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Henry G.

Manne, "Mergers and the Market for Corporate Control", Journal of

Political Economy, Vol. 73, No. 2 (Apr., 1965), pp. 110-120



George ivashington Vniversity Law School

years many of the tradi- market. Antitrust problems in the merg-

tional economic justifications of our er field seem more and more to be con-
antitrust laws have been seriously fined to discussions of relevant product
cluestioned. A new sophistication has de- and geographic markets and perhaps to
veloped, and economic activities fre- the issue of quantitative ~ u b s t a n t i a l i t y . ~
quently held illegal by the courts are now Presumably there is still a so-called
thought by many to be consistent with failing-company defense to an illegal
our antitrust goals. The rules against merger charge. The announced justiiica-
tie-ins, vertical mergers, predatory com- tion for this doctrine was that, if indeed
petition, among others, have to a greater the merged company was failing, then it
or lesser degree had their theoretical foun- was not actually a competitor in the in-
dations considerably weakened. Recently d u ~ t r yBut
. ~ there are strong suggestions
even cartels, the most venerable victim that even that defense may be unavail-
of American antitrust laws, have found able when a large corporation is making
their near champion.' the acquisition, or when there is any
One practice, however, remains gener- chance of absorption by a non-competing
ally condemned in both the economic firm, or when the acquired company has
literature and the most recent Supreme not "lailed" e n ~ u g h . ~
Court rulings. Mergers among competi- Almongthe recent articles and cases bearing out
tors mould seem to have no important this conclusion are the follo~ving:Donald Dewey, op.
saving grace. The position has gained ctt ; Rlchard E. Day, " ~ o n ~ l i m e r a tMergers
e and
the 'Curse of Bigness,' " Xorth Curolina Law Re-
considerable legal currency that any rnerg- view, X L I I (1961), 511-66; James A l .Rahl, "Current
er between conipeting firms is a t least Anti-Trust Developments in the Merger Field,"
suspect and perhaps per se illegal. The Anti-Trrrst Bulleti~z,V I I I (1963), 193-515; United
States v. El Paso Natural Gas Company, 376 U S.
latter result seems especially likely when 651 (1961); and United Statcs v. First National
one of the combining firms already occu- Bank and Trust Company of Lexington, 376 U S.
pies a substantial position in the relevant 665 (1961).
International Shoe Company v. Federal Trade

IIelpful criticislns and suggestions on this article Commission, 280 U.S. 291, 294 (1929); but see

by Professors Armen .I.Alchian, Joseph .lschheim, Derek C. BOB,"Section 7 of the Clayton Act and the

Ilonald Deney, and Joseph P. LlcKenna are grate- Merging of Lalz and Economics," Ilaizlard Law Re-

fully acknou ledged. t ' i e k , LXXIV (1960), 226-355, esp p. 340, nhere

A companion article to this one by the same concern for the interests in the failing company is

author, entitled "Some Theoretical Aspects of Share -

argued t o be the most llkelv reason for the doctrine.

Voting," appears in Col~cvzbia Lati) Reeiew, LXIV

(1951), 1127-45. That article analyzes the strategies
, Derek C. Bok, o p , tit,, pp. 339-47; and see cases

cited in anonymous comment, 'lAln Updating of the

aviiilahle to shareholders when different techniques 'Failing Doctrine in the Section

for taking over control of a corporation are used. 7 Setting," .Wicl~igan Laq~'Rez'iew, L X I (1963), 566-

Donald Dexey, "The Economic Theory of Anti- 83.

Trust: Science or Religion?" T7irginia Lati) Rezdew, There is also a "solely for investnlent" defense to

L (1961), 413-31. This article also contains refer- Clayton .lct charges. This appears a s an explicit

ences to the other iconoclastic literature (pp. 126- proviso in the third paragraph of Section 7, 15

