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Hello everyone, you're listening to After Hours.
I'm Felix.
I'm Meher.
And I'm Kristen Mugford.
I'm a member of the finance faculty at Harvard Business School, and I teach a course on corporate
restructuring.
Thank you for welcoming me.
Wonderful to have you.
Thank you.
It's great to be here.
Felix, I've known Kristen a long, long time.
Like how long is a long, long time?
It's embarrassing.
Kindergarten?
It's in the decades.
Let's put it this way.
But like fine wine, we just improve with age.
Exactly.
So in addition to being one of the smartest people, I know she's also incredibly sunny and positive.
And yet, Felix, she's spent her career thinking about bankruptcy and distress.
But it feels friston like a total mismatch between a personality type and an area.
Does it ever feel like you should have gone into venture investing or something like that?
No.
I think the misnomer about bankruptcy is that bankruptcy I describe is about healing
sick companies.
So we often think about bankruptcy as liquidating businesses.
But really, it's about being a trauma surgeon for companies.
So I like to be optimistic and believe that we can use bankruptcy to make companies healthier.
See what she's just done me here?
Exactly.
Being the positive spin on bankruptcy.
Exactly.
I love it.
There's no way to do that with a sunny disposition.
That's great.
And so I'm guessing, Kristen, you brought a sunny topic?
I brought a topic about bankruptcy.
Yes.
So I'm looking forward to talking about one of the very hot topics in bankruptcy right now,
which is about mass torts.
So how companies are using bankruptcy to handle situations where their products have made
people sick.
This is like Johnson & Johnson Purdue Farm.
Exactly.
Okay, great.
And Felix, what did you bring?
I would love to talk about luxury markets and what's happening in luxury markets, how
prices move, how customer habits change.
Ice.
Let's do it.
From bankruptcy to Birken bags.
So Kristen, mass torts and bankruptcy.
What's the connection exactly?
So when we think about bankruptcy, we often envision companies that are having really significant
financial problems.
They're losing money.
They're running out of cash.
I want to talk today about a different way that companies are using bankruptcy.
And I'm really curious to get your thoughts on it.
And this has to do with all the lawsuits that arise when it turns out that a company's
products hurt people.
So one good example of this is Johnson & Johnson.
So Johnson & Johnson has lots of lawsuits that alleged that their talcum powder caused
cancer.
They've won some of these suits.
They've lost some of these suits.
But the number of suits is now in the thousands.
So what Johnson & Johnson decided to do is they decided to take all these claims, put them
in a subsidiary, and then file this subsidiary for bankruptcy.
So the current proposal is that Johnson & Johnson is going to put some money in this subsidiary,
about $9 billion, and the money is going to be used to pay these claims.
But a lot of people are asking the question, is this use of bankruptcy okay?
And just to be clear, Kristen, Johnson & Johnson is nowhere close to being bankrupt.
It's kind of got the feel of opportunistic bankruptcy in a way.
Exactly.
And it's also been used in these other high profile cases, including Purdue Pharma for
opioids.
And even in situations like the Boy Scouts of America and USA Olympics, with sexual abuse.
So it's a really widespread in many, many ways.
Correct.
And there's a long history of it with asbestos.
There were many companies that filed for bankruptcy, where they filed the whole company, like
W.R. Grays, for asbestos.
It's more new that we're seeing companies use it opportunistically to just file a subsidiary,
to not file the entire company, and use this as a tool to take care of thousands of
lawsuits.
Maybe we can begin by comparing a typical outcome under bankruptcy and a typical outcome
under the more traditional mass-tour system.
Sometimes mass-tourists can result in just extraordinary rewards for a small group of
people.
In Johnson & Johnson's case, there was a Missouri verdict that awarded $2.1 billion to 20 women,
just extraordinary.
While this feels like a really great story, I think there are two problems with it.
The first problem is the unpredictability of these outcomes for companies.
It is super, super difficult to plan.
This feels like a very generous award.
With other victims, they lose because the jury was not quite as favourably inclined, and
they get nothing at all.
One of the advantages of bankruptcy procedures is that generally these procedures are pretty
good at divvying up the awards in an even manner.
It doesn't matter so much that you file early, that you file late.
What people get feels like a fair outcome.
Yeah, this is exactly right.
One of the big benefits is it's seen as really fair and equitable, that there is this
schedule.
