Method to the Merger Madness
Revisiting the ’80s takeover boom

by Dale Arthur Oesterle

Dale Arthur Oesterle is the Monfort professor of law at the University of Colorado School of Law in Boulder, Colorado.

Last year, the frequency and size of mergers and acquisitions in the United States hit new heights. The trend began in 1993, set records in 1994, and continued strong in 1995. In 1996 there were seven deals larger than $10 billion and two larger that $20 billion.

To put the trend in perspective, (and avoid the overreactions common from policy makers) revisit the 1980s; a decade that also saw $20 billion deals, extraordinary gains and losses in wealth, and $100 million professional fees. Reaction to current mergers seems less panicked than in the ‘80s. Compare the meager public attention given to $20 billion deals in 1996 with the shock waves that attended Kohlberg, Kravis and Roberts and Company’s (KKR) $24 billion leveraged buyout (LBO) of RJR Nabisco in 1989.


Public Perceptions

During the "decade of greed," movies portrayed takeover artists as slick Gordon Geckos, destroyers of wealth. Policymakers initiated new regulations to deal with the perceived economic adversities of takeovers. An increasing number of studies by financial economists suggest that public condemnation was, at minimum, too harsh and perhaps wrong. Still, laws and regulations from the decade survive as flotsam, making mergers dangerous sailing and possibly sinking future attempts by firms adjusting to new competitive and economic realities. Unlike the 1980s, the current boom lacks financial takeovers; takeovers leading to reorganized, more efficient companies, and a more efficient distribution of assets. It is useful to dispel the myths about mergers, about who "won" and "lost" in the 1980s as prelude to needed policy changes.

The first myth portrays buyers as fools. Bidders, driven by big egos and fast-buck greed, made acquisitions that actually reduced the value of their firms. Despite unequivocal warning (the drop in their stock price upon the acquisition announcement) the hubris-infected individuals persisted; tragedy resulted. While sellers, lawyers, and investment bankers benefited, firms that gobbled up others suffered; post-acquisition cash flows rarely met the overblown expectations of the pre-acquisition hype. Moreover, there were often innocent casualties such as target employees, target bondholders, and target customers.

Robert Campeau is considered by many as the best example of a fool. The Campeau Corporation completed a successful hostile takeover of Federated Department Stores on 29 July 1988. Fortune magazine called it "the biggest, looniest deal ever." Campeau paid $8.17 billion for the stock of a company with a pre-acquisition market value of $2.93 billion. Campeau financed 97 percent of the purchase price with debt. Less than two years later, Federated filed for Chapter 11 bankruptcy and Campeau lost his job.

Other deals considered equally foolish included Beatrice Foods Company’s acquisition of Esmark Inc.; LTV Corporation’s acquisition of Republic Steel; Baldwin United’s acquisition of MGIC Investment Corporation; Pan American Airline’s acquisition of National Airlines; Standard Oil Company of Ohio’s acquisition of Kennecott Copper Company; and the leveraged buyouts of Macy’s, Southland Corporation, and Revco D.S. Inc.

The second myth portrays buyers as quick-buck artists. Some takeovers in the 1980s made lots of money but, according to critics, at the expense of unfortunate victims. The successful quick-buck artist assembled a war chest of cash based on short-term debt financing. He found a vulnerable company, bought it, squeezed it, and resold it for a handsome profit. Usually one of two possible causes produced profits. First, the target company was undervalued in the stock market. Second, the bidder knew how to extract cash by firing employees; liquidating assets; stripping pension plans; cutting investment in long-term projects or research and development; eliminating charitable donations; and milking short-term, cash-producing assets at the expense of the assets’ long-term earnings potential. He looked only at the bottom line, regardless of local economies, the families of employees, the loyalty of customers and suppliers. The critics point to Carl Icahn’s takeover of Trans World Airlines, which lurched along on the edge of bankruptcy as he continued to make huge personal gains by trading the company’s stock.

