Believe it: Sometimes Governance is to Blame More than the Tax Code

The recent discussion in the media about the litigation around the Tribune Company LBO in 2007, is an excellent illustration of the consequences of a governance failure as well as the failure of many commentators to recognize the causal relationship. In the linked article, Holman Jenkins of the WSJ correctly notes that this deal was ill-conceived from the beginning.

To sum up a complicated situation, a bankruptcy judge has now decided that the Tribune’s unsecured creditors can sue everyone involved in the leveraged buyout, including the lending banks, on grounds that the deal was a “fraudulent conveyance”—they knew or should have known they were piling on more debt than the company could survive. Already a special examiner appointed by the bankruptcy judge has found sufficient evidence to support such a claim. 

He pins the blame on our convoluted Internal Revenue Code, specifically its provisions awarding special dispensation to Employee Stock Ownership Plans, one of the vehicles used to bring the deal to fruition.

While there is little doubt that IRC incentives played some role in the debacle, the fact remains that the deal was quite aggressive in all events. This was the case even with the most favorable tax consequences and economic assumptions, and prompted significant concern at the time by those asked to pass on the company’s solvency ex post. In other words, the deal resulted from bad decisions by both purchasers and sellers. There was simply insufficient vetting of the deal by anyone.

As we know, the corporate governance field exists in large part to cause companies to avoid such bad decisions. Caused in large part by terrible decisions in the financial sector (as well as households entering into the overly aggressive mortgages), the Great Recession attests to the fact that governance law has not worked in the intended manner and that substantive changes are required to have it work properly.

While there is no question that our IRC is sorely in need of overhaul for many reasons, it is important that its deficiencies not be used as a scapegoat for governance failures. It is important that public dialogue about what needs to be done to avoid the sorts of bad decisions that led to the Great Recession be properly focused and prominently note the role of governance and the need to change its framework so as to bring about fewer bad decisions.

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