Corporate Mergers; S. Richman

?R? lustrated than in the coverage of and comment on the recent spate of cor porate mergers. The Du Pont-Con oco merger last summer set off an hysterical display of economic igno rance that still might find its way into law. Unfortunately, this igno rance is found not only in the writ ing of journalists and antimarket spokesmen, but in the articles and speeches of business spokesmen who themselves have fallen victim to the confusion. Typical of the way mergers have been discussed is this opening para graph from Newsweek's July 27 (1981) cover story (the italics are mine): One prominent banker called it a "feeding frenzy," and last week, as the biggest takeover battle in American cor porate history gained momentum, the description seemed right on the mark. Three giant companies-Du Pont, Sea gram and Mobil-were battling for conCORPORATE MERGERS: METHOD OR MADNESS? 283 trol of Conoco, Inc., the nation's ninth largest oil concern, and the bidding was fast approaching the $6 billion level.

Meanwhile, other cash-rich corporate giants were eying their own acquisition targets and frightened companies scram bled to protect themselves. By the end of the week, the hunters and their prey had stocked up war chests of bank credits worth more than $25 billion-enough to buy Detroit's Big Three automakers with $10 billion to spare-and many analysts predicted that the marauders were prE~ paring for a long-term merger binge of unprecedented proportions. "Having had that first taste of blood," said Larry Goldstein, chief economist for the Petro leum Industry Research Foundation, "it is hard to believe they will pull back." To take this sort of writing seri ously is to believe that firms are ra bid bears preying on defenseless Bambis in a gentle forest, or Attila the Hun pillaging a placid hamlet. If language was ever used to obfus cate and mislead, here it is. Merger by Consent Contrary to popular impression, a merger does not occur by one firm eating another against its will.

Mergers occur when a firm buys a sufficient portion of another firm's stock to enable the first firm to de termine the second's management and policies. The key word is "buys." Before a company can buy stock, the owners of the stock must be willing to sell; only the state and muggers think they may acquire property without the [owner's consent. To complain abol/lt mergers, then, is to complain about the stockholders' freedom to sell their property as they like. But what 'about "hostile take overs"? This, misleading term de scribes merg~rs in which the man agement (or s~me stockholders) don't want a contrplling share to be ac quired by so~eone else. It certainly is not hostile to those who find bids on their stock attractive. Economic historian Robert Hessen made an important potnt about hostile take overs when h~ testified in Congress about conglorperate mergers: If a company remains privately held, the owners tliereby guarantee them selves against la hostile takeover. How ever, if they gp public, that is, if they allow shares of their stock to be traded on public exchajD.ges,then they know that one of the inherent risks of being a pub licly traded company is that someone or some coalition of people can buy enough stock to be able to elect one or more di rectors and ultimately to change the pol icies and personnel of that company ...

There is a variiety of (private) options to keep a company, even a publicly traded company, froJiIl an adverse or hostile takeover without needing to ban con glomerate melj"gers.. . There are much more specific lj"emedies which any good lawyer could riecommend to a company to protect itself from the possibility of a takeover. Another t~ing about mergers that concerns some people is their effect 284 THE FREEMAN May on economic growth. Business Week, for instance, declared in a recent ed itorial that "mergers are not growth." Others say they do not create jobs or make better use of capital. The most fundamental answer to these com plaints is, so what? In a free society, people should be at liberty to trade their property without having to justify it to anyone in any terms. But the answer in economic terms goes further. Two parties agree to swap their property only when each sees prospective benefits as a result otherwise the exchange does not oc cur. Mergers entail the exchange of titles to capital goods, whose price is determined by the market's assess ment of their capacity to produce what consumers want most. One company does not acquire the assets of another unless it expects them to be profitable, that is, produce things consumers will be willing to pay enough for.

To believe that a transfer of capi tal goods from one person to another is unproductive is to miss the point of capital goods altogether. They are not merely physical things; in eco nomic theory, the essential charac teristic of a capital good is its role in someone's plan. As New York Uni versity economist Israel Kirzner writes, A capital good is not merely a produced factor of production. Rather it is a good produced as part of a multi period plan in which it has been assigned a specific function in a projected process of produc tion. A capital good is thus a physical good with an assigned productive pur pose. (The Foundations of Modern Aus trian Economics, Edwin G. Dolan, ed., p. 137) It stands to reason that two per sons or groups can have different plans for the same capital good; one may be more suited to future con sumer demand, (that is, more pro ductive for workers, among others), one less suited. We can't be certain prospectively, only retrospectively.