Everyone with similar medical problems would get the same payout.
In a way, this is all kind of a reflection of how screwed up the mass-tour system is.
If you could have all those people go at the same time through some kind of a class action
mechanism, then that would be good in some sense.
But it turns out that's really hard to do.
What the bankruptcy procedure effectively allows you to do is immediately aggregate all
those claims and stop all the gaming about timing and stop all the gaming about who's
in and who's out.
In all those ways, it sounds great.
And I confess, there's a part of me that feels like, yeah, this is right.
This feels good.
The problem, I guess, is two things.
One is you are getting a little bit of opportunism here.
So you're getting away from jury trials because bankruptcies are judges.
And jury trials are going to be better for the plaintiffs, then bankruptcy judge is going
to be because that's just something that happens in these situations.
And then the second is you can kind of, in bankruptcy land, be a little bit more opportunistic
about the kind of venue you get or the judge you get.
It's a little bit of a small world.
And then finally, I think it doesn't really provide the sense of justice that some of these
people are looking for.
And that's a very big idea.
But I think that's why it feels icky.
So there's every part of me feels like this is great.
But there is an ickyness to it underneath it all.
Yeah.
You think about this more than we do.
What do you make of this?
I think this justice point is a really important one.
And this is where Purdue pharmaceuticals comes into the story.
As you referenced earlier, Felix, Purdue pharmaceuticals, it's a private company.
It makes oxycontin.
Oxycontin is an opioid that played a really central role in the huge, tragic opioid crisis
in the United States.
And Purdue had tens of thousands of lawsuits, so they filed their bankruptcy.
And in this case, it's not like Johnson and Johnson, where it's worth $400 billion.
The creditors have pretty agreed to turn the whole company over to the creditors.
What makes it interesting is the Sackler family.
The Sackler family owns Purdue.
They were part of its management.
They also were facing thousands of lawsuits.
And they agreed to contribute about $6 billion of their wealth in exchange for a release.
And this is where there's a lot of debate.
This goes back to my here's point about justice.
Because part of the issue is that for families who were impacted by the opioid crisis, they
often care about justice sometimes more than money.
And the bankruptcy process is really about taking harm and putting it into dollars and
cents.
And in the case of the Sacklers, what a lot of people want is for the Sacklers to go to
trial, to have to have all the disclosure that comes with that, to have them have to face
a jury.
And it feels like we're getting all these economic benefits from bankruptcy, but we're losing
some of this justice in the process.
So I agree that justice point is really important.
But even more narrowly financial, I'm not always sure if bankruptcy is really the right
tool to use for the following reason.
You transfer all the liabilities to a subsidiary.
And if the subsidiary has zero assets, there's not
nothing to distribute in the Johnson and Johnson case where I think there are a little more
fair minded is probably the right thing to say in their first attempt to do this procedure.
They are very generous with the subsidiary.
They promise that the subsidiary can draw on up to $60 billion in funds.
And then if that's needed, they would distribute these funds among the victims.
That is shut down by a court.
They're saying, well, if the subsidiary can draw on $60 billion, how others can be bankrupt?
It's not bankrupt.
And so then the solution is this strange outcome where now they're trying to file for bankruptcy
again.
But this time they're only providing funds of $9 billion.
Even abstracting from the justice question, the big unresolved question is how much money
should be available to settle these claims in the first place?
Who gets to decide how it's divided up?
The first way to solve that is to have, for example, the attorney general who brought
the case against Purdue have to sign off on going into this bankruptcy.
And similarly with the J&J claimants, they had to kind of sign off on this idea.
So that'll help a little on your point about day and court, Kristen.
There is this piece that I think is different, right?
There are these weird third party releases that you highlighted, Kristen.
It only happens in bankruptcy.
We basically immunized the sacriote family against any civil claims against them if they go
and do this for $6 billion spending on public health campaigns.
I don't know.
That was kind of gross, I thought.
I kind of get the idea of J&J doing this thing.
And then maybe we have to watch out Felix for making sure that it's done in a way that
the claimants want.
But the third party release is super weird to me.
That's the part I'm not sure if I like.
And it only happens in bankruptcy land where you can just say we're releasing all these
people from any liability claims forever.
What makes the Purdue case also complicated is that the saculars have disclosed that their
net worth is around $11 billion and they're contributing about six of it.
