Corporate Bailouts in Taiwan: Lessons from AIG

Taiwan’s legislature recently passed a partial revision of the Company Law that included a set of complementary rules to address future corporate bailout cases, stipulating, for example, when corporations accepting government relief must present their own rescue plans: If the amount of bailout assistance exceeds NT$1 billion, corporate officers must report their rescue plans to the Legislative Yuan; at the same time, the regulatory authority may place appropriate restrictions on executive compensation. However, other related laws, regulations and other supporting measures await further planning. That being the case, it seems Taiwan’s authorities could use the experience of other countries, in terms of legislation and practical action, for a reference in planning the necessary supporting measures for bailout rules.

Following the bursting of the housing market and sub-prime mortgage bubble, the U.S. has been inundated by a virtual tsunami of financial sector woes. The economy has fallen into a deep recession and many businesses have encountered the bleak prospect of mounting losses or even bankruptcy. In order to stabilize the financial system, the U.S. government has taken a series of actions to bail out certain businesses. The legal basis for these relief measures is essentially two-fold:

One is Section 13(3) of the Federal Reserve Act, which provides that in “unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank” to lend at discounted rates, but borrowing companies must first prove that they are unable to secure sufficient funds from other banks.

The other is the Emergency Economic Stabilization Act of 2008, passed in October of that year, which authorizes the Treasury Department to purchase troubled assets from financial institutions, or to guarantee such assets, “to restore liquidity and stability to the U.S. financial system and to ensure the economic well-being of Americans.”

In the case of AIG (American International Group), the New York Federal Reserve Bank provided the insurance company a credit facility of some US$85 billion. [The Wall Street Journal (online.wsj.com) reported on May 8, 2008 that AIG had borrowed $45.5 billion of the available funds as of May 6.] The Treasury Department later purchased US$40 million in preferred stock and adjusted the conditions on the credit provided in September. The New York Fed accompanied this with loans in connection with AIG’s residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs).

It is worth noting the terms of the agreement AIG signed for the Treasury Department’s 40-billion-dollar purchase of its preferred shares. These stipulated the class, characteristics and rights of the preferred shares, as well as the conditions under which AIG may redeem them. More important still were the closing conditions agreed to for the preferred stock, including Treasury Department oversight of AIG governance, restrictions on the use of subsequent earnings, and the Treasury’s own exit mechanisms. The purpose of these conditions is to ensure that taxpayer-provided bailout funds are put to the most effective use, while also ensuring as much as possible that the Treasury will be able to recover the bailout funds being provided.

Government bailouts typically involve large sums of taxpayers’ money, and their goal is both to provide specific relief to genuinely distressed corporations and to look after the taxpayers’ interests. To achieve these goals, the key is for bailout methods to be appropriately planned at the outset. Therefore, if Taiwan’s regulatory authority wants to provide relief by purchasing preferred stock, we suggest that it draw upon the relevant U.S. experience described above, with special reference to the following aspects, in order to make the most of well-intended bailout plans and restore stability to the financial system:

Proper attention to how bailout recipients issue preferred shares: restrictions on such share issues; addressing the relationship between preferred share equity issued under a bailout and various commercial paper already issued by companies receiving bailout assistance; and designing comprehensive exit mechanisms for the governing authority.

Strengthened oversight of bailout recipients: controlling the recipients’ financial flows, ensuring their operations can develop in a sound manner; stronger oversight of recipients’ governance, specifying what types of information must be reported to the regulator; consideration of whether or not to participate in the actual running of companies receiving assistance, while avoiding confusion over the governing authority’s role, as well as conflicts of interest among the companies receiving aid.

Preparation and signing of complementary measures and legal documents: the proper handling of potential labor-management disputes arising from Company Law revisions that restrict executive compensation at companies receiving bailouts—so-called diets for fat cats. At the same time, legally binding documents can be signed between the government and recipients regarding the bailout methods and other stakeholders that might be affected, such as managers whose compensation has been reduced, setting out their rights and obligations. This can help ensure that bailout beneficiaries fully abide by their commitments, substantive and procedural, while avoiding disputes over attempts to take advantage of procedural ambiguities and thwart the government’s good intentions.

[This article appeared in the Economic Daily (Taiwan) on February 23, 2009.]

Ross Yang is a partner at PricewaterhouseCoopers Taiwan. Please send your comments and questions to ross.yang@tw.pwc.com.