Meet the CEO Who Owes a Billion

N E W   Y O R K, May 17, 2002 -- There are bad loans, and then there are bad loans.

Millions of Americans owe some money to banks, credit-card companies, friends and family or even less savory lenders. But consider the whopping debts racked up by some one-time chief executives who owe money to their former employers — and in the process have seriously damaged the finances of those firms.

Pennsylvania-based cable company Adelphia Communications, for instance, guaranteed $2.3 billion in loans to former chief John J. Rigas and his family — mostly so they could purchase company stock. Amid fallout from the deal, Rigas resigned on Wednesday, followed on Thursday by the exit of his son, Timothy J. Rigas, the firm's chief financial officer.

That comes on the heels of last month's resignation by WorldCom founder and CEO Bernard J. Ebbers — whose exit was largely due to the telecom giant's recent struggles, but who happens to owe the company a cool $408 million as well.

Other firms, like Indiana-based Conseco, have acknowledged similar (if smaller) financial arrangements with executives.

At a time when the financial practices of public companies in America are drawing ever more scrutiny, the predicaments of Adelphia and WorldCom have left observers of corporate ethics shaking their heads.

"I've always thought it was a bad idea," says Charles Elson, director of the Center for Corporate Governance at the University of Delaware. "The company is not a bank, it's a company."

Adds Clyde Stickney, a professor of management at Datmouth's Tuck School of Business, in Hanover, N.H: "I would certainly question the ethics of it."

CEO Gamble: Borrowing to Buy Stock

The basic premise of these financial transactions is simple enough: The Rigas family and Ebbers essentially borrowed money from the company, in order to buy the company's stock. They hoped, of course, to see the share price rise, in which case they could have sold the stock, made a profit and paid back the loans.

But when the share prices of Adelphia and WorldCom plummeted, the net worth of the executives also dropped precipitously, reducing their ability to make good on the loans and leaving the company in the hole as well.

On May 2, for instance, Adelphia announced a restatement of its finances to account for the loan guarantees, saying its books "should reflect borrowings and related interest expense … primarily incurred in connection with other Rigas entities which purchased Adelphia securities, as liabilities in its consolidated financial statements, with a corresponding decrease in shareholders' equity."

Those liabilities now total $1.6 billion in the Adelphia restatement, with an internal review in the works. Interim CEO John Kailborne is promising "a complete, unflinching review of all the questions that have been raised," but the Securities and Exchange Commission is also looking at the company and investors are looking askance: the share price plummeted to $5.70 on Tuesday, when the Nasdaq halted trading on the stock. Adelphia's 52-week high was nearly $43 per share.

Today, Adelphia also acknowledged that two federal grand juries are examining the company's finances.

Confidence Game?

It may seem ironic that the executives have lost so much money — and hurt their firms in the process — by, in effect, showing confidence in the company's prospects.

After all, executives from many other companies — from Enron's Jeffrey Skilling to Global Crossing's Gary Winnick, among others — have been criticized for unloading company stock before it fell, helping them make, in a few cases, hundreds of millions of dollars. By contrast, the Rigas family and Ebbers have held company stock while it slipped, hoping for a rebound.

But Elson argues that kind of rationale for their actions does not carry much weight. The executives, he notes, are "playing with house money." And he says that as an investment strategy one the part of the firm, "it doesn't make any sense."

Additionally, arrangements such as these can make oversight of the firm excessively fraught with potential conflicts of interest.

"It creates a very difficult relationship between the CEO and the company," says Elson. "The company finds itself as a creditor, and that puts the board and the CEO in a very awkward position."

Payback Time?

For the moment, Adelphia and WorldCom are faced with the problem of trying to recoup some of their losses. WorldCom has announced a five-year schedule of repayment for Ebbers, who plans to sell other holdings to come up with the $408 million. Adelphia has not made clear when or how it expects Rigas to repay his loans.

And for ordinary investors, questions remain: How many more cases like these could be out there, undisclosed? And how can shareholders gain fair warning about these activities?

"I think it is common," says Stickney. "Whether they can do it or not should be in the by-laws of the company." He thinks firms also need to do a better job of spelling out loan arrangements such as these, which can seem like obscure financial arrangements: "I would go toward the disclosure solution …If the company is responsibly material, they [the loans]need to be in the notes of the financial statements."

Elson agrees that investors in other companies may be in for rude awakenings soon, for the same reason: "There are loans out there, and they will come to light."

But he also thinks the sheer size of the Adelphia and WorldCom loans is highly unlikely to be matched by any other firms, and expects the practice to become less popular precisely because of the publicity the companies have received.

"It's common," says Elson, "But it will be not be as common as it was a year ago."