HN Explorer

Why do governments favor bailout of companies rather than issuing new shares?

7 points by DamienSF ↗ HN
Isn't the public market supposed to offer public companies a way to recapitalize whenever they need it? In recent years public companies have been spending huge amounts of cash buying back their own shares. Wouldn't a functioning economy/financial system promote the issuance of new shares as the main mechanism to raise cash? It's obvious why public companies would prefer a bailout than issuing new shares but why government acting in the interest of its constituents would be so prompt to bail out public companies rather than having them raise cash through the public market? At the minimum wouldn't it be sound to condition a bailout amount to a fraction of cash raised through the market? Is there a way to explain this other than incompetence or corruption?

10 comments

[ 2.9 ms ] story [ 28.4 ms ] thread
mneil
I'm just an average consumer. But to me, thinking about capitalism, businesses should not be bailed out ever by government. They should fail and new business will take it's place and do it better, faster, or cheaper.

That said, the shutdown is government mandated. We're completely outside the spectrum of capitalism at this point. There is no free market when the government intervenes at any point. Since the feds shut it down it does make some sense that they also prop it up.

giantg2
I agree. It also depends on how they prop it and to what extent they get involved.

For example, they became shareholders in of companies during the last bailout and even turned a profit. That's sort of free market because they are utilizing the existing market structure and investing sort of similarly to regular investors. The only concern is how they would exercise their voting rights if they choose to, especially if they ever became a majority owner.

mxab
You're forgetting that there are some businesses that have a special strategic importance for a country, for example airlines or defence-related stuff. The rules of capitalism don't really apply to those kind of businesses, because governments would like them to be around even if capitalism itself happens to come crashing down.

Also, since a government has to take into account the political fallout from any bankruptcy, e.g. joblessness, the decision to bail out a company can be a rational choice inside capitalism's framework of rules from the government's perspective, especially in countries with a stronger welfare system.

giantg2
The problem with recapitalization is that you need someone willing to capitalize you. If tens of millions of people have lost their jobs, this can cause a systemic impact that reduces the amount of capital available. Not only do they not have the money to invest because they lost their income, but also their 401k investment that their employer was potentially making for them stops.

With such a drastic change in market cap and other factors that come with stay at home orders, active and even index funds will rebalance. That rebalance will help some companies, but it will hurt others.

DamienSF
That would be true for private companies but I'm not sure what would prevent public companies to raise capital by issuing new shares. Obviously the stock price would take a hit but new capital would be raised. That's the function that public markets are supposed to fulfill.
giantg2
My point is who is buying those shares?

You can issue new shares and have it sit in your company treasury, but you need people or institutions in the market to buy those shares in order to recieve that capital (their payment).

DamienSF
The shares are issued on the public market so market participants would buy the shares. Order book and market orders will determine at which price these shares would be bought.
giantg2
You still need a sufficient number of people willing to buy. Demand volume has to be greater than the current sell volume. When you hit this sort of economic crisis some people pull out of the market, others shift to less risky investments. Why invest in LUV when you can buy NAT? Especially when issuing new shares reduces the dividend and EPS, making it less attractive.
DamienSF
The price would go down until it finds enough buyers for a given price and there will be a price for which the stock is attractive again. For instance, if a company raises capital by doubling the volume of its shares, at half the price the company will be worth the same so there is no reason why nobody wouldn't buy shares of the stock at half the price. Now if there is for some reason 0 buyers, the stock is illiquid and the stock price goes to 0 but the company can still issue new shares.
giantg2
Yes, that's a textbook scenario that makes sense when the economy is functioning as it should. To truly understand how it applies in these current times you would need to take a systems-thinking approach.

Sure, someone getting in wants to buy at half price, but the existing people want to sell as soon as they hear about a potential issue diluting their ownership/price/dividend. Then the company might get a reputation for a tendency to issue shares and investors will see it as less attractive (buybacks are attractive).

Now, let's say a bunch of companies need this money, maybe like the $1T in US bailout money (Not including the other $1T+ in stimulus). Where does that money come from? Some of the largest financial companies have about $5T AUM, but it's already invested. A stock issue will only erode the value they have to work with. Billionaires and millionaires are typically listed as that based on ownership of assets (stock in their company), not what's in the bank, so they don't have enough cash to make an impact. We are close to 20% unemployment, so this tends to rule out the masses from investing new money on a large enough scale to make that sort of systemic impact (not to mention that the masses generally shy away from investing in individual stocks).

We are a consumption based economy and when consumption rapidly declines, and even goes to near zero for some industries, then the system will not produce the textbook outcomes. Talk to professionals, they will tell you they have seen some odd things in the past few months.

Bonds would typically be a better way for the company to adjust their capital short-term for a number of reasons like not constantly buying back and issuing stock. Of course that market has been screwed up since the last recession, so this textbook approach isn't likely to be effective either.