Managerial Decisions and Financial Difficulties

W. T. Grant became mired in finance capital markets partially because a long series of unrestrained managerial decisions produced severe cash shortages. These decisions included exceedingly rapid overexpansion, a poorly conceived and inadequately managed inhouse credit system, an incomprehensible inventory system, and an ill-conceived and confusing attempt to shift its merchandising emphasis from soft goods to durable goods. The net result of these managerial decisions was that by 1974 Grant had suffered substantial cash losses, and it eventually filed a Chapter XI bankruptcy. A prolonged investigation, prompted by contentious litigation over the firm's liquidation, revealed the banking community's tacit approval and encouragement of management's decision making. Through their representation on the firm's board of directors,

the banks were in a position to know of and to participate to an extent in these managerial decisions (Morgan Guaranty Trust Company of New York v. Charles G. Rodman, as Trustee of the Estate of W. T. Grant Company, 1975, hereafter cited as Morgan v. Grant ).

An example of Grant's unrestrained and shortsighted managerial decisions was its store expansion program. The company's objective was to open stores in relatively small towns where rival major department stores had not yet gone. Outside director DeWitt Peterkin, Jr., vice chairman of the board of directors of Morgan Guaranty Trust, testified that this expansion program was "a management decision." (See Dramatis Personae 1 for the names and positions of actors in W. T. Grant's bankruptcy.) Yet no one on the board asked management to defend its selection of expansion sites or questioned why other major retailers weren't in these areas if the proposed locations were so good. No one even asked for an analysis of "who the Grant customer was" (Peterkin, in Morgan v. Grant, 366–367, 32, 34). The expansion program was so fast that between 1969 and 1973 Grant opened 369 stores. According to James G. Kendrick, a former chief executive officer, "The expansion program placed a great deal of strain on the physical and human capabilities of the company." Said another former executive: "Our training program could not keep up with the explosion of stores. . . . And it did not take long for the mediocrity to show" (Business Week, 19 July 1976, 60–61).

Another example of poor and unchecked managerial decisions was Grant's credit system. Credit was extremely easy to obtain from Grant, and repayment schedules were often as low as one dollar per month. The firm instituted this program to induce its customers to purchase expensive appliances and furniture. Managers, who are traditionally expected to maximize profits, were under constant pressure to increase credit sales. These same managers were responsible for giving the final approval on new credit accounts. A former finance executive stated that "the stores were told to push credit and had certain quotas to fill." One former manager grumbled, "We gave credit to every deadbeat who breathed" (Business Week, 19 July 1976, 61). Since each store was responsible for promoting credit, collecting payments, and maintaining credit information, Grant in effect had 1,200 credit offices. Indeed, custom-

ers could build up huge amounts of credit by opening separate accounts in different Grant stores.

Richard W. Mayer, Grant's chief executive officer, president, and chairman of the board, testified that the store managers were responsible for both sales and credit granting because of corporate founder William T. Grant's philosophy that "the store manager was . . . 'The King.' And he [sic ] had control over all functions in the store. There is no more reason why he [sic ] should not have control over his [sic ] credit program" (Mayer, in Morgan v. Grant, 82–83). Mayer indicated that no one from Grant's accounting firm (Ernst and Ernst) or Grant's board of directors ever questioned why the same store manager handled the conflicting functions of sales and credit.

The ill effects of the easy-credit lure instituted in 1969 appeared as early as 1970. Yet the company did not become concerned about the situation until after the fiscal report of 1971, which revealed the credit problems. According to John G. Curtin, financial vice president and treasurer at Grant, there was a steady and significant "rise in write-offs of uncollectible credit accounts. Uncollectibles rose from 2.1% in fiscal 1970 to 3.2% in fiscal 1972" (Women's Wear Daily, 4 Feb. 1977, 24).

Peterkin told the court that the company's lax policy toward delinquent creditors was a product of the recession. Since so many of Grant's customers seemed to be adversely affected by the recession, management decided "not to go after delinquencies so hard as they might have otherwise in the hopes that economic conditions were going to improve and these customers were going to be able to get back on current basis" (Peterkin, in Morgan v. Grant, 188).

Grant extended its customary grace period to accommodate its delinquent customers: "Until 1975 it allowed 36 months to pay, with a minimum payment of $1 per month" (Business Week, 19 July 1976, 61). Under this lax policy, Grant's delinquent accounts increased "appreciably" from 1972 to 1973. By 31 January 1973, Grant had approximately 56,000 delinquent accounts. The following year that number had increased to around 102,000 (Peterkin, in Morgan v. Grant, 321). This figure represented a loss of $602.6 million, compared with $556 million in 1973, "and up 86% over the $324 mllion in 1969" (Business Week, 19 July 1976, 61).

