05 April 2006

Is General Motors upside down?

What if General Motor's positive net worth is simply a product of an accounting flaw?

New accounting proposals, not yet in place, would require companies to report their pension deficits. With the GMAC sale, the new accounting rules would leave GM with a negative shareholders' equity of $43 million (instead of the positive $14.6 billion under existing rules).

One way of interpreting the liability-equity side of a balance sheet, is as a list of people who have claims on the assets of the company. If pension liabilities are understated to the point that shareholder equity is negative, then bondholders and employees are the true financial owner's of the company, and shareholders don't really deserve to have a say in the company's affairs any more. Indeed, in Colorado, there is some case law holding that when a corporation gets upside down, that the board of directors owes fiduciary duties to the creditors, rather than the shareholders, at that point.

Of course, $43 million is just barely upside down in a huge publicly held company like General Motors, which has about 835 million shares outstanding. The per share deficit would be about a nickle a share (indicating that unlimited liability would hardly crush most people), and there is always some possibility that the company will turn itself around. But, it has a market capitalization of about $12.5 billion (quite close to its balance sheet value which is encumbered with historical costs), and if shareholder's equity is really even a little negative, General Motors should be a penny stock.

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