In February 1988, Leonard Cohen released an album entitled “I’m Your Man.” As I read a piece published today in the Washington Post regarding millions of dollars that recently went to executives ahead of Chapter 11 filings, the first stanza of the third track on that album, “Everybody Knows,” came to mind:
Everybody knows that the dice are loaded
Everybody rolls with their fingers crossed
Everybody knows that the war is over
Everybody knows the good guys lost
Everybody knows the fight was fixed
The poor stay poor, the rich get rich
That’s how it goes
The Washington Post reported that since the pandemic took hold in March of this year, at least 18 large companies awarded executives large bonuses before filing for bankruptcy. Collectively, the Post reported, these companies paid out more than $135 million in executive bonuses while carrying $79 billion in debts. Simultaneously, these companies laid off or furloughed tens of thousands of workers. The companies that took these actions include: Hertz Global; J.C. Penney; GNC; Tuesday Morning; Hi-Crush; Dimond Offshore Drilling; Whiting Petroleum Corp.; Neiman Marcus; Briggs & Stratton; and Chesapeake Energy.
This is not the first time boards of directors have made such payouts to executives at the helm of failed companies. As you may recall, in the early 2000s there was a significant public outcry when formerly-high-flying titans of corporate America like K-Mart, Enron and WorldCom filed for Chapter 11 bankruptcies and subsequently paid millions of dollars in bonuses to senior managers.
In 2005, Congress responded to this public outcry by banning Chapter 11 debtors from paying retention bonuses to high-level executives. However, this law did not ban firms from paying managers before or after the bankruptcy case — a loophole the companies who were the subject of the Washington Post piece availed themselves of. Furthermore, the law allows corporations to pay incentive bonuses to executives after declaring bankruptcy, provided they can convince a bankruptcy court to approve such an arrangement.
The Washington Post reported that Hertz attempted to take advantage of both mechanisms permitted in the law to funnel money to their executives before and after declaring bankruptcy. After paying $16.2 million in bonuses just three days prior to its Chapter 11 filing in May, Hertz then asked the court whether it could award another $14.6 million in incentive bonuses. To his credit, the judge rejected the request, calling it “offensive,” but later approved a plan to pay managers as much as $8.2 million if they met certain financial goals. Hertz owes creditors more than $24 billion and has laid off 11,000 workers since March.
The thinking behind such executive compensation schemes is that creditors and the remaining employees will benefit if the company is successful in retaining top management through the bankruptcy process and incentivizes them to perform well. Critics of such executive bonus plans question the logic of paying retention bonuses to the same executives who ran their companies into the ditch. They also express concern about the moral hazard created by compensation schemes that incentivize corporate executives to take excessive risks. In a world where executive bonuses are guaranteed even in the event of colossal mismanagement, executives may be induced to shoot for the moon, knowing that they are playing a game of “heads I win, tails you lose.”
Despite these concerns and the unseemliness of paying millions to executives while laying off thousands of workers, corporate boards have continued these practices by essentially doing an end run around the 2005 executive compensation reforms passed by Congress. This phenomenon is not unique to firms stricken by the pandemic. In 2019, Jared A. Ellias published a scholarly article entitled “Regulating Bankruptcy Bonuses” in which he performed a comprehensive review of pre- and post-reform executive compensation practices. Ellias concluded that the 2005 reform may have discouraged some firms from implementing opportunistic and unnecessary bonus plans and may have improved public confidence in our bankruptcy system. However, his detailed analysis of the data showed that, due in part to deliberate regulatory evasion and rich post-bankruptcy incentive plans, on the whole, the 2005 reform did not alter the overall compensation of CEOs of Chapter 11 debtors.
I’m not a bankruptcy expert and I do not have a prescription for how to remedy the glaring inequities between the treatment of executives and workers when companies go bust. However, I think most would agree that there is room for improvement in our current system. When exploring options for further reform of corporate governance and bankruptcy regulations, my hope is that those in power will be guided by principles of fundamental fairness and a concern for the wellbeing of lower-level workers who are too often cast overboard with no life preserver.
As a Conscious Capitalist, I believe, as Raj Sisodia has said, that “[i]n the long arc of history, no creation has had a greater positive impact on more people more rapidly than free-enterprise capitalism.” I also believe that capitalism is a work in progress, both here in the United States and around the world. I think the greatest threat to its continuation is the justifiable outrage caused by practices that exacerbate the yawning economic chasm between those on the bottom and those on the top that is exemplified by bankruptcy bonuses for executives and layoffs for line workers. To preserve the continued benefits of capitalism, we must make systemic changes to avoid a situation in which, as Leonard Cohen puts it:
Everybody knows that the boat is leaking
Everybody knows that the captain lied
Everybody got his broken feeling
Like their father or dog just died
If we fail in this endeavor, I fear that growing dissatisfaction with the status quo will further amplify forces already at work roiling our politics and cause many to question the morality of a capitalist system that appears to serve the few and exploit the many.
We don’t have to wait for more government regulation to strive for meaningful improvement. Instead, we business professionals can do our part now via self-regulation and working harder to be fair to all our stakeholders in both good times and bad.
Jim Nortz is founder & president of Axiom Compliance & Ethics Solutions. He serves on the Conscious Capitalism Rochester board of directors, is a member of the International Association of Independent Corporate Monitors and is a National Association of Corporate Directors Fellow. Nortz also is a former board member of the Rochester Area Business Ethics Foundation (“RABEF”) and the Ethics and Compliance Officer Association (“ECOA”). Nortz can be reached at jimnortz@AxiomCES.com.