But we do know that the market tends to reward entrepreneurs who successfully forecast future demand. Mere observers of the economic scene have little standing to say what is and is not productive activity. If they think they know better, let them bid for the resources and execute their superior plans. Another concern of merger oppo nents is conglomerates-firms that make many different products. They have yet to explain why anyone should worry about one firm produc ing both, say, luggage and yogurt. But in expressing this concern, they expose their hidden agenda. You'll note that these same people vigor ously oppose companies' merging with other companies in their own or related industries. This is said to be anticompetitive. If a large com pany creates a new firm in an unre lated industry, it is likely to be ac cused of either wasteful duplication 1982 CORPORATE MERGERS: METHOD OR MADNESS? 285 or unfair competition with the exist ing firms. In other words, anything a company does that breaks with the status quo will likely bring criticism and perhaps an antitrust investiga tion.

And this is the point! Critics of mergers are defenders of the status quo and opponents of the dynamism inherent in the free market. This makes them, in essence, advocates of privilege, for they would freeze the economic system where it is today, shutting out the aspirants and shel tering yesterday's achievers. These critics will tell you they only want to preserve competition, but that is not what they will aCCOIIl plish. Mergers are competitive by nature. Competition is the coopera tive process in which entrepreneurs seeking profit try to predict future consumer demand and arrange pro ductive resources accordingly. When the law stops or hampers this activ ity, it cripples the process and hamls consumers. Freedomto EnterIs the Key The critics' related worry about market concentration is also off the mark. The interests of workers and consumers do not depend on a spec ified number of firms or market structure. They depend on freedom of entry, uninhibited by regulation, taxation, inflation, licensing and pa tents. Moreover, the notion of con centration is inherently arbitrary. It implies that ~n observer categorizes products, then counts the number of suppliers in each category. But the observer's categories are irrelevant to how conS\ilmers, motivated· by personal conslderations, respond to the array of products before them.

Unbeknownst to the observer, con sumers may regard seemingly dis parate produ:cts as substitutes for each other, yanking the rug out from under the concentration doctrine. Consumers, and no one else, ulti mately deterpiine the structure of markets; their shifting preferences guarantee th~t markets are always in flux and that temporary advan tage is the ~ost any producer can hope for. The reasonS for the current wave of mergers are many and complex. Undoubtedly, inflation-which makes acquiring existing assets preferable to },>uildingnew ones-has much to do with it. So does the thick web of reguliations and taxes that inhibit small~r firms. So, no doubt, do Reagan administration hints of "leniency" on] conglomerate mergers (but not on i"horizontal mergers"). The exact re4.sons are not so impor tant here. Th¢ important point is that the market ~s a decentralized, vol untarist infoirmation and decision making process in which people grapple withiuncertainty in pursuit of their well-being. To interfere with this in the Jl.ame of protecting the people is the cruelest hypocrisy. , John Semmens SeDlantic Confusion in Economic Regulation IN ACCORDANCE with the Motor Car rier Act of 1980, a Congressionally appointed study commission is tour ing the country to investigate the consequences wrought by partial deregulation. One of the lines of in quiry the study commission is pur suing deals with the semantic con fusion that appears endemic to the regulatory task.

It is not surprising that there is a considerable measure of uncertainty concerning the terminology used in economic regulation. The Motor Carrier Act of 1980 is, itself, chock full of terms that are subject to varying interpretations. The Act calls for regulation to achieve "reason able profit" for carriers, eliminate restrictions that are "contrary to the public interest," pursue "equitable" treatment of interstate motor carri ers, and so forth. These terms are not clear-cut directives for specific regulatory rules or requirements. Reasonable men may differ in their opinion of how to "equitably" reMr. Semmens is an economist for the Arizona Department of Transportation". 286 solve the issues relevant to the "public interest." That the Act suffers from ambi guity should not be taken as an in dictment of the literary talents of Congress. Legislatures are unable to write unambiguous regulatory laws because of the fundamental impos sibility of the task of governing eco nomic activity by statutory means.

The impossibility of the task stems from some fundamental economic and political realities. Statutes are laboriously arrived at expressions of the consensus of a majority of the people's representa tives. The difficulty in creating a major piece of legislation makes it impractical to modify statutes ex cept at long intervals. The word statute is derived from the same source as stationary. There is an im plied or intended notion of perma nence entailed in the creation of a statute. Unlike commodity prices, statutes cannot be revised on a daily or hourly basis. Because laws must express the consensus of a majority of the peoSEMANTIC CONFUSION IN ECONOMIC REGULATION 287 pIe's representatives, they are nec·· essarily products of compromise. People's views on what constitutes the public interest differ. Juggling divergent views and interests produces legislation aimed at satis fying numerous objectives simulta neously. Some of these objectives will be mutually exclusive. Laws at tempting to accommodate mutually exclusive objectives cannot help being ambiguous.