So a lot of people would say, well, why not eight?
Why not ten?
Why not all of it?
There's a lot of say that they really caused a lot of harm.
Well the challenge is that the sacular family is a big family.
They live all over the world.
Their money is held in trusts.
And so there's this thorny question of how much money realistically could we get if we
went through this whole mass tort trial process?
Yes, we might feel like we get more justice, but maybe in bankruptcy, they're willing to
come forward with more money because they get this third party release.
Although it feels icky, it actually is a way to contribute more money that net net we end
up with a bigger pot to be able to put towards these claims.
The other interesting question which you've hit on a bit here, me here is who wins in
this bankruptcy?
So we talked about how maybe it's better for the claimants.
It's certainly better for lawyers.
The one winner always in bankruptcy is lawyers because everybody has a lawyer.
They're lawyers have lawyers and it's great to be a bankruptcy lawyer.
But what's interesting if you look at asbestos is very often you see the equity trade up.
And you ask, well why is that?
Well that's because we've now capped the liability.
There's certainty.
Yeah.
So it has these immediate financial consequences and particularly split with the lawyers
that you highlight the question.
But also if you think about why do we have mass torts in the first place?
Presumably the most important effect is to make sure that companies are really careful
before they release products.
To make sure that no one gets sick, that no one dies.
And just like the equity trade up, you can imagine that now knowing that, oh my god,
the worst of all circumstances where the entire company is pushed into bankruptcy
because we made a horrible mistake.
The moment that single biggest worry goes out the window, you can imagine a cynical company
now thinking, well, mass torts used to be a really big problem.
And as a result, we made extra sure that all our products were safe.
And now that's no longer the case.
It's interesting Felix, in a way you're arguing, not to put words in your mouth, that
the increased variability of outcomes under current mass toward claims is beneficial.
You're going to be even more cautious than you would have been otherwise.
That's interesting.
I mean, I think just to be clear, no one's going to get off Scott free here.
The plaintiffs have to sign up to do this.
And absolutely, they're really bad stuff happening where you create this little box and you
put a penny in it and then you put all the liabilities in it.
That's totally gross.
If you have guardrails against that, it feels like it's just going to be more certain,
which has got to be in this a benefit to everybody because it's not just capping the liability.
Capping liability is the thing that makes everybody get worried when we use that language.
So in a way, it is really about the certainty because I think Felix, you're making a case
for variability.
Yeah.
But usually we make cases for certainty over variability.
Can I push back against that?
So if you look at the details of the J&J case, where do the $9 billion come from?
That's a negotiation between J&J and the law firms where their target number was to have
something like 75% of the representatives of the claimants be in agreement with the $9
billion figure.
Right.
I think you're right in that it produces more certainty and that might be valuable to
all the parties.
But at the same time, given the incentive structure, given just how lucrative this is for the
law firms that are involved in this, are the incentives really that they're leaning
out the window or isn't it best for these law firms to say, look, if we can do this relatively
quickly and we get paid and the pay is not so bad, they actually thought it could be
up to $60 billion and now if all works well, they get away with nine, that's more than
just reducing variability.
That reduces the mean and variability at one at the same time.
All those crazy incentives are there in the mass toward situation too.
Yeah.
That's making up your decisions.
You're right about that.
I think one of the challenges you keep hitting at a 75% point, that's because you typically
need 75% of these mass toward claimants to agree in a bankruptcy.
You could say one benefit is we're going to pick the outcome that the 75% of the majority
agree with.
But that means 25% don't get their day in court that they vote no and there is some trade
off here in choosing a little more certainty, maybe a little more equity, but in doing so,
we kind of take away what feels like this basic right to have your day in court as an individual
in this mass toward system.
And there's some discomfort there, I think.
Right.
Personally, I think while bankruptcy is not a perfect process, it's the best we've got.
So in a choice between using this tool and making sure that we have lots of people agreeing
to the plan that we're really thinking about future claimants, then I think it's a lot
better than the vagaries of the mass toward system.
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Felix, I can't quite tell are you wearing Gucci or Hermes?
You should know.
I would never wear Gucci.
Sorry.
Okay.
Felix, you want to talk luxury brands?
I know we don't generally share investment advice on after hours, but here's a piece of
advice if you would like to make some money quickly.
