US capitalism: Are sharks or porcupine fish the danger?
HIDDEN among the ads on Page 35 of the Wall Street Journal last week was a brief, dry story with vast implications. A Delaware court, said the dispatch, had ruled in favor of Household International Corporation's strategy for defending its management against a hostile takeover. At least six other firms have adopted the same defense strategy. Many lawyers, the story added, believe the decision could be a landmark.
It could. The ruling is, in fact, likely to encourage wider use of the Household strategy. If so, what is meant as a protection against predators could also, ironically, become a landmark encouraging bad management. The US corporation is, alas, not immune to the same bureaucratic self-perpetuation that affects Washington agencies and Gosplan hierarchs in Moscow. The spirit of l'etat c'est moi lives on.
The corporate defense strategy in question is not unlike that of the porcupine fish, which when attacked puffs itself up to several times its normal size, thus becoming hard for predators to swallow. Household had adopted a program that gives its shareholders the right to buy additional preferred shares. In addition, the stockholders gain the right to buy shares of the acquiring company at discount prices if a merger is accomplished. The two steps add sharply to the cost of a takeover. That creates a hazard for the buying company's digestive system, just as the size and poisonous flesh of the porcupine fish does.
The investment trade has given this kind of takeover defense a different ichthyological label: shark repellent. That implies corporate managements need to be protected, like shipwreck victims, from the hammerheads and great whites of the financial world.
There's evidence for this view. The world has not run out of robber barons. Economists, business-school professors, and executives all point out that one of the major flaws in American capitalism today is the pressure that prevents top management from doing adequate long-term planning.
One of those pressures causing chief executives to look over their shoulders instead of into the future is the threat from takeover artists. That pressure is increased when institutional money managers (largely pension-fund managers) want to see increased earnings and profits each quarter even if that runs counter to long-term research and growth needs. Those institutional stockholders now hold about two-thirds of all shares of New York Stock Exchange companies. They are apt to back a takeover bid because it usually promises a sharp increase in the market price of shares.
The trouble with this picture of CEOs beset by sharks is that it isn't always accurate. Good management is usually adequate shark repellent. Often a takeover attempt occurs precisely because poor leadership has led the market to undervalue a firm's assets.
So the porcupine fish remedy may turn out to be as bad as the danger it seeks to prevent. It may rescue good managers from wasting time keeping predators out of the board room. But it also provides a convenient shield for complacent and inefficient managements.
Martin Lipton, the shrewd, thoughtful lawyer who designed the Household International shark repellent, argues that any such misuse would be self-correcting. When I raised the possibility of bad management using his creation to retain power, he asserted that stockholders would still be able to vote out such managers.
But that rarely happens in the real world. Stockholders, institutional or individual, more often sell and go elsewhere instead of mounting a fight against an entrenched management.
Mr. Lipton also expresses concern about the power of institutional stockholders. He asserts that there is ``hardly any major company [where] control is not in the hands of pension-fund managers.'' He calls attention to the newly formed Council of Institutional Investors, whose co-chairman is Jesse Unruh, an old Ronald Reagan California political opponent.
The council, which held its first meeting Jan. 24, represents organizations with assets totaling $100 billion -- a potent new lobbying force, since it represents both corporate and union interests.
The long-held American dream of ``people's capitalism'' -- with more Americans each year owning ``shares in America'' and voting democratically on corporate leaders' plans -- has long since shifted toward collective institutional ownership. But the managers of those institutions are charged with being prudent on behalf of the pensioners and mutual fund holders they represent.
The question then becomes: What is prudent? What management is best management?
Fortunately, these important but often overlooked questions about the fairness and efficiency of American capitalism are about to be examined once again by elected lawmakers. A House budget subcommittee chaired by Rep. Timothy Wirth (D) of Colorado has scheduled a trip to New York City on Feb. 11-12 to hear from leaders on both sides of the shark-repellent issue, and other controversies involving corporate leadership. The subcommittee will then begin a series of hearings in Washington Feb. 27.
There's always a danger of too much regulation of business. But in this case, some referee is needed to keep the game between sharks and porcupine fish fair. Otherwise, American competitiveness and growth will be the loser.
Earl W. Foell is editor in chief of The Christian Science Monitor.