America's economic rivals have been furiously rewriting the book on global competitiveness. Now, they're up to Chapter 11.
In a perverse way, our forgiving bankruptcy laws have been a source of innovation and entrepreneurial strength. "From an economic perspective," says Henry R. Cheeseman, University of Southern California adjunct professor of banking and business law, "an entrepreneur in this country has the opportunity to make more risky decisions to go into a venture because, if they guess wrong, the only thing at risk is their current assets; their future assets will not be at risk. What bankruptcy does is let you do a 'Bless me, Father, I have sinned' number and then go on with your life."
In other words, the bankruptcy laws make the risk-reward ratio look extremely attractive. They're a subsidy to taking a flier on a provocative idea or an intriguing technology. The upside is limitless, and the downside is covered.
What's more, this country doesn't even make you monogram a scarlet B on your shirt if your company goes belly up. Atari, Pizza Time, Androbot, etc., founder Nolan Bushnell may be no stranger to bankruptcy court, but that certainly hasn't shut him out of entrepreneurial opportunities. Frank Lorenzo -- who is to entrepreneurship what Torquemada was to scripture -- was for years a veritable connoisseur of bankruptcy law until his piggish practices got him booted from Eastern Air Lines.
Bankruptcy entrepreneurs like Lorenzo are alien to European and Asian business. Indeed, the idea of bankruptcy as a strategic sword and shield, a` la Texaco and Manville Corp., is somewhat off-putting to overseas industry. But Japan and a Europe facing 1992 economic integration are exploring a revision of their own bankruptcy laws. In Germany and Japan, there is a stench associated with an economic failure like bankruptcy. That helps explain why entrepreneurial activities there simmer instead of bubble over. Liberalizing the bankruptcy laws would be a small but significant step in encouraging entrepreneurial risk.
And yet America's experience with entrepreneurial bankruptcy reveals that there are risks that haven't been figured into the public policy equations, particularly when it comes to emerging technologies. To wit, an entrepreneur launches a high-technology company. It does reasonably well, grows quickly and innovates even faster. Then, the cycle turns. Orders go soft. Competition intensifies. Margins disappear. The fundamental technology remains strong, but the market dynamics have gone limp.
"Technology is tough. It's not like a shoe company," says Henry Owsley, a partner with the Gordian Group, a New York merchant bank specializing in distress situations. "Products are incompatible, life cycles are short; not all technology companies are salable at any reasonable price. Being financially distressed in technology is horrible. When there's a business downturn, it can be the kiss of death."
Owsley, who has worked with troubled technology companies on both coasts, asserts that the formalities of Chapter 11 create a more orderly market for distressed firms. "I do see it as a huge help in the acquisition of distress situations," he says. "Chapter 11 has pretty clear rules. Using Chapter 11 as a backdrop, as your shadow -- a buyer can use that as a huge tool." These companies may be small, Owsley says, but they have genuine potential.
In an increasingly global economy, those buyers aren't just Americans. They're foreign companies looking to buy technology and other assets at 22 cents on the dollar. The days when foreign buyers would only spend top dollar to acquire blue chips or toss a few million in to launch a prestige start-up are over. Bottom fishing can yield a treasure.
It's not, however, the Japanese and Europeans who are most active in the distressed marketplace, Owsley says. It's the Little Dragons: South Korea, Taiwan, Singapore and Malaysia. "They're less than a third of the buy side now," he says. "By 1992, they have the clear potential to be nearly half of that market. Once they get comfortable with buying trouble, they'll have a domestic platform. This will feed on itself. Foreign buyers who have a presence here can find themselves with terrific deals."
Right now, there are about a dozen of these sorts of deals. For example, he points to Wyse Technology -- a troubled California computer manufacturer with a solid technology and distribution network -- that was recently acquired by a Taiwanese group. The future will see a lot more.
"There's more bottom fishing by the newly industrialized countries than by the Japanese," says Charles H. Ferguson, a research associate at Massachusetts Institute of Technology's Center for Technology Policy and Industrial Development, who is concerned about what he describes as America's eroding high-technology base. "They're not getting the crown jewels by doing this, but they are building a very important base while acquiring technology they don't yet have."
The irony, of course, is that most of these distressed firms would vanish if not for foreign takeover. These sorts of investments preserve jobs and boost creditors. If -- as Michael Boskin, chairman of the Council of Economic Advisers, says -- "it doesn't matter if we export computer chips or wood chips," things are all fine and dandy here. But for people who are concerned about transferring technology to America's economic rivals at 22 cents on the dollar, this is a topic of concern.
It's neat that our economy offers easy entry to and exit from the marketplace in high technology. In a global economy, however, that ease may come at an unanticipated price. I'm not saying that high-tech bottom fishing by foreign firms should be curtailed; I'm simply saying that we should be aware of what's going to be an everyday phenomenon.
I have absolutely no doubt that this is something European and Japanese policy makers will keep in mind as they reevaluate their own bankruptcy laws. It's a new reality that a source of microeconomic strength may be evolving into a source of macroeconomic weakness.
Michael Schrage is a columnist for the Los Angeles Times.