Michael C. Jensen
EDSEL BRYANT FORD PROFESSOR OFBUSINESS ADMINISTRATION,HARVARD BUSINESS SCHOOL
BEFORE THE HOUSE WAYS AND MEANS COMMITTEEFebruary 1, 1989
The corporate sector of the U.S. economy hasbeen experiencing major change, and the rate of change continues as we head into the last year of the 198Os. Over the past two decades the corporatecontrol market has generated considerable contro- versy, first with the merger and acquisition move-ment of the 196Os, then with the hostile tenderoffers of the 197Os and, most recently, with theleveraged buyouts and leveraged restructurings of the 198Os. The controversy has been renewed withthe recent $25 billion KKR leveraged buyout of RJR-Nabisco, a transaction almost double the size of thelargest previous acquisition to date, the $13.2 billionChevron purchase of Gulf Oil in 1985.These control transactions are the most visibleaspect of a much larger phenomenon that is not yet well understood. Though controversy surroundsthem, and despite the fact that they are not allproductive, these transactions are the manifestationof powerful underlying economic forces that, on the whole, are productive for the economy. Thoroughunderstanding is made difficult by the fact thatchange, as always, is threatening-and in this case thethreats disturb many powerful interests.One popular hypothesis offered for the currentactivity is that Wall Street is engineering transactionsto buy and sell fine old firms out of pure greed. Thenotion is that these transactions reduce productivity,but generate high fees for investment bankers andlawyers. The facts do not support this hypothesiseven though mergers and acquisitions professionalsundoubtedly prefer more deals to less, and thussometimes encourage deals (like diversifyingacquisitions) that are not productive.There has been much study of corporate controlactivity, and although the results are not uniform, theevidence indicates control transactions generate value for shareholders. The evidence also suggeststhat this value comes from real increases in produc-tivity rather than from simple wealth transfers toshareholders from other parties such as creditors,labor, government, customers or suppliers.
I have analyzed the causes and consequences of takeover activity in the U.S. elsewhere.
My purposehere is to outline an explanation of the fundamentalunderlying cause of this activity that has to date re-ceived no attention. I propose to show how currentcorporate control activity is part of a larger develop-
“Active Investors, LBOs, and the Privatization of Bankruptcy*”
Seigel (1987, 1989) analyze Census data on 18,000 plants and 33,000 auxiliary establishments in the U.S. manufacturing sector in the period 1972-81 and find thatchanges in ownership significantly increase productivity and reduce administrativeoverhead. See F. Lichtenberg and D. Seigel, “Productivity and Changes of Ownershipin Manufacturing Plants,” Brookings Papers on Economic Activity, 1987, and “TheEffect of Takeovers on the Employment and Wages of Central Office and OtherPersonnel,” unpublished manuscript, Columbia University, 1989.2. See Michael C. Jensen, “The Agency Costs of Free Cash Flow: CorporateFinance and Takeovers,”
American Economic Review
, Vol. 76 No. 2 (May, 1986); seealso my articles “The Takeover Controversy: Analysis and Evidence,”
Midland Corporate Finance Journal
, Vol. 4 No. 2 (Summer, 1986), pp.6-32, and “Takeovers:Their Causes and Consequences,” Journal of Economic Perspectives, Vol. 1, No. 1(Winter, 1988), pp. 21-48.
AND CORPORATE DEBT
Selections from the Senate and House Hearings on
*This is part of an ongoing research effort that includes Clifford Holderness, Jay Light, Dennis Sheehan, and John Pound. General research support has been receivedfrom the Harvard Business School Division of Research and a grant has been awardedby Drexel Burnham Lambert to the University of Rochester.For the argument that takeover gains to shareholders come from wealthredistribution from other parties, see Andrei Shleifer and Lawrence Summers,“Breach of Trust in Hostile Takeovers,” in
Corporate Takeovers: Causes and Conse- quences
, Alan Auerbach, ed. (University of Chicago Press, 1988). However, noevidence has yet been produced that supports this argument. For surveys of theevidence on the effects of control-related transactions, see Michael C. Jensen andRichard Ruback, “The Market for Corporate Control: The Scientific Evidence,”
Journal of Financial Economics
11 (1983) and Greg Jarrell, James Brickley, and Jeffrey Netter, “The Market for Corporate Control: The Empirical Evidence Since1980,” Journal of Economic Perspectives, (Winter, 1988), pp. 49-68. Lichtenberg and