MBA PROGRAMME

SCHOOL OF BUSINESS AND MANAGEMENT

CHRIST (DEEMED TO BE UNIVERSITY), BANGALORE

CIA III (Component A)

TITLE: AGENCY PROBLEM AT GENERAL MOTORS

Submission date 13th December 2020

Under the Guidance of

Dr. MAREEENA MATHEW

Submitted By

PRATIBHA KUMARI 2027108

SUNDARA GANESH N 2027131
RESHMA MENON 2027153
 Introduction

General Motors is an American worldwide organisation plan, fabricates, advertises, and

circulates vehicles and vehicle parts, and sells financial services. It was established by William
C. Durant On September 16, 1908, as a holding company. It is one of the biggest car makers in
the world. The organisation is primarily involved in corporate autos and trucks, automotive
motors, and furthermore occupied with monetary administrations.

An agency problem is a conflict that occurs between the agent and the principal where the
principal legally appoints the agent to make a decision and take actions on its behalf. The types
of agency problems are:

a) Manager versus shareholders – The conflict between managers (agent) and shareholder
(principal) arises because managers focus only on maximising their own wealth, and
shareholders want the manager to make decisions that will increase the share value, which
leads to conflict between both parties.

b) Shareholders versus bondholders – Conflict can also arise between shareholders and
bondholders because bondholders receive fixed payments regardless of how the company is
doing in the market, but shareholders receive dividends according to how well the company
is doing better in the market resulting in a conflict of interest.

Agency Problems Identified

I. A conflict between the CEO and Shareholder arose in the year 2005 when Kirk
Kerkorian was controlling nearly 10% of the company and was the company's third-
largest shareholder. He lost several hundred million dollars because of the stock's
decline, which lead to conflict between Kerkorian (principal) and CEO (agent).
II. On June 01, 2009, the company filed for the largest industrial bankruptcy in the
history wherein GM was split into a newly restructured company ("NewCo") with a
clean balance sheet, comprising of GM's best brands and operations which would
receive government funding and "OldCo", the leftover GM with the most of its debt
obligations (Bigman, 2013)
III. As part of the restructuring, GM offered bondholders a debt-for-equity swap wherein
the $27 billion in debt will be traded for a 10 per cent ownership stake in the new
company (France24, 2009)
 Reason for Conflict

I. General Motor stopped making profits in 2005 by losing $1 billion in the 1st quarter
& 286 million in 2nd quarter. The losses were due to the failure of operations in North
America. GM's net loss of $1.1 billion, or $1.95 a share, stood in contrast to its net
profit of $1.2 billion, or $2.12 a share, in the first quarter of 2004.
General Motors' concern was that when the deals eased back down, they experienced
difficulty reducing expenses because the vast majority of their costs were fixed. As
the misfortunes mounted and the economy battled, the company couldn't make due as
a profitable business.
Kirk Kerkorian was the organisation's third-largest investor and had just lost several
hundred million dollars due to stock decline. He tried to save General Motors by
placing an associate, Jerome York, on the board who was well-known in the
Turnaround strategy; however, the management hesitated in approving the proposal.
(Times, 2005)
II. The restructuring of the "NewCo" would result in US Treasury receiving a 50% stake,
and the United Auto Workers (UAW) union would get a 39% stake. However, the
existing shareholders of "OldCo", or Motors Liquidation, will receive only 1% equity
in the restructured company. The common stockholders had already suffered a
significant loss as the stock price plummeted from $50 to $3 by the end of 2008 and
were outraged with the decision of 1% equity which all but wiped out their share in
the company profits.
III. GM hoped to reduce debt and labour costs to prove its viability to receive further
emergency funding from the US government and survive the decade lows in sales.
Bondholders criticised the unfairly low payout of 10% stake in the restructured
company compared to the 39% stake given to the UAW union (Carey, 2009). They
demanded a fair settlement - a majority stake in the restructured company - to help
them recoup their investments.

