There must have been a lot of quiet celebrating among top business executives recently when a Delaware court approved the $14-billion merger between Time Inc. and Warner Communications Inc. This was more than a legal decision. It signified that, as a practical matter, corporate chieftains had finally succeeded in barricading themselves against most hostile takeover offers. This is a bad development that harms U.S. economic competitiveness.
Congress and most Americans don't think hostile takeovers do any good. But they do. They represent one way to overhaul inefficient companies. More important, they prod companies to stay efficient. Few hostile takeovers actually occur. It's the mere threat that keeps executives on their toes. Like the rest of us, they do best when they're ultimately accountable for how well, or how badly, they perform.
In the 1970s, hostile takeovers were far rarer than now. Presumably, managers' freedom was greater. But lo, companies are being better managed now than then. Since 1981, business productivity has increased at an annual rate of 1.6%, double the 0.8% average between 1973 and 1980. Corporate research and development spending is now about 25% higher (as a share of gross national product) than in 1975.
These improvements don't stem only from the disciplining effect of hostile takeovers. In the 1980s, many new pressures came to bear on management: tougher foreign competition, deregulation and the severity of the 1981-82 recession. But the statistics belie the claim that hostile takeovers are harming American business. What they really jeopardize is the job security and status of top executives.
One can only marvel at the massive defenses they have now erected to shield themselves from this menace. They've persuaded 39 states to pass laws impeding management-opposed takeovers, reports the Investor Responsibility Research Center in Washington. Delaware's law is the most important, because nearly two-thirds of major U.S. companies are chartered in Delaware. This law effectively requires that a hostile purchaser buy 85% of a company's stock. Otherwise, the buyer must wait three years before being able to exercise full control over the company.
Even the tiny opening afforded by the 85% rule is being quickly closed. Companies are rushing to create--or expand--ESOPs (employee stock ownership plans) that place 10% to 20% of the firm's stock in friendly hands. The idea is that employees would oppose most hostile takeovers.
In theory, boards of directors are supposed to check abusive management power. In practice, they rarely do, because they're appointed by management. The significance of the Time-Warner decision is to sanctify this passivity. If directors are following a "strategic plan," theDelaware court said, they can ignore shareholders' views, even if--as the court also found--the main aim of the "strategic plan" is to entrench management.
Great benefits are claimed for the Time-Warner merger. But after reviewing the evidence, Chancellor (Judge) William T. Allen of the Delaware Chancery Court concluded that business reasons were not "the transcendent aim of Time management or its board" in pursuing the merger. The main aim was to keep Time "independent"--that is, prevent a hostile takeover. Allen doubted that maintaining the journalistic integrity of Time's magazines was a genuine concern, because the magazines will represent less than 25% of the new company's revenues. Its main businesses will be cable TV and movie production.
Still, Allen blessed all this as "bona fide business strategic planning." The absurd result was that Time's directors were allowed to reject a hostile merger proposal from Paramount Communications favored by most shareholders. Paramount would have paid them $200 a share for Time stock; that was more than a 50% premium over Time's previous price. But Time's executives preferred to buy Warner for $70 a share, because the Time-Warner agreement guaranteed their jobs.
Why should anyone care about shareholders? First, they're not just rich individuals. Pension funds own a quarter of all common stock. Second, the shareholders' desire for profits keeps pressure on managers to improve efficiency and avoid waste--including wasteful mergers. Hostile takeovers often break up unwieldy conglomerates formed by poor mergers. Most takeovers are still "friendly" between companies. In 1988, there were 2,258 mergers and acquisitions, reports W.T. Grimm & Co., a consulting firm. Of these, only 27 were "hostile."
The result of Allen's decision and other anti-takeover measures will not be fewer mergers, only fewer takeovers opposed by management. There will be more "strategic planning"--studies, task forces and meetings--to create a legal record justifying rejection of unwanted offers. This sounds like unproductive make-work because it is.
Congress could--and should--rewrite the takeover rules to put shareholders and managers on an equal footing. There's no constitutional bar to overriding state takeover laws. Corporate takeovers are clearly interstate commerce. The main issue here transcends fairness to shareholders and involves the competitiveness of our major companies. Short of bankruptcy, there needs to be some check on inept management. Hostile takeovers, a blunt instrument, are better than nothing.
In practice, Delaware is now making national economic policy--and doing a bad job. Delaware favors management, because incorporation fees are a major source of state revenues. But Delaware's interests are not the nation's interests, and companies shouldn't be run mainly for top executives. Perhaps Congress will one day awake to these simple truths.