In Defense of the Corporate Coup

(Page 2 of 2)

But the opportunity for the executives of one corporation to pay a premium to the stockholders of another corporation to induce them to accept a merger is vital to the market. This transaction with shareholders is the primary protection our economic and legal systems offer against poor management, since the holdings of individuals are generally too small to allow them to rid a company of a managerial team that has caused stock prices to decline.

A buyout offer made by another corporation, which is itself subject to the same capital-market discipline, is also the best evidence (not perfect, but the best) that a change in the control of the assets of the target firm would improve economic efficiency. So takeovers not only protect shareholders against managerial abuse; they also enhance the efficiency of the economy's distribution of resources, including managerial talent.

The incumbent managers of a firm can and do construct roadblocks against a tender offer. Some of these defensive tactics may be useful in ensuring that shareholders get an appropriate price for their shares. But it is hard to believe that antitrust claims of the sort frequently used to fend off takeovers honestly reflect any legitimate concern that target company managers have either for their own shareholders' or for society's welfare. One can just imagine how incumbent managers could use a vague "public interest" rule to protect themselves from being replaced by another management team.

The case is no stronger-albeit less ironic-when the government sues on antitrust grounds. An FTC or Justice Department decision to prevent a merger implies that government lawyers and economists can know more about the business desirability of a specific merger than can the parties involved. For, even assuming that a merger gives some monopoly power (usually a heroic assumption), this merely reflects the "cost" side of the transaction. But there is also a "benefit" side-the benefits to be derived by all shareholders from active and unrestricted competition in the market for corporate control.

The pernicious effects of the government's antimerger activities under the antitrust laws are compounded by the securities laws. Current federal securities regulations significantly increase the purchase price of target firms. This decreases returns to acquiring firms and reduces the volume and productivity of takeovers. Hence, an unknown number of productive takeovers are deterred, and the takeovers that do occur produce smaller social gains.

It is common sense that stockholders are better off when offered a premium for stock that was selling for less before a tender offer. But it has taken imaginative, sophisticated statistical studies by financial experts to drive home the point. The results of research by economists at leading universities like Chicago, Rochester, and UCLA can be briefly summarized: the stockholders of a target firm make a good deal of money from a tender offer; the stockholders of the acquiring firm also realize significant gains, as their stock's price generally increases; and even if a tender offer is successfully blocked by the target firm's management, the stock declines in price but does not drop back to its pre-tender level.

Fans of monopoly theory may see such evidence as supporting the notion that mergers breed monopoly profits, but the facts do not bear this out. If a takeover increased the market power of the acquiring firm, the firm would be able to raise product prices (otherwise, why be concerned about market power?). But if this firm can raise its prices, so can other firms competing in the same industry. So the price of these companies' shares would also go up on announcement of a takeover, as the market reflected their new potential for higher profits.

In fact, however, analysis of stock-price data shows that the value of competing firms' stocks does not go up in response to a takeover bid. This supports the view that takeovers are evidence of competition in the market for corporate control and not of efforts to achieve market power. Likewise, government antimerger activities, such as ordered divestitures, have not been found to depress stock prices in the affected industry.

The evidence also shows that mergers generally perform a beneficial function in reallocating physical resources from less-efficient to more-efficient users. And while some takeovers prove less desirable than the parties to the merger predicted, government authorities certainly have less ability to predict the results of any given takeover than do the parties involved or the stock market.

Contrary to popular worries, then, mergers and tender offers are not economically wasteful. Takeovers are not simply power games but reflect competition in a vital market, the market for control of valuable corporate assets. And there is no good reason for the government to interfere with the private, voluntary agreements that fuel takeovers.

Henry Marine is a professor of law and the director of the Law and Economics Center at Emory University. Among his numerous publications is "Mergers and the Market for Corporate Control" (Journal of Political Economy, 1965), the basis for most subsequent scholarship on the market for corporate control.

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