27). U.S.C.A. sec. 18 (1962). But the famous du Pont-

There is general agreement among market were perfect and a merger con-
economists that the courts' approach to ferred no monopoly power, a rising firm
horizontal mergers is c o r r e ~ t Professor
.~ would be indifferent between the two
Donald Dewey, who appears slightly re- forms of e x p a n s i ~ n . "Thus ~ a rapidly ex-
gre.tfu1 about the severe treatment of panding industry with a relatively short
mergers by our courts and administra- life cycle of its firms would be character-
tive agencies, concedes that no important ized by substantial external growth of
economies can be attained through a successful firms. hlergers then would
merger which cannot be gained either by "most commonly indicate not the decline
internal growth or, a t worst, by a cartel, of competition but its undoubted v i g ~ r . " ~
if that were legal. But Dewey is certainly Ilewey's argument is, however, only a
not as severe in his personal indictment partial redemption of mergers, since a
of horizontal mergers as most other great many have occurred in industries
economists. H e has argued that most in which the life cycle of firms is not as
mergers iihave virtually nothing to do short as in the southern textile industry,
with either the creation of market power which he mentions as his example. Fur-
or the realization of scale economies. ther, Dewey's defense of mergers seems
They are merely a civilized alternative to be limited to those cases in which
to bankruptcy or the voluntary liquitla- bankruptcy or liquidation is imminent.
tion that transfers assets from falling to But, if a merger can be justified at this
rising firms."' stage of the firm's life, presumably it is
Consistent with his alternative-to- also desirable before bankruptcy be-
bankruptcy explanation of mergers, comes imminent in order to avoid that
Dewey points out that, ''[ilf the capital eventuality. If, as Dewey suggests, mer-
gers actually are superior to bankruptcy
G. hI. case, United States v. E. I. D u Pont tle S e - as a method of "shifting assets from fall-
mours and Company, 353 U.S. 586 (1957), seems to
have very substantially weakened the force of this ? "Xergers and Cartels: Some Reservations
proviso. Also see S ~ r i f and
t Co. v. F.T.C., 8 Fed. 2d a ? ~ o uPolicy,"
t Jiarket Economic Rezdew, I,I (Xlay,
595, 599, reversed on other grounds, 272 U.S. 554 1961), 257. Dewey analyzed four relatively unim-
(1925), where it is stated: "It ~ r o u l dbe difficult to portant cases of scale economies that can be real-
conceive of any case where one corporation pur- ized only through a consolidation, but he concluded,
chased all the stock of its competitor solely for in- in substantial agreement with Stigler and Adelman,
vesttilent. Such a case would be a rare one." "that the present experiment discouraging growth
There was once thought t o be a n illegal purpose by mergers should be continued" with a ban in any
requirement for convictions under the Sherman .Act. industry not generally considered a good example of
See Eugene V. Rostow, ''hlonopoly under t h e Sher- workable competition (p. 261).
man . k t : Power or Purpose?" Illinois Law Reciew, Jesse W. hlarkham has remarked that some
S L I I I (1919), 745-92. But recent Supreme Court mergers are the "means by xrhich some entrepre-
decisions in the merger field have left little vitality neurs make their exit from the industry, selling their
to that notion. Cf. United States v. First National undepreciated assets to other entrepreneurs. . . .
Bank and Trust Company of Lexington, 376 U.S Since 1930 most mergers appear to have been of the
665, 659 (1964). ordinary business variety in that they had neither
See George J. Stigler, "Jlergers and Preventive monopoly nor promotional gains as their objective"
Anti-Trust Policy," Pennsyki'ania Law Review, CIV ("Survey of the Evidence and Findings on I l e r g -
(1955), 176-84 (Stigler too recognizes the possibility ers," in B ~ t s i i ~ e sConcentration
s nnd Price Policy
that some mergers may increase competition, but he [New York: National Bureau of Economic Research,
finds i t "most uncommon" [p. 1811); 11.A. Adelman, 19551, p. 181). He concluded that "xrhile some merg-
"The Anti-Merger . k t , 1950-60," American Eco- ers impair a competitive enterprise system, others
no9nic Review, L I (May, 1961), 236-54 ("The hori- may be an integral part of it" (p. 182).
zontal elements of mergers . . . have been treated
"hlergers and Cartels . . . ," op. cit., p. 257.
severely and-if maintaining competition is the ob-
ject-rationally" [p. 2381). "bid.
ing to rising firms," and if mergers were A fundamental premise underlying the
completely legal, we should anticipate market for corporate control is the exist-
relatively few actual bankruptcy pro- ence of a high positive correlation be-
ceedings in any industry which was not tween corporate managerial efficiency
itself contracting. The function so waste- and the market price of shares of that
fully performed by bankruptcies and company.'O As an existing company is
liquidations would be economically per- poorly managed-in the sense of not
formed by mergers a t a much earlier making as great a return for the share-
stage of the firm's life. holders as could be accomplished under
other feasible managements-the market
price oi the shares declines relative to the
The conventional approach to a merg- shares of other companies in the saine
er problem takes corporations merely as industry or relative to the market as a
decision-making units or firms within the whole. This phenomenon has a dual im-
classical marliet framework. This ap- portance for the market for corporate
proach dictates a ban on many horizon-
tal mergers allnost by definition. The
I n the first place, a lower share price
basic proposition advanced in this paper
facilitates any effort to take over high-
is that the control of corporations may
