How corporate buyouts have inducted the gospel of shareholder value
In an excerpt from his new book, Ages of American Capitalism, economic historian Jonathan Levy explains how “the financiers blew up post-war industrial society and dethroned the post-war ruling class.”
Editor’s Note: The current debate in economics seems to lack historical perspective. To try to fill this gap, we decided to launch a Sunday column on ProMarket centered on the historical dimension of economic ideas. You can read all the pieces in the series here.
Drexel Burnham Lambert investment bank is a good place to begin to delve deeper into the character of post-1982 business development. In business, the shift to appreciating leveraged assets required nothing less than ‘a revolution in corporate governance in the United States, in which financiers, including investment bankers, continued to wrest ever more power from an already struggling managerial class.
The weapon was the new “shareholder value” gospel, which required managers to act in the pecuniary interest of shareholders. This often meant cutting wages, forgoing long-term investments, or selling assets, all in order to benefit the immediate bottom line. There was and still is no hard law that states that American businesses must be motivated to maximize short-term profits. Most post-war industrial companies, focused on long-term growth measures and maintaining “organizational slack,” had not even tried. With the shareholder value revolution of the 1980s, the current market price of company shares has once again become the measure of corporate success.
What has inducted shareholder value is a wave of sometimes hostile corporate buyouts. The movement began in the late 1970s, when oil companies, overflowing with cash due to the high prices of the oil shock, came to believe that the shares of large diversified energy companies were trading below the value of their assets. physical. During its attempted takeover of Gulf Oil in 1983, Texas oil tanker T. Boone Pickens said in The Wall Street Journal, “We are committed to improving shareholder value.” It was one of the first uses of the term. Pickens tried to convince the majority of Gulf Oil shareholders to turn the company into Pickens’ “royalty trust”. Then he sold assets unrelated to the oil business, returning money to the owners. After that, he would offer the dismantled oil company to the public, hoping it would earn a high value. Pickens never acquired majority control of Gulf Oil, but management paid him a “greenmail”. In other words, they bought back the shares that Pickens and his allies had accumulated at a price above the going market rate – well above what the Pickens group had originally paid for. Boone, Houston oilman Oscar Wyatt, Jr. and New Yorker Carl Icahn, among other corporate “looters”, have followed this strategy successfully. Icahn even “traded” US Steel.
The corporate looters could never have succeeded in the shareholder revolution on their own. They needed help in the financial markets. Institutional investors, especially public and private pension funds, have joined corporate raiders. In other words, the capital accumulations resulting from post-war compensation policy funded changes in corporate governance that, ironically enough, undermined compensation policy. The critical economic site has shifted from income to ownership. If workers began to use debt to offset falling wages and to support consumption, then debt buyouts demonstrated how landowners could use debt to cash in on their investments. Overall, relative income growth has shifted from labor to capital.
By the 1970s inflation had reduced the return on investments of pension funds, and new federal and state laws allowed them to seek riskier investments. In 1975, pension funds held $ 113 million in stock. In 1980, they had $ 220 million. In 1985, they had $ 440 million. It was a perfect example of how capital began to cross into new asset classes during this time. The fund managers in charge of these investments thought they could hedge the risk of stock market investments through new financial products. For example, pension funds bought “portfolio insurance,” in which computers automatically sold stocks in their portfolios if stock prices fell. The academic theory behind portfolio insurance assumed transactional liquidity, “that continuous trading is possible” – that there would always be two sides to a trade and not everyone would always be on the sell side. Additionally, in 1982, the Chicago Mercantile Exchange began selling stock index futures – essentially, an asset that tracked the price of the Standard & Poor 500 (called the “spooze”). Institutional investors, with the approval of regulators, bought them to hedge their stock positions.
Cover in hand, institutional investors followed the raiders. In 1984, Texaco paid the Texas Bass family $ 55 million in “greenmail” at $ 55 a share when the market price was $ 35. Directors of the California Public Employees’ Retirement System (CalPERS), America’s largest public pension fund and one of Texaco’s largest shareholders, wondered why CalPERS got nothing. CalPERS led the Council of Institutional Investors (1985) and joined the chorus demanding greater corporate focus on shareholder value. At all costs, leaders must focus on the company’s stock price.
“Shareholder value” has been the rallying cry for a wave of leveraged corporate buyouts and related mergers and acquisitions. In 1982, in the midst of a revolution in antitrust law, Reagan’s Justice Department changed its “merger guidelines.” The objective was no longer, as stated in 1968, to “preserve and promote market structures conducive to competition”. The new standard for evaluating a merger was only whether or not its outcome “would keep prices above competitive levels”. This reflected the growing influence of the Chicago Law and Economics movement, which held that the only standard relevant to antitrust enforcement was “consumer welfare,” or lower prices – not market structure or barriers to entry. The judges removed the antitrust requirements against vertical and horizontal mergers from the law. Between 1985 and 1989, there were thousands of debt buyouts valued at over $ 250 billion.
Assuming the proper greenmail was not paid, the art of leveraged buyout was as follows. The raiders as well as the new “private equity firms” – the largest at the time was Kohlberg Kravis Roberts (KKR, founded 1976) – bought part of the shares of the target company, usually between 5 and 10 percent. hundred. The game had started. Other shareholders, especially large institutional investors, must have been willing to sell themselves off for buyer’s interest. Management could even choose to participate, and often business consultants encouraged them to do so. A company was much more likely to engage in a buyout transaction when the company’s finance rather than production or sales executives were at the helm. If the managers resisted, the takeover would be “hostile”. To raise cash for the purchase of stocks, buyers obtained lines of credit from banks or issued rotten bonds – risky corporate bonds offering high yields. That was the last ingredient: the newly booming junk bond debt market. They are the ones who leveraged the buyout. Investment bankers, especially Michael Milken of Drexel Burnham Lambert, made this deal. Finally, after groups of investors built up a large position in equities, he made an offer to boards of directors – a set share price – to buy out the company and take it over and own it. .
Thus, publicly traded companies have become private property. But the company then had to raise cash to meet the debt repayments. This normally meant selling physical assets and reducing operating costs, including labor costs. Dramatically, employee pension funds, to offset the uniform growth in compensation of their employees, sought returns by participating in debt buyouts, which in turn led newly indebted companies to cut wages and squeeze in. cut jobs so that they can meet their obligations. Usually, the conglomerates were divided into several parts, and many divisions were sold. It was a vertical and horizontal disintegration of post-war multidivisional industrial society – no more purging of fixed capital, no more hemorrhaging of blue-collar jobs. After that, the company was sold on the public financial markets, in the hope that the new share price justified the initial purchase. If stock prices continued to rise, it usually was. Even if the share price rose, did that necessarily mean that the underlying company was worth more than it was before the leveraged buyout? If the share price rose, did that matter?
Extract from the book Ages of American Capitalism: A History of the United States by Jonathan Levy. Copyright © 2021 by Jonathan Levy. Posted by Random House, an imprint and a division of Penguin Random House LLC. All rights reserved.