Are hostile takeovers good or bad for the economy?
That was the principal question addressed, but not answered conclusively yesterday, as congressional hearings on the merits and pitfalls of the boom in mergers and acquisitions continued.
However, two officials from the Office of Management and Budget and three academic experts who testified seemed to agree that new federal legislation would not be the best way to solve most of the problems caused by the dramatic increase in takeover activity.
Some of the disagreement among the experts over whether hostile takeovers are good or bad for the economy can be attributed to disagreement over how to measure their impact. University of Rochester professor Michael C. Jensen, who believes the takeover activity has been beneficial, looks at changes in stock prices as a barometer.
Jensen pointed out that, according to the Securities and Exchange Commission, the total gains to stockholders of acquiring and acquired firms in all takeovers in the last three years have been $35 billion. Jensen believes the activities of hostile takeover specialists such as Carl Icahn, Victor Posner and T. Boone Pickens Jr. lead to more efficient utilization of resources. He cites higher stock prices as evidence.
Jensen does not believe fear of takeovers causes managers to emphasize short-term profits at the expense of long-term competitiveness, by neglecting such activities as investment in research and development. He believes stock prices disprove the theory that fear of takeovers leads to an emphasis on short-term earnings.
"Even casual observation of the equity markets indicates the market does not value only current earnings," Jensen said. "It values growth as well. The mere fact that price/earnings ratios differ widely among securities indicates the market is valuing something other than current earnings. Indeed, the essence of a growth stock is one that has large investment projects that yield few short-term cash flows but high future earnings and cash flows."
Frederick M. Scherer, economics professor at Swarthmore College, disagreed yesterday with Jensen's belief that the merger boom is benefiting the economy and also disagreed with his use of stock price changes as supporting evidence because of its emphasis on the short-term.
In his analysis, Scherer also attacked the Council of Economic Advisers support of takeover activity.
He said CEA's views fail "to explain why business performance was good when there were few contested takeovers and poor when there were many."
"It ignores the 'undervalued assets' explanation for takeovers. The stock market studies on which it relies are short-run in orientation. Longer-term analyses suggest different results.
"It fails to examine the actual behavioral changes following a takeover. It implicitly approves the short-run reward goals that drive tendering decisions. But short-run profit maximization leads to weaker, less competitive companies in the long run."
Harvard Business School professor Warren A. Law said many takeovers are accompanied by dramatic increases in debt, which decrease the target company's flexibility and its willingness to take risk. Law also said target companies, the typical result of takeovers, "make bigger errors and have the resources to continue them longer."
OMB Deputy Director Joseph R. Wright said takeovers perform valuable economic functions, including promoting economies of scale and allocating resources to higher-valued uses.