constitute a valuable asset; that this paying managerial positions. The com-
asset exists indepcndent of any interest O' The claim of a positive correlation between
in either economics of scale or monopoly managerial efficiency and the market price of shares
profits; that an active market for corpo- would seem a t first blush to raise an empirical ques-
tion. I n fact, holyever, the concept of corporate
rate control exists; and that a great managerial eniciency, with its overtones of an entre-
many mergers are probably the result of preneurial function, is one for which there are no ob-
the successfui worliings of this special jective standards. But there are compelling reasons,
apart from empirical data, for believing that this
market. correlation exists. Insiders, those xvho have the most
Basically this paper will constitute an relial~le information about corporate affairs, are
introduction to a study of the market for strongly motived financinlly t o perform a kind of ar-
bitrage function for their company's stock. T h a t is,
corporation control. The emphasis will be given their sense of what constitutes efficient man-
placed on the antitrust implications of agement, they will cause share prices to rise or de-
this mnrliet, but the analysis to follow cline in accordance with that standnrd.
T h e contention is often made that stock-marlcet
has important implications for a variety prices are not accurate gauges, since far more
of economic questions. Perhaps the most trades take place without reliable iniorn~ationthan
important implications are those for the with it. n u t there is reason to believe that intelli-
gence rather than ignorance ultimately determines
alleged separation of ownership and con- the course of indivitlual share prices. Stoclc-market
trol in large corporations. So long as we decisions tend to be of the one-out-of-t~vo-alterna-
are unable to discern any control rela- tives variety, such as 1)uy or not l ~ u yhold
, or sell, or
put or call. T o the extent that decisions on these
tionship between small shareholders and questions are made by shareholders or potential
corporate management, the thrust of shareholders operating without relial~leinformation,
Berle and Means's famous phrase re- over a period of time the decisions will tend to be
randomly distributed and the effect will therefore be
mains strong. But, as will be explained neutral. Decisions made 11y those with a higher de-
below, the market for corporate control grees of certainty will to that extent not meet a can-
gives to these shareholders both power celing eifect since they will not 11e made on a random
l~asis.Over some period of time it would seem that
and protection commensurate with their the average market price of a company's shares must
interest in corporate affairs. be the "correct" one.
pensation from these positions may take can be obtained by borrowing the funds
the usual forms of salary, bonuses, pen- with which the shares are purchased, al-
sions, expense accounts, and stock op- though American commercial banks are
tions. Perhaps more important, it may generally forbidden to lend money for
take the form of information useful in this purpose. -4 comparable advantage
trading in the company's shares; or, if can be had from using other shares rather
that is illegal, information may be ex- than cash as the exchange medium. Given
changed and the trading clone in other the fact of special tax treatment for capi-
companies' shares. But it is extremely tal gains, we can see how this mechanism
doubtful that the full compensation re- for taking over control of badly run cor-
coverable by executives for managing porations is one of the most important
their corporations explains more than a ((get-rich-cluick" opportunities in our
small fraction of outsicler" attempts to economy today.
take over control. Take-overs of corpo- But the greatest benefits of the take-
rations are too expensive generally to over scheme probably inure to those least
make the "purchase" of management conscious of it. -Apart from the stock
compensation an attractive proposition.12 market, we have no objective standard of
I t is far more likely that a second kind managerial efficiency. Courts, as indicated
of reward provides the primary motiva- by the so-called busi1:ess-judgment rule,
tion for most take-over attempts. The are loath to secoild-guess business deci-
market price of shares does more than sions or remove directors from office.
measure the price a t which the normal Only the take-over scheme provides
compensation of executives can be "sold" some assurance of competitive efliciency
to new individuals. Share price, or that among corporate managers and thereby
part reflecting managerial efficiency, also affords strong protection to the interests
measures the potential capital gain in- of vast numbers of small, non-controlling
herent in the corporate stock. The lower shareholders. Compared to this mecha-
the stock price, relative to what it coulcl nism, the efforts of the SEC and the
be with more efficient management, the courts to protect shareholders through
more attractive the take-over becomes to the development of a fiduciary duty con-
those who believe that they can manage cept and the shareholder's derivative
the company more efficiently. And the suit seem small indeed. I t is true that
potential return from the successful take- sales by dissatisfied shareholders are
over and revitalization of a poorly run necessary to trigger the mechanism and
company can be enormous.13 that these shareholclers may suffer con-
Altlditional leverage in this operation siderable losses. On the other hand, even
greater capital losses are prevented by
" "Outsider" here refers to anyone not presently the existence of a competitive market for
controlling the affairs of the corporation, even
though it m:ly include one or more individuals on the
corporate control.14
cor~~oration'shoard of directors. l 3 The clearest modern illustration is p r o l ~ a l ~ l y

