January 10th, 2018
Assessing the need for public bailouts of failing corporations
Government policies could also contribute to enhanced risk-taking behavior. The monetary policy adopted by the government to shield against adverse economic times could for instance lead to excessive lending due to lower interest rates even on aversion of the adversity. Larson (2007) for instance notes that “ rather than acting as a moderating force, the Federal reserve often played an important role in further inflating the housing bubble” (p. 18). By following a reduced banking rate policy in an attempt to shake adverse economic impacts, the Federal Reserve is advanced to have driven the interest rates to below average thus allowing massive supply of cheap credit (Larson, 2007). In such cases then the government could be held captive to bailout plans based on its role in fueling the crisis. The immediate and long term effects of failed organization to stakeholders and the economy however might be the main reason that public bailouts for failing organizations are carried out.
The collapse of organizations bears significant implications for a number of stakeholders. For investors in common stock, the collapse is the worst nightmare as this would deprive them their rightful return on investment. Further the situation is complicated by the fact that interests of other stakeholders such as secured debtors, preferential creditors and other lenders supersede those of ordinary investors in the event of re-imbursement out of the money realized from the collapsed firm’s assets (Insolvency Service, 2009). For depositors, with regard to deposit accepting institutions, the retail deposit insurance cover provided by such institutions may not be adequate for complete reimbursement of deposited funds (Hanc, n.d). In such cases then delays in acquiring ones funds would be a possible scenario. By failing to cushion the public against losses through instituting stringent regulatory policies, the ruling elite could fall prey to public backlash in the elections. Further organizations that have been labeled to be “politically more connected” have been argued more likely candidates for bailouts incase of failure than their less connected counterparts (Faccio, Masulis & McConnell, 2006). This reinforces the view that bailouts could be an incentive for perpetuation of moral hazards in corporations that are viewed to be “too big to fail.” Such diverse perspectives form part of the discussions that have characterized recent cases of corporate bailouts by governments.
The primary reason however advanced to inform public rescue to failing organizations is the negative effects that massive liquidations would have on the economy. The House of Commons (2008) report for instance notes that by providing assurances to Northern rock depositors; the government was able to prevent diminished public confidence in the banking system. With fading public confidence, the report observes that, the effect of the recent financial crisis both to the depositors and the UK would have been worse (House of Commons, 2008, p. 55). In other literature it has been advanced that the immediate benefit of a bailout is that it prevents “the deadweight loss associated with bankruptcy” (Albuquerque, 2010, p. 117). However, it is debatable whether government bailouts plans are usually adequate to avert the spill over effects of failing corporations. Weiss and Larson (2008), for instance note that the bailout plan that had been proposed for failing U.S. banks in the wake of the recent financial crisis was “too little, too late for the debt crisis” (p. 6). With more organizations having been impliedly under the risk of collapse than had been indicated by industry regulators such bailout plan for failing corporations might have just been a drop into the sea hence inadequate to provide substantial remedy (Weiss and Larson, 2008). With these perspectives the question to what the optimal bailout plan for failing organizations would be arises. Go to part 3 here.