Contrary to negative perceptions, many leveraged acquisitions in the 1980s profited buyers and strengthened the acquired company. Some found poorly run companies and turned them around. Some saw opportunities based on a unique combination of factors.

The federal government had relaxed antitrust restrictions on mergers. State courts and legislatures were not yet serious about blocking acquisitions. Many major firms had been pursuing unsound business strategies that reduced their market values but offered potential profits for those who could run them more competently. And new innovations in debt financing made money cheaper.

The time was ripe for strategic acquisitions. Companies could purchase reasonably priced assets in their own industry or sector. Strategic deals dominated major sectors of business such as oil and gas, pharmaceutical and chemical, retail clothing and food, media and entertainment. Such takeovers might include Quaker Oats’ acquisition of Gatorade, General Electric’s acquisition of RCA, Wells Fargo Bank’s acquisition of Crocker National, and KKR’s buyout of Beatrice and Duracell.


Winners and Losers

By the late 1980s, conditions affecting mergers had changed. Debt financing became more expensive as interest rates rose. Higher stock prices made potential takeover targets more expensive. The scandals of high-profile financiers soured the junk bond market. The collapse of several large LBOs made banks more cautious about participating in such deals. Further, federal regulators restricted the participation of savings and loans as well as insurance companies in such buyouts. State legislatures and courts came down firmly on the side of targets, enhancing their negotiating position. The result: death of the 1980s takeover binge.

Studies by financial economists, for example Claudio Loderer and Kenneth Martin in a 1992 Financial Management article, found that shareholders of bidding firms in the 1980s just about broke even, the findings varying by time period and type of acquisition. Some early studies even found small losses on bidder share values. The data on returns to shareholders of bidders in leveraged acquisitions remains largely incomplete, however.

The gains of privately-held bidders (the LBO groups whom most believe were very successful in the 1980s) are not yet well quantified and have not been added to the bidder mix. Moreover, the gains or losses of shareholders in large publicly-held bidders have proven to be very difficult to isolate and measure accurately. But some findings glimpse the conditions of shareholders.

An unpublished 1995 study by Sanjai Bhagat and David Hirshleifer found that bidders seem to overpay slightly in cash tender offers. The study also found, however, that bidder share prices, measured on announcement, may not quantify all of the bidders’ gain. First bidders in multiple-bidder contests earned, on average, profits equal to 3.4 percent of target value on their initial target shares.

Average gains for shareholders in bidder companies is based on a weighted average of the heterogeneous collections of bidder subsets. Thus Ajeyo Banerjee and James Owers maintained in a 1992 Financial Management article that "white knight" bidders, that is, a friendly bidding firm actively sought by target firms that resisted acquisition by a hostile bidding firm, did not fare well. They experienced greater abnormal losses than their black knight bidding counterparts.

Nicholaos Travlos demonstrated in a 1987 piece in Finance that negative bidder returns in the 1980s correlated with stock financing and with low managerial ownership of bidder stock. Bidders received better returns with cash offers than stock exchanges. Bidders were more likely to enjoy positive returns from an acquisition if managers owned significant amounts of stock or if outsiders composed more than one-half of the board of directors.

There is no uncertainty about the effect of leveraged acquisitions on the shareholders of companies that were takeover targets. By the end of the 1980s, shareholders in leveraged acquisitions gained significant wealth. Analysts disagree only over the amounts gained. Roberta Romano maintains in a 1992 Yale Journal of Regulation article that on average, stock prices increased 20 percent over pre-announcement prices for mergers, 30 percent for tender offers, and 20 percent to 37 percent for leveraged buyouts.

With bidding firm shareholders breaking even and target shareholders enjoying significant gains, leveraged acquisitions in the 1980s produced a total shareholder wealth increase. Bhagat and Hirshleifer found that average value improvement (the total gains by bidder and target shareholders) was 45 percent of the value of the target.

