Capitalism: Heads I win, Tails I win


The best kind of ‘risk’ to take is the risk of no-risk. I.e.: a sure thing. when you’re talking about capitalism, that means “win/win” scenarios should look indistinguishable from when the game is rigged in someone’s favor. Otherwise, you haven’t rigged it hard enough.

This is a fairly typical scenario: [usa]

BERGEN COUNTY, N.J. – The judge overseeing the Toys R Us bankruptcy case ruled Tuesday that the insolvent retailer can pay its 17 top executives $14 million in incentive bonuses.

Toys R Us, which is based in Wayne, N.J., agreed to trim its original $16 million bonus proposal by $2 million, and to make $5 million of the bonus payout contingent on the company creating a business plan that allows it to emerge from bankruptcy.

The company said the bonuses are necessary because they motivate executives to boost sales during the critical holiday shopping season.

Read that carefully, because it says, “we are going to pay you at least $9 million in bonuses for being behind the wheel when a retail giant stumbles and collapses.” Because, if they weren’t guaranteed those big bonuses, the executives would presumably leave and go screw up someplace else.

Usually, when a company is performing well, executives are granted stock options (I will do a posting on how those work) as a form of performance-based compensation. The options are justified based on the principle that, if the stock goes up, everyone makes money, and the higher it goes, the more money the optionees make. Sometimes you get a perverse incentive, there, in which the optionees just do some things to spike the stock, sell it, and leave. In this case, Toys ‘R Us’ shareholders are expected to take money out of the company, which might be used to stave off financial ruin, and give it to the executives who oversaw the financial ruin. I would not be surprised if the executives have it in their contract that they should also get a “thank you” card with the check: they are getting incentive pay if the company survives, and a bonus if it fails.

Of course it’s going to fail; Amazon.com killed it. Toys ‘R Us has been staggering around with a giant arrow through the knee for the last decade. Which means that the board of directors should have only been hiring executives that were going to attempt a “turn-around” or “comeback” and would be compensated if they succeeded.

Other than the inevitable collapse of its market, what happened to Toys ‘R Us in the first place?

The Week gives an overview of how Toys R’ Us failed to avoid the great big iceberg with its name on it. [the week] If you want to follow along on asset stripping 101, you can refresh here: [stderr]

Our story begins in 2004. After big success in the 1980s, Toys ‘R’ Us’ performance turned lackluster in the 1990s. Sales were flat and profits shrank. Toys ‘R’ Us was a public company at the time, and the board of directors decided to put it up for sale. The buyers were a real estate investment firm called Vornado, and two private equity firms named KKR and Bain Capital. (You may remember the latter from 2012 campaign ads: It was co-founded by former Republican presidential candidate Mitt Romney, though he’d moved on well before this.)

 The trio put up $6.6 billion to pay off Toys ‘R’ Us’ shareholders. But it was a leveraged buyout: Only 20 percent came out out of the buyers’ pockets. The other 80 percent was borrowed. Once Toys ‘R’ Us was acquired, it became responsible for paying off that massive debt burden, while also paying Bain Capital and the other two firms exorbitant advisory and management fees.
Oh, look:

Whatever magic Bain, KKR, and Vornado were supposed to work never materialized. From the purchase in 2004 through 2016, the company’s sales never rose much above $11 billion. They actually fell from $13.5 billion in 2013 back to $11.5 billion in 2017.

On its own, that shouldn’t have been catastrophic. The problem was the massive financial albatross the leveraged buyout left around Toys ‘R’ Us’ neck. Just before the buyout, the company had $2.2 billion in cash and cash-equivalents. By 2017, its stockpile had shriveled to $301 million, even as its debt burden ballooned from $2.3 billion to $5.2 billion. Meanwhile, Toys ‘R’ Us was paying $425 million to $517 million in interest every year.

This enormous cash drain probably made it impossible for the company to invest or innovate even if its trio of buyers had been up to the challenge.

The interest payments are the company, paying the people who borrowed the shares to buy the company, interest on their loan. Once they owned the company, they could decide (“hey, it’s our company! let’s repay ourselves! Show of hands? Surprisingly unanimous.”) to repay themselves – and the management fees are just icing on top of a cake that is already a great big glob of icing.

Bain, KKR, and Vornado will have to write off their investment, of course. But they did suck around $200 million in fees out of Toys ‘R’ Us over the course of their ownership.

“Look! We shot the mammoth! And it died! Yay Us!”

This particular mammoth was probably already heading toward extinction, but a bullet through the lungs didn’t help its chances of survival in the slightest.

