Corporate Mergers: Method or Madness?
MAY 01, 1982 by SHELDON RICHMAN
Sheldon Richman is editor of Competition, published by the Washington-based Council for a Competitive Economy. This article is reprinted from the October 1981 issue of Competition.
There is an easy way to tell when a person misses the fundamental point of economics: He or she discusses the subject in the metaphors of warfare and the animal kingdom. This is so common it goes unnoticed. But the significance of using terms of violence to describe voluntary exchange for mutual benefit should not be underrated.
We’re familiar with the terms cutthroat competition, predatory pricing and import invasion to describe processes in which people freely offer to trade their property at the best terms they can find. How ironic that such processes are couched in these metaphors, while actual violent pro cesses are called “economic planning.”
Nowhere is this more vividly illustrated than in the coverage of and comment on the recent spate of corporate mergers. The Du Pont-Conoco merger last summer set off an hysterical display of economic ignorance that still might find its way into law. Unfortunately, this ignorance is found not only in the writing of journalists and antimarket spokesmen, but in the articles and speeches of business spokesmen who themselves have fallen victim to the confusion.
Typical of the way mergers have been discussed is this opening paragraph from Newsweek’s July 27 (1981) cover story (the italics are mine):
One prominent banker called it a “feeding frenzy,” and last week, as the biggest takeover battle in American corporate history gained momentum, the description seemed right on the mark. Three giant companies—Du Pont, Seagram and Mobil—were battling for control of Conoco, Inc., the nation’s ninth largest oil concern, and the bidding was fast approaching the $6 billion level. Meanwhile, other cash-rich corporate giants were eying their own acquisition targets and frightened companies scrambled to protect themselves. By the end of the week, the hunters and their prey had stocked up war chests of bank credits worth more than $25 billion—enough to buy Detroit’s Big Three automakers with $10 billion to spare—and many analysts predicted that the marauders were preparing for a long-term merger binge of unprecedented proportions. “Having had that first taste of blood,” said Larry Goldstein, chief economist for the Petroleum Industry Research Foundation, “it is hard to believe they will pull back.”
To take this sort of writing seriously is to believe that firms are rabid bears preying on defenseless Bambis in a gentle forest, or Attila the Hun pillaging a placid hamlet. If language was ever used to obfuscate and mislead, here it is.
Merger by Consent
Contrary to popular impression, a merger does not occur by one firm eating another against its will. Mergers occur when a firm buys a sufficient portion of another firm’s stock to enable the first firm to determine the second’s management and policies. The key word is “buys.” Before a company can buy stock, the owners of the stock must be willing to sell; only the state and muggers think they may acquire property without the owner’s consent. To complain about mergers, then, is to complain about the stockholders’ freedom to sell their property as they like.
But what about “hostile takeovers”? This misleading term describes mergers in which the management (or some stockholders) don’t want a controlling share to be acquired by someone else. It certainly is not hostile to those who find bids on their stock attractive. Economic historian Robert Hessen made an important point about hostile takeovers when he testified in Congress about conglomerate mergers:
If a company remains privately held, the owners thereby guarantee themselves against a hostile takeover. However, if they go public, that is, if they allow shares of their stock to be traded on public exchanges, then they know that one of the inherent risks of being a publicly traded company is that someone or some coalition of people can buy enough stock to be able to elect one or more directors and ultimately to change the policies and personnel of that company . . . There is a variety of (private) options to keep a company, even a publicly traded company, from an adverse or hostile takeover without needing to ban conglomerate mergers . . . There are much more specific remedies which any good lawyer could recommend to a company to protect itself from the possibility of a takeover.
Another thing about mergers that concerns some people is their effect on economic growth. Business Week, for instance, declared in a recent editorial that “mergers are not growth.” Others say they do not create jobs or make better use of capital. The most fundamental answer to these complaints is, so what? In a free society, people should be at liberty to trade their property without having to justify it to anyone in any terms. But the answer in economic terms goes further. Two parties agree to swap their property only when each sees prospective benefits as a result—otherwise the exchange does not occur. Mergers entail the exchange of titles to capital goods, whose price is determined by the market’s assessment of their capacity to produce what consumers want most. One company does not acquire the assets of another unless it expects them to be profitable, that is, produce things consumers will be willing to pay enough for.
To believe that a transfer of capital goods from one person to another is unproductive is to miss the point of capital goods altogether. They are not merely physical things; in economic theory, the essential characteristic of a capital good is its role in someone’s plan. As New York University economist Israel Kirzner writes,
A capital good is not merely a produced factor of production. Rather it is a good produced as part of a multiperiod plan in which it has been assigned a specific function in a projected process of production. A capital good is thus a physical good with an assigned productive purpose. (The Foundations of Modern Austrian Economics, Edwin G. Dolan, ed., p. 137)
It stands to reason that two persons or groups can have different plans for the same capital good; one may be more suited to future consumer demand, (that is, more productive for workers, among others), one less suited. We can’t be certain prospectively, only retrospectively. But we do know that the market tends to reward entrepreneurs who successfully forecast future demand. Mere observers of the economic scene have little standing to say what is and is not productive activity. If they think they know better, let them bid for the resources and execute their superior plans.
Another concern of merger opponents is conglomerates—firms that make many different products. They have yet to explain why anyone should worry about one firm producing both, say, luggage and yogurt. But in expressing this concern, they expose their hidden agenda. You’ll note that these same people vigorously oppose companies’ merging with other companies in their own or related industries. This is said to be anticompetitive. If a large company creates a new firm in an unrelated industry, it is likely to be accused of either wasteful duplication or unfair competition with the existing firms. In other words, anything a company does that breaks with the status quo will likely bring criticism and perhaps an antitrust investigation.
And this is the point! Critics of mergers are defenders of the status quo and opponents of the dynamism inherent in the free market. This makes them, in essence, advocates of privilege, for they would freeze the economic system where it is today, shutting out the aspirants and sheltering yesterday’s achievers.
These critics will tell you they only want to preserve competition, but that is not what they will accomplish. Mergers are competitive by nature. Competition is the cooperative process in which entrepreneurs seeking profit try to predict future consumer demand and arrange productive resources accordingly. When the law stops or hampers this activity, it cripples the process and harms consumers.
Freedom to Enter Is the Key
The critics’ related worry about market concentration is also off the mark. The interests of workers and consumers do not depend on a specified number of firms or market structure. They depend on freedom of entry, uninhibited by regulation, taxation, inflation, licensing and patents. Moreover, the notion of concentration is inherently arbitrary. It implies that an observer categorizes products, then counts the number of suppliers in each category. But the observer’s categories are irrelevant to how consumers, motivated by personal considerations, respond to the array of products before them. Unbeknownst to the observer, consumers may regard seemingly disparate products as substitutes for each other, yanking the rug out from under the concentration doctrine. Consumers, and no one else, ultimately determine the structure of markets; their shifting preferences guarantee that markets are always in flux and that temporary advantage is the most any producer can hope for.
The reasons for the current wave of mergers are many and complex. Undoubtedly, inflation—which makes acquiring existing assets preferable to building new ones—has much to do with it. So does the thick web of regulations and taxes that inhibit smaller firms. So, no doubt, do Reagan administration hints of “leniency” on conglomerate mergers (but not on “horizontal mergers”). The exact reasons are not so important here. The important point is that the market is a decentralized, voluntarist information and decision-making process in which people grapple with uncertainty in pursuit of their well-being. To interfere with this in the name of protecting the people is the cruelest hypocrisy.