Ethics Case 14–8 - Hunt Manufacturing - Debt for equity swaps; have your cake and eat it too ● LO5
The cloudy afternoon mirrored the mood of the conference of division
managers. Claude Meyer, assistant to the controller for Hunt
Manufacturing, wore one of the gloomy faces that were just emerging from
the conference room. “Wow, I knew it was bad, but not that bad,” Claude
thought to himself. “I don’t look forward to sharing those numbers with
shareholders.”
The numbers he discussed with himself were fourth quarter losses which
more than offset the profits of the first three quarters. Everyone had
known for some time that poor sales forecasts and production delays had
wreaked havoc on the bottom line, but most were caught off guard by the
severity of damage.
Later that night he sat alone in his office, scanning and rescanning
the preliminary financial statements on his computer monitor. Suddenly
his mood brightened. “This may work,” he said aloud, though no one could
hear. Fifteen minutes later he congratulated himself, “Yes!”
The next day he eagerly explained his plan to Susan Barr, controller of
Hunt for the last six years. The plan involved $300 million in
convertible bonds issued three years earlier.
Meyer: By swapping stock for
the bonds, we can eliminate a substantial liability from the balance
sheet, wipe out most of our interest expense, and reduce our loss. In
fact, the book value of the bonds is significantly more than the market
value of the stock we’d issue. I think we can produce a profit.
Barr: But Claude, our bondholders are not inclined to convert the bonds
Meyer: Right. But, the bonds are
callable. As of this year, we can call the bonds at a call premium of
1%. Given the choice of accepting that redemption price or converting to
stock, they’ll all convert. We won’t have to pay a cent. And, since no
cash will be paid, we won’t pay taxes either.
Required:
Do you perceive an ethical dilemma? What would be the impact of
following up on Claude’s plan? Who would benefit? Who would be injured?
