A failure to align incentives

Somehow I missed this earlier: the UAW plans to dump its shares in Chrysler.

The Obama Administration ignored prior bankruptcy law and forced bondholders (including nonprofits) to take 29¢ on the dollar for $6.9 billion in Chrysler debt. At the same time, the administration gave unions ownership of 55% of Chrysler in exchange for eliminating its $5 billion (unsecured) liability for retirement medical coverage.

The best argument for giving unions equity in a bankruptcy situation is to keep the incentives aligned: the company needs the full cooperation of its workers to succeed, and thus they should have a financial incentive to do everything they can to make the company succeed.

The union claims financial exigiencies in its plans to dump the stock. As the London Times reported

the Voluntary Employee Beneficiary Association (VEBA), which provides healthcare benefits to Chrysler retirees, would be forced to sell its stake in the company in order to keep funding the trust.

"As soon as the VEBA’s in a position where we can sell stock, we will be required to sell stock in order to keep the benefits going," [UAW President Ron] Gettelfinger said.

He said that the VEBA would start reducing benefits for retirees from July 1 because the trust is already struggling with funding.

Perhaps the union leaders are not that financially sophisticated, but this is buy low, sell low. Right now, the market sees Chrysler’s chance of survival as being low, and thus Chrysler equities are as low as they are going to be. Or does the union know something that the markets do not — that the chance of Chrysler surviving is not good, and thus they want to dump the shares while they’re still worth something? Or that once they dump the shares, they can go back to the UAW’s traditional role — a zero sum fight to transfer money from customers and shareholders into workers’ pocket?

Sometimes employee ownership does a good job to align interests, but my impression is that it only works when there are good labor relations to build upon. Building on its strong corporate culture and positive labor relations, Southwest Airlines has long used employee stock ownership as a motivation tool. However, when an ESOP was used in a United Airlines bankruptcy, the employee-management conflicts were brought to the fore (as a 1998 paper showed), and employees eventually filed a class action lawsuit when the stock price plummeted after 9/11.

This issue will come up again with the Federalization of GM. So if employee shares are intended to keep employees motivated, it’s a nice idea but probably won’t work given poisonous UAW-Big Three labor relations. If it’s a settlement of an unsecured claim, then the issue of who deserves which payment is one best settled by a judge — following the rule of law — in bankruptcy court.