The Free Market 7, no. 6 (June 1989)
The broadly held corporation was one of the most important developments of the 19th century. The capital of thousands and then millions of stockholders made possible the profitable development of large firms, which enriched not only their owners, but society as a whole.
The railroads were the first to develop this mass-based ownership. They were also the first to develop the unfortunate management-government collaboration that has done so much to harm customers and stockholders.
Railroad lawyers lobbied for, and then staffed, the Interstate Commerce Commission, the first federal regulatory agency. The ICC—which Congressional propaganda said would protect farmers and other shippers from high prices—as its first act outlawed price competition.
This devil’s pact led to the long decline and eventual bankruptcy of many railroads, but the managers, politicians, and bureaucrats of the day benefited, and they took a Keynesian view of the long haul.
“A successful corporation is ultimately never controlled by hired managers,” observed Ludwig von Mises in 1946. Instead, the “conduct of business” should be “exercised by the stockholder.”
Compelling the managers of big corporations to abide by this principle has been much harder in the 20th century than in the 19th. Too often leaders of big business have lobbied for anti-competitive laws and regulations, as well as outright subsidies and privileges. They have also sought to keep stock-holders from exercising their will over management. The consequences have been relative economic stagnation and the growth of corporate bureaucracy, as well as a transfer of wealth from stockholders to managers, who are able to enhance their power and income.
In 1957, C. Wright Mills, in The Power Elite, said that “over the last half a century, in the economy as in the political order, there has been a remarkable continuity of interest, vested in the types of higher economic men who guard and advance them.” They have worked for “a continuation of a world that is quite congenial to the continuation of the corporate rich. For in this stratum are now anchored the ultimate power” and it rests upon “managerial control.”
Mills was a leftist, but his power-elite analysis was correct. Especially during the latter half of this century, a managerial elite has dominated the corporate world (and much of U.S. government policy), often to the detriment of entrepreneurs, customers, and stockholders.
Ludwig von Mises also saw the problem of a managerial elite and understood its source: “the emergence of an omnipotent managerial class is not a phenomenon of the unhampered market economy. It [is], on the contrary, an outgrowth of the interventionist policies consciously aiming at an elimination of the influence of the shareholders and their virtual expropriation.” This is, he said, the “preliminary step on the way toward the substitution of government control of business for free enterprise.”
Only unhampered competition can check the power of a managerial elite. In a free market, if the managers are not running a company at its potential, the stockholders—as the owners of the company—have the right to fire them and hire new ones.
In a free society, then, there is a market for corporate control. In this market, even top managers face constant competition for their positions. Any entrepreneur who thinks he sees a profit opportunity is always able to make a tender offer to buy enough shares to replace incumbent management, and reform the company. Even the threat of such a move is often enough to change the way a company is run. To successfully compete in a free market for corporate control, management must seek to do everything possible to enhance stock values, and dividends to the owners.
Today, those who make tender offers against the wishes of entrenched hired managers are scorned as “raiders” and “pirates.” Yet they serve an extraordinarily important entrepreneurial function. By seeking out undervalued stocks and bringing them, and their companies, to full market potential, they root out waste and bureaucracy and create value.
Government intervention, however, has hampered such a market in the United States. When a free market in corporate control threatened politically powerful corporate elites in the mid-sixties, they lobbied for legislation to hamstring the market. The result was the Williams Act, which forced anyone who bought 5% of a company’s stock to stop and announce his takeover plans. This, as intended, increases the price of the stock, makes the takeover more difficult, and allows management to develop stockholder-financed defensive strategies to keep stockholders from profiting from their holdings.
For more than a decade, the managements of blue-chip companies had virtually no challenge to their positions, and the result was American decline. In the eighties, however, the market found a way around this intervention: the high-yield bond pioneered by entrepreneur Michael R. Milken. The establishment called these securities “junk bonds.” But that title is no more apt than calling more speculative equities from new companies “junk stocks.” In fact, the real problem with these
bonds is that they allow the “raidet” to raise enough money—without going through the big banks which cooperate closely with elite managements and the government—to make a successful tender offer.
Also essential to this process have been the “arbs”—the arbitrageurs who seek to make money by speculating on the difference between the price of a stock at the time of a tender offer and the final price. -They guarantee a specific number of shares at a certain time and price, and so fulfill the key entrepreneurial function of risk-bearing.
But to function effectively, the arbs need all the information possible. That’s where the non-crime of “insider trading”—investing on the basis of non-public information— comes in. As long as the information is honestly acquired, there is nothing wrong with inside information. In fact, all successful investing is based on non-public data. Warren Buffet doesn’t release his private analyses. Only because of the Williams Act is there such a high premium on this specific information, however. As entrepreneur-professor Jim Rogers of the Columbia Business School says, “most of the problems with so-called insider trading result from too much government regulation.”
So extreme are the regulations that you could be sitting at a restaurant in New York’s financial district, overhear a conversation about a planned takeover, buy stock as a result, have the stock go up when the takeover is announced, and be convicted of the felony of insider trading. Such a law makes neither economic nor moral sense.
Insider trading had been a regulatory crime, but to further hamper takeovers, the government made it a legislated crime in the Insider Trader Sanctions Act of 1984. But the Reagan administration and Congress refused to define the crime, supposedly because “raiders” and “arbs” might find technical loopholes. In fact, the feds didn’t want to define the law because the right people might then not break it. Authoritarian governments always seek to enact vague laws, which give leeway to the enforcers. Citizens can never be sure where they stand, and special interests can easily bend the vagueness to their advantage.
Not satisfied with all this intervention, people in the Bush administration, Congressmen like Dan Rostenkowski (D-IL) and Jim Wright (D-TX), neo-conservative intellectuals like Irving Kristol, and Wall Street establishment figures like Felix Rohatyn are pushing legislation to effectively abolish stock-holder rights. These proposals would limit the deductibility of interest on - takeover debt; place new restrictions on tender offers; require SEC bureaucrats to approve all deals before they take place; -and impose huge taxes on profits derived from the -sale of stock held less than a year.
Rostenkowski and Wright claim they’re worried about corporate debt, as they help increase the national debt by a quarter trillion every year. As usual, they aren’t telling the truth. Congress, the administration, the SEC, and the special interests want to entrench the “omnipotent managerial class” Mises warned about at the expense of middle-class stockholders.
There are, of course, risks with corporate debt, although the dangers have been exaggerated by anti-takeover forces for political purposes. But those who worry should remember that in a free market, takeovers would be cheaper and less risky.
Republican Keynesian Ben Stein recently attacked Michael Milken in Barron’s as a “betrayer of capitalism” because he “undermined trust... between stockholders and management.” But the issue is not “trust.” It is property rights. The stockholders are the owners of the company and should have the right to work their will on management. Only under state capitalism are stockholders called upon to blindly trust management.
In the last 10 years, a freer market for corporate control has changed corporate America for the better. So naturally, the U.S. government is trying to impede it. If the feds are successful, we will pay the price in our country’s deteriorating economic health. age
