Introduction to Economics                                                     Lesson of September 2006



Coles Myer, one of Australia’s biggest companies, has been subjected to a takeover offer by an international consortium, led by leading New York investment bankers, Kohlberg Kravis Roberts & Company [“KKR”].  KKR has been behind a number of major corporate takeovers in recent times, including, in 1989, the then biggest corporate takeover in history, that of the food and tobacco company R J R Nabisco, for US $ 24.7 billion. 

Subject to conditions, the offer is $14.50 per share for what was recently valued by the market at $10.60.  In approximate gross terms this amounts to an offer of $17.5 billion as opposed to a market valuation of $13 billion.  Based on the cost of raising the necessary funds and other expenses and the anticipated return it aspires to earn, it would appear that the consortium would expect a share price of $22 in 3 years.  The offer has raised yet again questions as to the desirability or otherwise of market corporate takeovers. 



In 1932, two Americans, Adolph Berle and Gardiner Means published a very influential book “ The Modern Corporation and Private Property”.  In it they propounded what became known as the Berle-Means thesis; large major corporations were no longer controlled by their owners, the shareholders, since typically shareholdings were too diffuse and small for any one shareholder or group of shareholders to do so.  Rather large modern corporations were controlled, and largely run for the benefit of the executives and managers, who did not necessarily seek to maximise the returns to shareholders, but rather to themselves.  It was seen as a situation of strong managers and weak owners.  More importantly it threw into question the neo-classical economic theory of the superior efficiency of private property.

Partly in reliance on the Berle-Means thesis, socialist economists such as J K Galbraith suggested that the role of major corporations was not to serve for the benefit of the shareholders but rather for the benefit of the public generally.  In effect it was a justification for a Clayton’s nationalization, to be effected by regulation and taxation. If the technocratic managers were not running the business for the shareholders, but rather for themselves, then Galbraith thought it was better that they should be required to run it for the benefit of the public instead.

In 1965, Henry Manne, an American law professor, pointed out in a seminal article, “Mergers and the Market for Corporate Control”, that the seeming unrestricted power of executives and managers was in fact controlled by the stock market; if management did not perform well, the price of the relevant share would fall, making it easier and more attractive for a merger or takeover to occur and for the management to be replaced.

If an existing corporation wishes to expand it can do so by creating and producing new productive assets.  Alternatively it can determine that it can do so more cheaply or more profitably by purchasing already existing assets.  This is particularly so if the existing assets are not being well managed or utilised to their best advantage.  A functional and efficient stock exchange enables this to occur.  The tendency is thus for assets constantly to be moved towards their highest valued uses.  Ultimately this is of benefit to society generally.

Established management and corporate structures tend to dislike smooth flowing takeover processes since it places them under constant pressure to perform.  They criticise much takeover activity as mere paper shuffling or managerial empire building, often at the expense of workers and established environments, and they seek to restrict takeovers by government controls and judicial interference.

In the 1980’s, takeover activity worldwide increased significantly.  It coincided with a number of financing innovations.  Previously takeovers had tended to involve proxy fights with the disputing parties seeking to garner the support of a sufficient number of existing shareholders.  The 1980’s saw the introduction of the leveraged buy-out.  In America, takeover specialists like Michael Milken and Ivan Boesky caused huge sums to be raised to buy out existing shareholders.  Typically this was done by issuing high yield bonds, dubbed junk bonds by critics of the process.  It is said that at his peak in 1987 Milken was earning US $ 550 million commission per year.

The increase in merger and takeover activity associated with the 1980’s resulted in considerable criticism, much of it severe.  It was dubbed the “Decade of Greed” and led to one of cinema’s defining scenes in Oliver Stone’s film “Wall Street”, when Gordon Gecko, played by Michael Douglas, declares that ‘greed is good’.  It also tended to create a coalition of powerful opponents such as the existing executive elites, some of the more powerful unions, whose own practices were threatened by corporate changes, and the banks and established bond traders, whose dominant intermediary role in the provision of finance was challenged by the direct floating of high risk, high return, so-called ‘junk’ bonds on the market.

A number of best selling books appeared commenting on the era including “Barbarians at the Gates” by Burrough and Helyar [dealing particularly with the RJR Nabisco takeover], and Stewart’s “Den of Thieves”.  Colourful phrases such as ‘corporate raider’ and ‘hostile takeover’ entered the language. It is interesting to note that a number of recent Australian newspaper reports referring to the takeover offer for Coles Myer have resurrected the use of the word ‘barbarians’.  In the upshot it ended rather badly with Milken and Boesky both going to jail.

Takeovers and mergers remain a controversial subject.  Milken and Boesky continue to have their supporters, who see them as more sinned upon than sinners.  The particular viewpoint tends to depend on the outlook of those concerned, with the market orientated and the Liberal on the one hand and the conservative and Socialist on the other.  Perhaps more importantly, as the Coles Myer situation demonstrates, takeovers and mergers, although perhaps more restricted than previously, continue to play a major part in Western economies generally.



As usual, the Coles Myer takeover is likely to generate a considerable amount of nonsense, typically from vested interests.  If it makes economic sense, and it seems to, it is likely to go ahead, if not for $14.50 per share then perhaps at $16-17.  If rearranging the assets increases the returns, and some very experienced people are betting a lot of their money that it will, then overall it is likely to benefit the community generally; more profits, more employment, more opportunity, more taxes paid to government and more prosperity.  



                                                     David Sharp

                                                         September 2006






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