Corporate Governance

The Auto Manufacturers and the Failure of the Market for Corporate Control

By J. Robert Brown

We are talking about a recent book written by Jon Macey at Yale titled Corporate Governance, Promises Kept, Promises Broken.  Ultimately Macey believes that the solution to the corporate governance problems in the United States is a more vigorous market for corporate control.  In other words, the inefficient company can be taken over and inefficient management replaced.  Thus, the acquisition of General Motors would likely result in a wholesale purge of top management, including the CEO, Rick Wagoner, and the board of directors who only seemed to take an active role in the crisis after a public relations disaster when the CEO went to Washington asking for a bailout without a plan and returning in a private jet.

There may well be a need for a more active market for corporate control.  The market has been shut down by the Delaware courts, leaving to management almost unlimited authority to rely on poison pills to stop unwanted ventures.  Thus, even the worst managers can remain in office, behind the poison pill shield.  Once again, the explanation rests with the Delaware courts.

But those who push an active market for corporate control as a solution often ignore the negative consequences of the approach.  One of them is that it discourages risk taking.  Companies wanting to enter a new market generally have two choices.  They can acquire an existing participant, purchasing market share and income streams, or develop their own capacity.  The risk of failure (and, presumably a hostile takeover), is greater with the development of capacity.  There is a chance that the entire venture will fail (smokeless cigarettes by RJR back in the 1980s for example), result in damage to profitability and a fall in share prices.  Buying an existing participant entails less risk of failure (and, concomitantly, a takeover).  But is this the best approach?  Let's take a look at the auto industry in the US.

Back in the 1980s, when hostile acquisitions raged, many car companies decided to go up market, to distribute a premium brand.  In the US, GM bought Saab (acquiring a 50% stake in 1990 and now for sale), Ford bought Jaguer, Aston Martin, Land Rover (all three subsequently sold), and Volvo (Ford is currently exploring "strategic alternatives" for Volvo, "including divestiture").  The Japanese auto makers, where hostile acquisitions were almost impossible, approached the same issue from an entirely different perspective.  They developed their own premium brand, with Toyota developing the Lexus, Honda the Acura, and Nissan the Infiniti.  A ranking of the luxory brands by customer loyalty in 2008 showed Lexus at the top with Land Rover, Jaguar and Saab at the bottom. 

In other words, an active market for corporate control could easily have been one factor in US companies uniformly expanding into a market through the least risky method, buying existing brands rather than starting their own.  In other words, it is no panacea to say that takeovers result in the removal of inefficient management.  They also arguably result in a risk averse strategy in business, something that has real and long term costs.

Full post as published by The Race to the Bottom on December 08, 2008 (boomark / email).