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The (Free) Market for Corporate Control

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MinisterofInfo
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« on: December 12, 2007, 09:16:35 pm »


The (Free) Market for Corporate Control

By Brad Edmonds
Posted on 12/12/2007
Mises.org

The Securities Exchange Commission (SEC) was created as a response by forcible government to the perceived excesses of the free market that led (if you believe government reports) to the 1929 stock market crash that precipitated the Great Depression.

In actuality, loose credit policies, possible only when an entity divorced from the pressures of supply and demand creates a money substitute not based in any economic reality, were what led to the rampant speculation that led in turn to the 1929 correction in the stock market. The depression that followed, itself a result of government market interventions such as high minimum wages and trade protectionism, convinced the central government to create more rules and bureaucracies to rein in the speculation that itself was a child of government intervention.

What we have now is a cornucopia of SEC regulations having the force of law intended as surrogates for investor due diligence. These are accompanied by state regulations that in large part are advertised as shareholder prophylactics that in practice are nothing more than expensive favors given to local corporations by sympathetic state legislatures.

This describes the market for corporate governance. Corporations owe their existence to the fact that, for hundreds of years, mankind has enjoyed technology that allows a single wily entrepreneur to improve the standard of living of millions of people. A single idea, such as the automobile, can bring about major changes for all of us. Many such important ideas are difficult to realize without the aggregated savings of hundreds or thousands of individuals. Hence the invention of the corporation: a fictional legal entity, a set of relationships governed by contract and statute, that makes possible great accumulations of wealth that can be focused on specific brilliant visions.

Along with these great aggregations of wealth comes the possibility of conflicts of interest. Rationally disinterested investors, like you and me who hold our little 401k retirement accounts that are invested in dozens of large corporations, are the true owners of the corporations. While we are the owners, the great wealth amassed on our behalf is controlled by a few — perhaps seven to eighteen — corporate directors and officers. These directors and officers control great wealth, and are entrusted to employ it to our benefit. As these individuals control the wealth, they face incentives to grant themselves lavish perquisites, and to instantiate defenses against loss of control in order to entrench themselves in their cushy positions. Ross Johnson and the officers of RJR Nabisco, who lost control in a takeover battle memorialized in a book and movie, provide an example: their 20 corporate jets and other emoluments helped make RJR Nabisco a stagnant, mediocre performer ripe for takeover by anyone who could raise the funds and make better profits after taking control.

This market for corporate control, exemplified by mergers, acquisitions, hostile and friendly takeovers, and all manner of complicated transactions — reverse triangular mergers, statutory short-form mergers, cash buyouts, etc. — designed to skirt otherwise-mandatory shareholder votes and statutory obstructions, often is the only incentive for managers to pursue diligently corporate efficiency and profitability. Reputation and credibility are often enough to induce managers to perform well. When this is not the case, the threat of losing one's job certainly lights a fire under even the most complacent corporate officer.

And yet, in the guise of coming to the rescue of hapless shareholders (who, incidentally, rely on the expertise of analysts who buy securities for large institutional investors such as retirement funds, mutual funds, and insurers), in gallops the valiant SEC and state legislatures to save the day.

The term "poison pill" denotes a variety of takeover defenses, most authorized by statute, that make corporate takeovers difficult for one who wants to acquire a corporation whose directors and managers decide to resist. Here's how a poison pill works: Boards of directors create "rights" held by owners of common stock in a corporation. These rights are similar to stock options or warrants, granting the holder the opportunity to, for example, buy a number of shares (in accord with the number of shares already owned) at a discount price. Upon a triggering circumstance, such as a certain percentage of stock owned by an outsider (usually 20%), the rights are instantiated, and the rights apply only to the shareholders not attempting to take over the corporation.

Michigan and Indiana are examples of (the many) states that have anti-takeover statutes in effect. Under such statutes, if a single stockholder crosses a specified threshold of ownership (again, usually 20% of the outstanding shares), that stockholder loses his voting rights unless a majority of the other shareholders vote to restore those rights.

The result: There are fewer corporate takeovers than there were in the 1970s and 1980s, before such statutes were passed, and before the poison pill was invented by the inventive corporate defense attorney Martin Lipton. The takeovers that succeed today are "friendly" ones, of which the target corporation's board of directors approves, as opposed to the "hostile" takeovers that characterized the wild and woolly 1980s. In friendly takeovers, please note, the acquirer usually buys out the directors and officers with offers of lucrative "consultant" contracts that keep the ousted officers and directors gainfully employed.

State legislatures approve such laws because the laws are lobbied for by representatives of the corporate directors and officers in the legislatures' jurisdictions. "We mustn't let some outsider come in and fire all our constituents" is the usual lobbyists' battle cry. The result for shareholders, however, is loss of wealth — essentially, the possible gains in value of all our little retirement accounts are transferred to the sellout directors and officers.

Before all the anti-takeover statutes, hostile acquirers would offer shareholders a premium price for their shares — usually 25 to 100% above the current market price. In the face of such takeover bids, directors and officers would find some reason to persuade courts that the takeover bids presented some kind of "threat" to the "corporate enterprise" (as though the corporation should be considered an entity apart from the shareholders themselves). Usual threats included the dire possibility of liquidation (we hear a gasp from the audience) — as though you, the shareholder, would be upset to be offered a tidy profit on the shares you hold, and as though you'd care what happened to the corporation, including its half-dozen senior officers, after you made your profit.

 
Corporations exist ultimately for the benefit of their owners. The owners of all the major corporations in the US and the world are you and me. The market value of a share of stock is the net present value of its future cash flows — dividends, plus a gain in the share price realized upon later sale of the stock. If you, the stockholder, can realize a sudden and greater-than-expected gain, you are better off.

The market for corporate control, at its freest, absent government impediments to corporate takeovers, induces managers to continually strive for greater efficiency and profitability. Hampering that market entrenches managers and directors at your expense. Government makes a pursuit of hampering that market.

Thus, in the market for corporate control as in every other regulated industry imaginable, government creates barriers to the creation of wealth at the behest of the wealthiest and most connected among us, and at the expense of the rest of us. While it is inconsistent with Austrian economics and the ethics of liberty to begrudge the good fortune of entrepreneurs who become wealthy as a result of improving our lives, it is good to resent government intrusions that divide us into camps, with some benefiting at the involuntary expense of others.

This sums up the effect of any forcible government on any free market: those connected with forcible government are benefited while overall human progress is stunted. There is nothing government can do that free markets can't do better.
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Volitzer
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« Reply #1 on: December 13, 2007, 02:31:29 am »

The Corporatocracy.
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