You buy an Hermes Berk in 25 back for $10,000.
You then sell it to Pribe Porter for $16,000, just a couple of minutes after you bought it.
And then they will turn around and sell it on Instagram for $24,000.
Prices in luxury are completely fascinating.
This feels a little bit like the Taylor Swift concert drama where there is much available
and then you get these strange price movements.
But it's also interesting relative to Chanel.
They have used this opportunity to really increase prices dramatically throughout the pandemic,
interestingly.
Then a house like Hermes, you see much more stability and prices.
What do you make of what's going on in luxury?
Why do we see this strange pricing behavior?
Chanel and Hermes have taken different pricing paths, but both companies have had tremendous
financial results.
It's astonishing to me when you think about the world's richest man is no longer Jeff Bezos,
not Elon Musk, it's Bernard Arno, who's the head of LVMH, a luxury brand.
There's something going on here more broadly that the valuation of these companies are skyrocketing.
I think in April, LVMH became the first European company to hit $500 billion in market
cap.
Estonishing, yes.
Estonishing that of all European companies.
That would be the one that would not have been my guess.
This is happening at a time when 2022, the stock market didn't do particularly well,
trying to have a big customer of luxury goods.
People were in lockdown.
Yet the financial performance of these luxury brands just keeps going up and up and up.
What do you make of it, Kristen?
Is this some kind of a bubble in bags and stocks or do you buy into the underlying economics
of these things?
Well, I think there's a couple of things going on.
First is just basics of supply and demand.
We've seen luxury just explode over the last decade.
Some of that is the rise of the Chinese consumer who is buying both at home and abroad.
When we think about some categories of luxury like fine wine, we're not making any more
20-year-old burgundy.
When you have more demand and no more supply, the prices are effectively going to go up.
That's a piece of this.
It also feels like there's something maybe different culturally happening.
I confess that when I first started to think about these luxury brands, it feels like it's
all very unsustainable.
As I've thought about it more, I've come to think of it as being quite reasonable.
If you think of it as in the broader sweep of history, especially in the handbag market,
for example, just to take one market, you have women exerting more purchasing power and
more rights over household income within households and across households.
They're choosing these kinds of goods to spend money on.
If I think back to my mother, she had these sari's and she had jewelry and she had some
gold and she had China and we had these porcelain yadros.
All these collectibles, people don't do any of those things anymore in the same way.
Effectively, it doesn't feel in some sense to be that crazy.
If you think about all that spending power being channeled towards a new set of goods, which
is what the handbag market is, really, like a really novel category, it all feels actually
quite rational.
In a way, the puzzle is why there aren't more verticals that allow these folks to channel
that consumption.
I don't know, Felix, what do you make of it?
Yes, I agree.
I think changing the income distribution definitely have a big role to play here.
That is just more people who are now at levels of income that you can afford, a $10,000,
$20,000, $100,000 handbag, which seems crazy, but there are some people who are willing
to spend that much.
I think there's two other things that I find really interesting.
The first one is there is this trend towards younger people buying luxury earlier in their
lives.
It's very pronounced now with millennials.
Part of that is probably I'm guessing the pandemic where you couldn't do the luxury
experiences so easily and so you gravitated from experiences towards products like the
rest of the economy.
Then what goes hand in hand is these really unusual combinations of purchase decisions.
Patterns of consumption broke down in interesting ways.
People would order pizza and drink champagne.
People would fly coach and then stay at the best hotel in town.
That was super, super expensive.
I think this loosening of the category coupled with the pandemic and lots of people having
the kinds of income that is necessary to play in this market, those three things in some
sense conspire to now produce as you point out, Chris, then just much more demand than
we have supply.
It feels like, though, you're telling a little bit of a story about people wanting to treat
themselves coming out of the pandemic.
Yes, I think that's right.
We were all locked up and we deserve something luxurious as a reward for having survived
the pandemic.
Then that would say that what we're seeing is temporary and my instinct is that there's
something more fundamental going on here.
I think to your point, me here about collectibles, these companies have been brilliant in tapping
into the desire of humans to collect things.
So whether it was baseball cards or you talked about China or figurines, they market in a way
to make the thrill of the hunt very exciting.
You can't walk into an arameas store and buy a Birken bag.
There's a whole elaborate dance that goes on, building a relationship and hopefully getting
offered one.