On top of this lax payment plan, Grant's managers consolidated delinquent accounts to "make them current." They "would take two different types of credit accounts of a Grant customer and consolidate them into one account. And where one or both of the accounts were delinquent, [they] would make the new account current" (Peterkin, in Morgan v. Grant, 329).

Furthermore, Grant had a policy of "refinancing" a delinquent account: "A new credit agreement would be arranged whereby payments would be spread out over a longer period of time and the . . . new account would thereby be characterized as current." Delinquent customers could make their accounts current by paying small amounts of money toward them (Peterkin, in Morgan v. Grant, 331–332). Again the easy credit was promoted in a short-term effort to increase sales during the recession, to the long-term detriment of accounts receivable.

Store managers were hardly in control of the situation. They disliked being pressured by Grant's reward-punishment manner of promoting increased credit sales and new accounts. For example, managers and clerks were "offered $1 bounties for each customer they signed up for a [credit] card" (Forbes, Apr. 1976, 110). Any store manager who failed to sign up his quota of new credit customers suffered the public humiliation of "eating beans instead of steak at the next promotion dinner . . . or having his tie cut off . . . or getting a pie in his face . . . or having to wear a diaper" (Women's Wear Daily, 4 Feb. 1977, 1).

They disliked even more the responsibility of final approval of new accounts, since it often conflicted with their responsibility to maximize credit sales. The situation deteriorated the retailer's fi-

nances so quickly that when the credit system was dismantled in 1974, it was really too late to undo the damage.

To gain some control over the alarming increase in delinquent accounts, Grant's management decided to "centralize the collection function away from the stores" (Peterkin, in Morgan v. Grant, 340). But centralization addressed only the collection of delinquent accounts, leaving the power of granting credit with store managers who were still responsible for sales. Furthermore, the situation was already so problematic that centralization did little to ease the crisis.

Few of Grant's managers and directors were concerned about Grant's credit promotions. Indeed, Peterkin could name only two who were: Raymond H. Fogler and Louis C. Lustenberger (both directors and former presidents of the firm), who had suggested that Grant might be "pushing too hard on credit." Peterkin suggested, however, that these two directors' concerns were ignored because, "of course, this [credit promotion] was an effort in order to increase sales and sales were the name of the game" (Peterkin, in Morgan v. Grant, 335). Defending the directors' silence on the firm's lax credit policies, one former senior Grant executive asked, "What could the board do?" (Business Week, 19 July 1976, 61). Such a question by one of the firm's own executives suggests that the board had little power to control the corporation.

Although the company's management did not seem fully aware of its actual inventories and accounts receivable, there were ample signs of declining health. Sales volume per square foot declined 33 percent from 1966 to 1975. Although sales increased from $1.2 billion in 1969 to $1.8 billion in 1974, "inventories more than doubled to $450 million" (Business Week, 19 July 1976, 60). The company's earnings per sales dollar also declined from 7 cents in 1969 to 2 cents in 1973. Lustenberger and Fogler tried in 1971 to "mobilize the outside board members to force a change because they were alarmed by the company's rapid expansion, inventories, and general lack of leadership" (Business Week, 19 July 1976, 60). They were ignored until September 1974, at which point the board appointed James G. Kendrick of Zeller's, Ltd. (Grant's Canadian subsidiary), to be president, chairman, and chief executive officer of Grant. "He immediately went public with the bad news, which

had not been disclosed" (Business Week, 19 July 1976, 60). As a result, by the end of October Grant had to publish a restatement of its earnings for the entire year: $177 million in losses, $92 million of which was written off as bad debt.

Court-appointed trustee Charles G. Rodman opened an investigation after the firm went bankrupt. He suggested that several of Grant's policies (including insufficient inventory controls, insufficient credit controls, and rapid overexpansion) encouraged the exercise of managerial discretion with few constraints. This discretionary power appeared to be an important factor in the internal generation of the firm's cash flow problems. Ironically, instead of pursuing financially sound goals, the banking community (well represented on Grant's board) continued to extend credit and failed to constrain managerial decision making despite great evidence of mismanagement.

Since financial institutions and corporate board interlocks sometimes act as constraints on such discretionary power, Rodman was interested in ascertaining the precise role banks played in Grant's operations. He charged that to further their own interests the lead banks concealed the real financial state of the retailer. He carefully investigated the Grant Foundation, which he named as a defendant in his suit against the banks. This foundation was reputedly a charitable organization instituted by founder William T. Grant and Connecticut Bank and Trust Company, which was also the agent for a number of the founder's private trusts. Rodman alleged that funds from the foundation were used for "fraudulent stock purchase deals with the company" (Women's Wear Daily, 21 Dec. 1977, 11). The suit sought damages of $50 million from the Grant Foundation.

