June 10, 2003

Becht and DeLong Oozes Under the Door

Marco Becht and I are writing a paper for a conference that is now a... frighteningly short number of days away.

On the other hand, we have some truly neat stuff. Here is a graph of our estimates of the the smallest number of the shareholders of Standard Oil (NJ) you need in order to have 50% of the vote at the annual meeting. It shows strikingly and remarkably the transformation from personal or family or financial capitalism early in the century to "managerial" capitalism--the situation in which ownership is so dispersed that it is very hard indeed to even think about how one would try to replace an entrenched, incumbent management--at mid century. The least number of shareholders needed for 50% control goes from 7 in 1912 to more than 650 by 1950.

So this makes me happy...

Posted by DeLong at June 10, 2003 03:04 PM | TrackBack

Comments

Well, one mechanism through which to hold corporate management accountable for their performance would be to re-open the market for corporate control by doing away with the all of the legal tricks that companies now use to insulate themselves from LBOs.

The rise of the LBO in the 1980s ushered in one of the most dynamic periods in the history of American corporate capitalism. Finally it was possible to oust bad managers by taking advantage of the first fruits of their bad management - a low stock price. Indeed, as the 1980s drew to a close, Michael Jensen of Harvard Business School was predicting that the LBO partnership would replace the chartered public corporation as the primary means of organizing American business.

Oh but Prof. Jensen didn't understand the power of corporate lobbying! Under the cover of a populist backlash against "corporate raiders," a backlash that was fed by demonstrably false claims that LBOs were causing millions of Americans to lose their jobs, the entrenched managements of American corporations were able to put in place legislation making it much more difficult, in many cases all but impossible, to mount a successful LBO of a large corporation. The American Left bought into this campaign hook line and sinker, thinking they were joining a nobel cause to protect American workers from greedy corporate pirates. In fact they were protecting greedy corporate insiders from any sense of accountability.

Posted by: sd on June 10, 2003 03:42 PM

There's a flipside to to your graph: the least number of companies that have to go bankrupt before a Rockefeller is poor. It''s gone from one in 1912 to hundreds today. Diversification. And it measures the degree to which wealth has become entrenched. And entrenched wealth is no longer at risk from economic downturns. Cut its taxes and it doesn't care what happens to the economy.

This makes me unhappy.

Posted by: jam on June 10, 2003 04:23 PM

So jam, are you saying that you would feel happier in a world where more people could go bankrupt more easily?

Posted by: achilles on June 10, 2003 04:39 PM

The general question, of course, is "to whom do these corporations belong?"

too often, we have overpaid (at least in retrospect) officers, hired by interconnected boards who screw up. Absent true fraud (and sometimes not) they file Chapter 11 the results of which is that directors and officers are often paid bonuses to stay on and repair the damage they did, while shareholders end up with nothing, unsecured creditors end up with little, employees are either fired or suffer reduced compensation and may lose previously earned benefits.

there ought to be a penalty to those who done bad, and there is none. The Bankruptcy laws ought to be changed to get rid of the exclusive reorganization plan rights of the debtor in possession, directors and officers ought to be presumed to be gone after no more than 90 days, unless a trustee persuades the Bankruptcy Judge that circumstances are such they should stay, the presumption being overcome.

This won't help the poor sharholders who are frozen out, but it will stop the directors and officers from opting for what may be an easy fix.
There ought to be consequences for those who make the decisions.

Posted by: Barry on June 10, 2003 05:21 PM

The general question, of course, is "to whom do these corporations belong?"

too often, we have overpaid (at least in retrospect) officers, hired by interconnected boards who screw up. Absent true fraud (and sometimes not) they file Chapter 11 the results of which is that directors and officers are often paid bonuses to stay on and repair the damage they did, while shareholders end up with nothing, unsecured creditors end up with little, employees are either fired or suffer reduced compensation and may lose previously earned benefits.

there ought to be a penalty to those who done bad, and there is none. The Bankruptcy laws ought to be changed to get rid of the exclusive reorganization plan rights of the debtor in possession, directors and officers ought to be presumed to be gone after no more than 90 days, unless a trustee persuades the Bankruptcy Judge that circumstances are such they should stay, the presumption being overcome.

