Let’s Be Cautious in Efforts to Curb Corporate Mergers

Corporate merger activities of investment banking firms on Wall Street are undergoing intensive federal investigation. Several “star” performers already have gone to jail, and no one knows who is next. Frenzy has seized merger-makers and lawmakers alike. Congressional committees are racing to design legislation to restrict mergers.

Caution should be the watchword.

Mergers can be the market’s protection against mismanagement. A constructive merger reinvigorates drifting managements, stimulating dormant resources.

International competition is a powerful force in today’s business environment; 70% of our products are competing with foreign manufactured goods. In order to achieve the economies of scale so that a company can be competitive, size is often critical. A corporation can expand quickly through the merger route.

Constructive mergers do keep our economy vital and ever-advancing. So, to understand how to deal effectively with the abuses that have been occurring, we have to examine the functions of middlemen and accessories. In one law firm in New York that specializes in mergers, every partner earned more than $800,000 in 1985.

Fierce competition among banking firms (some induced by the loosening of government regulations) has stimulated changes in investment banking and commercial banking practices and techniques, and has added to the mania. Examples are the use of “junk bonds,” participation in leveraged buyouts and expanded use of arbitrageurs.

Trading stock on the basis of insider information is not only illegal; it also distorts the constructive goal that a well-intentioned merger seeks to accomplish. The laws on the books should continue to be diligently enforced. Make no mistake about it, investment bankers, lawyers, accountants and other professionals know insider information when they see it. No new legislation is needed, but consistent enforcement is necessary.

“Greenmail,” whereby the raider is paid by the target corporation a higher price than the public receives in the market, cheats the public stockholders and creates needless tumult under the guise of merger action. It should be outlawed.

Many arbitrageurs tend to so manipulate the merger process as to cast an unsavory shadow on the function itself, leading to disruptive practices by both management and acquirer. Something that might be helpful would be a regulation requiring a holding period for stock--say, three months--before it could be voted in an acquisition action. Stockholders should vote on all mergers.

Takeovers conducted by a company’s own officers through a leveraged buyout strike me as inherently wrong. Officers have a fiduciary responsibility to the stockholders of the company that they manage. If they believe that they can increase the value of a company’s stock, then they have a moral (and perhaps legal) obligation to take such actions on behalf of all the stockholders. Hard probing by regulatory authorities and/or Congress is justified in this area. Legislation severely limiting the percentage of equity that incumbent officers could own after an in-house, leveraged buyout would help.

An increase in fines and prison terms beyond those provided for by current law is not necessary. Additional fines in the many millions would have no significance in an environment of $100-million merger fees. Even six months in prison completely destroys a career.

Although “junk bond” financing may have been used to excess in some circumstances, the major abuse is not in the high interest rate that the investor receives, or in the credit rating. The danger is in possibly creating too high a debt-to-equity ratio and in creating high-cost fixed obligations for the corporation, thereby weakening its equity base. Nevertheless, I believe that legislation to restrict the use of such low-rated bonds is an unnecessary intrusion into our free-market economy and could create more problems than it would solve.

Requiring fully committed financing before beginning a takeover, as some senators are now proposing, is not the solution. With the close relationships between investment bankers and their takeover clients and the enormous amounts of capital available to publicly held investment banking houses, such a requirement could prove to be largely ineffective.

Some members of Congress have proposed a shortening of the holding period, from the current 10 days to two days, for reporting to the Securities and Exchange Commission when 5% of a company’s stock is acquired. This could be useful, but only in limited circumstances.

The investment banking industry apparently has not adequately monitored itself in all aspects of merger and acquisition activity in the past. Nor do I believe that the ferocious money-making drive and the adulation of “star” performers that pervade Wall Street will fully enable it to do so in the future. Tighter surveillance is in order.

Legislation only for the purpose of slowing corporate takeovers, as is being widely proposed, could adversely affect the vitality of our economy. We do not need to harm constructive merger activity in order to control current abuses in the merger process by the middlemen.