To determine whether takeovers created or destroyed wealth, one must examine target firms post-acquisition. Several studies found cash flows of companies improved significantly after the acquisition. Tim Opler in a 1992 article in Financial Management, for example, found that the median post-LBO operating cash flow to sales ratio rose 11.6 percent after adjustments for industry effects. Professor Steven Kaplan, of the University of Chicago, found that equity investors in management buyouts made, on average, a 41.9 percent excess market adjusted return. In large acquisitions that led to subsequent divestitures of the target company, many assumed a mistake had been made by a bidding company. Actually, returns to the purchaser from the sale were positive in 50 percent to 70 percent of the cases.

Increasingly, studies focus on the type of companies targeted by bidders in the 1980s. Unfortunately, most do not subdivide their findings into successful and unsuccessful acquisitions. Most leveraged acquisitions reallocated assets from diversified firms and conglomerates to firms in the same industries as those assets. If a bidding firm and target firm shared their core business, the purchaser saved the core business and sold any others. Other firms acted as conduits, buying diversified firms and selling off assets to corresponding businesses; known as "bust-ups" or "sell-offs."


Sources of Gains

Three interrelated sources produced gains. First, strategic acquisition firms enjoyed gains by expanding their operations in their own industry or business. Classified as synergy gains, the value of the combined firm was greater than the value of the two firms operating separately because of real operating efficiencies. Acquisitions of firms in businesses related to the bidder were generally profitable. Acquisitions of unrelated companies in the 1980s produced significantly lower returns.

Second, bidders in financial takeovers produced gains by eliminating the value-destroying effects of excessive diversification. In a 1992 Journal of Finance article Steven Kaplan and Michael Weisbach showed firms that diversified in the 1960s, 1970s and early 1980s lost significant value (on average about 15 percent of the value of their lines of business) becoming ripe candidates for takeovers. Acquisitions cured the ills created by incumbent managers’ strong aversion to value-maximizing divestitures. A significant portion of the gains from hostile takeovers came from a reallocation of target assets; for example, sales of assets to owners of related assets. Firms that swam against the current, making diversifying acquisitions, were four times more likely to later divest the assets than firms that made acquisitions in their own or a related field.

And third, bidders purchasing poor performing targets benefited from replacing the existing management while leaving the target with enough new debt to motivate whoever was left. LBOs targeted firms with high cash flow and low performance histories. Accordingly, poor performers were usually targets of tender offers. In 1992, Financial Management published a study by David Denis about the investment decisions of LBO candidates over a five-year period prior to the LBO. The study found that such firms had invested in projects having a negative net present value as viewed by the market. Kenneth Martin and John McConnell reported in the Journal of Finance in 1991, management turnover to be much more frequent after a takeover.

Usually managers run companies in ways that improve their authority; that is, control and compensation at the expense of the companies’ owners, shareholders, and long-term strength. Takeovers weed out or discipline such managers. After a takeover, the increase in the debt-to-equity ratio in the target effectively adjusted managers’ incentives, better aligning them with the interests of the shareholders. The pressure of periodic interest obligations disciplined managers to better generate and marshal cash.

Critics of LBOs assume that bidding firms successfully squeezed additional cash flow out of the target’s operations by expropriating the wealth from third parties, for example the federal government. Takeover targets pay less taxes because interest payments on debt are tax-deductible while dividend payments to shareholders are not. Two other candidates considered vulnerable to abuse were employees of the target companies who would face lower wages or lost jobs; and customers who would have to pay the monopoly prices of the new company. The data demonstrates, however, that on average, gains from "victimizing" any of the groups equal only a small portion of the premiums paid to target shareholders.

To many observers, the tax code explained the preference of bidders for firms with modest debt-to-equity ratios during the 1980s acquisition spree. Increases in leverage and deductibility of interest payments on debt became the most important potential source of tax gains in acquisitions.

Kaplan, in a 1989 Journal of Finance study of leveraged buyouts, showed that tax savings from leverage explained at least 50 percent and perhaps 100 percent of the takeover premium paid by the bidders for target company stock. The strength of his finding is tempered somewhat, however, by the fast debt repayment typically following leveraged acquisitions and by the increased tax payments made by selling target shareholders and by post-acquisition debt holders.

