WHAT KIND OF BAIL-OUT DOES EACH COMPANY DESERVE?
Starting with Data to Design a Fair Bail-out
On March 15, United Airlines (UAL) CEO Oscar Munoz sent a letter to the nearly 100,000 employees of the UAL, warning them of the calamities to come and letting them know that he is looking ways to “reduce payroll expenses”. A few days later, he went to Congress and asked for a nearly $60 billion bail-out for the airline industry, accompanied with a thinly veiled threat that if UAL does not get this infusion, it may have to lay off even more employees than it had already planned.
I am hesitant to single out Oscar Munoz because his behavior has become the norm among American CEOs. Yet, I want to look at the numbers and understand what this means. In 2019, UAL made $43 billion in revenue and paid $12 billion to its employees. Let's say that the bail-out share of UAL is $15 billion. This amounts to four months of revenue and fifteen months of employee salaries. Does this make sense?
In a time like this, we should lay all our deep-rooted assumptions on the operating table.
- Is this the best way the US treasury can spend $60 billion, surely most of the airlines will survive anyway?
- What happened to the corporate tax windfall that UAL and other airlines got in 2018?
- Why not ask the banks for a loan?
I will compare 2017 with 2019 to capture the impact of corporate tax break that was given to corporations in 2018. Again, this is not to single out UAL or Mr. Munoz. A quick look at some other companies indicate a systemic problem in the way the modern American corporation allocates surplus profits and windfalls. The table below contains a small excerpt of data.
|UAL Income Statements (December 31)||2019||2018||2017||Change from 2017 to 2019|
|Labor & Related Expense||12,071||11,458||10,941||10.3%|
|Labor & Related Expense per Employee (000's)||126||125||124||1.1%|
|Total Operating Expense||38,958||38,074||34,166||14.0%|
|Income Before Tax||3,914||2,648||3,023||29.5%|
|Provision for Income Taxes||905||531||1,069||-15.3%|
|Effective tax Rate||23%||20%||35%||-34.6%|
|Net Income After Taxes||3,009||2,117||1,954||54.0%|
|Basic/Primary Weighted Average Shares||259||276||303||-14.5%|
|Basic/Primary EPS Incl. Extraordinary Items $/share||11.63||7.68||6.46||80.0%|
|CEO ompensation (2018 is used for 2019)||10.50||9.55||9.9%|
|Base + Bonus + Other||5.25||1.70|
|Re-purchase of common stock||-1,645||-1,235||-1,844||-2,880|
By the end of 2019, the annual revenue of UAL hit $43.25 billion dollars, a 14.5% increase compared to 2017. Labor and related expense increased by 10.3% to $12.1 billion dollars. But when adjusted by the number of employees, average compensation per employee increased by 1.1% over two years. Since expenses increased slower than revenue, income before taxes increased by 20.5%.
Then the benefit of the 2018 corporate tax cut kicked in. As a result, the Net Income increased by 54%. It is amazing how these improvements in performance look better and better as we get closer to the shareholders. If UAL were paying a 35% tax rate as it did in 2017, it would have paid $860 million more in taxes in 2018 and 2019. UAL gifted this windfall to its shareholders by buying back its own shares. No meaningful increase in salaries, no paydown of debt. In fact, debt increased by about $425 million. UAL bought back $2.88 billion of its own shares, decreasing the number of shares outstanding by almost 15%. The increase in net income and the decrease in number of shares resulted in an increase of 80% in EPS (Earnings per Share).
If UAL were paying a 35% tax rate as it did in 2017, it would have paid $860 million more in taxes in 2018 and 2019. UAL gifted this windfall to its shareholders by buying back its own shares.
Within the time that average employee salary increased by 1%, shareholder return increased by 80%.
EPS is one of the most important performance measures of the modern American CEO. Analysts look at quarterly increase in EPS. In that case, what better way is there for a CEO to maximize his income than to first negotiate a share-based compensation, and then make those shares as valuable as possible within the analysts’ time frame: one or two quarters. Mr. Munoz gets a substantial portion of his compensations as shares.
All of this “alignment of interests” would be acceptable until we realize that the world does not work this way for the ordinary UAL employee. In good times, a typical UAL employee gets paid a market salary which is less than 1/100 of the CEO compensation. In bad times, the typical UAL employee is laid off or at best asked to take a severe pay-cut. For sure, if the employee had made as bad a decision as buying shares at $90 in 2019, which then went down to $25 in 2020, he would be fired.
What happens to the CEO?
If the board is strong enough to let him go, he collects his departing bonus, which is likely multiples of what a typical UAL employee will make in his lifetime. If he is not immediately fired, he will go to the government and ask for a bail-out, hinting, “or else I will have to lay off many employees”.
CEOs can behave recklessly because we have created a system in which they cannot fail. The neo-classical argument I hear for this is “well, the government gives the money to the companies because they can allocate resources better”. But if the companies are so much smarter, why do they keep going back to the government for a handout? Whereas I did not have to go for a handout even once. The answer is very simple, because I knew I was not allowed to go and ask for a handout.
American government should tell Mr. Munoz that “Instead of giving UAL billions, how about if we give each employee some funds to get by and maybe start businesses. This creates a long runway for the employees to re-adjust to the new world.”
UAL owns enough equipment (aircraft) and infrastructure to put up as collateral for bank loans. If there is a bail-out, it should be conditional on protecting jobs. But if some capital is given to the employees who are now without a company, I bet that a few of them will put the money to good use and may even build one of the best new companies of the next decade. As Joseph Schumpeter said, This process of Creative Destruction is the essential fact about capitalism.
I will publish data for a few other popular companies next week and you can judge for yourself, what kind of bail-out each company deserves.
Please share your thoughts!
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