The New Face of Capitalism

“The revolution is over, and Gordon Gekko won.

Three decades on from the leveraged buyout boom, the morals, or lack thereof, of the fictional private equity titan have become the morals of management: greed is good, more is better, and employee benefits are an inconvenient obstacle to unlocking shareholder value. In other words, it’s not just corporate raiders coming after your pension now; it’s corporate America too.

Just look at Patriot Coal. That’s the spin-off company of Peabody Energy, the country’s biggest coal producer, that was larded up with 40 percent of its parent company’s healthcare liabilities and just 13 percent of its assets back in 2007. A year later, Patriot saddled itself with even more obligations when it bought Magnum Coal, itself a subsidiary of Arch Coal, the nation’s second-largest coal company. The end result of all this financial chicanery was Patriot getting stuck holding the bag of retiree health benefits for 22,000 people — 90 percent of whom never worked a day for Patriot, but rather for Peabody or Arch.

Well, guess what. Patriot went bust. And now, as the Wall Street Journalreports, a bankruptcy judge has ruled that it can discharge its $1.6 billion of union healthcare obligations and replace it with … a $300 million trust, “tens of millions” more in revenue sharing, and 35 percent of the stock of the new Patriot Coal. Not much. Now, it’s not completely clear if Peabody deliberately designed Patriot to fail — that got a “maybe” or “maybe not” from the judge — as Temple University business professor Bruce Rader has argued. But it is clear that Peabody dumped the legacy liabilities and assets it didn’t want in Patriot, which, being generous, added several degrees of difficulty to it being a going concern.

Now, believe it or not, there were innocent-ish days of yore when management didn’t aggressively try to wiggle out of its promises to workers. That’s what buyout barons did. Indeed, as Larry Summers and Andrei Shleifer argued back in 1988, hostile takeovers often increase shareholder, but not economic, value, because they involve such “breaches of trust.” In any corporation there are what Summers and Shleifer call “implicit contracts” — agreements between shareholders and stakeholders that would be too costly to formalize. Of course, it would always be profitable for shareholders to renege on these informal deals after the fact, but they don’t (or didn’t), because if they did, stakeholders would stop entering into them. And besides, before the managerial revolution in the go-go 1980s, most bosses came up through the company they ran. There was (some degree of) loyalty to their fellow employees. Who would take away health benefits from people they knew?

But what if they didn’t know them? What if private equity gurus bought a company, and decided to scrap its implicit contracts (it’s not as if those were written down). That’s what Summers and Shleifer saw happening with the hostile takeovers of the day — with all kinds of ripple effects….”