Another source of tax gains involved merging a profitable company with one having significant carry-back tax losses or credits. Further, acquiring a company with depreciated assets and re-depreciating those at accelerated rates resulted in significant tax advantages. And finally, acquiring a company, then converting it to a partnership, allowed purchasers to avoid double taxation. In 1986, changes in the Internal Revenue Code eliminated the three latter tax benefits.

Frank R. Lichenberg and Donald Siegel showed in a 1990 Journal of Finance Economics article that companies purchased in leveraged acquisitions substantially reduced their number of white-collar employees. Union employees also suffered wage reductions, including pension reductions, though not as severely. Indeed a 1995 Industrial and Labor Relations Review study by Brian Becker found, in the aggregate, no statistically significant wage changes in leveraged buyouts. And Lichenberg and Siegel found no statistically significant wage changes between hostile takeovers and friendly takeovers. There were, of course, notable exceptions, such as Icahn’s acquisition of TWA.

Leveraged acquisitions creating significant consolidations of market power were the exception, not the rule.


What Hampered Bidders?

Entrepreneurs in the 1980s knew how to use debt financing to acquire troubled firms and turn them around. But a tough acquisition market gave significant bargaining advantages to their opposite parties, the sellers, and to subsequent bidders. It was one thing to see potential gains from acquisitions, but quite another to secure a profit in the price negotiations with a seller. Why was the split between seller and buyer in the 1980s so lopsided? At issue: whether the disadvantage was predominately determined by the market or the law.

Those who point to basic market phenomena when determining the buyer/seller split usually offer three explanations. First, the takeover market matured quickly, the buyers competed for targets. Competition among buyers drove the price of targets up until the marginal gains to a buyer from any acquisition were small. Second, successful buyers suffered a "winner’s curse." In an auction of targets, the buyer willing to pay the most paid above-market prices, the market being determined by the average price all willing buyers would pay. And third, managers in the 1980s habitually made poor decisions in acquisitions, by either overvaluing the target or choosing personal gain over shareholder interest.

If those market-based phenomena explained the disparity between the gains of bidder and target shareholders, one would expect market corrections. Bidding firms and their managers would learn from their mistakes and over time economic incentives would lead them to correct their practices. One would expect that managers of bidders would become more cautious, or firms, under pressure from their shareholders, would discipline reckless managers. Arguably, the lull in acquisitions from 1989 to 1992 and the numerous shareholder resolutions encouraging boards to welcome takeover bids represented such a correction.

Actually, a growing body of law aimed at restricting bidder power affected the takeover market. Three sets of regulations: disclosure rules, rules against preferential treatment of shareholders, and restrictions by state governments, help explain the course of takeovers in the 1980s.


Disclosure Rules

In the 1970s and 1980s the federal government’s Securities and Exchange Commission (SEC) increasingly required disclosure of important information about takeover plans. The rules "leveled the playing field" by eliminating any initial gains in the acquisition for the winning bidder. The rules forced bidders to reveal their strategy for using a target’s assets after the acquisition. The strategy explained and justifies whatever price the bidder is willing to pay. Second bidders could use the disclosed information to compete with the first bidder.

Even if competing bidders do not appear, a seller’s shareholders could use the bidder’s disclosures to price their stock before consummation of the acquisition, capitalizing the expected gain in the pre-acquisition stock price. The run-up in target stock price affects the acquisition price. At minimum, a seller’s managers would bargain for an advantageous price based on the bidder’s disclosures. What seller in any line of business would not want credible evidence of a buyer’s bottom line price?

The early disclosure requirements exacerbate two of the market phenomena noted above. Both the winner’s curse and competition among bidders debilitate winning bidders when all bidders are required to reveal their material information on the potential benefits of the target’s assets.


