You might not ever have to think about Delaware except for this: Although its citizens represent only 0.3 percent of the nation's shareholders, more companies are incorporated there than in any other state. There are 179,000 of them, including 56 percent of the Fortune 500. Delaware may soon enact an antitakeover law, which -- given the state's preeminent position -- would amount to a national antitakeover law.
This is a ghastly idea. Its only purpose is to shield well-paid executives against hostile takeovers. Corporate leaders like to project themselves as defenders of the productive economy against sinister financiers and "raiders." In fact, hostile takeovers promote greater efficiency and productivity. The whole antitakeover exercise smacks of corporate socialism: the marshaling of government powers to protect established businesses against change and challenge.
Executives want to sleep easier at night, and Delaware is eager to please. The corporate franchise tax and other fees provide 16 percent of state revenues. A Supreme Court decision last spring seemed to permit tougher state antitakeover laws. Since then, 13 states have passed new laws, bringing to 27 the number with antitakeover statutes. Delaware officials fear that companies will reincorporate elsewhere if the state doesn't offer greater protection. The local bar association is drafting a proposal, which the legislature may approve in early 1988.
The speed with which these antitakeover laws have passed represents a political triumph for big corporations. They've largely succeeded in portraying hostile takeovers as an economic pestilence. By now, the indictment is familiar. The takeover threat (it's said) forces companies to focus on short-term profits and sacrifice long-term investment or research. Corporate raiders cheat small shareholders by coercing them to sell their stock at low prices.
There's just enough truth to the indictment to make it seem compelling. Ivan Boesky was just sentenced last week. Some takeover bids are phantom, intended mainly to create speculative opportunities in the stock market. Outlandish trading profits are made. Not surprisingly, corporate raiders and investment bankers are the new villains of popular culture -- reviled in novels (Tom Wolfe's "The Bonfire of the Vanities") and movies (Oliver Stone's "Wall Street"). But beyond the imagery, the indictment against hostile takeovers is essentially false. Consider: They aren't rampant. In 1986 only 40 -- a record -- were attempted, according to W.T. Grimm & Co.; a mere 15 succeeded. What is rampant is executive anxiety about takeovers. In one survey of 200 large companies, 57 percent said they'd been subject to takeover rumors.
Hostile takeovers haven't cut total investment or research. Between 1979 and 1986, corporate-financed research and development rose 51 percent, after adjusting for inflation. The increase between 1969 and 1976 -- when hostile takeovers barely existed -- was only 12 percent. Investment, as a share of gross national product, is higher now than in the 1970s.
There's no evidence that shareholders fare worse in hostile takeovers than in friendly ones -- those negotiated by the managers of merging companies. Typically, investors get 25 to 40 percent more than the previous market price.
Still, the corporate rhetoric continues. Listen to H.B. Atwater Jr., chairman of General Mills. He deplores financial "manipulations" and bad "bust-ups." He says hostile takeovers create "no new wealth." He's probably right. But they can improve use of the existing wealth by redirecting wasteful corporate investment. Ironically, General Mills proves the point.
General Mills has an "extremely profitable base business that subsidized poor diversification," as Michael Porter of the Harvard Business School writes. The company is the second-largest cereal maker (Wheaties, Cheerios) and the leader in cake mixes (Betty Crocker). Food profits financed diversification in everything from toys to fashion to furniture. In 1985 Atwater overhauled the company. He sold poorly performing businesses and turned the toy and fashion operations into separate companies, whose stock was distributed to General Mills shareholders.
The results have been dazzling. The toy and fashion businesses have done better as independent companies. Focusing on fewer businesses, General Mills improved its return on shareholders' equity from 19 to 31 percent. Since 1984 its stock price (including the value of the spun-off companies) has risen about 150 percent. That's more than three times greater than the overall market rise. But suppose Atwater hadn't acted and a raider had? In 1985 someone could have bought General Mills for 50 percent more than its market price and, by doing what the company itself did, profited enormously. Would that be a financial "manipulation" or undesirable "bust-up"?
The economic value of hostile takeovers doesn't lie in the few that occur. It lies in the mere threat, which motivates managers to stay efficient. Just because the pressure operates through the stock market doesn't make it illegitimate. The Delaware antitakeover proposal aims to reduce the threat. Management-approved mergers are exempted. For others, the proposal would make it difficult for investor groups to borrow the money to finance hostile takeovers. Notably, many public pension funds -- large stockholders representing millions of retirees -- oppose the plan.
What Delaware and shortsighted executives are jeopardizing is a division of labor that's worked well for decades. Congress has left the details of corporate law to the states, as long as states don't use it to settle major issues of national policy. Once that happens -- as it is happening here -- the question arises: Why should Delaware have such power? The logical response is to abolish state corporate charters and replace them with a federal charter.
This step has long been advocated by social activists, but it's fraught with dangers. It would represent a huge politicization of the economy. Through federal charters, corporations could become the target of every passing political and social fad. It would be an economic nightmare. But if business leaders want corporate socialism, that's what they're risking. Those who beg for government protection are also inviting government control.