l2 T othe extent that executive compensation in- furnished by Louis iVolfson's successful venture into
creases n i t h higher share prices, the take over is lLIontgomery Ward. For details of this and other
most attractive a t the time when it is also most ex- large stock price gains associated with corporation
~xmsiive.Indeed, the danger of a take over may ac- "raids" see David Karr, Figlit for Cofztrol (Nelv
count lor managers' voluntarily decreasing their York: Ballantine Books, 1956).
com~>ens,ttionwhen the company's share price is l 4 Unfortunately the suppression of this market
do'i\n. ~vouldbe the consequence of propos:~lsmnde by sev-

There are several mechanisms for tak- stitute only a small percentage of threat-
ing over the control of corporations. The ened fights.16 The parties will generally
three basic techniques are the proxy prefer to negotiate a settlement in ac-
fight, direct purchase of shares, and the cordance with their respective strengths
merger. The costs, practical difliculties, than incur the costs of soliciting proxies.
and legal consequences of these ap- T h e more reliable the information about
proaches vary widely. The selection of relative strengths available, the more will
one or another or some combination of settlement be likely to occur. This sug-
these techniques frecluently represents a gests that proxy fights will be relatively
difficult strategy decision. An attempt more common when there is widespread
will be made in this paper to analyze distribution of the company's shares than
some of the considerations involved in a when there are relatively large holdings.
selection of one device over another. I n a number of cases the outsider
would probably like to own more shares
PROXY FIGHTS and take over control without waging or
The most dramatic and publicized of threatening a prosy fight. But if he is
the take-over devices is the proxy fight; unable to accumulate sufficient capital to
it is also the most expensive, the most purchase control directly, he may settle
uncertain, and the least used of the vari- for half a loaf. I n effect he indicates his
ous techniques. Indeed it is somewhat willingness to share the capital-gain po-
difficult to describe the necessary condi- tential with all other shareholders in ex-
tions under which a proxy fight rather change for enough of their votes to put
than some other take-over form will be him into control.
indicated. A\t first blush, the proxy fight When a proxy fight is announced, the
appears to be inexpensive since one does shares tend to rise in price, reflecting a
not have to own a large number of shares rise in both the market value of the vote
(or for that matter any shares) in order and the discounted value of potential
to wage a fight. But this fact is most gain in the underlying share interest if
relevant when the take-over is for the ' T h e courts draw a similar distinction for pur-
purpose of gaining the incumbents' com- poses of determining when contestants in a proxy
fight may recover their expenses from the corporate
pensation. If the outsider wants capital treasury. Generally they may recover if the contest
gains, he will be interested in owning is found to 1)e one of policy rather than a "purely
more, not fewer, shares. This suggests personal power contest" (Rosenfeld v. Fairchild
Engine & Airplane Corp., 309 N.Y. 168, 129 N.E.
that proxy fights will be relatively more 2d 291 [1955]). I t does not seem t o be too difiicult,
often used when the issue is not one of however, to establish the existence of a "policy"
controversy to the court's satisfaction.
management policies but of distribution
"'n the SEC's fiscal year 1962 seventeen com-
of insiders' compensation.15 panies were involved in proxy contests, while a total
Even as a device for settling internal of 253 persons, both management and non-manage-
ment, filed statements a s participants. The respec-
power struggles, actual proxy fights con- tive figures for 1961 were t h i r t y - t \ \ ~proxy contests
a n d 463 participant filings. Many non-management
era1 \\riters in the field. For a review and a criticism filings are multiple; that is, several people are in-
of this literature see Henry G. Rfanne, "The 'Higher volved in the same fight. But no breakdonn beyond
Criticism' of the Modern Corporation," Colz~mbia the total number of participants is available. There-
Law Review, L X I I (1962), 399-432. For another de- fore, it is impossible to prove the point made in the
fense of this market see Harry G. Johnson, The text from pul~lisheddata. See 27th and 28th A rzizzral
Canadiaiz Qzratzdary (Toronto: hlcGralv-Hill Book Reporls (Washington : Securities and Exchange Com-
Co., 1963), pp. xvii-xviii. mission, 1961 and 1962).

the outsider wins.17 Other outsiders will soliciting proxies. But while the incum-
fincl it in their interest to retain their bents finance the bulk of their proxy
shares or purchase shares, to vote for the solicitation expenses from corporate
outsider seeking control, and to share in funds, the outsider will have this aclvan-
the capital appreciation. I t may be tage only if he wins.18
cheaper to elicit the support of these
voters through expenditures on persua- DIRECT PURCHASE OF SHARES
sion than through outright purchase of The second mechanism for taking over
the shares. But to the outsider seeking control of a corporation is the direct pur-
control, every voter represents another chase of the requisite number of shares of
person with whom he must share the the corporations. There are several tech-
potential gain resulting from his more niques that may be usecl in the direct
efficient management. These voters are
analogous to, or substitutes for, the capi- l8 The SEC rules on proxy solicitations have aid-