Now, a quiz: did the toy market become more efficient as a consequence of this? Did the price of toys go up or down? Did customers notice an improvement in the availability of toys? How did the employees feel about this? Nobody needed more empty holes in the shopping mall parking lots.

These people are as merciless as wasps.

------ divider ------

A clarification: once you buy up a controlling interest in a company’s shares, you (as it implies) control the company. That means you can put your golf buddy in as CEO and your lawyer’s nephew as chairman of the board. Then, they can vote to pay you a $5 million bonus. And none of the employees or shareholders can do anything about it. There are some controls – the shareholders can sue if the directors of the company are too obvious about what they are doing – but by then it’s already way too late.

I used to know a guy who worked at a start-up that managed to go public. Prior to the IPO, when the company was setting up all the new financial structures it would need internally, they were told by one of their investors that they needed to hire his golf buddy to be on the board of directors. “It’s OK, he’ll never come to any meetings and will vote ‘yes’ for everything. He just wants a slice of the excitement.” What that meant was a tranche of stock options that wound up being worth $4,000,000, which he immediately dumped as soon as he had clearance (stock options come with a seller lock-out so you can’t just dump them) and drove the stock price down, stripping about $20,000,000 in market capitalization from the company. And he never appeared at a single meeting.

Sometimes the people who get hit with these maneuvers are real jerks, themselves, and it’s tempting to be unsympathetic. There is a certain amount of “what goes around comes around” but just keep your eye on the employees: it’s always the employees who wind up getting screwed. Because: win/win.

KKR are some of the most ‘famous’ asset strippers; they’re the ones that dismantled RJR Nabisco [wik] – the biggest leveraged buyout of its day.

Comments

  1. komarov says

    How about another clause for stock options: Only allow monetising while their worth is reasonably stable, no sharp rises or drops. That way you can’t create spikes that crash the business afterward. If you screw up badly enough you’ll get nothing except to go down with the ship.

    *Veering dangerously close to “patriotism” and what it has become these days…

    Whatever magic Bain, KKR, and Vornado were supposed to work never materialized.

    Hm, moneyticks? I hear they hide in big banks and stock exchanges and jump on passing companies. If not removed quickly, they can infect businesses, leaving them lethargic, paralysed or apparently even dead. Check yourself carefully if you’ve been hiking in areas where moneyticks, capitalists and other parasites have their habitat. (I note that by comparison the wasp is a noble creature. I sometimes share a flat with them. Noble or not, they struggle with half-open windows.)

    What that meant was a tranche of stock options that wound up being worth $4,000,000, which he immediately dumped as soon as he had clearance (stock options come with a seller lock-out so you can’t just dump them) and drove the stock price down, stripping about $20,000,000 in market capitalization from the company.

    Hang on, a company lost value because someone decided to sell their shares in it. The company – buildings, people, stores, products and customers – stayed exactly the same but was now worth 20 M$ less because some slightly vague ownership claim changed hands. Is that the gist of it? Remind me why we have stock exchanges? Who thought it was a good idea to make the value of industries dependant on how much demand there is not for their products but for their ownership? Also, can we kill a company by collectively deciding none of us want to own it? Oh, right, Facebook… *fingers crossed*

  2. brucegee1962 says

    Remember the movie “Pretty Woman”? Of course there were lots of things wrong with that movie, but the main thing I remember that was right about it was the unambiguous message that asset stripping is immoral. I would have been happy if the entire movie had focused on that plot and jettisoned the silly little love story.

    These things seem to simultaneously give home for capitalism and doom it, though. On the one hand, if capitalists can maintain some sense of communal obligation and at least half an eye on the public good (“We’re going to build ships!”) then it can still work for everyone. On the other hand, for every capitalist with a conscience, there will always be five who want to ruin everything.

  3. Pierce R. Butler says

    Old(er)-timers may recall a corporate entity named Beatrice Foods, an agribusiness giant against which literally thousands of (mostly farm labor) activists struggled, with very little positive result, for many years across the country.

    The white-collar raiders at KKR, seeing that Beatrice had lootable assets, dove in and took the whole conglomerate to pieces in a matter of months – with less than 40 people in toto. Quite a sharp lesson for those of us in the organize-against-the-monster(s) business.

  4. says

    ahcuah@#1:
    iHeartRadio Files For Bankruptcy After Accumulating Over $20 Billion In Debt.