In 1969 the foundation, which held 1.3 million shares of Grant's stock, decided to sell "to diversify its holdings." To avoid depressing the price of Grant's stock, the retailer and the foundation agreed that Grant would gradually buy back its stock from the foundation "rather than have that amount of stock in effect unloaded on the market" (Lustenberger, in Morgan v. Grant, 392). Rodman testified that Morgan Guaranty's trust department "had a very substantial position in Grant stock," estimated to be greater than 10 percent of Grant's common shares. Morgan sold these holdings around 1973 (Rodman, in Morgan v. Grant, 45, 46).

Richard Mayer indicated that he knew of Morgan's substantial holdings and of its sale of Grant stock because he received quarterly reports of all large holdings. He testified that he never asked outside director Peterkin (from Morgan Guaranty) why Morgan decided to liquidate its entire position in Grant stock. Mayer claimed that the situation was of "very little concern" to him in 1973 (Mayer, in Morgan v. Grant , 55). The precise reason for the sale is still unclear: no crisis had yet been declared. Perhaps Morgan, which was clearly in a position to know of Grant's developing difficulties, sold the stock to escape the impending crisis. As an important managerial consequence of that sale, Morgan relinquished the operational constraint such holdings would have imposed on managerial decision making. Clearly, the banks were not concerned about this apparent loss of their proxy constraint on the firm through Morgan's holdings. The power of collective purse strings in their loan departments would serve them better.

Mayer was a trustee of the W. T. Grant Trust, which purchased Grant stock between 1970 and 1972. Several letters written during that time indicate that Edward "Staley, as trustee of both W. T. Grant Trust and Grant Foundation, determined when and how the stock was to be purchased" (Mayer, in Morgan v. Grant , pt. 9, 72). Staley admitted that he "had power of attorney" over Mr. Grant's affairs, indicating that it was Staley's "decision for the Grant Foundation and the Grant Trust to start liquidating stock in '68" (Staley, in Morgan v. Grant , 1005–1006). Staley's remark signals a careful program of purchases. Furthermore, a letter from the Connecticut Bank and Trust Company dated 6 November 1969 indicates that the bank sold 246,664 shares of Grant common stock to the retailer (Mayer, in Morgan v. Grant , pt. 9, 74). These letters and events suggest that the stock purchases were "attempt[s] to solidify control of the company" and thus to increase managerial autonomy (Mayer, in Morgan v. Grant , pt. 9, 74). In a letter that supports this analysis, Staley wrote that he and William T. Grant established a "program . . . in 1968 to over a period of time liquidate the Grant stock holdings in the Grant Foundation and the trusts established by Mr. Grant in a way so that large holdings of Grant's stock would not fall into unfriendly hands" (Mayer, in Morgan v. Grant , pt. 9, 85). Under the schedule of purchases, Grant acquired 800,000 shares of its stock from the

foundation between 1969 and 1972 (although no stock was purchased in 1971 as Grant's finances began to get tight). When the agreement was terminated in 1973, Grant had purchased its own stock from the trust at a cost of $35 million (an average of $43 per share) and had spent another $15 million purchasing its stock from several trusts. These purchases represented a large portion of the retailer's cash flow.

Less than a year after Grant finished buying the stock, it was desperately in need of cash to pay its bills. Here, the constraints on managerial discretion posed by the banks' control of capital resources began to solidify. Since Grant had tied up its capital in stock purchases, it would have to rely on the banks for loans. "Ultimately, the stock became worthless as Grant's failed in an attempted Chapter XI reorganization and was liquidated" (Daily News Record , 12 Apr. 1978, 9).

Although many of Grant's difficulties clearly derived from a series of poor managerial decisions, some of those decisions were influenced by the presence of banks in its daily affairs. Between 1971 and 1973 Grant "was substantially in excess of the industry average in paying dividends as a percentage of earnings—eighteen percent or more in each of those years" (Staley, in Morgan v. Grant , 1008). Evidence of a significant positive correlation between dividend payout rates and a firm's interlocks with banks suggests that banks favor high dividends because such a policy "add[s] to the value of their stockholdings" (Gogel 1977, 174). High dividend payout rates also deepen the firm's dependence on external sources of investment capital, because substantial amounts of internally generated capital are diverted to stockholders. Consequently, high payout rates ordinarily make a stock attractive to banks. More important than attractive dividend rates to banks is the critical effect of these rates on Grant's cash flow position. This analysis suggests one role that banks may have played in producing the firm's cash flow problems.