tal or credit with which the outsider ed the insiders in unexpected and curious mays.
Outsiders in a proxy fight are not privy to the par-
would otherwise purchase control di- ticulars of corporate information as are the insiders,
rectly. so they must frequently "guess" u hy the company
Proxy-fight expenses have always in- is not doing as \\ell as it should. These "guesses" will
take the form of l~roadaccusations and innuendoes
cluded direct expenses of mailings, ad- directed at the incum1)ents. Outsiders nould like the
vertising, telephone calls, and visits to opportunity to include in their proxy solicitation
large share!lolclers. But since the Securi- such general statements as "the incumbents are
wasting corporate assets"; "the incuml~entsare pay-
ties Exchange Act of 1934, the cost of ing themselves fraudulently high salaries"; or "the
waging a proxy fight has probably in- officers of the company have been negligent in failing
to acquire new opportunities for the corporation."
creased substantially. Prior to the act, the The SEC generally refuses to allow such statements
proxy system operated largely through to be mailed to shareholders unless the insurgents
broker intermediaries acting as full can prove the truthfulness of the allegations. Fre-
quently there is no way the insurgents can find that
agents for the beneficial owners of the proof, short of discovery proceedings in a suit,
shares. To the brokers was delegated not though they might in all good faith suspect the facts
merely the ministerial job of voting but alleged. Therefore, the practice has developed of fil-
ing shareholder derivative suits when a proxy fight
the more important responsibility of de- is decided upon. Then the solicitation materials may
ciding how to vote. That practice has legally say, "4 shareholder's derivative suit is pres-
been largely replaced because of the SEC ently pending in the Federal District Court for the
Southern District of New Pork charging the oflicers
philosophy that the proxy system should and directors with waste of corporate assets"; or "a
duplicate actual meetings of shareholders suit to force the officers to pay back part of their
as closely as possible. Thus, today, "giv- salaries has been filed by a shareholder in Dela-
mare", etc.
ing a proxy" is really tantamount to vot- Not only has the Securities Exchange Act in-
ing. And, since the shareholder himself is creased the cost of naginga proxy fight l~ecauseofthe
additional materials that must be cleared through
voting, it is also felt that he should be the SEC, but it has also increased uncertainty be-
fully and truthfully informed about all cause of the panoply of SEC regulations. For in-
aspects of the corporation's affairs. This stance, the Chicago and North Western Railroad's
successful fight against the Union Pacific's first bid
has tremendously increased the cost of for control of the Rock Island Railroad was recently
voided on the grounds, among others, that unsolicit-
l7 See Henry G. LIanne, op. cit., pp. 410-13. I t is ed advice by a broker to his customer advising ac-
possible, of course, for the vote price to be rising ceptance of the C. & N.W.'s offer constituteti an
while the market value of the underlying investment illegal solicitation of proxies (Union Pacific Railroad
interest is declining, though this would seem to be Company v. Chicago and North \Vestern Railnay
uncommon. Company, 226 F. Supp. 400 [N.D., Ill., 19641).

purchase of shares. The most obvious is in equity to all of the shareholders. As a

