Christopher Mayer, a commercial loan officer, is studying for his MBA at the University of Maryland.
My home state of Maryland is considering adopting anti-takeover legislation to protect the small number of major corporations with headquarters in the state. The legislation would allow the directors of Maryland corporations to adopt defenses against takeovers without the consent of shareholders. Thus the legislation would legally permit company managers to consider interests other than those of the owners—say, the employees, suppliers, customers, the managers themselves—in deciding whether to reject a takeover bid. Managers would be relieved of their legal responsibility to report such bids to their employers, the shareholders.
There is simply no economic benefit to be derived from this legislation, which would put Maryland near the bottom of the list of states with regard to takeover rules. It is the product of parochial state interests and a fundamental misunderstanding of the economic role of the corporate raider. It is also another weapon in the emerging economic war between the states, along with direct subsidies and tax benefits. Such an attempt to prevent takeovers will be self-defeating because consideration of interests other than shareholder interests will result in lower productivity, lower output, and lower living standards. (The federal government already has built obstacles to takeovers.)
In the interest of full disclosure, I should say that I work for a bank with headquarters in Maryland and I might benefit from such a law. However, I have denounced this legislation at every opportunity. I believe it is a violation of shareholders’ property rights.
Why Maximize Shareholder Value?
In the United States it is an accepted fact of corporate life that a firm’s mission is to increase shareholder value. Failure to do so results in pressure from the board of directors, activist shareholders, and corporate raiders. The result might be a takeover—the purchase by one person or small group of a controlling share of stock—and the firing of the managers. That’s what provides an incentive for managers to perform well.
The role of the corporate raider is therefore essential. Yet the media portray raiders (and those, such as Michael Milken, who finance them) as shortsighted menaces. This makes for lurid journalism and sensationalist storytelling. Recall the bestseller Barbarians at the Gate by Bryan Burrough, which chronicled the battle for RJR Nabisco.
However, as G. Bennett Stewart III asks in his book The Quest for Value, “Did the ‘raiders,’ as the pejorative label suggests, pillage companies solely for their personal enrichment leaving a weakened economy in their wake, or did they instead promote improvements in corporate performance and increases in market values for all to share?”
In his book, Stewart outlines his comprehensive research on nearly 300 financial restructuring transactions completed in the 1980s. In a vast majority of cases the restructuring led to significant increases in market values and operating performance. The restructuring is one reason for the sustained economic growth the American economy has experienced.
The media home in on the job losses that often occur after takeovers. However, jobs are constantly being created as well as destroyed in a market economy. This is a mark of health, since workers are constantly moving to where they do more to satisfy consumers.
Takeovers are generally a threat only to managers whose companies are performing below their potential. Raiders buy stock only from willing shareholders, who surely don’t regard the transactions as hostile. The managers whose jobs are at risk understandably see a takeover as hostile to their interests. But they work for the owners. Why are they more deserving of sympathy than stockholders? (Stockholders are not all rich, of course, and managers make well above the minimum wage.)
The potential for a takeover is therefore a strong incentive for management to pursue projects and strategies that maximize shareholder value. Remove the threat of a takeover and you remove one of the shareholders’ most effective means of policing management. (It is curious that some of the same people who decry takeovers also, on occasion, decry the lack of accountability of corporate managers.)
In other parts of the world, this incentive of managers to maximize stock value is not present. In Germany and Japan managers are expected to consider a more intricate web of stakeholders in the corporation, such as customers, suppliers, government, employees, and even society at large. Maximizing shareholder value is seen as inefficient, shortsighted, or downright selfish and antisocial. However, as authors Copeland, Killer, and Murrain point out, “Shareholder wealth creation does not come at the expense of other stakeholders. Quite the opposite.” Research has shown that there is a close link between maximizing shareholder value (which requires an open market for corporate control) and higher living standards and greater productivity. Maximizing shareholder value is especially important in the increasingly global economy, where capital is generally free to seek the highest returns. Societies that do not adopt such a corporate ethic will find it hard to attract and retain investment capital.
Beyond this, there is the ethical matter of property rights. Corporate managers should do what is in the best interest of shareholders because the shareholders own the corporation. Managers work for them. To make a law that weakens this responsibility is to undermine the property rights of the shareholders. When you hire an attorney or an accountant, you expect him to act in your best interests within the framework of the rules. Legislation that permitted your attorney or accountant to consider something other than your interests would be met with derision and disbelief. So should anti-takeover legislation.
In the Interests of State
Why is the state pursuing this legislation? Richard Legin, the secretary of business and economic development and a prime advocate of the bill, says, “We have very few headquarters companies in this state. They’re very important to us. I don’t want to lose a Black and Decker or a Mercantile Bank.” Thus, stockholders are to be sacrificed to the parochial interests of the state government (and incumbent managers). Unfortunately, the bill’s supporters seem to outnumber the detractors. Supporters include the Maryland Chamber of Commerce, the Maryland Bankers Association, and the Maryland Bar Association.
Legin adds that hostile bidders are “doing it for sheer greed.” When badly performing managers try to cling to their jobs at the expense of stockholders, it is never characterized as “greedy.”
Dan Abramis, president of the investment fund Hillston Partners states, “I don’t consider this anti-takeover legislation. I consider it anti-shareholder legislation. I’m a money manager, this is my home state. But if [the bill] passes, I would be far more hesitant to invest in a Maryland company because of the risk that my hands would be tied if something went wrong.” The legislation would further re-enforce Maryland’s reputation as pro-regulation and hostile to business.
By adopting this legislation with the intent of preserving existing Maryland corporations, the state ignores the long-term dampening affect it will have on new investment in the state and on the probability of new corporate headquarters coming to Maryland. Behold the practical implications of ignoring Frederic Bastiat’s great lesson about disregarding the unseen.
- G. Bennett Stewart III, The Quest for Value: The EVA Management Guide (New York: Harper business, 1991), p. 477.
- See Charles Baird, “Recycling Labor,” The Freeman, April 1999.
- Tom Copeland, Tim Killer, and Jack Murrain, Valuation: Measuring & Managing the Value of Companies (John Wiley & Sons, 1995), p. 3.
- Peter Bahr, “Maryland’s Hostile Takeover Defense,” Washington Post, February 25, 1999.