The Takeover Controversy: Analysis and Evidence

Abstract

The market for corporate control is fundamentally changing the corporate landscape. Transactions in this market in 1985 were at a record level of $180 billion. These transactions involve takeovers, mergers, and leveraged buyouts. Closely associated are corporate restructurings involving divestitures, spinoffs, and large stock repurchases for cash and debt. The changes associated with these control transactions are causing considerable controversy. Some argue that takeovers are damaging to the morale and productivity of organizations and are therefore damaging to the economy. Others argue that takeovers represent productive entrepreneurial activity that improves the control and management of assets and helps move assets to more productive uses. The controversy has been accompanied by strong pressure on regulators and legislatures to enact restrictions that would curb activity in the market for corporate control. In the spring of 1985 there were over 20 bills under consideration in Congress that proposed new restrictions on takeovers. Within the past several years the legislatures of New York, New Jersey, Maryland, Pennsylvania, Connecticut, Illinois, Kentucky, and Michigan has passed antitakeover laws. The Federal Reserve Board entered the fray early in 1986 when it issued its controversial new interpretation of margin rules that restricts the use of debt in society. This paper analyzes the controversy surrounding takeovers and provides both theory and evidence to explain the central phenomena at issue. The paper is organized as follows. Section 2 contains basic background analysis of the forces operating in the market for corporate control -- analysis which provides an understanding of the conflicts and issues surrounding takeovers and the effects of activities in this market. Section 3 discusses the conflict between managers and shareholders over the payout of free cash flow and how takeovers represent both a symptom and a resolution of the conflict. Sections 4, 5, and 6 discuss the relatively new phenomena of, respectively, junk-bond financing, the use of golden parachutes, and the practice of greenmail. Section 7 analyzes the problems the Delaware court is having in dealing with the conflicts that arise over control issues and its confused application of the business judgment rule to these cases. The following topics are discussed: - The reasons for takeovers and mergers in the petroleum industry and why they increase efficiency and thereby promote the national interest. - The role of debt in bonding management's promises to pay out future cash flows, to reduce costs, and to reduce investments in low-return projects. - The role of high-yield debt (junk bonds) in helping to eliminate mere size as a takeover deterrent. - The effects of takeovers on the equity markets and claims that managers are pressured to behave myopically. - The effects of antitakeover measures such as poison pills. - The misunderstandings of the important role that golden parachutes play in reducing the conflicts of interests associated with takeovers and the valuable function they serve in alleviating some of the costs and uncertainty facing managers. - The damaging effects of the Delaware court decision in Unocal vs. Mesa that allowed Unocal to make a self-tender offer that excluded its largest shareholder (reverse greenmail). - The problems the courts are facing in applying the model of the corporation subsumed under the traditional business judgment rule to the conflicts of interest involved in corporate controversies.