outright purchase on the open market of general proposition, the courts have re-
the requisite percentage of shares.lg The fused to follow this thesis; and there are
outsider might also try to buy the shares numerous judicial statements to the ef-
from large individual owners, thus pre- fect that one may claim a premium for
serving secrecy and allowing negotiation control.21
on price. Finally, he may make a bid for X number of legal writers, following
tenders, that is, a request that share- Berle, continue to press for a rule of
holders make an offer to sell their shares equality in share purchase price when an
to him a t a certain price, usually above outsider buys control in a c ~ r p o r a t i o n . ~ ~
the market. This last form of direct pur- The economic results of such a rule could
chase is most apposite when the shares be most unfortunate. Many holders of
are widely held and there is a chance of a
20 Adolf A. Berle and Gardiner C. Means, T h e
fast increase in market price if the news Modern Corporation and Prirate Property (Yen
spreads that there is a heavy buyer in the York. hlacmillan Co , 1933), p. 244; 4doli X Berle,
market for the company's shares. A ten- '' 'Control' in Corporate Lan," Colzi~nbiaL a w Ke-
view, LVIII (1958), 1212-25, esp 1221.
der bid is usually stated to be effective
21 The difficult cases have been those in which
only if a minimum percentage of shares control carried with it peculiar advantages not nor-
is offered a t the announced price. Also, mally assumed to be part of the standard compen-
the bid will ordinarily be for less than 100 sation of corporate managers. The problem is illus-
trated by the now classic case of Perlman v. Feld-
per cent of the shares in order to avoid mann, 219 F. 2d 172 (2d Cir., 1955), in which only a
the problem of many individual share- controlling block of shares was purchasetl, but a t a
holders trying to be the sole hold-out. I n price reflecting the value of the right to allocate the
company's steel production to the purchaser a t a
practice, private negotiation for large time when quasi-oKicial price controls existed. The
blocks of shares may be combined with court found the control seller liable to the other
either open-market purchases or a tender shareholders for a part of the premium received over
the normal market price of the shares. The most con-
bid. vincing factor, not emphasized by the court, was
There are few serious legal problems that the company had probably been receiving a full
with any of the direct purchase tech- free-market price for its steel, with the difference
over the controlled price taken in the form of inter-
niques. I n fact, about the only one which est-free loans and guaranteed future orders. Indica-
has arisen with any regularity in recent tions were that the new controllers woultl sell to
years results from Professor Adolf A. themselves at the "quasi-legal" price and discon-
tinue these other valuable practices. Thus the pre-
Berle's contention that control is a cor- mium paid for the control block of shares was given
porate asset.20 The implication of this partly in exchange for a right more appropriately
notion is that any premium received by thought of as belonging equally to each share than
to the control group. That is, if a "gray-market"
an individual for a sale of control belongs profit was to be made, it should go to all the share-
holders. The court was explicit, however, that the
l9 This percentage may range from less than 51
seller could retain that part of the premium received
per cent if the purchaser is only interested in estab-
lishing a fountlation for a proxy fight; to 51 per cent for control not covering the power to allocate steel.
when only simple control is desired; to 66%or 75 per 22 Richard W. Jennings, "Trading in Corporate
cent, nhen state lam requires that percentage for Control," C a l i j ( ~ r n i aLard Kcziew, XLIV (1956), 1-
approval of a merger or reorganization; to 80 per 39; and Noyes Leech, "Trensactions in Corporate
cent, the figure required for consolidation of income Control," linirersity (,J I'eiz~zsylrania L a w K e r i c ~ ~ ~ ,
statements under the Internal Revenue Code as CIV (1956), 725-839. For a sharply opposing view-
well as for tax-free reorganizations; to 90 per cent, point see Wilbur G. Katz, "The Sale ol Corporate
the figure required for simplified mergers of subsidi- Control," Cl~icagoB a r Record, XXXVIII (1957),
aricq into parent companies in Delanare (95 per cent 376-80; also Alfied Hill, "The Sale of Controlling
in T<en York); or 100 per cent if no minority inter- Shares," I l a r ~ a r dLow Reriew, L X X (1957), 986-
ests are wanted. 1039.
control blocks of shares would refuse to a merger requires the explicit approval of
sell a t a share price which did not pay those already in control of the corpora-
them a premium a t least sufficient to t i ~ n . And
~ " most statutes require more
compensate them for the loss of net than a simple majority vote by share-
values presently being received from holders to effectuate a merger. If the
their position in the corporation. If all merger occurs after an acquisition of
non-controlling shareholders must ac- shares in a tender bid, then the tender
cordingly be paid a premium over the bid and not the merger is the actual
market price of their shares, then in a mechanism for changing control.
substantial number of cases the purchas- The requirement of management's ap-
er will not conclude the bargain. This proval for a merger generates some pecul-
further suggests that, if control is secure- iar results. Generally speaking, manag-
ly held in one block, the "market price" ers' incentives and interests coincide
of traded shares is the price for an under- with those of their shareholders in every
lying share interest without an aliquot particular except one: they have no in-
portion of control. That is, if one person centive, as managers, to buy manage-
owns 51 per cent of the shares of a com- ment services for the company a t the
pany, nothing will be paid for the vote lowest possible price.25Even if the mar-
attached to the other shares,23no matter ket for corporate control is working per-
how actively the shares may be traded fectly, so long as the cost to the corpora-
on the market. The less securely control tion of the incumbent managers' ineffi-
is held in one block, the more likely are ciency is below the cost to an outsider of
non-controlling shareholders to partici- taking over control, the insiders will re-
pate in the "premium," and the less will main secure in the positions with pro-
an outsider be willing to pay one share- tected high s a l a r i e ~ . ~ "
holrler for control. Both proxy fights and I n the case of tender bids, as we have
competitive tender bids are more likely seen, a preniiuln for control rnap be paid;
to occur under these conditions, since and in the proxy fight situation, in one
each of them gives shareholders the
power to sell their votes at a premium. Z4There is a slight possibility that outsitlers
might be able to force a merger vote by shareholders
under the Securities Exchange Act's "Stockholtler's
Proposal" Rule, although the SEC seems to take the
The third major mechanism for taking position that such a proposal may only be advisory,
not mandatory, on the board, if passed. See Louis
over control of the corporation is the Loss, Seczlrities Kegzrlatiorz (Boston: Little, Brown &
merger. Here, by definition, the acquir- Co., 1961), p. 908.
ing concern will be a corporation and not the extent that the same indivitluals are
an individual, and the medium of ex- also shareholders, their motivation will reflect a
change used to buy control will typically conflict. If their ownership interest is great enough,
they may sacrifice the emoluments of management
be shares of the acquiring company rath- in order to improve their position as shareholders.
er than cash. Another major difference The decision will simply reflect the greater of the
between the merger and other take-over two conflicting interests.
forms is that, almost without exception, 26 This may furnish some proof for the notion that
executive compensation is a function of size. If the
2 3 This holds true only to the extent that 51 per cost of taking over control is a function of the num-
cent is the relevant majority. If a higher percentage ber of shareholders, as it certainly is in the case of
is necessary for some purpose, minority votes xi11 proxy fights, it is likely that managers may be able
have some value so long as the requisite percentage to claim larger compensation to the extent of the
is not already controlled. higher cost to outsitlers of buying control.