Bars to Preferential Stock

The second heavy-handed takeover regulation required bidders to extend equal treatment to all shareholders in stock acquisitions. The SEC took it upon itself to protect shareholder equality in tender offers. It based its actions on the Williams Act of 1968. It put disclosure and timing restrictions on tender offers. The SEC went well beyond the explicit requirements of the Act, and in the 1970s and 1980s crafted a series of rules to protect small shareholders who otherwise could not command the takeover premiums due large shareholders.

As a consequence of the rules of that Act, bidders had to include all shareholders in a tender offer. For example, they could not discriminate among shareholders by offering some a preferred price for their stock. If an offer were oversubscribed, bidders were required to take some stock from all tendering shareholders pro rata. They could not purchase shares privately while an offer was open. They had to give price increases to all those who tendered before the announced increases, and had to commence their tender offer on the date of the first price specific public announcement of an intent to purchase.

The anti-discrimination rules, so uncritically accepted in that context, have been met with rebuke in antitrust law and in case law on the fiduciary duties of directors. The rejections are based on economic theory and on pragmatic notions that an individual ought to have the freedom to negotiate an offer at arms-length. Thus if takeover bidders could discriminate among shareholders, large shareholders would clearly be better off. In serious question is the knee-jerk conclusion that discrimination among shareholders, if permitted, would make small shareholders worse off. Clearly, bidders’ costs in successful acquisitions are higher with anti-discrimination rules. The anti-discrimination rules discourage the marginal bidders from making bids, resulting in fewer takeovers.


State Regulations

State courts and legislatures established the third set of regulations hindering bidders. They supplied target managers with a powerful array of defenses to structure the bargaining in their favor. State anti-takeover statutes and court opinions gave target companies more power to control the timing, pace, and process of negotiations. Targets could set or relax all the final offer deadlines once bargaining began. Some states gave targets the power to choose the structure of the sale, for example through auctions or privately negotiated bids. If an auction was the means of sale, the target could structure it as a closed or open bidding process. Obviously, a well-positioned bidder could force a desperate target to forgo those bargaining advantages. But between equally situated bidders and targets, the law gave the target advantage in negotiation at the margin.

The cumulative effect of federal and state regulations placed bidders at a severe disadvantage. A successful bidder required extraordinary care and foresight; normal perspicacity would not do. Only the very sagacious bidder could make serious money in such a bargaining environment. The result, marginal bidders were and continue to be discouraged from bidding. The falloff in takeovers at the end of the 1980s reduced not only the gains to bidders but the gains to target shareholders.


Mergers and Acquisitions: Then and Now

After a lull in the early 1990s, mergers and acquisitions have returned to the economic landscape, stronger than ever. Given the surge in deals, one might argue that the laws remaining from the 1980s have had little effect and should not worry us.

Economic forces drive the current pace of acquisitions. Relatively low interest rates make borrowing cheap. Record high share prices (based on price earnings ratios) encourage buyers to use them as the medium of exchange. The federal government relaxed fifty-year-old regulations to allow more freedom of movement in major American industries: banking, telecommunications, utilities, radio and television, and railroads. Enforcement of antitrust laws has also been relaxed.

But the current acquisition boom looks different from the boom of the 1980s in important ways. In addition to economic conditions and softening regulations, other factors are at work. First, announcements of hostile acquisitions as a proportion of all acquisitions announcements are down significantly as are cash deals. Highly leveraged buyouts are less infrequent.

A high percentage of hostile acquisitions currently in the news are hostile offers made by second bidders seeking to purchase a firm that has announced a friendly combination with a competitor. In such cases the second, unwanted bidder is worried about the enhanced market position of a competitor if an announced acquisition in its industry proceeds unimpeded. Currently, the number of hostile bid announcements made by first bidders is very small indeed.

A second major change from the 1980s is that financial buyers have largely disappeared, corporate strategic takeovers now hold center stage. Those buyouts, that characterized the 1980s saw purchasers of single firms conducting major reorganizations, changes in operations, or recapitalizations from the outside rather than the inside. They did not purchase targets to combine with the assets of an otherwise ongoing operating company. Rather, financial buyers spotted corporations they believed could maximize shareholder value through reorganization. Management in such targets were viewed as ripe for change. In short, there are few Ronald O. Perelmans, Carl Icahns, Michael Steinhardts, Saul Steinbergs, Fred Lorenzos, Jay Pritizers, T. Boone Pickens, or Sir Ronald Goldsmiths in the news.