It's really creating this excitement around collecting.
Part of what you're seeing is that luxury has just gotten better at being a collectible
than perhaps it has been in the past.
I think what's particularly interesting to me about that and Felix's point about this
loosening, which I think is a very deep point about consumers are no longer like the upper
east side, socialite, who is going down Park Avenue to visit arameas, but there's a lot
of different people buying.
But the amazing thing is alongside that loosening, they've preserved their elite status.
Yes.
That is like a real trick that these people have figured out.
So you have this loosening, which is effectively in some sense what might be characterized as
kind of going down market, going down to less elite buyers.
And yet the elite status of these goods only gets greater and greater.
Now maybe that's how the collectibles feed into this, but it feels like the game that
they figured out is how do you expand the customer base but not lose the elite status and they
just have done it just incredibly well.
In part, this is also supported by what's happening at the other side of the market, if you
will, in the market for super fake backs and super fake products, even experts are at
a loss to tell the difference between what's the writing and what's not the writing.
So how should you respond as a company if all of a sudden someone can produce what you
produce at a level of quality that people can't tell apart?
One intuition that I have is you would raise prices dramatically because in the end, obviously
no one really cares about the functional attributes of these products.
It's more about recognizing each other, recognizing who is a my group, who is not in my group.
And that's not just a single signal like the handbag.
That is the handbag and the dress and the restaurant that you eat at and the hotel you
stay in and the car that drives up to the hotel.
It's a collection of signals.
And as always, when you think about optimal price discrimination, if you get fakes in your
market, what you really want to hold on to is the really valuable part of the market,
where people care about these collections of signals.
Yeah.
The tricky thing about that, Felix, though, is I think that sounds right.
But in a way, they are widening the customer base to your point earlier.
They're doing both things kind of remarkably clear.
And in a way, with these counterfeits getting so good, and my understanding is the counterfeits
are amazing, which then makes you think that this good, it's partly about the consumption
experience, which is like a to carry around my Birken bag.
But in fact, it's also about the act of purchasing.
The act of purchasing itself has gained so much value.
That's really fascinating to me, that actually what we're buying is the act of purchasing
as opposed to the good.
Or maybe the customer values the authenticity.
Would you buy a painting that you knew was counterfeit?
Fair enough.
There's something about having the authentic thing, and there's appreciation of the craftsmanship.
Many of these bags and watches are handmade.
There's appreciation that these are beautiful works of craftsmanship.
And maybe the customer continues to appreciate that.
Yeah.
The space that's fascinating is that places like LVMH and Keryg for that matter are effectively
conglomerates.
By that, I mean, they have more than 100 houses in the cases of LVMH that are coexisting
under a common roof.
And usually conglomerates don't work.
Yeah.
And somehow Bernard O'Noah has figured out how to make it work.
Why do you think conglomerates work in the luxury space?
One of the theories why it's successful has to do with talent in the industry.
Think about if you work at LVMH and say you get a little tired of the brand that you're
working at, that list of other brands where you would likely be comfortable, that list
probably includes many of the brands that are also owned by LVMH.
So there's a little bit of a Walt Garden phenomenon where the best opportunities now sit
inside these conglomerates.
It's very hard for an upstart luxury brand to get the kind of cashier, to get the kind
of reputation that some of these older names have.
And as a result, the very best people, I think they often gravitate towards the brands
that are owned by the big guys.
And as a result, they do better work.
There's a little bit of research from a fashion and luxury insiders, annual judgments about
who comes up with the most amazing products.
And what you see there, at least if you believe these judgments, much of the best forms
of creativity, the best ideas, the best products that are launched in a particular year, they
come out of these really big conglomerates.
I guess when I think about these, I almost am reminded of Procter & Gamble.
Or these conglomerates, or these just companies that do a great job of managing a portfolio
of consumer brands and share some synergies behind the scenes.
And that this is just the PNG of today, but more expensive than in Europe.
Wow.
I'm going to go with your logic a little bit, Kristen, in the following sense, which is,
the analogy is not shelf space, which is one of the things PNG does really well is get
shelf space.
The story about LVMH is also real estate.
If you're one financial center in Shanghai, and you can bundle a lot of brands, and then
you get a really, really cheap real estate.
