It is a truism that the duty of a corporation’s directors is to maximize shareholder value. However, different directors and corporations and, yes, takeover artists and “turnaround specialists” define that duty in different ways. To offer an example that is simple bordering on crude, does that mean maximize next quarter’s dividend, or does that mean maximize earnings over the long haul while remaining financially healthy and competitive? Because, although they need not, these two definitions often clash.
And because they do, “turnaround specialist” can be someone who actually does return a troubled company to financial health — or someone who wrecks a company’s long-term stability for the sake of short-term profit, which may or may not actually go to shareholders, or to all shareholders in proportion to their holdings.
Guest poster Bernard Finel at Balloon Juice explains:
“Troubled” companies have a particular meaning on Wall Street. Sure, sometimes they refer to companies that are just muddled, have over-expanded, and are badly managed. But more often, what they are talking about is companies that do not seem to providing a large enough return to shareholders—a stagnating stock price in particular. But that does not mean a company is “troubled.” It can be quite profitable, have productive and loyal employees, have satisfied customers, and cash on hand.
What players like Bain do is enforce a Wall Street preference. There is a bias against companies that seek a “quiet life.” They are shunned by institutional investors, which depresses stock prices and makes these companies “troubled” in the first place. It isn’t that they are not profitable, but rather than institutional investors don’t like them, and as a result they trade at dramatically lower P/E ratios. Indeed, it isn’t even clear that takeover targets do have weaker stock performance if you lookat total returns, including dividends.
Once a company goes public, it is essentially subject to “disciplinary” takeovers if it fails to act in accordance with financial sector preferences. This is often phrased as “poorly performing managers,” but what does that really mean? That is really just about enforcing a certain conventional wisdom about what a company ought to do. But these preferences are socially problematic. Consider some of the things that seem to contribute to being a takeover target: slow growth, stable revenues, cash on hand rather than debt, generous employee compensation, conservatively-funded pension or insurance plans. (Again caveats abound. There is no simply model of predicting takeover targets.)
So, in a sense, Bain, and other buyout specialists, serve to enforce a particular type of corporate behavior that focus on expansion at the expense of predictability, risk acceptance in terms of contractual obligations to employees, and a ruthless focus on cost controls at the expense of employee loyalty and stability.
As a practical matter, it is not clear that this sort of approach is conducive to more rapid economic growth. Certainly the rise of this consensus and expansion of “disciplinary” takeovers since the 1980s has not resulted in any noticeable improvement in U.S. macroeconomic performance. And furthermore, the evidence on whether takeover targets overperform or underperform after being bought is mixed.
But what has happened is that as firms accept these practices, they become more dependent on the financial sector. They borrow more, become more active in raising money through equity sales, they run leaner by hedging through derivatives, and so on. In each case, they pay a cut to financial firms. The result has been that the financial sector’s share of corporate profits has risen dramaticallysince the 1980s.
Some of these companies will now be more successful, but many that move toward debt-fueled expansion will crash and burn. The financial sector wins either way. But it isn’t clear to me that corporate America in general win, and certainly workers whose pensions gets looted, and unions busted, and ride the boom and bust cycles of overtime and layoff do quite poorly.
I’m sure this is something of a problem with privately held companies as well. But the publicly traded ones are out there where everyone can see them. The example with which I’m most familiar is the newspaper industry. During the latter half of the 20th century, most privately held U.S. papers were bought by publicly traded chains (e.g., Gannett, Knight Ridder, Media General, Tribune, etc.). The cash from selling stock was useful for expansion, but it was a devil’s bargain: With it came short-term bottom line pressure. Perhaps the best example was Eugene Roberts, who took over as executive editor of Knight Ridder’s money-losing Philadelphia Inquirer in 1972 and led it to both profitability and excellence in local, national and global journalism, including 17 Pulitzer Prizes in 18 years. Roberts was forced out in 1990 for resisting budget cuts. At the time, the paper’s profit margin was around 8 percent — low for newspapers in that local-monopoly, pre-Internet era but a margin a lot of businesses would kill for, then and now.
I am not going to argue, particularly in light of Knight Ridder’s ultimate fate, that the Inquirer would be healthier today with Roberts at the helm. But I will argue that the biggest flaw in this scenario is not Roberts or the Inquirer or Knight Ridder management or even the whole newspaper industry’s lethal slowness to understand what the Internet was going to do to it. No, the biggest flaw, one merely illustrated by Romney’s exploits at Bain Capital, is that our current ethos of governance for publicly traded companies in any industry doesn’t just make it somewhere between difficult and impossible for even creative companies to survive long-term (which the odds are against in any business regardless of governance). In fact, that ethos, in many cases, is functionally indistinguishable from putting a loaded gun to your head and pulling the trigger. People call it “vulture capitalism,” but that’s an insult to vultures, which typically neither attack healthy animals nor redefine “healthy” to justify their predatory scavenging.
UPDATE: Just today, economist Dean Baker makes a related and very important point: Running a private-equity firm is much more about profiting from tax dodges than it is about making companies more efficient.