Shareholders are the owners of public companies. The CEO is elected by the shareholders to undertake the daily operating decisions of the company. It is important to understand that running a business is a risky endeavor, and business officials are incentivized to take risk. After all, how to do expect a company to reap the rewards without taking on risk? If you sue the CEO for taking on risk, the court will laugh at you. Now, if you were talking about doctors or surgeons, those are professions that penalize you for taking on risk. As a shareholder (owner/investor), if that person cannot stomach the fact that there is a potential for him to lose his entire investment, then that person should not be investing in the stock market to begin with. If the investor gets all excited when he sees his investment appreciate in price over the good years, and if he expects a government bailout when his company hits a rough patch and his investment quickly depreciates in price, then that person does not understands the game of capitalism and should stick to allocating his money towards his bank’s FDIC insured checking/savings accounts. Companies are bound to fail. Out of the Fortune 500 companies of 1955, there are only 60 of those original companies that remained on that list as of 2017. This means that 440 of the top 500 companies failed within a 62 year period.
As a value investor, I do not like when companies take on debt to support their everyday expenses such as payroll, utility bills, current liabilities, etc. It doesn’t matter if that lender is the government or a bank. Debt is debt. A shareholder expects the company to drastically reduce its expenses and operating costs before the company decides to take on more debt. If a company is taking on debt just to keep the lights on, then that company should fail; Shareholders are going to note this non-productive debt and withdraw their equity. Now, if that debt was taken to build a new factory, which would then lead to higher sales and higher profit for the shareholders, then yes, taking on that debt is justifiable. I tend to stay away from companies that have too much debt since those companies are less agile to market changes. As Warren Buffett says, “I do not like debt, and I do not like to invest in companies that have too much debt. With long term debt, increases in interest rates can drastically affect the company profits and make future cash flow less predictable.“
You might say that no-one expected a pandemic to disrupt the economy. So, maybe the airlines, the oil and gas companies, and all the other sectors affected by this virus outbreak should be rescued? Should the government and banks lend money at low interest rates to these companies in dire need of cash? This immediate cash infusion would help the company survive the near term crisis, however everyone needs to understand that a “Too Big To Fail” company would be in the making. Debt is debt, and it needs to be paid back someday. You can keep kicking the can down the road, but someday that can will become so heavy that you won’t be able to kick it any farther.
So, should public companies be allowed to fail? As far as shareholders (owners) are concerned, they can simply sell their shares if the company decides to take on more debt. Moreover, if that debt comes with strings attached to it such as the company is not allowed to buy back shares or pay dividends to its shareholders, then the shareholders are going to shy away from investing in such companies. As far as integrity of the economy and the free market goes, companies should be allowed to fail. Why create a behemoth that will take down many other companies with it when it goes down? Unfit companies should not be helped.
Just like mother nature, the market corrects itself and the companies within it to ensure that only the fittest survive. Many tech companies were left in dust after the dot com bubble burst, but the ones that survived were fit. Forest fires are a natural and necessary part of the ecosystem. Forest fires help nutrients return to the soil instead of remaining captive in old vegetation. Similarly, the unfit companies need to go away so that they can be replaced with innovate, newer, and agile companies that align with the consumer needs and prevalent market conditions. I understand that capital is destroyed and employees are laid off when a company fails (declares bankruptcy), but again, businesses are inherently risky and an investor cannot be naive and believe that asset prices and his investments only go in one direction – up.
Hope you learned a little and found this blog post helpful. We talked about why companies should be allowed to fail. As always, you can sign up for our free mailing list here. You can sign up for our paid subscription services here. Like us on our Facebook page here. Thank you!
Superior North LLC’s content is for educational purposes only. The calculators, videos, recommendations, and general investment ideas are not to be actioned with real money. Vyom Joshi is not a professional money manager or a financial advisor. Contact a professional and certified financial advisor before making any financial decisions. Please review the Disclaimer and Terms and Conditions.