And so that bundling is also really, really powerful, just like PNG, trying to get a lot
of shelf space.
I think that's the other source of their power in these settings.
I think we need to have some after hours merch.
If you had to create some after hours merch, what would you make it?
I'm Swiss.
So probably a watch.
There you go.
A beautiful timepiece.
What do you think, Kristen?
Look, the lesson learned from luxury is it's all about collaborations and footwear,
sneakers.
So what you want to do is go figure out how to get after hours on a Air Force One, and
you're going to be great.
I love it.
There we go.
How about you, me here?
What's your best idea for a luxury item?
I just think the handbag market is too good.
You just got to go where the money is.
I would go to the handbag market.
And like a nice little A H logo.
Yeah.
And I would see you walk around with an after hours handbag.
Yeah.
Who knows?
So Kristen, recommendations, what do you have for us?
Okay.
My recommendation is Formula One.
Now, many of your listeners are already huge fans of this, but this is a recommendation
for anyone who was like me 18 months ago and said, you've got to be kidding me.
This involves cars racing around a track.
I love Formula One.
And yes, my entry was the Netflix show drive to survive.
I never would have expected any of you who know me that this would be my passion.
It is this exciting intersection of science and sports.
You have all of these engineers and aerodynamicists who are developing the fastest cars in the
world.
And then you have drivers that show incredible athleticism and pull six Gs around corners
for two hours at a time.
They do pit stops in two seconds.
There's race strategy and unpredictability.
It's awesome.
Check it out.
Growing up, my brother was a big Formula One fan.
We didn't really watch that much television during the day, but I have these memories of
Sundays with the sound of engines somewhere in the background.
Yes, because me now, all my friends are completely flubbicked.
I have all people have become a Formula One addict, but I am now drafting my daughters,
my friends.
We're all into it.
And all listeners on after hours.
Exactly.
That sounds fantastic.
Felix, what did you got?
You watched American born Chinese.
No.
No.
It is an amazing show.
So it's a coming of age story of a second generation Chinese teenager going to high school,
trying to adjust.
It's mostly a white high school.
He's one of the very few Chinese students.
And then it's mixed with everything else associated with Chinese culture.
So there's martial arts.
There is mythology.
It borrows heavily from the 16th century novel Journey to the West.
And it jumps back and forth in completely unpredictable ways.
Sometimes the gods are in God land and in Garb.
And then next thing you know, the gods show up for a fight in the high school.
And part of I think what's really fascinating is it doesn't take time to explain elements
of Chinese culture.
It just takes them as given.
And the dialogue is sometimes in Chinese, sometimes in English and it goes back and forth
in unpredictable ways.
The storyline is really hard to follow because it jumps in various directions at any moment
in time.
But it's such a joy to watch.
Sometimes there's the show where I have a sense, oh my God, they created this just for
me.
And it's definitely one of these shows.
I feel like, oh my God, where have you been all my life?
It is amazing.
So American born Chinese on Disney Plus.
Fantastic.
That sounds great.
I was going to go with the new season of Happy Valley, but our last conversation triggered
a thought that I just want to instead use, although I did kind of sneak in the American
launch of Happy Valley.
Yes, of course.
But my real recommendation is loyalty programs are wonderful.
I like loyalty programs a lot, but they've gotten so tired and boring.
And I recently flew on KLM.
And I don't know if you've ever flown on KLM in business class, but they give you a
little delft house filled with Dutch gin.
And they have about 110 of them.
And that every time you take a trip, you get to pick one.
There is no way to purchase them.
So they've become collectibles.
And I have to tell you, first, it brought back this deep memory, which is that my father,
when he would travel, would bring them home.
And I remember that.
And he created this just intense feeling when I was able to pick my own.
So this is an old program.
It's 70 years old.
And they have continued it to today.
And I just thought, what a spectacular way to think about a loyalty program and what a
way to create luxury, Kristen, to your earlier point and to create a collectible and really
engender to our conversation last week, Felix brand loyalty.
So shout out to KLM for keeping this up and for anybody in charge of a loyalty program.
Really think hard about how to do something that goes beyond like miles.
It gives you this moment of delight in the sky.
Totally.
So that's my shout out to KLM for their little delft house program.
Excellent.
Perfect.
And this was it for tonight.
Thank you everyone for listening.
This is After Hours from the Ted Audio Collective.
