How To Think About Corporate Bailouts Correctly


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Planes.

As the negotiations over the economic response to the Coronavirus recession heat up, we are seeing more and more talk about how (or whether) to provide relief to corporations and industries that are facing bankruptcy due to the economic slowdown. Some of this talk is intelligent. A lot of it is not. So in this post, I hope to lay out what I believe is the correct way to think about corporate bailouts.

Due to an aversion to socialist rhetoric about “capitalists” or even “the wealthy,” American populist lingo tends to focus on “corporations” as the great evil. We talk about “corporate power” and “corporate concentration” and “corporate influence” and “corporate money” and “big corporations” instead of talking about “the capitalist class” or “the ownership class.” This kind of metonymy is, I suppose, fine in most cases. But sometimes taking it too literally can lead people astray when thinking about appropriate policy measures.

Generally speaking, a corporation is a legal entity that collects and coordinates labor and capital for production. School districts are municipal corporations that bring together teachers and school buildings to produce educational services. The Postal Service is a federal corporation that brings together postal workers and trucks to deliver mail and packages. American Airlines is a private corporation that brings together pilots, flight attendants, and planes to provide flights.

Bailing out corporations in tough circumstances is fine. Bailing out their owners is not. Thus, to understand the proper policy move, you need to actually pierce through the shorthand conflation of “corporations” with the “capitalist class.” The purpose of a proper bailout is to keep a corporation going and producing. It is not to prop up the balance sheets of the capitalist class.

How can you bail out a corporation without also bailing out its owners? It is very easy: have the government provide cash to the corporation in exchange for corporate equity. The issuance of this new equity dilutes out the existing shareholders, ensuring that those shareholders ultimately eat the losses of the pandemic shock.

Bailouts for equity would help reduce wealth inequality in the country. Based on my own calculations of Financial Accounts data (I, II), the top 10 percent of American households own around 80 percent of corporate equity while the bottom 50 percent owns less than 1.5 percent of it. (This figure includes each household’s share of pension assets that are invested in corporate equities and mutual fund shares.) Diluting out existing shareholders by bringing in the government as an equity holder in bailed-out companies could substantially shrink these differentials. This is especially true if you then place the new equity into a social wealth fund that all Americans own one share of, as I have proposed previously.

Bailouts for equity also pass any kind of reasonable fairness test for three reasons. First, these firms are going to go bankrupt without a government cash infusion. So the incumbent shareholders have, in a sense, already lost their money. Second, eating losses from tail risks is precisely what shareholders sign up to do. This is supposed to be why they deserve an investment return in the first place: because they take on this risk. Third, any other investor would require equity in exchange for the kind of investment the government is being asked to make. There is no reason why the public should be suckers.

Although the general equity-for-bailouts solution is pretty simple and straightforward, there are some complexities that do need to be addressed in any such deal. Specifically, not all equity is the same and indeed some equity is not really equity at all. To make sure we actually achieve the proper goal of these transactions, the equity needs to have at least the following characteristics:

  1. Proportional voting rights. If the federal government’s investment represents 75 percent of the bailed-out company’s post-money valuation, then it should have at least 75 percent of the shareholder voting rights. Those rights should then be exercised by the Treasury pursuant to voting guidelines established by Congress.
  2. Bankruptcy priority. The law authorizing the equity deals in question should stipulate that the equity and rights associated with it cannot be discharged or modified in bankruptcy.
  3. Dividend paybacks. The terms of the equity deal should require the company to suspend all shareholder payouts except dividends to the government’s shares until the government’s initial investment is paid back. After the government has recouped its money through these special dividends, the company will then be permitted to resume normal shareholder disbursements with the government only entitled to its proportional share.

Very few of the bailout proposals that have been floated so far require the companies involved to issue any equity. There are tons of little conditions people are attaching to the deals, like bans on buybacks, new rules for labor-management relations, and so on. This all sounds good and certainly it would be better to have those conditions attached than to provide a bailout with no strings attached. But no amount of conditions will ever make the bailout not a scandalous betrayal unless the companies are required to hand over equity. Using public money to recapitalize the capitalist class in order to get some company-specific regulations that you can already impose by law and that you could also impose if you owned their equity is simply a bad deal.

Democrats should insist that equity is an absolute must for any bailout deals.