Examples of financial takeovers in the 1980s followed by major operating changes included a retail clothing company that retained downtown department stores more valuable as office buildings; the takeover of an airline that was paying employees too much after the deregulation of the industry; and the takeover of an oil company wasting resources on marginally productive oil and gas exploration. Examples of financial takeovers in the 1980s leading to reorganizations included Ronald Perelman’s takeover of Revlon, a dinosaur conglomerate that needed to both spin-off under-performing divisions and refocus on its specialty divisions.

Two beneficial aspects of financial takeovers in the 1980s have not been properly appreciated. First, those takeovers often precluded strategic acquisitions as the financial buyer spun off companies to strategic buyers or resold the residual firm to strategic buyers or back to the public. In a sense, many financial buyers were intermediaries, dealers of companies they bought. As such, financial takeovers added liquidity to the acquisition market.

Second, the threat of a financial takeover based on unrealized gains in operating changes, recapitalizations, or reorganizations often stimulated change by incumbent managers. For example, to defend against a takeover by Sir James Goldsmith, Goodyear retained only its core tire and rubber business. Phillips Petroleum, defending against a takeover by T. Boone Pickens and later Carl Icahn, changed its exploration philosophy and made larger dividend payments to its shareholders.

Some of the strongest salutary effects of financial takeovers in the 1980s resulted from unsuccessful cases. That was, of course, a positive effect from takeovers too often ignored. When Warren Buffett, a premier takeover white knight, sided with public opinion and opined that takeovers LBOs do not create value, he was mistaken. Financial and operating restructuring, the effect of threatened and successful LBOs, did create value and the careful studies of financial economists on the takeovers of the 1980s found it.

One misses the discipline created by financial takeovers most sorely at the end of an acquisition wave. The financial takeovers of the 1980s corrected the mistakes of the conglomerate mergers of the 1970s. When the current boom in strategic acquisitions winds down, mistakes made and opportunities lost will leave some firms with sub-optimal operating strategies or sub-optimal organizational or capital structures. Sluggish incumbent managers, often responsible for the mistakes, will need the pressure applied by financial purchasers to make appropriate changes. Financial acquisitions then are an important market correction mechanism for mistaken mega-decisions by firms. At issue is whether the legal flotsam of the 1980s deters the financial purchasers we would otherwise expect to see in the late 1990s.


The Case of Conrail

The recently concluded battle between CSX and Norfolk Southern Corp. for control of Conrail Inc. provides a case study in the effect of 1980s anti-takeover law on a current acquisition. Conrail is a Pennsylvania corporation. Pennsylvania has the strongest anti-takeover laws in the country. CSX and Conrail had negotiated a friendly, $9.3 billion deal. Norfolk Southern, worried about its competitive position vis--vis a merged CSX and Conrail, made its hostile tender offer after CSX had announced its deal. Norfolk Southern offered approximately $1 billion more than CSX had agreed to pay for Conrail.

The CSX acquisition had an odd structure for a friendly, negotiated deal. The Conrail board first agreed to allow CSX to buy 19.9 percent of the Conrail stock and then consented to a front-end loaded, two-tiered tender offer. CSX offered to pay $110 in cash per share to those Conrail shareholders who had tendered their stock into a partial tender offer, for only 20 percent of the shares. They would then freeze out the remaining shareholders at a low price, exchanging CSX convertible preferred stock worth less than $100 for their shares. The Conrail board also agreed to a "lock-out" clause preventing it from shopping for any other merger partner for one year or retracting its poison pill for a 270 day period if the CSX merger fell apart. Conrail later augmented the lock-out in exchange for a sweetened deal from CSX, extending the lock-up to two years.

