankruptcy law allows solvent companies to file -- e.g., Texaco back in the 80s after a heavy court judgment -- but it's rare. There's still a good faith requirement, both at the outset and at the time of plan confirmation. If someone raised the facts in an evenhanded manner, and if we're getting the full set of facts here, then perhaps good faith could not be established. And it's true that IF the company is solvent, then the CEO should have been exercising his duty to shareholders. If the company were insolvent or dangerously close, then the law (arguably -- this concept has been called into question) transfers the fiduciary relationship to the unsecured creditors.
Still, I agree with the commenter that there's probably more than meets the eye here. I too saw a number of reports listing Donnelly as one of the biggest bankruptcy risks for months before it filed. Clearly there's a reason for that. Also, it's a shrinking business, as evidenced by the fact that one its biggest competitors, Idearc, is also in bankruptcy. So I too am suspicious that the poster is talking his book, or some bankruptcy parallel thereof.
then give us some facts to support your case.....
the writer provided his facts and they seem
prima facie credible. the core issue is that
options other than bankruptcy were available....
my god we have seen cit an 800 poound strip
tease artist do a table dance on schroeder's piano
avoiding bankruptcy so i don't see how rh
donnelly with purportedly vastly superior reserves
would not be able to fair much better....
the argument that the phone book business is in
decline is a total non-sequiteur....the financial
data supplied above are the relevant criteria....
until someone supplies specific details contradicting
the case the presented, i believe that massive
fraud and fiduciary direlection are matters which
should eventuate in a completely new board
and endless lawsuits hounding these crooks from
management....
I don't have a case and didn't mean to suggest that I do. I just said I was suspicious. I'd like to hear both sides before deciding.
Well, if you read the original post carefully, you will note that the very same CEO was the one who loaded up the debt to begin with, which was a necessary precondition to claiming the entity had too much debt driving the need for bankruptcy protection.
The only question that remains is intent, but any time the CEO increases his net worth while his shareholders decrease their net worth, I personally think the intent is crystal clear.
The smoke is so heavy and we are just getting stoned over the $$$$$$ we are going to make!!! TFG for bankruptcy court!!
I'll be damned.
Who ever thought all those Cheech and Chong skits were actually visions of the future?
Ah...
Once in a while i drop into ZERO HEDGE...to see what the lunatics are thinking...still a bunch of rebels without a cause..they moan about Goldman Sachs in one breadth..while they curse at czars and cutting bankers pay in another..
Maria seems to revel in dropping buzz words like socialism...or feign ignorance about how we got to our present predicament...(republican administration...with wild wall street jubilation intervenes in markets...)..now everybody thinks its cool to blame OBAMA...
truth be told OBAMA would be reckless if he didnt do something about these pay packages...the last thing one needs in fragile times like this is another dose of populist outrage...it distracts from sensible Governance...
therein lies my gripe with the author of this piece...its too simplistic...what u should be pointing out is that perhaps OBAMA is trying to keep the masses at bay with this one...and discuss the pros and cons of such action...
u see i get the feeling that half the cats that post on these boards(especially the ZERO HEDGE phonies..) dont know the real world...they live in a bubble where its okay to let companies fail...get 20% plus unemployment..and when the riots hit the cities...they are probably rich enuff and spoilt enuff to take the next plane out to france or canada.........
well lucky for the rest of us...we have leaders that look at the big picture...for whateva u may disagree with current policy....we have staved off a depression...basically retraced to DOW 10,000+...avg 401k is higher than it was at 2007....(i know mine is)....
sometimes it pays to know when to give it up..and move on...alas..it seems like MARIA and the rest of u PHONIES on ZERO HEDGE...dont know...like they say a bad clock is right twice a day...so maybe u guys will still be around when the next crisis hits in 15yrs...sigh.
You said, "they live in a bubble where its okay to let companies fail...get 20% plus unemployment..and when the riots hit the cities...they are probably rich enuff and spoilt enuff to take the next plane out to france or canada......"
- You're the one living in the bubble. And your 401K buys 30% less then it would have 10 years ago. And by the time you're 75 and too feeble to do anything about it; you'll have $500,000 in your 401K and still be broke and living on cat food, because you'll need that $500,000 for your medication (which will be running $1,000 per day) - and Obama will be giving the commencement speech at your alma mater and his fee will be $15million for a 20 minute appearance. He's going to be fine, you're the one who's going to be in trouble. So while your idolatry of the messiah might last a couple more years; we (the ZH readers as a group) know better. You are not only mistaken in your thinking, but appear to be lacking in any understanding of what it will take, financially, to survive the next 25 years.
