- Courtesy of the Library of Congress, Photographs in the Carol M. Highsmith Archive
In a 1987 speech, SEC Commissioner Charles Cox noted an unlikely phenomenon: corporate governance was a hot topic, not just on Wall Street and before the Bar, but on Main Street and in the bar rooms. “In times past, this subject had all the glitter of the Delaware Court of Chancery.” Where scandals and ivory tower debates had failed to kindle much interest, “Boone Pickens and billions of dollars” had succeeded.23
Hostile takeovers conducted by corporate raiders captured the public imagination in the 1980s, and along with the rise of institutional investors and reforms promulgated by the SEC, gave new emphasis to the shareholder voice in the operations of a corporation.
The mergers of the 1960s had produced sizeable but not necessarily efficient, corporations. These survived for a time as the Williams Act put a temporary damper on takeovers. But by federally regulating them, the 1968 legislation helped give legitimacy to takeovers. By the late 1970s, takeovers were again in favor as enterprising investors began buying up and dismantling the conglomerates, whose parts were often worth more than the whole.
From 1979 to 1988, the value of corporate acquisitions quintupled from $43 billion to $246 billion. To counter these offensives, a new breed of lawyers began specializing in takeover defenses. The constant takeover threat created a generation of managers obsessed with corporate and personal self-preservation. Because hostile takeovers inevitably followed when shares were undervalued, they put a premium on maintaining a high share price. 24
The takeover wave seemed to settle an old debate. Company leaders no longer enjoyed the option of managing with the long view in mind; they were encouraged to maximize short-term share value. The dictates of necessity got an intellectual boost from a revolution in legal thought. Since the 1960s, law and economics adherents to the “efficient market hypothesis” had insisted that free markets be allowed to regulate themselves. They argued that market activity would oblige managers to make decisions in the best interests of shareholders. The corollary was that shareholders should not hesitate to sell if they were unhappy with management performance.
Law and economics thinkers also rejected notions of corporations having multiple constituencies, including employees, communities, and the general public. They held that management’s sole responsibility was to the shareholders, and to maximize their investments.25 This effectively removed corporate social responsibility from the governance debate and lent credibility to hostile takeover attempts, since they often disciplined management, created greater efficiencies, and boosted share values.26
Boards and managers had traditionally enjoyed a great deal of discretion to act as they saw fit under what was known as the “business judgment rule,” even if it meant rejecting takeover offers that boosted share value. Martin Lipton emerged as the strongest advocate for the discretion of directors with publication of his 1979 Takeover Bids in the Target’s Boardroom. Although state court decisions, notably the Delaware Supreme Court and Delaware Court of Chancery, generally sustained the business judgment rule, the inexorable logic of the efficient market hypothesis put pressure on managers to optimize short-term performance as the takeover imperative remained strong.
In resisting takeovers, managers and boards developed an array of anti-takeover devices. The golden parachute gave executives generous pay packages in the event that they were ousted. The exclusionary tender offer provided that management would buy back shares from all shareholders except the bidder in a takeover attempt. The poison pill was a special class of stock, which, in the event of a tender offer, had to be redeemed at an elevated cost. These measures gave management some breathing room, but they also frustrated shareholders, who correctly recognized that they foreclosed potential increases in share value. Management also sought a ban on abusive takeover practices, particularly frontloaded offers, which left acquired targets with large amounts of debt; and greenmail, in which raiders forced management to buy them out.
Tender offers, however, remained subject to state law. When corporate managers turned to the SEC, they encountered Chairman John Shad, who put a premium on capital formation and was tolerant of hostile tenders. But phenomenon was too big to ignore. In 1983, Shad convened an Advisory Committee on Tender Offers. While avoiding the question of whether hostile takeovers were inherently good or bad, the Advisory Committee sought both to reduce barriers to takeovers and to end abusive practices associated with them. It advocated restricting anti-takeover practices such as self-tender offers and golden parachutes, yet also proposed curbing common takeover tactics and increasing the disclosure required of bidders.
Congress considered the SEC’s proposals in 1984 but failed to act. Throughout the next decade, the SEC made occasional new proposals regarding tender offer disclosure, while dozens of anti-takeover bills failed in Congress. Although the SEC favored national legislation regulating takeovers, Congress left tender offers to Wall Street and the states until the recession of the late 1980s and early 1990s stalled the takeover boom. By then, the takeover wave had fundamentally refocused the governance debate to emphasize shareholder value. As it did, shareholders, newly organized, emerged as a powerful new voice in governance matters.27
(23) May 28, 1987 Contracts, Corporations and Corporate Governance – Remarks by SEC Commissioner Charles Cox to The SEC-Finance Committee of the Westchester-Fairfield Corporate Counsel Association, Inc.
(25) Important works include Ralph K. Winter, Jr., “State Law, Shareholder Protection, and the Theory of the Corporation” The Journal of Legal Studies (June 1977), and Frank Easterbrook and Daniel R. Fischel, The Economic Structure of Corporate Law (Cambridge, 1991).
(27) April 15, 1983 Report of Basic Objectives Subcommittee, SEC Advisory Committee on Tender Offers; March 4, 1988 Reply to U.S. Representative William F. Goodling from Mary Beach, SEC regarding letter from George Ladd.
(Made possible through the support of the George Mason University Law and Economics Center and Simon M. Lorne)
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