VIEWPOINTS : MERGER MANIA MAKES ECONOMY ITS VICTIM : Wall Street--Not Main--Benefits From Buyouts

Corporate deal-mania has raged at an unprecedented, accelerating pace for nearly a decade. Since 1980, the cumulative value of mergers, acquisitions, takeovers and leveraged buyouts, friendly and hostile, has topped two-thirds of a trillion dollars.

But who benefits from this voracious feeding frenzy? Who really wins?

Not the typical small stockholder. Trotted out as the prime beneficiary in whose name the game is played, small stockholders, on balance, are not winners. In fact, they lose in a variety of ways.

According to the Center for the Study of American Business and other researchers, the stock value of acquiring firms typically falls--an average of 1% to 7% in the first year, and a cumulative 16% over the three years following corporate takeovers. This fact is not disputed, even by apologists for takeovers.

Typically, these declines cancel out any gains in the stock value of target firms at the time of takeover. Murray Weidenbaum reports that “the data do not support the notion that owners of acquiring firms generally benefit from takeovers. The available evidence of aggregate returns further suggests that acquiring-firm losses, on average, are large enough to completely offset the gains made by owners of target firms.”

Nor are leveraged buyouts (LBOs) a boon to small stockholders. When publicly held companies are bought up and taken private by a coterie of insiders, only to be later sold back to the public, the small investor is seldom in on the bonanza.

For example, Gibson Greeting Card Co. was taken private in 1982 by a group that paid stockholders $80 million; a year and a half later, the firm was sold to the public for $290 million--more than threefold what was paid to the original stockholders. In a recent sample of LBOs, the difference between the value paid to stockholders, and the value obtained when the assets were later taken public, amounted to 281% on average--spectacular gains which didn’t accrue to small stockholders.

Nor are small bond holders winners in corporate deal-mania. Bondholders are also losers when high takeover premiums, high debt-equity ratios and astronomically high fixed-interest charges combine to degrade the quality and value of their holdings.

In the aftermath of the recent buyout of Colt Industries, for example, the firm’s outstanding long-term bonds plunged as much as $200 for every $1,000 in face value. With bond rating agencies like Moody’s and Standard & Poor’s downgrading record numbers of corporate bonds in recent years, one analyst concludes that deal-mania is “slaughtering” bondholders.

Taxpayers also lose in deal-mania. The structuring of corporate deals to take advantage of tax loopholes and to obtain tax-free financing is hardly good news for the taxpaying public, which must make up for these tax losses (or add them to the monumental national debt). The fact that some commentators attribute the recent crash on Wall Street to congressional legislation that would eliminate these loopholes is significant. It attests to the magnitude of the benefits to deal makers and the tax burden to the general public.

The U.S. economy is another loser. A raft of empirical studies, in scholarly journals and influential business periodicals, shows that merger and takeover mania undermines production efficiency and obstructs technological innovation.

The high post-merger failure rate--40% or more of the corporate marriages consummated during the 1970s--is especially damning in this regard. So, too, is the track record for leveraged buyouts, where (according to the Congressional Research Service) for every anecdote describing efficiency gains, there are counterbalancing examples of deteriorating company performance under the burden of crushing debt loads.

The economy also suffers as the explosion of corporate debt and junk bonds generated by deal-mania undermine economic stability and erode the economy’s general capacity to withstand downturns in the business cycle.

Most destructive, perhaps, is the diversion of hundreds of billions of dollars into sterile paper entrepreneurialism away from the critically important task of investing in new plants, new products, new state-of-the-art manufacturing technologies and new jobs.

Who, then, are the winners? For whose benefit is the merger and takeover game played?

The lion’s share of the mind-boggling booty, it seems, is primarily captured by a small number of greed merchants on Wall Street--investment banks, corporate executives, professional arbitragers, and (at times) criminally culpable inside traders.

A handful of investment banks dominate the business of deal making. Last year, for example, the 10 largest deal-brokers arranged a total of 1,051 deals, with a combined value of $314 billion. According to one count, the three leading investment banks handle one-third of the very biggest deals, while the seven largest together handle 60%.

For this select group, deal-mania is a rapidly expanding and highly lucrative enterprise. They put companies “in play”; they profit when deals are put together, and they profit when deals are later undone. Through buyouts and “reverse” buyouts, they suck in the public’s money, then squeeze out the public’s participation. They operate perpetual motion money machines, in which their profits provide the base for carrying out the next round of deals.

Consider the Beatrice buyout in 1986. Who were the gainers? Drexel Burnham, providing junk bond financing for the deal ($86 million in fees, plus projected profit of $810 million); Kohlberg, Kravis, Roberts & Co., arranging the buyout ($45 million in fees, plus projected profit of $2.4 billion); Kidder, Peabody & Co. advising Kohlberg Kravis ($15 million in fees); Lazard Freres & Co., advising Beatrice ($8 million in fees), and Salomon Bros., advising Beatrice ($8 million in fees).

For these five participants, the fee package alone amounts to $230 million. For just two of them, projected profits amount to $3.2 billion . Top management also appears to do quite well in deal-mania.

In the Beatrice deal, the firm’s former chairman will receive $20 million in fees, plus a $1.3 million annual salary, plus projected profit from the deal of $277 million. The chairman of dressmaker Leslie Fay netted $60 million on his initial buyout investment of less than $1 million. The chairman of Uniroyal expects to receive $20 million on his buyout investment of less than $750,000. And the chief executive of Metromedia has garnered personal profit of about $3 billion--without investing any cash at all.

Other “prescient” persons also do well. According to an SEC study , the stock prices of target companies exhibit abnormal gains more than three weeks before deals are publicly disclosed. Those able to gorge themselves on such stocks at bargain basement prices--long before deals are announced--can be presumed to benefit handsomely. It is a loop that does not include the small investor.

Let’s face it. Deal-mania is a finance-driven game that benefits the razzle-dazzle artists on Wall Street, not the little investor on Main Street.