In four rounds of legal hearings before a federal district court judge in Philadelphia, Conrail and CSX prevailed in their argument that the Pennsylvania anti-takeover statutes empowered the Conrail board to refuse to deal with Norfolk Southern. The CEO of Conrail railed about the need to keep his system intact. Norfolk Southern wanted to dismantle Conrail’s routes.

Pennsylvania law frees a target from any obligation to sell itself to the highest bidder. The law allows a target to take into consideration not only its shareholders’ interests but also the interests of employees and communities affected by the target’s business. Federal District Court Judge Van Artsdalen described Delaware case law that focuses on target shareholders’ interests as "myopic" and applauded the Pennsylvania statutes that permit Conrail’s board to look at the railway’s "role in the national economy." The United States Surface Transportation Board agreed. Apparently the Judge agreed with the Conrail board’s resistance to Norfolk Southern’s plans of carving up Conrail’s routes.

CSX’s and Conrail’s victories in court were defeated in a Conrail shareholder meeting, however. The Pennsylvania statutes also require a shareholder vote for any stock acquisitions over 20 percent. When Conrail put the 20 percent tender offer to a vote of its shareholders, it lost. With CSX’s 19.9 percent stake and the 13 percent stake held by Conrail employees expected to vote with CSX, CSX needed only a few more votes to attain a majority. It did not get them. Apparently, the Conrail shareholders disagree with Federal District Court Judge Van Artsdalen over the best interests of their company.

After the shareholder vote, the three parties were deadlocked. CSX had spent $2 billion on Conrail stock and $16 million on acquisition expenses and Norfolk Southern had spent $1 billion on Conrail stock and $75 million on expenses; Moody’s Investors Service had downgraded the ratings of the long-term debt of both companies, citing the costs and uncertainties connected with the merger battle.

In the end, CSX and Norfolk Southern agreed to split up Conrail’s routes, and Conrail’s CEO lost his effort to keep his system together. The Pennsylvania legislature, reacting to anti-takeover hysteria, passed its anti-takeover statutes in 1990 after several large LBOs had declared bankruptcy in late 1989. But a 1992 Journal of Finance Economics study by Samuel H. Szewczyk and George P. Tsetsekos on the impact of the statutes, found that they cost shareholders of Pennsylvania corporations $4 billion. Steven Wallman, a Washington lawyer and the author of several of the Pennsylvania statutes, made a national reputation for himself by pushing the statutes at every public opportunity. He has since been rewarded with a position on the Securities and Exchange Commission.

In essence, the Pennsylvania statutes ask a board of directors to act as an adjunct of government, balancing the interests of various constituencies affected by corporate action. While that may appeal to some, Warren Buffett’s candid admonition, that the board will simply use such statutes as a way to "keep the keys to the store," seems to be borne out in practice. But such statutes are not necessary, they attempt to redress a nonexistent problem. Even the advocates of constituency statutes ought to find their application in the Conrail setting particularly odd. The Conrail board should not be required to fret about the country’s economic welfare. There already exists a government agency expressly empowered to oversee railway acquisitions to protect the public interest, the Surface Transportation Board.



The takeover boom of the 1980s introduced methods and styles of acquisitions that were novel for the time. It was high drama, we reacted with alarm. By the end of the decade, public perceptions of the harms created had outstripped fact, our government institutions (state legislatures, federal agencies and state courts) translated our misgivings into law.

In the current acquisition cycle, the public and policymakers are not as intimidated by large scale takeovers. Yet the residue of our alarmist days remains in our laws. The residue is not debilitating to acquisitions but has the same effect of sludge on the moving parts of an engine. We would have more economic horsepower without it.


Suggested Readings

Romano, Roberta Foundations of Corporate Law (Oxford University Press 1993).
Lowenstein, Roger Buffett: The Making of an American Capitalist (Doubleday 1995).
Fischel, Daniel Payback: The Conspiracy to Destroy Michael Milken and his Financial Revolution (Harper 1995)

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