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Boesky's Business Spurs New Controls

November 30, 1986|Charles R. Morris | Charles R. Morris serves as a consultant to several Wall Street firms

NEW YORK — The subpoenas fluttering around Wall Street in the wake of the Ivan Boesky scandal are almost as thick as the blizzard of ticker tape for the New York Mets' World Series parade--and almost as many people are cheering on the sidelines.

Some of the loudest cheers come from regulators and would-be regulators who have been nervously watching the firecracker-growth of junk-bond takeovers that were reaching heights of ecstatic excess in the rush to close deals before the new tax law's year-end deadline. If Drexel Burnham Lambert Inc., which has underwritten about half the $100-billion junk-bond takeover deals and has been the recipient of most of the post-Boesky subpoenas, turns out to have been a party to Boesky's criminal activities, it will befoul the entire takeover industry, and the cry for regulation will swell.

Boesky's business--politely called risk arbitrage--was betting other people's money on takeover stocks. Trading on inside information is like fixing a horse race. Boesky could buy shares cheaply from investers who didn't know their company's price would shoot up after a takeover bid. Corporate raiders had an incentive to feed Boesky information to ensure that the target stock would be in friendly hands before a takeover vote.

But the sins of a Boesky do not justify the wholesale restrictions on takeovers that Sens. Howard M. Metzenbaum (D-Ohio) and William Proxmire (D-Wis.), and economist John Kenneth Galbraith, among others, are calling for. Galbraith thinks all hostile takeovers "should be stopped" or at least put on a one-year hold, on grounds that they are just "paper shuffling" transactions to benefit no one but speculators. Not surprisingly, executives of some of America's largest companies--General Motors, Chrysler and Pfizer--are also in favor of restricting takeovers.

To decide whether or what kind of regulation should follow Boesky's chiseling, it is important to understand why the junk-bond takeover market came to be. With all due respect to Galbraith, financial fads don't spring to full-blown life because a junior investment banker wants a Porsche. Some underlying economic logic must be served or new ideas don't fly.

The current corporate buy-out frenzy is the backwash of the conglomerate frenzy that swept Wall Street in the "go-go years" almost two decades ago. Corporate swashbucklers like James J. Ling and Charles G. Bluhdorn discovered the magic of debt financing. If a little tough company bought out a big weak company entirely for debt, the big company's earnings would make the earnings per share of the little company's stock shoot up. Since the stock market thought that rising earnings per share was a good thing, the little company's price would soar, the swashbuckler would get rich.

Academics, always ready to support the latest fad with the latest theory, opined solemnly that diversified conglomerates were good for stockholders because they allowed managers to create a "balanced portfolio" of risk.

Go-go stopped when academics discovered that investors would balance their own portfolios of risk, thank you, and didn't need conglomerate management to do it for them. More important, the market discovered that conglomerate swashbucklers often didn't know much about managing the companies they were buying, particularly not big companies make weak by big debt. The stock market crashed, and stayed crashed for 15 years.

Everything on Wall Street is carried to wretched excess, and the stock market crash was no exception. The Dow Jones industrial average actually dropped slightly from 1968 to 1982, even though inflation halved the real value of a dollar's worth of stock. When canny investors took a fresh look at the market a few years ago they saw two things: good companies with stocks that were grossly underpriced relative to their earnings and assets; and good divisions of big conglomerates that were buried beneath layers of white-collar bureaucracy.

On came the sudden onslaught of raiders, like T. Boone Pickens, aiming at sitting-duck targets, like Gulf Oil; Gulf stock carried a total price tag lower than the value of the oil it owned. Such raids put the fear of God--or worse, the fear of job loss--into corporate managers, and started the frenzied process of stripping away unrelated businesses, shrinking corporate staffs and buying back cheap stock to protect against outside attack.

Galbraith is correct when he claims there is yet no proof that corporate America is more efficient as a result. But it's far too soon for such proof, and there is no doubt that big companies have been working hard to become less bloated. It is odd to find Galbraith, long the scourge of corporate gigantism, defending entrenched management.

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