Curiosity

2/7/09

I'm just wondering, should a company in financial trouble abandon their contracts? The legal answer is no. The strategic answer is that they should try to renegotiate them. Either way, they have a legal obligation to complete those contracts regardless of whether they make money on them. That is what drives capitalism. Risk. Every time a company enters into an agreement, there is a level of risk on either side that they will come out of the contract unsatisfied. To minimize risks, companies hire teams of lawyers to fashion contracts that attempt to forsee the likely events that would result in a loss. Companies insure against the risk they can't contract away.

When a contract is complete, the company experiences one of two outcomes. First they emerge with more than they entered with. This can be monetary or otherwise. It is called profit. Second, they can emerge with less than they entered with. This is called loss.

This logic is also true of the company's contacts with their employees. The company agrees to exchange a formula of salary benefits and sometimes bonus in exchange for the employee's performance. Sometimes that employee performs far above the expected standard. The company profits. Sometimes the employee's performance is lackluster. The company suffers a loss. But either way, the company is contractually bound to pay the employee their wages. In most states, they, of course, have the right to cancel their contract and fire the employee if they consistently underperform. In like manner, they may also promote a superior employee. But there is little case for paying employees after the work is done whatever the company sees fit to pay them. Unless. Unless there is a preexisting contract as in the case of profit sharing whereby the employee receives a bonus measured on the company's performance. Also in the case of commissions, where the employee is paid in proportion to their performance. But these features are negotiated at the point of hire, not after the work is complete.

Having said all that, why would an ailing company refuse to pay a top management official their contract. Of course, if their stock option or bonus is tied to performance and the company doesn't perform, there is nothing to talk about. But what about the management contract that states that after the first year the employee will be paid a bonus without conditions. If that employee works for the year and is not fired, they have met their obligation in good faith. Failure to pay them is a breach of contract.

I'll be the first middle-class person to jump up and down and cry that it isn't fair that these elite few make so much money. But I also know that if I ever became one of those elite few, I would see things quite differently. I am as confused as to how a baseball player is worth $25 million a year or a CEO worth $55 million a year. But according to the laws of supply and demand, if someone is willing to pay the price, that's all that is necessary.

In the corporate view, when a CEO is appointed and they receive a hefty package, the corporation posts it in an 8-K for all stockholders to see. The stockholders then have the opportunity to vote with their wallet by selling their stock if they believe the investment was a poor one. Likewise, those purchasing the stock going forward have the ability to weigh the asking price against the top management's packages and choose not to invest.