There are markets for products, and there are markets for corporate control. Markets for products determine which products will continue to be offered to consumers. Some products remain successful for a long time. Oreo cookies come to mind. Some products are failures. Edsel Ford is more than the name of a Detroit expressway. The market for corporate control determines what happens to the gains or losses from selling products. Losing managers get fired (absent clever accounting or government guarantees.) It does not follow, however, that succesful managers get to keep their jobs. Perhaps their staid products lose their appeal. Perhaps their strong cash position tempts more aggressive entrepreneurs who would like to deploy some of that wealth to develop new products. The right mix of staid and aggressive is difficult to characterize. We drive better cars and eat better food and post to the internet because somebody put money on projects that were by no means sure things. (Otto cycle engine? Watering troughs and collieries can't service it. Make milk safer by heating it? It spoils if it's not cooled. A computer on everybody's desk? There's work for ten mainframes, tops.)
Thus the 20th anniversary edition of Barbarians at the Gates: The Fall of RJR Nabisco
is more than a populist tract about capitalist abuses, as Book Review No. 48
will argue. The protagonist of the story is an ambitious Canadian, Ross Johnson, who can't leave well enough alone, but he spends his working life in businesses that produce a mix of staid products that sometimes throw off piles of cash. he works his way to the top at Standard Brands
. The name is vaguely Stalinist, and the product offering, including Standard margarine, Chase and Sanborn coffee, and "Baby Ruth" and "Butterfinger" candy, is Fifties bland. Boring, possibly on a glide path to oblivion. Mr Johnson arranges a consolidation with National Biscuit, now known as Nabisco
. Although Ritz crackers and Oreo cookies continue to be standards, the company's original hit, Uneeda Biscuit
, is these days a retro product. Again, there are opportunities to build bigger empires. Thus comes the merger of Nabisco with R. J. Reynolds
, a company generating lots of cash from cigarettes. A pile of cash held by a manufacturer of a product in a declining market is a target for a raider, and also an opportunity for the management to diversify. Consider Philip Morris
, currently only a tobacco products company, but at one time diversified into all manner of consumer products, so aggressively that a number of antitrust observers suggested it was using its tobacco profits to subsidize predation in other markets. A more charitable interpretation would recognize that the prospects for additional investment in tobacco were less promising than, oh, brushless shaving cream
Reynolds, however, was a staid Moravian company (the things you learn: also the etymology of Wachovia Bank
) not interested in such things. Enter Mr Johnson with a wad of cash, and thus emergeth RJR Nabisco. And now the troubles begin: the Johnson business model, if there is one at all, is Not. The. Moravian. North. Carolinian. Way. Thus come struggles with the combined board of directors, and ill-advised product development, and a stable of athletes on retainer for promotional purposes, and falling stock prices.
Here, the market for corporate control goes to work. The management can take the company private and get out from under the pressure of the quarterly earnings report. But to do so runs the risk of putting the company in play, as others can offer to buy the stock. Enter Kohlberg Kravis Roberts
, and something called the leveraged buyout. A passage on page 235 of the book spells out the tradeoffs. On one hand, the firm that arranges the buyout might work with the management to improve earnings, later to sell the stock at a capital gain. On the other hand, the buyout provides earnings, called fees, to the buyout firms, the investment bankers, and the bond specialists. And the leverage can take the form of exotic securities including the so-called "junk" bonds (not always correctly collateralized, but sometimes graded as more risky than they truly are) and payment-in-kind securities (your interest is yet another bond, leading one wag to invent the subordinated perpetual zero coupon that pays no interest and never matures) and other financial exotica. And yes, people get hurt, particularly when the company hives off assets and fires people to free cash to retire the debt.
The focus of Barbarians
, however, is on the human drama. There is no economic model spelling out an optimal trade-off between continuity and creativity. We rely on free agents to grope toward that solution. When those free agents are people with large egos, little previous experience with disappointment, and trophy wives to appease, bad things can happen. Often they do.
Thus the story. Anyone who has spent any time in a faculty meeting might draw some solace from the Biggest Transaction Of The Era bogging down over the minimum distance an employee must move to be eligible for a relocation allowance (hint: Winston to Salem didn't qualify, that wasn't the Moravian Way). God and Mammon might be at odds, with Mr Johnson giving the three rules of Wall Street (p. 492) as "Never play by the rules. Never pay in cash. And never tell the truth." That's after he got his comeuppance. The story hints at the comeuppance for the MBAs, something that has yet to run its course. And the Afterword (this being a 20th anniversary edition) reports that some of the trophy wives learned that they, too, were depreciating assets. (No spoilers here: but you might want to treat the book like a detective novel and keep a mental divorce pool as you go through it.) Great fun, if not necessarily the best (or the final) analysis of the market for corporate control.
(Cross-posted to Cold Spring Shops