Consequences

I. The management later agreed to appoint Jerome York on the board of the company.
Kirk Kerkorian furthermore proposed that GM should join an alliance with Nissan
and Renault which was swiftly rejected and dismissed. As a result, Kerkorian sold 42
million of his shares to offset the losses incurred by the continuous decline of the
share prices and exited the firm. The move resulted in a 6.3% drop in the share value
and reduced 26 points off the blue-chip average in the market (Patterson, 2006).
II. The company received $50 billion in government funding and was bailed out of
complete bankruptcy; however, the shareholders lost their investment. Post
 restructure the shares were worth a nickel with a promise that stockholders will be
able to recover their money once GM is a more sustainable and thriving business
(PBS, 2009).
The rationale applied in the allocation of such a meagre share is that in case of
bankruptcy, stockholders are 'last in line'. One of the major reasons why stock returns
are better compared to bonds is to compensate for the risk of heavy losses during a
closure.
The only option left for the equity holders was to write off the shares in Motors
Liquidation as worthless security and report them as a capital loss. The reporting
allowed the individuals to offset capital gains or up to $3,000 of ordinary income on
their 2010 tax return.
III. The large bondholders who have insurance (also known as credit default swaps) were
able to recover their funds as the swaps payout when a company files for bankruptcy
or closure. However, the small bondholders were hit the worst and were forced to
accept the company's proposal and incur losses (Carty, 2009).

TABLE: GM Share prices from 2000 to 2010

Gain or Loss Percent Gain

Year Opening Price Closing Price
(Annual) or Loss
2000 72.6875 50.94 -21.75 -29.92%
2001 50.9375 48.6 -2.3375 -4.59%
2002 48.6 36.86 -11.74 -24.16%
2003 36.86 53.4 16.54 44.87%
2004 53.4 40.06 -13.34 -24.98%
2005 40.06 19.42 -20.64 -51.52%
2006 19.42 30.72 11.3 58.19%
2007 30.72 24.89 -5.83 -18.98%
2008 24.89 3.2 -21.69 -87.14%
2009 3.2 0.471 -2.729 -85.28%
2010 0.471 36.86 36.389 7725.9%
Source: 1Stock1.com
 FIGURE: Share Price Trendline

STOCK TREND
53.4
50.94
48.6

40.06
CLOSING PRICE

36.86 36.86
30.72
24.89
19.42

3.2
0.471
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
YEARS

The above chart depicts the steady decline in the share price of General Motors due to
significantly low sales and increased fixed costs, by way of union contracts which ensured that
even when a plant is shutdown, the workers would still keep their jobs.
The company pensions and legacy healthcare costs were also fixed. Coupled with the sales
slowdown, the company eventually was unable to survive as a viable business and had to file for
bankruptcy.
On November 28, 2010, GM launched its IPO for its newly restructured company with the share
price trading at $36.86. Due to strong investor support, GM was able to significantly raise both
the price and the number of shares for a $13 billion offering.

Conclusion

General Motors, once a juggernaut of the automobile industry, had fallen due to
mismanagement, high labour costs, debt load and excess dealers. The company had come up
with an innovative alternative to liquidation and closure. The bankruptcy was a carefully
orchestrated restructuring with funding from the US Treasury.
However, in a desperate attempt to stay afloat, the company was not able to compensate
its myriad of stakeholders, resulting in loss of goodwill and tarnishing of the company's
reputation. Also, financing the company with the taxpayer's income involved heavy scrutiny
from the citizens and opposition party (the Republican) in Congress.
 References

Bigman, D. (2013, October 30). How General Motors Was Really Saved: The Untold True Story
Of The Most Important Bankruptcy In US History. From Forbes:
https://www.forbes.com/sites/danbigman/2013/10/30/how-general-motors-was-really-
saved-the-untold-true-story-of-the-most-important-bankruptcy-in-u-s-
history/?sh=527209c87eea
Carey, N. (2009). GM small bondholders cry foul over bond exchange. From Reuters:
https://in.reuters.com/article/instant-article/idUSN2942515420090429
Carty, S. S. (2009, April 28). GM's proposal would give bondholders next to nothing. From
abcnews: https://abcnews.go.com/Business/story?id=7444740&page=1
France24. (2009, May 28). GM edges closer to bankruptcy after failed debt exchange. From
France24: https://www.france24.com/en/20090528-gm-edges-closer-bankruptcy-after-
failed-debt-exchange-
Patterson, S. (2006, October 6). Blue Chip Run Ends As GM's Stock Tumbles. From The Wall
Street Journal: https://www.wsj.com/articles/SB116013445284284769
PBS. (2009, April 3). If GM Is Restructured, What Happens to Shareholders? From PBS:
https://www.pbs.org/newshour/economy/if-gm-is-restructured-what-hap
Times, N. Y. (2005, April 19). GM Reports $1.1 Billion loss. From The New York Times:
https://www.nytimes.com/2005/04/19/business/gm-reports-11-billion-loss.html