sense a t least, the premium is paid in the There is still another very important
form of expenditures necessary to per- reason why mergers may be more desir-
suade shareholders to vote a certain way. able than proxy fights or take-over bids
But the merger has considerable cost ad- as a way of operating in the corporate-
vantages over the other two forms of control market. This is a market in which
take-over, not the least being the ability reliable information about valuable op-
to use shares rather than cash as the pur- portunities will be extremely difficult to
chasing medium. discover. For reasons already mentioned,
The shareholders should ordinarily be the corporate insiders will generally have
willing to accept any offer of a tax-free no incentive to advertise this kind of in-
exchange of new marketable shares worth formation. Blatant cases will, of course,
more than their old shares. But the man- be evident from casual observation of
agers are in a position to claim almost the industrial affairs and the stock market.30
full market value of control, since they The great problem in the corporate-
have it in their power to block the merger control market is finding reliable infor-
by voting against it.27 When we find mation about new opportunities. There
incumbents recommending a control have generally been a few individual
change, it is generally safe to assume that operators in this market, and perhaps
some side payment is occurring. they have found the more obvious cases
Side payments are often not simple of bad management. But to guarantee
transactions a t law because of the rule effective cornpetitition in the market for
that directors and officers may not sell corporate control, it seems clear that cor-
their positions shorn of the share interest porations must be allowed to function
necessary to insure a transfer of control.28 therein. Managers of a competing firm,
The most obvious kind of side payment unlike free-wheeling individual partici-
to managers is a position within the new pants in the market for corporate con-
structure either paying a salary or mak- trol, almost automatically know a great
ing them privy to valuable market infor- deal of the kind of information crucial to
m a t i ~ n .This
? ~ arrangement, easily estab- a take-over decision. Careful analysis of
lished with mergers, can look like normal cost conditions in their own firm and the
business expediency, since the argument market price of shares of other corpora-
can always be made that the old manage- tions in the same industry will provide
ment provides continuity and a link with information that can be relied upon
the past experience of the corporation. with some degree of confidence.
Since, in a world of uncertainty, prof-
2 7 The greater the shareholdings of mangement,
the more likely they are to approve a merger offer
itable transactions will be entered into
with little or no side payment.
30 The most obvious example is that of a corpora-
28 Essex TJniversal Corp. v. Yates 305 F.2d (2d tion whose total assets in liquidation would be n o r t h
Cir., 1962). more than the aggregate market value of all of its
29 See, e.g., Smith v. The Good hlusic Station, shares. This situation can continue to exist only be-
129 .\.2d 242 (Del. Ch. 1957), and Borak v. J. I. cause no individual shareholder believes there is any
Case Co., 317 Fed. 2d 838, a t 844 (7th Cir., 1963), way of claiming the premium, since the managers
aff'd 377 C.S. 426 (1964). There are no reported will take no stel) toward liquidation and there is no
cases of differential numbers of shares being offered indication that the corporation will not continue to
controlling and non-controlling shareholders in a be badly run. Perhaps the classic case of this sort was
merger. Such a n arrangement may be illegal under the take-over by Louis Wolfson of the Capital
state statutes, ant1 it is not likely to receive the high- Transit Corporation. For this and other examples
majority-share vote required for most mergers. see Karr, op. cit., p. 150.
more often by those whose information corporate control implies a number of
is relatively more reliable,31it should not important advantages which must be
surprise us that mergers within the same compared to those existing in present
indostry have been a principal form 041
antitrust enforcement. Among the ad-
changing corporate control. Reliable in- vantages of the former, as we have seen,
formation is often available to suppliers are a lessening of wasteful bankruptcy
and customers as well. Thus many verti- proceedings, more efficient m a n a g e m e ~ t
cal mergers may be of the control take- of corporations, the protection afforded
over variety rather than of the "fore- non-controlling corporate investors, in-
closure of competitors" or scale-econo- creased mobility of capital, and generally
mies type. Undoubtedly many more merg- a more efficient allocation of resources.
ers, both horizontal and vertical, would The greatest dificulty in assessing the
have occurred but for our antitrust laws. proper role for the market for corporate
The managers of corporations have con- control comes in the area of horizontal
