Du Pont pays $7.5 billion to buy up Conoco. Santa Fe Industries and Southern Pacific agree to merge in a $5.2-billion deal, creating the third largest railroad in the country. Allied acquires Bendix for $2.3 billion in a celebrated takeover battle started when Bendix tries to absorb Martin Marietta. How could such high-priced shuffling of corporate assets possibly benefit the economy?
The popular wisdom is that it doesn't and can't. Harvard professor Robert Reich, darling of the neo-liberals, is typical of the most recent anti-merger sentiment. In The Next American Frontier, his apologia for a government industrial policy published last spring, Reich put corporate mergers at the top of his list of sins of "paper entrepreneurialism." Soon Time magazine was characterizing corporate takeover battles as "paper chases."
But if Reich managed to coin a catchy label, he is not alone in his view that the business mergers that have been making headlines don't make much economic sense. Here are already-huge corporations apparently diverting their firms' resources from production or from their own stockholders. Often, in "hostile takeovers," the managers of the "target" firms don't want their companies to be acquired. The "raiding" corporations seek to gain control anyway via tender offers—using public solicitations to buy stocks directly from the target firms' shareholders, at high premiums over the stocks' market value. Thus the parries, thrusts, and billion-dollar deals that can seem like a waste of time and money.
"I think it is time for the Congress to send a clear signal to corporate America that we will no longer tolerate unrestrained warfare between top management for control of corporate assets," declared Rep. Peter Rodino (D–N.J.) last summer, when he introduced legislation to restrict large mergers. The proposed measure would ban any large mergers not deemed to be "in the public interest" by the Justice Department and the Federal Trade Commission. The two agencies would be enjoined to judge a merger's effect not only on competition (that, they've always been empowered and eager to do) but on employees and the "effective management of corporate assets." Whether or not the legislation passes—it seems unlikely at this time—it embodies widely held sentiments.
Meanwhile, the Securities and Exchange Commission (SEC), the government's main arm of stock market regulation, is carrying on a review of tender-offer policy. Tender offers are used in only a small percentage of mergers; in 1982, for example, there were 2,400 mergers, of which 94—only 3.9 percent—involved tender offers. But these are the ones that can make news in the mass media, and in the wake of the Bendix-Martin Marietta battle in late 1982, the SEC initiated a study of its regulation of corporate takeovers, with a view to better protecting stockholders' interests.
Up till now, the government's primary weapon against mergers has been the antitrust laws. Mergers, particularly among firms in the same industry, have often been deemed among the least defensible kinds of behavior under US antitrust laws—right up there with price fixing.
Thus we find the Federal Trade Commission (FTC) voting unanimously in 1982 to stop Gulf Oil from buying Cities Service, claiming that the proposed merger could jeopardize competition. The FTC's action succeeded, as Gulf withdrew the offer, citing antitrust obstacles, although other factors may have been involved as well.
The FTC also challenged the acquisition of two hospital chains by the Hospital Corporation of America, because its share of the acute-care market in a 13-county area around Chattanooga, Tennessee, would rise from 16–17 percent to 30–32 percent. Further evidence of the supposed threat to competition was the estimate that the company's share of the market for inpatient-psychiatric services in the same geographic area would rise from about 7 percent to about 38 percent.
The antitrust laws also played a major role in stopping Mobil's attempt in 1981 to take over Conoco and then Marathon. Du Pont won the contest for Conoco, but its ability to acquire it at $98 a share, compared to Mobil's offer of $120, was helped by threats from the FTC and the Justice Department to go to court against Mobil if it won. Investors were properly concerned that if they accepted Mobil's offer, the deal would later be nullified.
Later, Mobil failed to acquire Marathon even though it offered up to $126 for stock that had been selling at $64. Marathon executives secured an injunction against Mobil under the antitrust laws, and the FTC proceeded to file suit in opposition to the takeover. Marathon executives were thus able to fend off Mobil in favor of a "friendly takeover" by US Steel.
Why should the government, and sometimes incumbent management, be using the antitrust laws to block mergers that the market, by the existence of willing buyers and sellers, demonstrates to be desirable? The long-standing rationale is a fear of monopolization; consumers are to be protected from high prices by preventing industry concentration via merger. Under new proposals, the government would gain additional weapons, ostensibly needed to protect shareholders and the public interest. Unfortunately, all this ignores significant new learning in economics—the discovery of how capital markets, unlike government regulations, actually serve the public and provide protection for consumers and shareholders.
Briefly, the apparatus works like this: The stock market accurately measures and reflects in the stock price the relative quality of each company's management. If for any reason a company is receiving lower-quality management than someone else would be willing to provide, the company's stock will be priced lower accordingly. This lower price will attract the interest of competing managers who see an opportunity to give better management to the company. They will want to purchase enough of the company's stock, for which they will have to offer a premium over its low market price, to acquire managerial control. By better management, they hope to realize a gain on the shares purchased.
In this light, modern economic scholarship has shown the traditional view of mergers—as a threat to the competitive economy—to be a highly simplistic and even perverse view of things. For while there is a possibility of market power being generated by the merging of two firms, such mergers are essential to the competitive functioning of the market for corporate control. The possibility of takeovers is an extremely effective device for assuring significant competition for managers' positions. They are thus spurred to act in the shareholders' interest. And if they do not, the shareholders will benefit from competing managers' buying up their stock at a premium over its market price.
An understanding of the market for corporate control lays to rest most of the hoary bugaboos about the "separation of ownership and control" that have plagued our corporation laws since Adolf A. Berle, Jr., and Gardiner Means popularized that concept 50 years ago in their famous work, The Modern Corporation and Private Property. Berle and Means correctly pointed out that in the form of business ownership known as the corporation, the stockholder-owners have no active voice in corporate decisionmaking. Much has been made of this in the ensuing years, and while it has been pointed out that the arrangement is suitable precisely to investors who wish to provide capital but do not have to be involved in management, many laws have been passed to make sure that corporate directors and managers don't use the firm's assets to serve their own interests at the expense of the shareholders'.
In fact, though, the best thing the courts and lawmakers can do to protect shareholders is to allow competition in the market for corporate control. By stifling the market, with antitrust laws and other measures, they protect from significant competition those individuals currently functioning as the managers of stockholder-owned companies. The fact that those managers do not like competition for their positions—while enthusiastically praising it elsewhere, of course—certainly does not argue against a change in government policies. After all, who does like competition for his position?
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.
This article originally appeared in print under the headline "In Defense of the Corporate Coup".
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