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Inside Wall Street Two Arrows

by WealthEffect Staff

Having considered the major Wall Street players in the takeover game, let's now look at the boom itself.

Stockholders are the owners of public corporations and, as such, have the legal right both to hire and to fire managements. The reality, however, has generally been one of entrenched managements. Like a government bureaucracy, the primary concern of many of the senior executives became the maximization of their personal wealth and power base, rather than the maximization of their owners' wealth.

By the early 1980s, the stage was set for a takeover boom. The past was defined by a decade of economic turmoil and depressed stock prices in the past, the present by a Federal Reserve committed to low inflation and by a new tax law which improved cash flows, and the future by an improving economic outlook worldwide. There were opportunities for individuals buying stocks, "raiders" buying companies, and companies buying each other.

Equally important, until the 1980s, most large corporations were immune from outside pressures. The Board of Directors answered to the Chairman, who usually was also the CEO. If the company was run inefficiently, if capital was allocated poorly, there wasn't much which shareholders or anyone else could do about it.

Takeovers were rare, since banks and insurance companies were hesitant to finance multibillion-dollar deals. This was especially true of the riskiest portion of these deals: the subordinated debentures (in the event of bankruptcy, such bonds have no claim on any specific assets and are repaid only after senior debt holders have been paid in full). Perhaps there was also a sense among banking executives that gentlemen shouldn't finance unfriendly acquisitions, known as hostile takeovers.

The growth of the high-yield debt market provided the additional financing that made size a considerably less effective deterrent to takeovers. Investors in these bonds — commonly referred to as junk bonds — received higher yields in return for accepting the greater risk. Stockholders received a higher price for their shares. The acquirers made profits (sometimes quickly) from these takeovers which have ranged from impressive to obscene. The exiting management all too often received a generous severance payment, known as a golden parachute. And the remaining company, as well as its sold-off divisions, was forced to operate with maximum efficiency, in order to meet the interest payments on the new debt.

Everybody wins, right? Hell no, say the critics. Buzzwords like "efficiency" and "rationalization" are often a fancy way of discussing layoffs, they argue. Meanwhile, highly leveraged companies are that much more likely to find themselves in eventual trouble or in bankruptcy, creating severe losses for the company's employees, lenders, and investors.

Managements who oppose hostile takeovers also criticize the short-term mentality of the stock market, as they see it. How can we operate for the long term, they ask, if a raider may step in to buy the company before the benefits of our planning are reflected in the stock price? Or, why should we feel forced to repurchase stock or restructure just to boost our stock price in the short term?

From the stockholders' point of view, the argument against takeovers is an interesting one. Even at a takeover premium to the current price, long-term investors might be better off if their investment isn't taken out of their hands.

Both sides have arguments to make. One thing is clear, however: companies are being managed with more focus and concern for the shareholders — and the fear of takeovers has been one of the reasons why.


Suggestion: Go to Management Buy-Outs (LBOs)