This won't help the poor sharholders who are frozen out, but it will stop the directors and officers from opting for what may be an easy fix.
There ought to be consequences for those who make the decisions.

Posted by: Barry on June 10, 2003 05:23 PM

from achilles :
>The general question, of course, is
>"to whom do these corporations belong?"


or: "alienated management"

ha

Posted by: bianco on June 10, 2003 07:34 PM

>from achilles :
>The general question, of course, is
>"to whom do these corporations belong?"

Uh Bianco, if you are going to make pithy rejoinders, at least take a second and direct them at the right person.

Posted by: achilles on June 10, 2003 08:14 PM

I had never thought about this before, but I do see the point. It's interesting to note that many (very) large newer firms probably now have 50% of voting shares distributed among a fairly small number of people once again: Microsoft, Oracle and Walmart come to mind. For that matter, I think large institutional investors can now exert a kind of power that was unknown in the time of Rockefeller. And one more thing: is the 50% number the one you want to use, or should that be 51% of the number of shares that actually get voted? I'll bet the voting rates are lower now than at some points in history.

Posted by: Jonathan King on June 10, 2003 08:52 PM

Does anyone know what the average covariance of most stocks with the stock market was during this time period? I'd like to see the correlation between ownership dispersal and average covariance.

Anyone have information on this? I'm sure that someone else has looked at this carefully, but I haven't heard of the specific theory, model, or evidence.

Posted by: Julian Elson on June 10, 2003 09:04 PM

Given that the Rockefellers were fairly fecund and
that the period is about three generations, you get
a fair way to 650 from 6.

Posted by: Joshua Halpern on June 10, 2003 09:07 PM

Brad,

Isn't there just an element of time here -- the longer a company exists the more its shareholding dilutes as people die, spread the risk etc?

Do you think it holds true for the stock market as a whole?

James

Posted by: James on June 11, 2003 04:25 AM

Achilles,

I'm sorry. I wasn't clear. I wasn't addressing personal bankruptcy. I was addressing corporate failure.

As it happens, I do think that it's better for society that people who groan under a load of debt should have the means of getting free from it through bankruptcy and that current and proposed bankruptcy laws in the US are somewhat too restrictive. So the answer to your question is yes.

But that has little to do with the subject at hand which is the divorce between riches and corporate control. On the one hand, Brad likes the continuity of management that it enables; on the other, I dislike that it entrenches wealth. If it is harder for people to move down the social scale, then it becomes harder for people to move up it. There's clear evidence of lowered social mobility in the recent US. If the rich feel invulnerable, they may adopt more extreme political positions, which they may have the leverage to impose.

The Rockefellers, of course, are something of an outlier. But it's worth ppointing out that their relative invulnerability was noted as early as 1929. During the second week of the crash, John D. had made an "encouraging statement:"

Believing that fundamental conditions of the country are sound . . . my son and I have for some days been purchasing sound common stocks.

To which Eddie Cantor is said to have replied: "Sure, who else had any money left?"

Posted by: jam on June 11, 2003 04:59 AM

I do agree that people under debt should be able to get out of it and make a fresh start. I always thought that U.S. bankruptcy law was pretty good about that, too good in fact for some creditors who were trying to get legislation passed (but I am no expert).

As for your other point about families not moving up the ladder if others aren't moving down, well I am not sure I stand. I am in favor of estate taxes with generous exemptions so I guess I agree with you, but to me its not so much the rise up the ranks that matters as much as the rise in real income (in other words a 10% rise in real income with a 1% rise in the ranks I consider to be better than a 1% rise in income with a 10% rise in the ranks). One of the high points of the 1990s was that income increased across the board (less at the bottom than at the top) but increased nonetheless. I wonder sometimes, if we will see the same pattern in the next expansion.

