Article by J. Robert Brown, Jr.
Leveraged buyouts have become a popular bête noire. The gargantuan size of the transactions and the perception of unconscionable profits have led to a general pillorying in the popular press. Their unpopularity has generated a congressional call to arms and proposals for “reform” by the Securities and Exchange Commission. The plain effect of these efforts, if successful, would be an increase in the cost of buyouts, thereby reducing their frequency.
While perhaps politically attractive, a reduction in frequency may have long-term, harmful consequences. Leveraged buyouts, particularly those inspired by management, represent the ultimate antitakeover device. No longer can an interloper seize control from existing managers through a hostile tender offer.
Benefits flow from this heightened isolation. The “omnipresent specter” of a takeover attempt induces management to implement strategies designed to preserve independence. In contrast to the suppositions of the reigning view, the desire to remain independent does not cause management to profit maximize. Instead, rational management may choose to “hide”; that is, to avoid the characteristics of the most common class of target companies. Hiding involves a strategy of satisfactory earnings and aversion to risk.
Hiding has costs. The strategy encourages companies to forego those risks that, if unsuccessful, can depress share prices and, perforce, lead to an acquisition attempt. Widespread risk aversion will render companies uncompetitive, particularly since companies from other countries do not share the same attitudes.
Reduction in takeover activity may solve the problem of excessive risk aversion. Increasing costs through added regulatory burdens represents a possible approach. Alternatively, management-sponsored buyouts (MBOs) represent a solution of sorts. By eliminating public shareholders and the threat of a hostile acquisition, management may be able to implement an investment strategy premised upon greater risk.
Absent regulatory intervention, MBOs represent the only effective mechanism for overcoming market inhibitions to increased risk taking. Legislative efforts to reduce the frequency of leveraged buyouts would force non-profit-maximizing companies that are seeking to remain independent to opt for the inefficient strategy of hiding. To the extent legislative intervention appears necessary, it should focus on a reduction in takeover activity rather than on limits on leveraged buyouts.
This Article will accomplish two things. First, it will identify the source of the widespread aversion to risk currently evident in corporate board rooms and the harmful consequences that flow from the approach. Second, the Article will examine a pair of solutions to the problem of risk aversion. One entails regulatory intervention designed to increase the costs of hostile acquisitions. Raising costs provides broader “mistake” parameters. Companies can take risks, fail, and know that, within a range, they will be immune from a takeover attempt.
The other involves a market solution. Companies wishing to take greater risk can remove the threat of a hostile acquisition by eliminating public shareholders and taking the company private in an MBO. This suggests that, while imperfect, leveraged buyouts enhance efficiencies by providing a mechanism for ensuring independence that does not require systematic risk avoidance. More capable of taking risks, these companies are in a better position to compete in the international marketplace.
About the Author
J. Robert Brown, Jr. Assistant Professor, University of Denver College of Law; Of Counsel, Holland & Hart; 1981-1982, Law Clerk, Honorable Frank M. Johnson, Jr., United States Court of Appeals for the Eleventh Circuit.
Citation
65 Tul. L. Rev. 57 (1990)