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Kmart, in Letter, Seeks to Reassure Its Suppliers

"Kmart Corp., seeking to reassure suppliers worried about its financial condition, has sent vendors a letter contending the discount retailer’s troubles are ‘predominately’ behind it and that it expects to return to profitability this year.

In the letter sent late last week, Kmart Chief Executive Officer Floyd Hall also disclosed [that] the nation’s No. 2 retailer is current on payments to vendors, has sharply reduced operating expenses, and finished 1995 with the best pre-square-foot sales figures in its history. In addition, he said Kmart expects to complete a refinancing in coming months that will resolve worries over the company’s long-term ability to pay bills." (WSJ, 2/16/96, p. A3)

Theoretical models of the firm (i.e., what should the objective of managers be?) ignore the importance of the role of stakeholders in value maximization by taking into account only the objective of the manager/firm to match that of shareholders. Although agency theory (principal-agent problem) adds the creditors dimension, the importance of other stakeholders such as employees, suppliers, customers, and the "environment" are ignored.

There are two important messages in this news: (1) demonstrating that in the real world, the interest of other stakeholders should be considered too. Thus, existing models of the firm should have the interests of stakeholders taken into account to make these models more in line with reality. (2) Unhappy suppliers are an indirect cost to the firm. These costs can potentially include suppliers not willing to provide adequate inventory or new lines of products for fear that the company might go under and thus would not be paid.

In addition, financial distress is a distraction to managers in trying to alleviate the fears of stakeholders. Employee moral might suffer too.

INTERMEDIATE LEVEL

An illustration of costs associated with financial distress. Capital structure theories point out that one of the variables affecting a firm’s optimal debt-to-equity level is financial distress, sometimes refereed to as bankruptcy cost. Remember:

(1) As the explanation above demonstrates the company does not have too be in bankruptcy proceedings to incur such costs.

(2) "Optimal" refers to the level of debt-to-equity that maximizes the price of the stock.

(3) Debt-to-equity reflects market values of the company’s total long-term debt and its equity, not book values.

 

By Alex Tajirian