Who Benefits From Bankruptcy?

Bankruptcy. This ominous b-word brings to mind abject failure. If you invest in a company that goes bankrupt, here's a newsflash: Equity investors are last in line for any financial remuneration, meaning you'll most likely get exactly zilch when all is said and done.

Believe it or not, though, there are cases when some individuals derive handsome benefits despite the dire bankruptcy end result.

Guess who?

Good pay for CEOs, bad times for shareholders
In some bankruptcy cases, corporate CEOs have still raked in plenty of cash despite the obvious failure of their leadership and strategies.

The Wall Street Journal recently studied 21 companies that filed for bankruptcy, and the shocking median CEO compensation at those companies was a whopping $8.7 million, a measly $400,000 less than the median CEO compensation at companies in good financial standing.

For example, General Growth Properties' (NYS: GGP) CEO Adam Metz managed to rake in $57.7 million in total compensation while that entity went through bankruptcy in 2009 and 2010.

In 2009, Lear Corp.'s (NYS: LEA) Robert Rossiter made $17.4 million in total pay while the company was closing factories, slashing 20,000 jobs, and leaving shareholders out in the cold. Furthermore, the company sought $20.6 million in bonuses for key employees during that time, including $5.4 million for Rossiter.

In 2010, Visteon (NYS: VC) CEO Donald Stebbins racked up $26.8 million while the company struggled through bankruptcy proceedings. Last year, United Auto Workers' President Bob King called Ford's (NYS: F) Alan Mulally's pay "morally wrong," but Mulally actually performed and executed very well during a difficult time for automakers.

And get this: Stebbins pretty much made the same amount as Mulally in 2010. Now that's what I'd call immoral.

Speaking of which, now-defunct Borders raised eyebrows when it sought $8.3 million in retention bonuses for some executives during its initial bankruptcy phase. A judge approved the bonuses on an amended plan that included strict stipulations on performance targets for the bonuses to be paid out.

Who gets hurt?
Every once in a blue moon, investors don't get utterly wiped out when their companies file for bankruptcy; they might even make some money. My Foolish colleague Dan Caplinger highlighted such a case with Dynegy (NYS: DYN) last year. The aforementioned General Growth Properties bankruptcy also didn't result in complete ruin for investors.

However, I echo Dan's cautionary stance: Such cases are extremely unusual and for the most part, bankrupt companies are about the worst, riskiest places to be invested.

Meanwhile, shareholders aren't the only ones financially hurt by bankruptcies, whether the companies make it through to the other side or not. The attempt to survive bankruptcy often includes slashing workforces to cut costs, which contributes to the economy-busting ranks of the jobless.

Increased numbers of unemployed people help deteriorate consumer spending, leading to pain for other industries and companies, too. Although bankruptcy is most certainly the logical answer for companies that can't compete adequately, given these financial ripple effects that affect many people, shelling out millions in CEO pay during any kind of bankruptcy procedure is an utter outrage.

The worst bankruptcy of all
Despite it all, chief executive officers always seem to land on their feet financially, no matter how terribly their tenures turn out. In the case of CEOs of bankrupt companies, the rationale is that they may not have the giddy-up to steer their companies out if they're not given major financial incentives.

This brings up shades of another utterly flawed policy that cushions chief executives, and too often results in pay for failure: the golden parachute. That rationale goes something like this: Why would anybody accept the "risk" of being a CEO if they could be financially ruined if things go wrong?

Why, indeed. As you can see, these pay-for-failure poster children illustrate a situation where shareholders take on all the risk; chief executives take on none. Despite the rationalized arguments, it's exceptionally rare that any American CEO is financially ruined by what goes on under his or her watch; generally, they're financially rewarded, regardless of outcome.

And it's pretty bad when you're basically told that a certain type of person -- who is supposed to be the responsible, accountable steward of the company you've invested in -- needs to be continuously bribed with millions of dollars to show up and even to do a shoddy job. What does that say about corporate America, or even America for that matter?

As long as we're on the topic of bankruptcy, let's just call this state one of moral bankruptcy. Shareholders must stand up to this behavior, as we vote our proxies and weigh which companies we'll take the risk of investing in.

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Check back atFool.comevery Wednesday and Friday for Alyce Lomax's columns on environmental, social, and governance issues.

At the time thisarticle was published Alyce Lomax does not own shares of any of the companies mentioned. The Motley Fool owns shares of Ford. Motley Fool newsletter services have recommended buying shares and creating a synthetic long position in Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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