The Market Affords Options In contrast to statutes which must say one particular thing about the wayan activity is to be regulated, the market proffers numerous op tions. One Congress must enact one law for all. The market, however, can supply a wide variety of solutions to the varied economic needs of the participants. Law requires unifor mity of treatment as a means of pro moting equity. People's material needs are very nonuniform. A clear, concise law that specified one solu tion to nonuniform needs would be grossly inefficient, not to mention fundamentally inequitable. In addition to being diverse, the economy is also dynamic. Needls change over time. The methods of satisfying needs change as well. New technology revises the ways in which the market can satisfy material needs. The conditions under which economic participants operate to ca ter to material needs are frequently changing. Supply and demand for the factors of production fluctuate with changes in weather, political ten sion, consumer taste, and the vagar ies of chance.

Economic activity is not a sphere of human undertaking suitable to comprehensive regulation by statu tory means. Tp.e permanence of stat utes is incompatible with the dy namic, diverse nature of economic activity. The i existing inaptness of regulatory co~trol over motor car riage inspired Congress to attempt "to reduce unnecessary regulation." Perceptive observers could point out that merely reducing unnecessary regulation pqts Congress in a diffi cult spot. The language of the Act would appear to assure that at least some unnece~sary regulation will be retained. The remaining unnecessary regu lations that ~ave not been reduced are to be enforced by the Interstate Commerce Commission in a ''just and reasonable" fashion so as not to "un duly restrain" the market in a way that is "contIiary to the public inter est." Th.e de¢isions on equity have been passed, on to a Commission made up of ~en. These men will be asked to rendjer judgments and make rules based upon their opinions of what is just,! reasonable, and equi table-matters subject to wide var iances in opinion.

Given the latitude granted in the charge to be r "just and reasonable,"

288 THE FREEMAN May the Commission could make arbi trary rules. The power to regulate is the power to destroy. Denial of a rate change or enforcement of a bureau tariff could force some carriers out of business. If the Commission wanted to, it could use the inherent ambiguity of statutory laws pertain ing to motor carrier regulation to ride roughshod over the industry and the consumers who depend on it. If it seeks to be conscientious, the Com mission will become bogged down in minutiae trying to determine if rates are or aren't "compensatory," whether they are "discriminatory," and if they are, whether they are permissi ble as part of a broader scheme of "cross subsidization." When these terms are defined, they are often defined differently. Even if uniformity of definition could be ar rived at, the question of whether the defined act is allowable as a "rea sonable" practice· is still subject to difference of opinion.

The petitioners before the Com mission are rarely very helpful in defining terms. Words and phrases are used in a pejorative fashion. They become weapons to batter one's op ponents in the hearing process. A petitioner will ask the Commission to disallow a competitor's rates be cause they are discriminatory and show undue preference which upsets both rate stability and rate unifor mity. In a future case, the roles might be· reversed, and the original petitioner will have to defend the same acts it railed against in an earlier case. Defini tions of these terms are plentiful and inconsistent. There are two reasons for this situation. First, the terms are always situational in nature. Firms employ a double stan dard. If the other .guy does it, it's "discrimination." If we do it, it's "cross subsidization." "Discrimina tion" is, of course, impermissible. Whereas, "cross subsidization" is so cially beneficial. Pricing practices, which a third party would view as similar, will be defined in diametri cally opposed terms by contending parties.

. Second, the terms are difficult to define because the concepts are more imaginary than real. "Discrimina tion" and "cross subsidization" are so difficult to define because, like leprechauns, only some people can see them. The fact that few others can see them does not stop some peo ple from espousing, at great length, what they eat, what they wear, and where they live-i.e., leprechauns eat cross subsidies in order to maintain rate uniformity. Is the task of economic policy making a hopeless endeavor? Like everything else we've looked at, it depends on how that task is defined. As long as the aim of government economic policy. is to intervene in private transactions for the purpose of imposing trade conditions that the 1982 SEMANTIC CONFUSION IN ECONOMIC REGULATION 289 transacting parties would not have agreed upon themselves, the task of government's economic policymak ing is impossible.

