I think it's also worth noting that Risk of bankruptcy enables similar accounting games even for healthy company's. Basically a bank that's leveraged 10x might as well leverage 50x because the upside keeps increasing linearly with more debt but the downside is practically fixed.
The upside would not keep increasing linearly. When leveraging, the current debt burden of the company would be used to determine the level of risk and thus the interest rate.
The level is risk is associated with the level of assets of the company (thus the ability to recover in case of default).
I would agree that a bailout creates a floor to loss, but then again a natural floor exists anyways (the net assets of the company).
I wouldn't put any weight on an analysis by Megan McArdle either. I like Warren as a politician, am deeply ambivalent about her as a policymaker or regulator, have no idea about her credibility as an academic, and read McArdle long enough to know that her issue here is ideological, and that she's not particularly credible on issues that touch that ideology.
Preempting the obvious challenge to this comment: it's not that I'm going to point to any particular point in this particular blog post of hers and call BS on it (although I think it covertly lapses into subjectivity several times), but rather that her particular choices of papers and theses to take issue with aren't necessarily a fair representation of Warren, "scholar". Which is what her headline purports the post to be.
There was no way McArdle was going to be objective about Warren. That's a little bit like expecting Paul Krugman (not that I'm putting them on the same level!) to be objective about Paul Ryan.
> I wouldn't put any weight on an analysis by Megan McArdle either.
No one suggested "it's by McArdle, therefore it's good". (However, folks have suggested "It's Warren, therefore it's good".) Instead, let's look at the arguments offered.
Call me elitist, but I hardly think that a single story from a blogger/editor at the Atlantic is enough to discount all of the work of one of the preeminent scholars of bankruptcy law in the United States.
Warren has successfully defended her conclusions in academic circles for years.
We could use a bit more elitism. If the best criticism of Warren's work one can find comes from an innumerate like McArdle [1], it's probably pretty sound.
Another interesting thing to note about profit coming from bankruptcy is the Legal and Banking/Restructuring fees. The restructuring advisors both on the legal and financial side get massive fees from bankruptcy advising (negotiating debt settlements and post-bankruptcy cap structure, and other things like that) and these fees are prioritized over even the most senior liens of debt. These fees can literally be 1-15% of the total debt of the distressed company.
I live in Rochester NY, home of Eastman Kodak which is going through a bankruptcy, and looks like it may be coming out of it (probably will go back in it or get sold in my opinion).
I an not suggesting that Kodak's downfalls was due to management looting the company but we do see evidence of upper management grabbing all they can get. Just recently upper management asked for millions of dollars of bonuses (earmarked for upper management only) if Kodak successfully pays off its creditors. Bonuses use to be rewarded for turning a profit, apparently now you get rewarded for just paying your bills.
Not till they turn a profit. He still gets a more than adequate salary for his work. A bonus not linked to performance is no longer a bonus, but rather another way of paying wages.
He still gets a more than adequate salary for his work.
Wait, are we talking about a real situation?
Looks to me like you declared something about what is "adequate salary" without knowing what that salary is, what the bonus model being speculated upon would be, or what the opportunity cost for that hypothetical CEO would be for taking on such a high-risk position.
Upon what information do you base even having an opinion on what salary is adequate?
The example given by the OP was RIM (in a situation where they are losing money) - CEOs received $1.2 million each as a salary until recently, total compensation was $5.1 million in 2011. That seems more than adequate to me for a company bleeding revenue and market share.
My point was that a bonus taken in lieu of salary is no longer a bonus but a wage, and extra rewards should be commensurate with the company's performance, not taken for granted for people at the top, who ultimately should take responsibility for the wellbeing of their company and employees. That means taking a cut in bonuses and perks when the company is doing badly, whether it is their fault or not, just as employees may lose their job, even if they do a good job but the company is struggling.
And if you have a CEO running another company who is already making $5 million/year who has a great track record and could be the best bet for staunching the bleeding at RIM and maybe even turning it around.
Why would that person take a risk of going to RIM?
My point is that sideline "this is an adequate salary" ranks up there with saying, "that's an adequate temperature for boiling that liquid". Well what's the liquid? What's the ambient pressure?
It's a case of: "Well, the operation was a success, even if the patient died."
A turnaround isn't a success until the company is in the black. If the new CEO just ends up producing a smaller crater (no such thing as a "soft landing" in bankruptcy court), he still failed.
uh, correct me if i'm wrong but isn't that her job to do that and typically those jobs pay extremely well?
And on the flip side, if there was a large bonus for reducing debt by that much by year end, would that incentivize this person to do anything possible to reduce debt even at the cost of the companies long term survival?
Expanding on that it seems reasonable to consider the possibility that bonuses for some year end goal could be causing CEO's and others to do whatever it takes to get their bonus while damaging companies long term survival, because they put their bonus first not the company.
For years before the banking blowup that preceded the Great Recession, people knew that there was a lot of risk somewhere. It's just that nobody knew where. It turns out that too-big-to-fail banks and fears of systemic collapse meant that the risk was with taxpayers.
Or you can look at private equity's privatization of gains and socialization of losses:
I think it's also worth pointing out that the data tends to show that the use of personal bankruptcy to game the system is actually very low.
I find that when the subject is brought up in a political context, this distinction is often not made.
Here is a great lecture from Elizabeth Warren on the subject: http://www.youtube.com/watch?v=akVL7QY0S8A