Dr. P.V. Viswanath

pviswanath@pace.edu

Book retailer Borders Group Inc., which is shuttering hundreds of stores in a bid to stay alive, is seeking bankruptcy court approval to hand out as much as $8.3 million in executive bonuses, including nearly $1.7 million to President Mike Edwards.

Papers filed with the U.S. Bankruptcy Court in Manhattan outline a proposed bonus program that is keyed to the company either reorganizing under Chapter 11 or selling itself as a going concern. The bonus proposal is due for review April 14.

Mr. Edwards is also president and chief executive of Borders Inc., the principal unit of Borders Group. Bennett LeBow, chief executive of Borders Group Inc., isn't included in the bonus plan, which was outlined Thursday.

For Borders' five highest-level executives, the bonuses would mean extra pay of between 90% and 150% of their base salaries, depending on how quickly the company exits bankruptcy or is sold as a going concern.

Saddled with leases on big stores, Borders has said it will try to get out of bankruptcy by August or September. The Ann Arbor, Mich., company said the bonus program should help ensure that happens because rewards are linked to an "aggressive" time frame for exiting Chapter 11. The bonuses won't be paid if Borders liquidates.

Seventeen top executives are covered by the largest program, which could add as much as $7.1 million to the pay packets of leaders who stick with the company in bankruptcy.

Court papers say 70% of the group have been with the company less than 18 months, and many joined Borders less than a year ago.

A second $1.2 million bonus program covers 25 "director-level" managers "critical to the debtors' reorganization and to ongoing business," court papers say.

One veteran publishing executive whose company is an unsecured Borders creditor on Friday expressed frustration with the proposed bonuses but said that he felt the alternative would be even more expensive.

"The idea of retention bonuses are killing me, but you'd have to pay a king's ransom for the next group," said the executive. "It irks me because it's money that won't go to paying creditors."

He added, "I want to see Borders come out of this. If they don't have these guys, I don't see a chance."

A Border spokesman said the retailer "has asked the court to approve incentive and retention compensation plans to certain executives with respect to the Chapter 11 proceedings."

Borders has yet to file court reports that will spell out how much company insiders made in the year before the company's Feb. 16 bankruptcy filing.

Due to financial distress, the company decided not to pay bonuses for the 2010 period, Borders said in court papers. Additionally, the company said corporate employees haven't seen a salary raise in nearly four years. Mr. Edwards's predecessor as chief executive, Ron Marshall, collected about $806,000 in total pay for 2009, and more than $1 million for the previous year, SEC filings say.

Securities and Exchange Commission filings show that Mr. Edwards collected nearly $762,000 from the company in 2009, more than half of it in the form of stock and options. That was for services as chief merchandising officer, before he was named president and chief executive of Borders Inc. in January 2010.

Questions (from the WSJ Finance Weekly Review):

1. How much is Borders asking the bankruptcy court to approve in executive bonuses? What is the rationale behind the firm's request?
2. If you were an unsecured creditor of Borders would you ask the court to accept or reject the bonus plan? Explain.
3. If you were an executive at Borders would the proposed bonuses keep you from looking for another job? Explain.
4. What type of employee is the bonus plan most likely to retain? Explain.
5. If you were the judge would you approve or reject Border's plan? Explain.

My questions:

The following description is taken in a slightly paraphrased form from Jonathan Berk and Peter DeMarzo's textbook, "Corporate Finance" 2nd edition, page 513:

In Chapter 7 bankruptcy, a trustee is appointed to oversee the liquidation of the firm's assets through an auction. The proceeds from the liquidation are used to pay the firm's creditors, and the firm ceases to exist. In Chapter 11 bankruptcy, all pending collection attempts of creditors are automatically suspended, and the firm's existing management is given the opportunity to propose a reorganization plan. While developing the plan, management continues to operate the business. ... The creditors must vote to accept the plan, and it must be approved by the bankruptcy court. If an acceptable plan is not put forth, the court may ultimately force a Chapter 7 liquidation of the firm.

When discussing corporate governance, we noted that it was the entirety of a corporation's organization and structure as well as the contracts, implied and explicit between the firm and its stakeholders and we suggested that the goal of the firm's governance structure was to maximize firm value, i.e. the sum of the values accruing to all its stakeholders. If this is true, then the choice of Chapter 7 or 11 in bankruptcy should be guided by which one maximizes firm value. The bankruptcy petition of Borders Group, Inc. in the United States Bankruptcy Court of the Southern District of New York, was filed on Feb. 16, 2011 by Scott Henry, the CFO of the Borders Group and is available online at http://www.bordersreorganization.com/pdflib/20_10614.pdf.

Read the introductory paragraphs 1-6 and specific portions of the General Background, viz. sections A-B and D-H (i.e. paragraphs 7-14 and 21-34 , which are to be found between pages 3 and 11, skipping section C) and section J ("Restructuring Goals" paragraphs 47-49, page 16). Then answer the following questions:

1. Do you think Chapter 7 or Chapter 11 is most appropriate for Borders, Inc., assuming that the objective is firm value maximization? Use the information provided and any other information you may wish to obtain on the Internet. You don't have to accept management's conclusions or opinions.
2. According to the 10-Q statement filed by the company on 12/9/2010, the number of shares outstanding were about 72 million. Michael Edwards (557,000 shares), the CEO of the company and Scott Henry, the CFO (200,000 shares) were the largest direct shareholders of the company (shareholding data from http://finance.yahoo.com/q/mh?s=BGP+Major+Holders). Do you think that the current bankruptcy law, which allows existing management to propose a reorganization plan is conducive to the presumed goal of firm value maximization? Explain your answer, with reference to the Borders case. If you don't think that the current rules are optimal, how would you change them?