SLG: Assignment on ‘Barbarians at the Gate’ | Group 4 | Section B

Krati Bansal (BJ20085) | Shitij Manojkumar Agarwal (BJ20108) | Raghava Krishnan T E (BJ20115)
Aprajita Srivastava (H20129) | Pushkar Chaugule (H20161) | Sharon Jane Koshy (H20168)

Below are 7 corporate governance issues with possible solutions to each:

1) Principal-Agent Problem: This is portrayed as a conflict between the principal

(company and shareholders) and the agent (CEO F. Ross Johnson) when the agent strives
towards personal gains at the cost of the principal. The CEO tried to undertake a
Leveraged Buyout (LBO) to increase his personal gains and the value of the company.
There was no attempt at reducing expenditure on excesses such as a fleet of 10 private
jets, personal villas etc. which catered to the CEO.

Solution: To have tight budgetary allocations and a limit to the perks and benefits the
CEO and other agents can avail. These allocations can be linked to the performance of
the CEO along with an approval by the Board of Directors. These should not be at the
cost of the principal losing important funds and resources.

2) Unbridled Expenditures: The CEO spent millions of dollars throwing lavish parties to
keep their external partners like the retailers satisfied and in the hopes of being in their
good graces. The potential benefits of using these non-market strategies cited were the
promotion and the push of RJR products by these retail partners. The spending went
unchecked, and the CEO went ahead with these parties despite the better judgment of
the head of the cigarette division, Mr. John Greeniaus.

Solution: The company should look at the ROI of these activities and keep the expenses
to the limit. The potential upside that the company expects from these activities needs
to be quantified for apt budgetary allocations. Also, transparent discussions with
departments/divisions of the company which are important stakeholders with respect
to such non-market strategies being employed.

3) Over-optimism over an Untested Product: Critical information was not disclosed in a

timely manner to the parties involved. This is evidenced by Mr. Ross Johnson’s
reluctance to admit to Shearson that the product on which future trajectories and debt
repayment potential is based (premiers) was not fit to be rolled out to market. This
encouraged them to make inflated bid prices against ever mounting debts.

Solution: The true state of affairs regarding should be a part of mandatory disclosures.
This would enable financial backers and shareholders in making a more informed
decision and hold the parties involved accountable for the proposal they make.

4) Leveraging Loopholes in Tax & Legal Systems: As mentioned in the movie when
Henry Kravis raised the bid price to $90 per share, Mr. Jim Robinson suggested Ross
Johnson to leverage the loopholes in the existing American tax system to raise more
money and hence eventually to increase bid price per share. Also, LBOs were initially
introduced as a potential means to evade estate taxes and preserve the family wealth.
Also, as mentioned in the movie Henry Kravis was known to raise money by leveraging

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the junk bonds which despite promising higher returns, the party issuing them could fail
at any time, setting the stage for a default on their outstanding bonds. As a result, the
bond buyer may lose his entire investment.

Solution: Stringent rules against tax avoidance needs to be formulated along with the
revision of existing tax policies. The Tax Administration Reform Commission needs to be
established by the government to make structural changes to tax matters in order to
streamline and effective tax procedures.

5) Layoffs and Divestment: As a consequence of the inflated bid prices, more and more
jobs and entire divisions were under threat of layoffs or divestment (the company is
eventually broken up), in stark contrast to the billions that CEO Johnson stood to make
for himself as a part of the buyout. This is unfair treatment of the company’s
employees and is not in the company’s best interest to undergo such disruptions as the
new owners/ management will be met with additional hostility making transitions even
more difficult.

Solution: Include union representatives and more prudence is required when the board
appoints the head of the management. It is vital that these management leaders have
the right set of morals and prioritize the company over their personal victories.

6) Lack of Transparency: The company and the CEO displayed a lack of transparency
throughout the process of the LBO. The KKR firm was stonewalled by the firm after it
expressed interest in buying the company as none of the employees disclosed
information on the assets and the challenges of the firm. Although legally mandated to
co-operate in the due-diligence process, the firm could not gauge the value of the firm
until one of Henry's sources provided the information. Another instance of the lack of
transparency is Peter not knowing the true results of the Premier cigarette range. He
was willing to increase the share price on the hopes of an increased revenue after the
launch of Premier.

Solution: These issues are of a personal nature taken by people in key responsibilities.
More prudence is required when the board appoints the head of the management. It is
vital that these management leaders have the right set of morals and prioritize the
company over their personal victories.

7) No limit for Debt for LBO: To finance the LBO, debt was accrued. As the bid amounts
rose (in Billions), more debt was accrued to finance it. The lack of a limit on the amount
of debt that can be taken out meant that by the end of the 80s, Wallstreet had
collectively managed to bring debt of more than $1 Trillion Dollars, leading to recession
shortly after. This limitless borrowing is detrimental to the entire nation as it creates a
bubble that eventually plunges the nation into a recession.

Solution: Enforcing a percentage limit of how much debt can be accrued against an LBO.
It would moderate the amount of debt as well as the bids that can be reasonably placed,
favoring “real people with real money” as mentioned in the movie.

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