Posted on 10/04/2002 6:33:37 PM PDT by TheMole
How did executives obtain such drastically increased compensation over the last 10 years? Why did boards allow it?
The answer lies in regulatory and court decisions that have impeded hostile takeovers over the last 12 years. These decisions took away one layer -- a most important one -- from the checks and balances controlling boards' and CEOs' behaviour. The elimination of this layer and its unintended consequences were, in themselves, unintended effects of events in previous years, especially some taking place between 1982 and 1992.
Following the Williams Act passed by U.S. Congress in 1968, American states passed so-called "first generation" anti-takeover statutes. By 1979, every state had them. In Illinois, for example, the statute prohibited acquisition of any firm with significant assets in the state -- unless officials approved. Then in 1982, the U.S. Supreme Court struck down this Illinois law, as well as other anti-takeover statutes. Over the next decade, takeovers restructured U.S. companies representing 50% of the corporate sector's market value, significantly increasing the market valuations of U.S. companies.
But the courts cannot easily defeat politicians and regulators. The states passed new statutes blocking takeovers -- this time focusing on corporate law, a state prerogative, rather than regulations, which could be contested in the Supreme Court. Whereas between 1982 and 1990 roughly half of the takeovers -- again, measured by market value -- were hostile, since then almost none have been. The statutes, combined with the weakening of the high-yield bond market following the Milken hysteria, prevented a vibrant takeover market. As a consequence, boards and management that misbehaved and compensated themselves nicely couldn't be taken over. Even if the earlier decades' "takeover artists" knew that boards and compensations were getting out of whack, they had little incentive to make their views public.
Some might wonder whether Michael Milken's famous compensation of US$500-million one year during the 1980s did not also indicate outrageous compensation. The answer is quite simple. Milken did not receive this compensation through options, but because of his contractual agreement upon joining Drexel, then an obscure, small investment bank. His contract stipulated getting both 30% of the profits of his unit -- which he created -- and also bearing all of the unit's losses. As it turned out, the profits his unit left on the table subsidized the rest of Drexel. In contrast, 1990s-style compensation worked the other way around: Investors and the rest of the company were bled to pay for management's compensation.
Milken single-handedly created the liquid high-yield bond market, which rapidly expanded to US$200-billion. In the process, Milken transformed corporate America, his high-yield bonds financing the creation of some of the defining companies of the last two decades (MCI, CNN, Mirage, McCaw Cellular, Medco etc.), and also engineering major LBOs and the Time-Warner merger. Unlike many wealth-destroying CEOs of the 1990s, Milken's financial entrepreneurship created wealth. The proof is in the pudding: Once the hysteria disappeared, the high-yield markets had staying power. Put his bonus-type compensation in this perspective.
Why was there, then, such an orchestrated hysteria to Milken's high-yield market? The reason came to the fore over the last decade, as the markets he created were weakened. The high-yield market had allowed investors to finance takeovers and LBOs, and to throw out boards and incompetent yet highly compensated management. Once governments and the courts erected obstacles, there were fewer checks and balances that could stop management from claiming large compensation, and from paying hand-picked board members enough to put them in a state of comfortable, well-paid somnolence.
Think about your house being populated by cats and mice. Remove one cat and the mice have more space and time for mischief. The mice haven't become more greedy, just less subject to checks and balances.
The Romans debated: Who guards the guardians? Who guards their behaviour and prevents abuses of power? For corporations, one of the best ways is through the "market for corporate control," in the words coined by legal scholar Henry Manne.
Takeovers, whether friendly or hostile, are part of this market. Governments and the courts have destroyed them -- maybe with the best of intentions. Now we see the unintended consequences of such misguided policies. Unfortunately, the new regulatory remedies may lead to more error and complexity as the law of unintended consequences continues to wreak havoc.
Reuven Brenner, author of Force of Finance, lectures at McGill University's Faculty of Management.
© Copyright 2002 National Post
The near elimination of hostile takeovers may play a small role in todays obscene levels of executive compensation, but to give it full credit for the phenomenon is nonsense.
I don't know the writers true agenda. It may be simply to create an excuse to heap praise on the disgraced Milken.
One BS resurrected after the demise of another.
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