Center on Corporate Governance
"We have entered the era of the two-tier, front-end loaded, bootstrap, bust-up, junk-bond takeover." —Martin Lipton
Until recently, takeovers typically involved larger firms digesting smaller firms, a process that most theorists have assumed was driven by the pursuit of synergistic gains. Lately, however, this dynamic has dramatically reversed itself. To a considerable extent, the large conglomerate is now the target, and such prototypical conglomerate firms as General Foods, Richardson-Vicks, Beatrice, Revlon, SCM, CBS,USX, and Anderson, Clayton and Co. have either been acquired or forced to restructure themselves within the last three years alone. The new bidder in turn tends to be a financial entrepreneur – either a single individual or an ad hoc collection of individuals, smaller entities, and investment banking firms – who intends not to assimilate the target, but to dismantle it. Since 1984, we have entered the era of the "bust-up" takeover – that is, a takeover motivated by the perceived disparity between the target's liquidation and stock market values. A new breed of financial entrepreneur, originally typified by Carl Icahn and Boone Pickens, but more recently expanded to include major investment banking firms acting for their own account, has appeared on the scene, who essentially arbitrages this difference between stock and asset value by first acquiring control and then partially liquidating the target in order to pay down the acquisition indebtedness. Tactically, it is easy enough to explain how this new era has arrived: new financing techniques – most notably, the appearance of the "junk bond" in late 1983 – have vastly extended the capability of the smaller bidder, by allowing it to borrow more and to use the liquidation value of the target as its collateral. What is more puzzling is why discounts between a firm's asset and stock market value have arisen that are sufficiently large to justify multi-billion dollar takeover contests. Even more anomalous is the apparent ability of target managements, when confronted with a hostile takeover bid, to undertake a financial re-structuring, themselves, that substantially reduces the size of this discount. Why then did the discount persist for so long? If the contemporary takeover market is driven by the existence of these discounts, none of the conventional theories of the takeover supplies a satisfactory explanation for this phenomenon. The standard synergistic model cannot easily account for why the bidder seeks to dismantle the target, rather than integrate its operations with its own. Similarly, the more controversial disciplinary thesis, which holds that superior managements are displacing inferior ones, cannot explain why even the best operationally managed companies seem to experience such disparities between asset and stock value, and the "private information" theory, which assumes that the bidder knows something that the market does not, cannot be reconciled with the fact that the existence and size of such discounts are apparently well known to the market. Nor can any of these theories easily account for the bidder's belief that value is to be maximized by reducing the target's scope of operations by selling off or closing down marginal divisions. This article will offer an alternative explanation for what is occurring – one that is intended not as a definitive account of all takeover activity, but as a partial explanation of those trends that raise the most serious social issues.
John C. Coffee Jr.,
Shareholders Versus Managers: The Strain in the Corporate Web,
Mich. L. Rev.
Available at: https://scholarship.law.columbia.edu/faculty_scholarship/533