As the nation grapples with the profound human tragedy of COVID-19, U.S. companies have been feeling the business and economic impacts of the global public health crisis. Many companies have already filed for bankruptcy protection, while others have warned that they may need to liquidate or restructure. Business leaders from a wide range of industries have warned of an impending liquidity crisis and lobbied for bailouts from Congress. Some requests have been granted, while others continue to be debated in the legislature and public discourse.
Corporate bailouts may take many forms, including emergency loans and guarantees, stock and asset purchases, and grants that do not require repayment. Relief may also come with a variety of strings attached, such as restrictions on the use of funds and limits on executive compensation. At the national level, these are resource allocation decisions. Accordingly, the public discourse on corporate bailouts tends to frame choices in economic and political terms, relying on assumptions about the way corporations respond to various incentives or disincentives.
But at a firm level, the process of exploring options in response to financial distress is a highly individualized exercise in corporate finance, performed by managers who owe duties to the firm and its stakeholders. As corporate managers consider liquidity-enhancing options such as participating in a bailout program, pursuing capital market transactions, or even filing for bankruptcy, their decisions are naturally constrained by the firm’s overall financial condition and existing legal commitments.
In recent months, publicly traded companies have provided thoughtful commentary in their public company disclosures regarding the financial decisions they have made in response to the COVID-19 crisis. Meanwhile, public and private companies have filed for bankruptcy protection, providing detailed narrative accounts of the events leading up to the filing and the various steps they have taken to stem losses and maintain the company as a going concern.
In a recent article, I use these disclosures and declarations to take a closer look at the firm-level decision-making process. Specifically, I analyze how companies in the cruise, airline, health care, and consumer sectors have recently adjusted their finances in response to COVID-19. Although the case studies are mere snapshots in time of twelve large and mid-sized companies with public company disclosures or bankruptcy filings, they nonetheless provide useful insights, allowing us to identify the key factors that have influenced firm-level bankruptcy, bailout, and other recapitalization decisions. Each individual account reveals how corporate managers have exercised their broad discretion in this time of crisis. And, when the case studies are analyzed together, certain patterns emerge, revealing the hidden assumptions and preferences that may be driving corporate decision making.
Specifically, the case studies reveal the following patterns:
- Operation Decision. Outside of bankruptcy, corporate managers of the profiled companies have followed a remarkably similar decision pathway in response to the COVID-19 crisis. First, firms slashed costs and reduced employee headcount. For instance, all of the companies swiftly reduced expenses, generally by slashing unnecessary expenditures, reducing employee compensation, and furloughing or terminating staff. Interestingly, only one of the profiled companies reported voluntarily reducing executive compensation. Of course, many of these cuts are the natural consequence of voluntarily or involuntarily scaling back operations; in other cases, firms likely chose to make reductions of this sort because there are typically few if any legal impediments to doing so. But whether voluntary or involuntary, the choice to scale back operations generally means allocating economic burdens to employees, vendors, suppliers, and, in the case of firms that provide an essential service, the broader communities they serve.
- Financing Decision. A firm’s subsequent choices appear to be constrained by its overall financial condition and its existing legal commitments. For instance, companies with substantial open lines of credit were able to draw down available funds to shore up cash. Meanwhile, those with stronger balance sheets were able to obtain new debt and equity financing from the capital markets.
- Governmental aid. Virtually all of the profiled companies that were eligible to receive governmental bailouts accepted the assistance—in both grant and loan form—with little apparent concern for the conditions and restrictions attached to such funds. This finding stands in tension with a political argument that some have recently made—namely, that too many restrictions and limitations may disincentivize firms from accepting bailout funds, forcing them to file for bankruptcy instead.
- CARES Act. Of course, it’s possible that The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) simply did not come with enough conditions and restrictions to have any real deterrent effect. The restrictions and limitations carved into the CARES Act were designed to delay or prevent U.S. corporations from taking the predictable first step of allocating economic burdens to employees and, in the case of airlines and health care companies providing essential services, their broader communities. But the case studies suggest that policymakers can go quite a bit further. For instance, it may be possible to use conditions, restrictions, and clawbacks to disincentivize firms with stronger balance sheets from accepting taxpayer support. At the same time, policymakers should consider offering rapid emergency funding—in loan or grant form—to help smaller companies that lack sufficient reserves to pay employees while waiting for bailout funds to arrive.
- Bankruptcy. The case studies suggest that to the extent other options are available, corporate managers may view bankruptcy primarily as a legal or strategic tool rather than as a true financial restructuring option. Several of the profiled companies appear to have been motivated by the specific leverage they would gain over certain creditors by the power to reject executory contracts and unexpired leases. Others required the breathing room afforded by the automatic stay.
- Others. Perhaps because of certain underlying assumptions about bankruptcy, no company seems to have actually weighed participation in a governmental bailout—with or without strings attached—against the option of filing for bankruptcy. Rather, these alternatives—like all of the major decisions firms make in response to a sudden liquidity crisis—appear to have been independently examined at very different points in the lifecycle of a distressed firm.
As a bankruptcy law scholar, the latter points are especially intriguing to me. One possible explanation is that, concerning sudden liquidity crises, corporate managers may view bankruptcy as a highly risky recognition event, potentially locking in what may only be temporary losses. This is because bankruptcy relies on current (and often very conservative) estimates of future value to permanently redistribute rights in the firm. And, while the debtor normally has the exclusive right to propose a plan (and its managers enjoy the benefit of the business judgment rule with respect to most decisions), bankruptcy can be a highly litigious process. Other parties—including the smallest stakeholders—may intervene, generating additional costs and introducing high levels of uncertainty. Even where there appears to be consensus among the parties, the judge or the U.S. Trustee may object to the debtor’s proposals. For all of these reasons, in the case of a solvent company—or even a potentially insolvent company with other market-based or government-supported liquidity options—bankruptcy probably carries too much risk of irreversibly harming shareholders and other stakeholders.
This suggests, then, that bankruptcy and bailouts are fundamentally different tools. For corporate managers who are not yet ready or willing to turn the company over to creditors, bankruptcy helps companies shed assets, break contracts, and allocate losses among stakeholders, while bailouts are designed to buy time and forestall decisions of this sort. Thus, while bankruptcy may be floated rhetorically at earlier stages of the process, it does not appear to be a first-choice liquidity enhancer.
Diane Lourdes Dick is a Professor of Law, Seattle University School of Law
The post is adapted from the paper “Bankruptcy, Bailout, or Bust: Early Corporate Responses to the Business and Financial Challenges of COVID-19” published in Bankruptcy Law Letter.
