The idea that Chrylser should not get a bailout because it is owned by the private equity firm Cerberus Capital Management is close to becoming conventional wisdom. That’s unfortunate because it is worse than nonsense. It’s dangerous nonsense.
Let’s put aside the argument against any bailout of automakers so we can focus on the specific argument against bailing out Chrylser. As we understand it, the argument against bailing out Chrysler hinges on the idea that privately held companies are less deserving of a bailout because the benefits would be more concentrated than they would be for public corporations. But Cerberus has already said it will give up any profits on a future sale of the car company if it receives federal financial aid, so the idea that the bailout will be a windfall for the PE guys who run the company is bunk.
What’s more, Cerberus investors are the same kind of institutional investors, such as pension funds, who own the other two car makers. 60-eight per cent of Ford is institutionally owned. Control of Ford rests with a small group of holders of special shares reserved for Ford family members. 50-five per cent of General Motors is institutional owned. The bailout of any car company will benefit institutional investors, regardless of whether its equity is owned via publicly traded shares or a private equity company.
It’s also unclear why any shareholder in a publicly traded company is more worthy of a bailout than a private equity investor. We can even imagine a plausible argument the other way: only privately held companies should be bailed out because the moral hazard costs of bailing out public companies is too great. If we want shareholders of public companies to be more vigilant about corporate governance, bailouts are counter-productive. This isn’t as much of a problem with companies owned by private equity firms, which are typically quite vigilant about governance.
Underlying the argument against bailing out Chrysler is a bias against private equity partnerships in favour of publicly held corporations. But there’s little rational policy behind this bias. As the institutional ownership shows, none of the companies are held or controlled directly by ordinary investors. So much for the populist argument.
More importantly, we should be suspicious of adopting a government that thwarts innovations in corporate ownership. The publicly held corporation has been the dominant form of business ownership for quite some time. But it has widely known weaknesses, including the difficulty it has with controlling agency costs. This is one reason alternative forms have been emerging.
Law professor Larry Ribstein has been leading the charge in describing the rise of what he calls the “uncorporation.”
“The managers need to be compensated like partners, with both upside and downside risk. The investors have to have access to the cash through distribution and liquidity events, which forces managers to face the judgment of the capital markets,” Ribstein writes. “I suspect that this is the long-term future of Wall Street and many other industries – that we’re seeing the beginning of an epochal shakeout that will mark the end of the corporate era.”
We’re not sure whether Ribstein is right about the overall direction of business ownership. But we do think that having the government declare that alternative forms are somehow less worthy of survival than the traditional public corporation is simply wrong-headed government planning. Why reify a bias against innovation through the bailout?