    That seems like a suspiciously large number, to me. Sometimes businesses are bought so that they can run up debt, then the asset strippers move on and let the business collapse. I was part of a company that had that happen; it was pretty horrible (it’s impossible for the company to do anything because all revenues are spent paying interest on the debt).

  5. says

    komarov@#2:
    Only allow monetising while their worth is reasonably stable, no sharp rises or drops.

    They’d figure out a way around it. Most of the arcane financial maneuvers in use today were developed as responses to well-meaning attempts to prevent some other maneuver. There are very very smart people who sit and think up new ways to game the system, constantly.

    That was part of why the government didn’t go after any of the companies that caused the 2009 collapse. Two reasons: 1) it was – by design – impossible to determine who had done what and everything looked like semi-legitimate bets 2) the traders who caused the collapse were not using that technique any more because, well, it caused a collapse and lost them some money – so they were on to another thing.

    Hang on, a company lost value because someone decided to sell their shares in it. The company – buildings, people, stores, products and customers – stayed exactly the same but was now worth 20 M$ less because some slightly vague ownership claim changed hands. Is that the gist of it?

    That’s exactly it. I can see that the next episode of these “capitalism 101” postings should be Market Value. That’s, uh, a fun topic.

  6. says

    Pierce R. Butler@#5:
    Quite a sharp lesson for those of us in the organize-against-the-monster(s) business.

    That’s a good point. If there were enough decent people who were willing to pony up money, they could probably really do a hatchet job on companies like Monsanto and Pfizer. The problem is, they’d probably lose a lot of money. And – it’s no coincidence that the worst evil corps are privately held: you can’t touch Shel Adelson or the Koch Brothers, their companies are completely under their control. They own governments, not the other way around.

    That’s why George Soros is considered a terror by various goofballs: Soros basically triggered a run on the Bank of England to push the value of the pound down, gambling (at the right time) that the crown would prop the money up (which made it go back up) Soros made a mint on the down-swing and made all the remaining mints on the up-swing. It was the final proof that the financial markets controlled the governments, not the other way around. That’s why all the gold bugs and chemtrails guys think Soros is the devil: he conclusively broke the power of the Bank of England. Currency traders rule! Basically what Soros did was the maneuver that was demonstrated in Trading Places with orange futures and options, except he did it with pounds sterling options and broke the bank.

    The Adam Curtis Mayfair Set series have a bit of the Soros story in them. If you want to believe that economies are stable, and are not simply roulette wheels, it will scare the shit out of you.

  7. lanir says

    The other 80 percent was borrowed. Once Toys ‘R’ Us was acquired, it became responsible for paying off that massive debt burden, while also paying Bain Capital and the other two firms exorbitant advisory and management fees.

    So they paid for the company with money they charged to the company? So it bought itself? Huh. The rich really are different. I mean, not really but damn do they pretend hard.

    If I did something like this to make money from myself magically appear to buy things my financial institution would call it check kiting and the only fees would be the ones they slapped me with. Plus I’d be in for some really nasty sounding legal penalties, possibly more than if I walked out and shot some random passer-by on the street.

  8. says

    I can see that the next episode of these “capitalism 101” postings should be Market Value.

    OK, then I’m looking forward to that.

    By the way, they don’t teach these kinds of things in “capitalism 101” courses. The first time I had an economics course, they taught about supply and demand, the benefits of free market, inflation, that sort of stuff. Then, later, in the aftermath of the 2008 crisis, they taught about economic crises, debt, bailouts, currencies (specifically, everything that’s wrong with the eurozone) and so on.

    How to abuse the existing laws within a capitalist economic system was definitely not part of any courses I have taken. Of course, I knew about some of this stuff, but there were also some new things I found out from your blog posts. Now I’m starting to wonder whether they are intentionally skipping all the interesting stuff in order to ensure that students remain happy to live in our current capitalistic economic system. After all, if professors added this kind of information to their courses, their students might, gasp, start wondering about whether capitalism really is as great as we are expected to believe.

  9. says

    lanir@#9:
    So they paid for the company with money they charged to the company? So it bought itself? Huh. The rich really are different.

    I know, right?
    The crazy thing is that some of these deals are done by people who really aren’t worth a damn thing (financially, I mean) (personally, that’s understood) The guys who started Enron were nobodies when they started it, but once they created this ballooning balance-sheet everyone looked at the number on it and went “WOW! Can we sell ourselves to you!?”
    I am, honestly, not exaggerating or being silly. That’s how some of this stuff works.

    After I do my posting on Market Capitalization 101 it’ll all be much more incomprehensible.

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