May 16, 2012

But the Japanese are able to carry such high levels of debt because when they get into financial difficulties the government bails them out.


From Connie Bruck's 1989 book The Predators' Ball: The Inside Story of Drexel Burnham and the Rise of the JunkBond Raiders:

In their 1985 annual report, the President's Council of Economic Advisers had weighed in with its conclusions, surprising only in their ambitiousness. They purported to settle once and for all the decades-long debate over whether takeovers are beneficial or harmful. This august council concluded that mergers and acquisitions "improve efficiency, transfer scarce resources to higher value users, and stimulate effective corporate management." The conclusion was remarkably definitive but, apparently, more polemical than proven. In some of the more interesting testimony that emerged from the congressional hearings on takeovers, F.M. Scherer, a Swarthmore College economics professor, had rebutted the Council's findings. In his testimony in March 1985 he pointed out that the report's conclusion that takeovers improve efficiency relied on stock market event studies, which are short-run in orientation (examining stock prices during periods ten to thirty days before and after the announcement or consummation of the merger). If one looks at a period of ten years or so, Professor Scherer testified, the results are very different.

Scherer has developed the premier data base in this country for looking at the financial consequences of merger. This data base draws upon twenty-seven years of merger history and seven years of sell-off history for nearly four thousand individual businesses.

These are some of Scherer's findings, from his case studies and statistical research:

- Contrary to the Council's view that merger-makers sought companies where management had failed, most in fact targeted well-managed entities. What they were generally attracted by was not sick companies or slipshod management but undervalued assets.

- Takeovers by firms with no managerial expertise in the acquired company's line of business tended to impair, not improve, efficiency.

- Takeovers frequently led to short-run profit-maximizing strategies, such as the "cash cow" strategy under which "a business is starved of R & D, equipment modernization, and advertising funds, and/or prices are set at high levels inviting competitor inroads, leading in the end a depleted, non-competitive shell."

- On average, acquisitions were less profitable for the acquiring firms than the maintenance of existing businesses and the internal development of new business lines.

- Many of the takeovers led to selloffs, which did improve the efficiency of the simpler, self-standing entity.

- While Scherer had relatively few hostile takeovers in his sampling, in those he did study he found that the takeover aggravated performance deficiencies that existed earlier.

In response to questions from panel members, Scherer also made and interesting point about the high-leverage, or debt-intensive, capital structures of many U.S. companies, which are coming to resemble Japanese companies' financial structures. Indeed, in the gospel according to Milken which is spread by so many of his acolytes, it is often noted that Japanese companies have for years carried much higher debt-to-equity ratios than American companies. True enough, Scherer commented, but the Japanese are able to carry such high levels of debt because when they get into financial difficulties the government bails them out.


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