It’s in the news today that Toys R Us executives are going to be granted bonuses, despite the company entering bankruptcy. It was a little over a year ago that the same thing happened with Sports Authority. In the case of Sports Authority, there were going to be bonuses, then a judge said no, then another judge said yes. There was lots of public outrage. Why should executives get bonuses for a failed company, especially when all the floor workers just lost their jobs?
I’m going to take an unpopular position and say that the bonuses should be awarded. I can’t address the loss of employment for the rank and file workers. I am also very sensitive to income inequality and I would hope that somehow we can curb outrageous executive pay in the future. The only thing I am focused on is putting the blame where it belongs. And that blame is actually not on the executives. The fault is higher up than them.
Both Toys R Us and Sports Authority are victims of leveraged buyouts. You can expect that Guitar Center will soon be joining them, because Guitar Center has the exact same situation stemming from its own leveraged buyout. This article has a very succinct description of how the bought-out company is doomed after a leveraged buyout.
Private equity firms like Bain take mid-sized companies and pump them full of debt with the express intent of making them industry-dominating competitors, selling them to the stock market as a candidate for massive growth, and cashing in. To make this possible, private equity’s stake in the company is usually represented by “payment in kind” (PIK) notes, a type of bond that pays crushing interest – in this case 14.09% – but requires no cash outlay until the bond’s maturity. So that 14.09% is accruing, but it isn’t due for years, ideally after the company has been sold to what is often charmingly referred to as “the dumb money,” the retail investors who buy a stock without knowing the company’s true financial position. Before any of the company’s real problems are revealed, the private equity firm receives its payback in the form of stock, since PIK notes can be paid back in any medium of exchange. If all goes to plan, the stock price shoots up after the IPO and the PE firm makes a tidy profit – all in about three to five years.
The end result is that the company has enough money to pay the daily bills, but has no reserve cash to pay off this growing obligation. It’s a lot like interest-only mortgages back before the last housing crisis.
But back to the executives. These guys didn’t write up the buyout. They weren’t able to stop it from happening. When the buyout did go through, they kept the machine running. They kept the company viable, if not spectacularly profitable.
So, how much at fault are they? They did their job and fulfilled the duties in their job description to receive their full compensation package, which would include defined bonuses. You can very easily protest, “They didn’t earn it! The company went bankrupt!” The company didn’t go bankrupt through their actions. That card was cast long ago by people much higher than them. These executive’s only fault was hitching their wagon to a falling star.
My point in taking this controversial stand is that the blame needs to go where it deserves. It’s not with the executives, it’s with the companies that are executing leveraged buyouts and destroying perfectly valid corporations for their own gain.
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