siderable incentive to exploit such oppor- mergers, where, as previously indicated,
tunities for their corporation, just as theythis market may operate most effective-
are motivated to find any good new in- ly.32I t may be that, so long as entry into
vestnient opportunity. Alnd there are an industry is kept open, there is no rea-
both legal and practical barriers to the son a t all for rules against mergers, a t
individuals' utiliaing such opportunities least short of a monopolization charge
for themselves. under Section 2 of the Sherman 4 c t . I t
is extremely unliliely, however, that Con-
gress or the courts would ever adopt such
Mergers seem in many instances to be a rule,
the most efficient of the three devices for F~~more likely is an ad jzoc recognition
cor~oratetake-overs.Consecjuentl~,tlley of the importance of the market for tor-
are of consiclerable importance for the porate control ill individual cases,33
protection of individual non-controlling courts or agencies might begin to look
and are a a t such factors as the average life cycle
general welfare-economics point of view. of firms in tile industry, the amount of
Certainly they are than total new investment in the industry, the
the increased number of bankruptcies condition of the acquired firms in terms
that would undoubtedly ensue if this both financial and managerial
avenue of taking over control were total- strength, the number of bankruptcies in
ly closed. the industry, and the amount of prosy-
This is not to suggest that the anti- fight and tender-bid activity. These fat-
trust norm of competition in the product
market need be entirely sacrificej to the 3 T h e case for a free market in corporate control
as between supplier and customer firms seems quite
norm of in the market for strong, since the arguments in favor of present anti-
corporate control. Rather it points up merger policy are perhaps neakest there. See Robert
some of the serious problems ,Tith cur- Bork, "Vertical Integration and the Sherman Act:
The Legal History of an Economic hlisconception,"
rent antitrust doctrine. The market for rn;;,r,ity o j c C l ~ i c a g o L a w R e v i e w , X X I I ( 1 9 5 4157-
31 Cf. H. B. Ilalmgren, "Information, Expecta-
tions, and the Theory oi the Firm," Qitarterly Jour- 3 3 This might he clone either through the resurrec-
nal of IEco)tontics, L X X I S (1961), 399-421; and tion oi the "business-purpose" doctrine or, in Clay-
George J. Stigler, "The Econonlics of Inforn~ation," ton Act cases, by beefing up the "solely-for-invest-
Joitrnal o j Politicul Economy, 1,XIX (1961), 213-25. ment" proviso. See n. 5 ahove.
tors would then have to be weighed on The price of the shares of the acquiring
the scales with the more traditional ap- company in such a merger should then
proach in terms of number of firms in the tend to decrease and those of the
industry, concentration ratios, size of the acquired company to increase upon the
acquiring firm, and its acquisitions his- announcement of the merger. If, on the
tory. But no longer does the tendency to other hand, the merger is motivated by
hold most mergers illegal per se seem a quest for market power, or by econo-
justified. mies of scale available to both corpora-
One real problem will be in devising tions, then the price of stock of each com-
statistical methods for distinguishing pany should increase on the announce-
mergers motivated by a quest for monop- ment of the merger terms. The first of
oly profit from those merely trying to these two results conforms to what seems
establish more efficient management in most frequently to occur when mergers
poorly run companies. But if the theo- are announced, though no data arc pres-
retical aspects of these transactions are ently available on this subject.34 The
well enough understood, this should not study of the economics of the market for
be insuperable. There may be different corporate control is still in its infancy.
effects on the prices of shares depending
3 4 A study of the effect of mergers on stock prices
on the motive behind the merger. In the has heen con~pletedby the staff of the Su1,committee
normal merger for accluisition of control, on Anti-Trust and hlonopoly of the Senate Judiciary
something will be paid by the acquiring Committee. T h a t study was unavaila1)le a t the time
of writing this article.
company for the control opportunity. Another possihle approach to proof in this area is
Since this factor does not figure largely to determine if actual changes in the management
in the market price of even badly run personnel ultimately follow the merger. I n mergers
for market power, there is little reason to believe
companies until the possibility of a take- that this will occur very quickly; whereas, if the posi-
over is known, the exchange ratio in the tion is in the nature of a side payment, as it would
merger will appear to be too favorable to be if the merger was motivntetl more 1)y the control
potential. Lve might antici!)ate some\vhat eltrlier
the L ~ c ( I ~ i~~vcl dn l ~ d l ~j iy~,l l ~ c l( l~ ythe efforts to "ease out" the old managers oi the
relative premerger announcement prices. acquirctl compnny.