NegotiableTerms In a market economy, all parties have the freedom to negotiate terms of their own transactions. Noone has the authority to impose mandatory trade conditions on anyone else. In such an environment, there is no as surance that the parties can get ex actly. what they want on their own terms. Losers in the competitive struggle find it easier to blame the "unfair" practices of their rivals than to face the prospect of failure. Eco nomic regulation is a manifestation of this response to unfavorable com petitive outcomes. Proponents of government intervention argue that if everyone can be made to conform to "fair" rules, then all can make reasonable profits and survive. In the absence of government in tervention to compel uniformity among competitors, members of the industry are reduced to whatever private agreements they can nego tiate. Rate bureaus and traffic pools are an almost ancient device for pursuing private agreements. Pri vate price maintenance agreements rankle antitrust lawyers, while pub lic price regulation is granted greater acceptance. Our public policies ought to be the exact reverse of what they now are. Namely, private price maintenance agreements ought to be allowed, but nQt legally enforceable.

Government enforced price mainte nance agreements ought to be abol ished. The old cOmfmon law practice in which pooling and price fixing were allowed, but not legally enforceable, has much to recommend it. Mem bers of the motor carrier industry claim they neep to arrange for rates in concert in order to facilitate in terlining. In many instances, this may be true. However, the need to discuss rates 3jnd reach agreements for interlining!purposes does not re quire that the agreements attain the force of law, th~t they be voted upon and collectiyjely imposed on all members of the rate bureau, with the threat of government sanctions for noncompliance. It is the desire to resort to govern ment coercion! that breeds the se mantic confus~on that Congress is now probing. ·]f no firm were forced to adhere to government imposed economic regulfitions, there would be no need to wr~ngle over the mean ings of terms like discrimination or cross subsidy.! As anyone familiar with actual bU$inessoperations must know, the real cost of a particular service is mu~h more complicated than the mere sum of the obvious factors. Firms imay legitimately em ploy apparent jbelow-cost pricing as part of a marl;tet penetration strat egy, as a loss leader, as a connecting 290 THE FREEMAN link in a longer route, as a portion of a larger shipment, and so on. There is no way that a third party can ob jectively assess a rate between transacting parties as "non-compen,;.

satory." Nei ther can the seeming difference in rates between similar moves be objectively labeled as "dis criminatory." In short, the prices charged in voluntary transactions are nobody else's business but the par ties to the transaction. SuggestedRemedies Problems with economic policy will persist as long as the alternative re mains of resorting to force of law to compel trade conformity. Collusion and price fixing would be insignifi cant if there were no legal barriers to entry. Because the public sector has sought to intervene in private economic acti vity, assorted minor market imperfections have been re placed by substantive difficulties. To address the specific question of where we go from here, let us sug gest the following semantic reme dies. The government should define any private voluntary economic transactions as "just and reason able." Any voluntary economic act between consenting adults should be considered "equitable" and "in the public interest." Government should cQp.cern itself with preventing the employment of coercion by criminal organizations or individuals. This is the sphere wherein government can exercise its legitimate police pow ers. Protecting the public from overt and covert coercion in business practices is the most productive realm for government action.

Semantic confusion stems from the lack of focus on what public power can accomplish and on the inherent incompatibility of attempting to control dynamic economic activity through static statutory means. If the government seeks to control mil lions of transactions through regu latory rules, public policy will fail to achieve either justice or efficiency. If the legal effort is focused on main taining a free market system, it can succeed. Creating the legal forms which will protect all free market transactions is a clear and attain able mission. It is free of semantic clutter and accounting headaches. That the Interstate Commerce Com mission should have to examine cost accounting systems, revenue data, industry profitability averages, and the like in an attempt to promote equitable regulations is a laborious and futile exercise. The government really needs to ask only one basic question: Is an economic transaction voluntary? If it is, government has no role to play.

If it isn't, the coercive act should be prosecuted as would any other act of extortion. In this way, government would perform the function for which it was established in this country: defending the people's freedoms. , * EVER SINCE September 1973, when a military junta seized power in Chile, the world has been treated to the rare spectacle of an unexpected restora tion of the market order by military fiat. Socialism with many of its ram ifications was summarily replaced with an individual enterprise order. National borders were opened to in ternational trade and commerce, markets and prices were set free from bureaucratic restraints and restric tions, government learned to live within its means, that is, balance its budgets, the national currency was reformed, and many public enter prises were returned to private own ership. Even in such fields as edu cation and old age insurance, government beat a hasty retreat and Dr. Sennholz heads the Department of Economics at Grove City College in Pennsylvania. He's a noted wri ter and lecturer on economic, political and monetary affairs.