Posted by: achilles on June 11, 2003 05:36 AM

sd I've always wondered how the US was so tolerant of poison pills, is this connected. Is this the answer?

Posted by: Jack on June 11, 2003 08:56 AM

Jack,

Poison Pills are indeed one of the most egregious examples of the legal tricks that corporations use to insulate themselves from LBOs.

The idea behind the "market for corporate control" is this: If a company's management does a good job, then the company's stock price will be high and it will be safe from corporate raiders, who would have to buy the company at high prices and thus wouldn't have any room to later sell the company for a big capital gains profit. But if a company's management does a bad job, the stock price will fall and corporate raiders will move in, taking advantage of the low stock price to buy the company on the cheap and then install a new management team (or, in some cases, keep the old management team but re-structure their compensation plan so that they stand to make tons of money if the company's stock does well). The new management (or the now properly incentivized old management) will then presumably do a better job and thus the stock price will climb, allowing the corporate raider to make a handsome profit. Typically these takeover bids are financed with a lot of debt*, thus the term LBO - Leveraged Buy Out.

But Poison Pills get in the way of this by making it very costly to mount takeover bids.

Basically, Poison Pills are provision of the corporate charter that say that if an outsider acquires more than x% of the company's stock, then current shareholders will have the option of buying more stock at discount prices. This dilutes the company, making the outsider's initial stake in the company (that triggered the poison pill) much less valuable. Thus LBO funds will only mount a takeover bid on a company with posion pill provisions if then under-perfromance of the company's stock is truly extraordinary.

Poison Pills hurt stockholders because they neutralize one of the most important tools that the markets use to dsicipline bad managers - the threat of a hostile takeover.

SD

* The use of debt in LBO transactions is more than a matter of convenience, its actually critical to the logic of these deals. The LBO fund uses debt to buy a controlling interest in the company, then essentially transfers the debt burden to the company itself (swapping debt for equity). This leaves us with a company with a much smaller equity base, and a lot of debt. The LBO fund then gives the new management team a significant share of the remaining equity. So the situation facing management is this: If we are profitable, we can pay off the massive debt in 3-5 years, then we will end up owning a huge stake in a very valuable company and we'll get fabulously rich (and the common shareholders will see their own stock appreciate significantly as well). If we are not profitable, we won't be able to make the debt payments and the company will enter bankruptcy, we'll lose our jobs and our equity will be worthless. Kind of focuses the mind.

Posted by: sd on June 11, 2003 09:24 AM

Is this just occurring to macro-economists? Why rehash Berle & Means (1933) now?

Posted by: cw on June 11, 2003 09:40 AM

sd,

I couldn't agree more with your short treatise on LBO's. What it proves is that entrenched American corporations are against capitalism.

achilles,

To answer your question of whether I'd prefer more people to go bankrupt more easily. Yes, I would. Shouldn't the goal be fluid class movement within a generation or so? Where true talent and ability are rewarded as opposed to entrenched wealth and a "who do you know" system.

Posted by: Double B on June 11, 2003 12:45 PM

Double B, what's the link between "a system where true talent and ability are rewarded" and a system where more people go bankrupt easily. There are many countries, Zimbabwe being the best example at the moment where going bankrupt can be accomplished very easily, in far less time than a generation. Doesn't seem to quite be what we should strive for, nor does it seem to be a system where true talent and ability are rewarded.

So perhaps the goal should be "a system where true talent and ability are rewarded" instead of "a system where people can go bankrupt more easily"?

Posted by: achilles on June 11, 2003 02:04 PM

7 to 650? Diversification or estate-tax induced sales? If it’s the latter, I’m afraid the current regime could be setting us up for a restoration of “American Royalty” not seen since Rockefeller, Carnegie, and Vanderbilt.

Posted by: wallster on June 13, 2003 06:30 AM
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