Government Equity in Private Companies: A Bad Idea-

Gary Becker

The Federal government of the United States has seldom taken an equity interest in private companies, although this has been proposed sometimes, especially as a way to get higher returns on social security assets. However, the new financial bailout bill provides not only for the government to buy assets from banks, but that it also take an equity stake in the banks being helped. The purpose is to protect the government from paying too much for the many difficult to value assets that are acquired. The thinking is that if they overpay for some assets, they can make that back through a rise in the value of the stock or other equity interest that they would have.

However, the main purpose of the buyout is to increase the liquidity of the banking system and thereby reduce the banking system’s retreat from riskier investments. Yet the government’s actions regarding an equity interest seem to be based on a fear that it will be outsmarted in the prices it pays for assets that are very difficult to value because they have no market. Whether the government will lose after the fact is not clear since it can afford to hold the assets to maturity. Moreover, taking an equity interest is also unnecessary in order to protect taxpayers from overpaying. Modern auction theory offers various ways to induce sellers (or buyers) of assets and other objects to “tell the truth”; that is, to bid their best estimate of an asset’s worth. In using auction to buy bank assets it would be helpful if the government did not automatically take all assets offered by banks, so that banks have to compete against each other. Competition can also be increased by spreading the auctions out over time (I am indebted to my colleague Phil Reny for useful comments on optimal auction design). To be sure, the seller’s estimates of the worth of their assets may turn out to be wrong, so the government would bear some risk. However, with an optimal auction mechanism design, the government need not fear grossly overpaying ex ante for the assets they acquire.

Even if the government were to lose money on this buyout, it is a bad precedent for it to take an equity interest in private companies. Inevitably, this leads to government involvement in business decisions and corporate governance. Experience shows that political rather than economic criteria tend to dominate in the pressures exerted by government shareholders on corporate decisions. This is already reflected in the bailout bill since it limits compensation for executives, including “golden parachutes” for executives of the companies helped. One can hardly have a high opinion of the executives who led such venerable institutions as Merrill Lynch and Lehman Brothers, and many other banks, into investment portfolios with such poor capacity to withstand a financial disturbance. Still, many of these executives have lost most of their very considerable fortunes since they usually owned or had options on many shares of their companies, and these shares have plummeted in price. It is appropriate that top executives suffer major losses when their companies collapse.

There is no good reason, however, for the government to interfere and impose limits on salaries and severance pay. Controls over wages and salaries have never worked well, and only encourage myriad ways to get around them, including generous housing allowances, vacation homes, easy access to private planes, large pensions, and other fringe benefits. There develops a war between the government’s closing of loopholes, and the ingenuity of accountants and lawyers in finding new ones.

Governmental ownership of shares, with or without voting rights, opens up possibilities for much greater mischief than controlling executive salaries. For example, a bank or other company may want to reduce its employment in order to regain greater profitability. The government owners of these shares will be under pressure from congressman and senators who represent districts where employment would be affected to try to rescind or modify these cuts. Even without government ownership, congressmen protest corporate efforts to shift various activities overseas because labor and other resources are cheaper there. Such objections will be magnified when governments have direct equity stakes.

There are many illustrations of the bad influence on corporate governance exerted by the governments of France, Italy, Russia, and many other countries that own shares in private companies. One current appalling example is the situation of Alitalia Airlines, where the government owns almost half the stock. This has been a very inefficiently run airline that is hostage among others to powerful unions. Strikes have been common, flights frequently takeoff and arrive quite late, and baggage losses are high- experienced travelers try hard to avoid using Alitalia. Since Alitalia’s command of routes into and out of Italy has market value, stronger European Airlines, such as Air France and Lufthansa, have wanted to take this airline over. However, the Italian government has resisted these efforts and continues to finance the sizeable monthly deficits of the airline. It fears the power of the unions who realize that many airline jobs at Alitalia will be lost if a more efficient airline takes charge.

This and other examples of harmful government interference in the running of companies where they have an equity interest provides a very good lesson for the United States. Avoid taking any equity interest in private companies when buying assets of banks under the bailout bill, or when investing other government revenues.

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