Hostile Takeovers As a Check on Corporate Misbehavior
October 3, 2002
The recent string of corporate scandals might have been prevented had the market been allowed to operate free of certain laws and regulations, say academic observers of the business scene.
Here is how the thinking goes:
- Through the ever-present threat of a hostile takeover, markets work to prevent greed in the form of excessive compensation, bonuses, sweetheart stock options, insider trading and cheating on the published financial accounts.
- Such practices reduce the value of a company's shares, inviting competitors and financial specialists to purchase controlling interest in the offending company's shares.
- The acquiring company installs new management and cleans up the company, making in the process a profit sufficient to pay off the costs of the acquisition -- with a tidy sum left over.
- To succeed, the takeover process must usually be conducted in secret, so as not to awaken managers of the target company to the threat.
But during the 1960s and 1980s legislation and government regulations were adopted which protected poorly run companies and their executives from hostile takeovers -- by making such raids more expensive and destroying the vital element of surprise.
- The Williams Act of 1968 required the Securities and Exchange Commission to be notified of an intent to sponsor a takeover.
- State regulators authorized the early use of poison pills and other practices that allow the managers of targeted firms to delay or prevent the takeover.
- They also permit executives to exact large settlements for themselves before they lose their jobs.
So these changes in the rules actually fostered a climate in which fraud and incompetence was protected -- leaving shareholders and employees at the mercy of dishonest executives.
Source: Herbert Grubel (Simon Fraser University), "Regulators vs. Adam Smith," Wall Street Journal, October 3, 2002.
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