What Happened to the Hostile Takeover?
OCTOBER 01, 2002 by SHELDON RICHMAN
“No man’s life, liberty or property are safe while the legislature is in session.”
-Unidentified New York Surrogate Court judge, 1866
“President Bush has strongly hinted that he will sign any bill that emerges from Congress.”
-New York Times, July 17, 2002
Did you hear the one about the congressional committee that grilled the businessman about fraudulent accounting and lies to stockholders?
Whatever other reasons there are for the fall in the markets, one is crystal clear. Who could be enthusiastic about investing while Congress is running amuck? Politicians pontificating sanctimoniously about corporate fraud and greed, pandering to an economically ignorant electorate, parading CEOs before congressional tribunals, and promising new regulatory edicts are hardly confidence-building measures.
Are we really so immune to irony? This is the same gang that can’t account for trillions of dollars, that wrote the book on creative budgeting, that reduced budget projecting to propaganda, that took the “owners’” retirement money and squandered it, and that has devalued the dollar for decades.
Now these same sterling stewards of the people’s wealth sit in judgment of a few crooked businessmen, smearing the rest by association and decreeing new rules that will do nothing to prevent fraud in the future and may actually create new opportunities for it.
The last thing we need is new technical rules. The business world is awash in rules. After decades of government regulation, you’d think that the recent scandals might prompt some rethinking of that approach. You’d think that until you remember the vested interests involved.
The fact is that regulation makes big business scandals more likely. The regulatory state anesthetizes people’s natural wariness. “The watchdogs are on the job, so I don’t need to be so alert” sums up the attitude engendered by the regime. Agencies such as the Securities and Exchange Commission require the frequent disclosure of so much information, much of which would never be demanded by investors, that an overload occurs. It has to dull the senses.
Also, in its zeal to regulate, government has short-circuited one of the most effective checks on management misconduct: the hostile takeover.
Beginning with Adam Smith, there has been concern that the corporation separates ownership from management. This is known as the agency problem. Stockholders own a firm, but managers run it. Most stockholders don’t have a strong enough incentive to monitor the managers closely. So the managers are able to get away with things the owners wouldn’t tolerate if they knew what was going on. Even if the typical stockholder gets wind of problems, he’ll find it easier to dump the stock than to try to change things.
This indeed may at times be a problem. Unfortunately, it has been used often to justify government regulation of corporations, most famously by future New Dealer Adolph A. Berle Jr. and Gardiner C. Means in their 1932 book, The Modern Corporation and Private Property. There they wrote that the corporation’s division of ownership and management “destroys the very foundation on which the economic order of the past three centuries has rested.”
That was a grossly inaccurate statement by two men with a socialist agenda. As usual, the market generates its own solution. Its solution to the agency problem is the corporate takeover. If managers are misusing a corporation’s assets, there will be profit opportunities for the alert entrepreneur who figures it out, buys up a controlling share of the stock, and replaces the bad managers with better ones. This is a hostile takeover. Notice that the only ones with a reason to be hostile are the inefficient or corrupt managers, not the stockholders who freely sell their shares at attractive prices.
The Market for Corporate Control
The takeover is a key tool in what Henry Manne, the great economist and former dean of the George Mason University Law School, long ago dubbed “the market for corporate control.” As Manne wrote recently in the Wall Street Journal, “New scandals will continue until we bring back the most powerful market mechanism for displacing bad managers: hostile takeovers.”
Why do they have to be brought back? Where did they go? The federal and state governments have done all they can to prevent corporate takeovers. In 1968 the federal government enacted a law forcing anyone who acquires a specified amount of a corporation’s shares (today it’s 5 percent) to disclose his intentions. Obviously, if someone announces that he intends a takeover, the stock price will rise, reducing or wiping out the anticipated profit. That was the point.
The law was passed when managers afraid of losing their jobs lobbied Congress and the president. It was special-interest, protectionist legislation all the way, but its proponents managed to portray the takeover specialist as a villain. In fact, he is a hero.
In the 1980s the state legislatures and state courts imposed even harsher anti-takeover measures. The result? “The number of hostile tender offers dropped precipitously and with it the most effective device for policing top managers of large, publicly held companies,” Manne writes. He adds that that the barriers shifted wealth from stockholders to bad managers.
No one would say that the drop in the markets was purely a result of impediments to takeovers, the general regulatory regime, or today’s unpredictable politicians itching to do something. There’s a fourth culprit, the Federal Reserve. The run-up of the market is now widely seen as a bubble that was waiting to burst. As the Wall Street Journal wrote, “Serious people can debate just what a bubble is, but if there was one, then who created it? One suspect would have to be the Federal Reserve itself, for feeding the economy too much liquidity for too long.”
The Journal continued: “But one former Fed official we know cites as a crucial mistake an FOMC [Federal Open Market Committee] meeting in September 1996, when the Fed failed to tighten. [Fed Chairman Alan] Greenspan nonetheless eased again in 1998, though perhaps prudently amid the Asian crisis and Russian default. Economist Arthur Laffer argues with a lot of evidence that the Fed really goosed the bubble by easing money in the run-up to the Y2K scare, only to pop it later when it drew liquidity back out. The broader point is that much more was fueling the stock market in the late 1990s than ‘greed,’ infectious or not.”
Socialized money fails again.