The shit is still going to hit the fan - it just may take a little longer. And when it does, I'm going to buy your wife with one of the 10oz silver bars I have in the safe and still have money left over to hire your daughter as well.
www.cretincountry.blogspot.com
My the Goldman Sucks sock puppets are busy today. Whats amata? Not busy sucking Geithner's wang today?
What was the stock price in the months leading to bankruptcy? Almost nothing. That's because the market had decided the company was worth less than the debt. The bankruptcy judge agreed or he would have thrown out the case. EBITDA was falling rapidly and continuing to pay out cash was just postponing the inevitable. The YP companies need to spend to transform into Net rather than printing companies and the debtholders knew that. Regardless of management's intentions, on the first covenant violation the lenders would have declared a default to stop sending money to those lower in the capital structure. That they chose to keep management was their choice, not a certainty for management. This was not a smart equity investment. Focus on enterprise value, not short-term positive cash flow.
Another fine example of agency theory. Management exists for its own benefit, shareholders be damned. Why does anyone continue to own equities?
Had NO idea such things were going on and I'm no rube about our financial system.
If you watch mainstream media its individuals suing companies that are ruining our society, and its individuals filing personal bankruptcy when all they did was overspend (not true if cause majority of bankruptcy due to health issues/health costs)
and yet is business by far the worst immoral actors, and abuse of our legal system and bankruptcy laws...not that some individuals don't act badly, but if we start with worse offenders that do the most harm the common wealth...its big businesses in certain industries, they act as if they are above the law..just us little people should be honest and pay our debts..
wow. This is just beyond wrong. I'm...speechless.
That's crazy. Thanks for posting this.
If you would like to look at the one place that has institutionalized rewarding failure time and again, look at the government. It is the only place where getting fired for anything other than what looks bad is unheard of. Where even if you commit crimes you get a pension and nice speaking fees or lobbying credentials. Where you can reward one party at the expense of another (take from a successful business and prop up a failing one) or (take money from a hard working citizen and spend it for votes from a loafer) and call it "equality".
The quality of government in general reflects the bountiful rewards of failure.
Mr Ryan,
Sorry to break this to you bud, but you bought stock in a massively levered phone book company. And you blame the company for entering bankruptcy?
I think you've got no one but yourself to blame. Sorry.
There is an excellent article about a similar situation with the Simmons Bedding Company. The article is called "Buyout Firms Profited as a Company’s Debt Soared" and it originated with the New York Times but is easy to find on the internet (for example, at http://www.cnbc.com/id/33177139).
Read it if you want to be further enraged about the state of "management" in the U.S.
Ryan -- what a whiner!
Ryan could have hired his own $800 per hour lawyer to draft a competing plan of reorganization using the debtor's disclosure statement.
If that 10% management piece is such a plum, Ryan could have acquired that piece for the other unsecured creditors and installed his own puppet management to run the company.
With hundreds of millions if not a billion or more at stake, instead of whining in a letter, Ryan should have done something about it.
Such as? Use the same framework plan, offer bondholders a slightly better spiff, and screw current management by firing them without severance.
The remedies -- possibilities were only limited to the imagination.
Oh yes, I practiced commercial bankruptcy law for a decade.
A fool and his money...
They should hack a guy like this up in the middle of the street with a machette and then burn him on the spot.
This happened to National Gypsum in the early '90s. Goldman Sachs took it into bankruptcy. LaFarge Cement owned the common--that became worthless. Someone named C.D. Spangler ended up owning the company. Owners of the OID 15.5% Subordinated Debentures were represented by Wilbur Ross, who got them out alive, with warrants. At the same time they were being put into bankruptcy Boeing was assured that there would be no problem. Austin Consulting wholly owned by National Gypsum was the general contractor for Boeing's 777 plant. The plant was built on time as far as I know even as National Gypsum vanished.
So why did Ryan leave out the fact that Donnelly had $12 billion of debt to service with only $1 billion of EBITDA and a primary business (phone books) that is a dinosaur?? He honestly believes they went through bankruptcy JUST to enrich/entrench management?? Then boy are those debt holders who took a $6 billion haircut on their investment really stupid too. Wow. That is nonsense. He is talking his book. Memo to file: never buy a Doddsville managed investment.
And given his grave concern post-bankruptcy "that company has a tremendous cost advantage over its competitors," I sure hope he was pounding the table on the Government throwing money at Chrylser and GM -- talk about advantages! He must fully support only buying Ford or Foreign Cars - as I do.