Two Ways to do Government Corp Fin
The United States government is one of the largest, and few, investors in corporate finance deals these days. Congress authorized Treasury to use up to $350 billion in government funds to invest in corporate America (with a contingent increase of another $350 billion). Its authorization to Treasury is very broad, and has allowed it to make any form of investment (mostly but not exclusively in financial institutions), on such terms as the Treasury Secretary deems advisable.
The approach to investing these funds appears strikingly different between Bush Administration Treasury Secretary Hank Paulson and Obama Treasury Secretary Tim Geithner.
Paulson took a tailored, deal by deal approach. He never published clear guidelines concerning in which companies he would invest. Sometimes he invested by lending and sometimes in preferred stock. Sometimes he’d negotiate for covenants from the other side and sometimes he would not. He did not publicize resulting investment contracts. In general, he did not impose covenants on investees, such as restrictions on making asset distributions to common stockholders, although in some cases he did extract those concessions (e.g., with General Motors Acceptance Corporation).
Geithner on Tuesday issued a general template for his investment program. He has published guidelines for what investees must do to earn his investments. They have to explain how they will use funds, requiring that they be used to run the business, not hoarded, meaning, for banks, lending money to customers. Investees have to make monthly reports to Treasury showing how they used the funds to make loans or support loans made by other institutions. Investees must undergo a threshold financial stress test, assessing their financial position, and capital needs.
Geithner’s standard form of investment is going to be preferred stock, with a competitive dividend rate, convertible into common stock, at a competitive conversion rate, should market conditions justify conversion. He is also insisting on blanket covenants prohibiting investees from distributing assets to common stockholders, by dividend or stock buy-back, or using cash to make acquisitions. He is also imposing limitations on executive compensation, generally capping it at $500,000 annual cash per executive, except for compensation paid in common stock that is not allowed to be sold or otherwise liquidated until the government investment is redeemed.
How different are these two approaches? In some sense, they appear simply to adopt different default rules. Paulson took a deal by deal approach, but most of the deals looked pretty much the same. Geithner announces a standardized package, but allows himself considerable tailoring, by reserving the right to waive various provisions, so that he can tailor deal terms to particular deals.
Perhaps the most striking difference concerns transparency. Geithner’s Treasury will publish most of the information it gets from investees on its newly-created, dedicated Web site, www.financialstability.gov. Information is to include each investee’s plan for use of funds, monthly reports on actual use, and all investment contracts between Treasury and investees. It does not appear that the stress tests will be published, however.