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⁴ This proposition should be familiar to those who know Ronald Coase's work. See especially, The Firm, the Market, and the Law (Chicago, Ill., 1988)Google Scholar.

⁵ Acquisition strategies also broaden managerial career opportunities; see Kaufman, Allen and Kaen, Fred, “The Work of Managers,” American Business Review 4 (1986): 25–31Google Scholar.

⁶ For a general discussion of these concerns and rules, see Roe, Mark J., “Political and Legal Restraints on Ownership and Control of Public Companies,” Journal of Financial Economics 27 (1990): 7–41.CrossRefGoogle Scholar

⁷ Davidson, Megamergers, 137-45; and Ravenscraft, David J. and Scherer, F. M., “Mergers and Managerial Performance,” in Knights, Raiders and Targets: The Impact of the Hostile Takeover, ed. Coffee, John C. Jr., Lowenstein, Louis, and Rose-Ackerman, Susan (New York, 1988), 194–210.Google Scholar

⁸ For an elaboration of these issues, see Conrad, Alfred, “Beyond Managerialism: Investor Capitalism?” University of Michigan Journal of Law Reform 22 (1988): 117–78Google Scholar; and Black, Bernard S., “Shareholder Passivity Re-examined,” Michigan Law Review 89 (1990): 520–608.CrossRefGoogle Scholar For a general introduction to the problem of collective action, see Hardin, Russell, Collective Action (Baltimore, Md., 1982)Google Scholar.

⁹ Anders, George, Merchants of Debt: KKR and the Mortgaging of American Business (New York, 1992), 156, 39, xvi-xvii.Google Scholar Wall Street Journal reporter Anders was given access to KKR partners and documents and has recently published this first detailed inside look at KKR.

¹⁰ Bernstein, Peter L., Capital Ideas: The Improbable Origins of Modern Wall Street (New York, 1992)Google Scholar; “The Ebb Tide,” The Economist, 27 April 1991, 13-17; Whitley, Richard, “The Transformation of Business Finance into Financial Economics: The Roles of Academic Expansion and Changes in U.S. Capital Markets,” Accounting Organizations and Society 111 (1986): 171–89CrossRefGoogle Scholar, especially 171-80.

¹¹ Jensen, Michael C. and Meckling, William H., “The Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Journal of Financial Economics 3 (Oct. 1976): 305–60.CrossRefGoogle Scholar Berle, Adolf and Means, Gardiner in their classic work, The Modern Corporation and Private Property (1932; New York, 1968)Google Scholar, had already outlined this approach. For a discussion of the relationship between their work and modern financial theory, see Kaufman, Allen and Zacharias, Lawrence, “From Trust to Contract: The Legal Language of Managerial Ideology, 1920–1980,” Business History Review 66 (Autumn 1992): 523–72.CrossRefGoogle Scholar

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¹³ Michael Jensen defines the conflict of free cash flow in the following way: “Free cash flow is cash in excess of that required to fund all projects that have positive net present values when discounted at the relevant cost of capital. … Payment of cash to shareholders reduces the resources under managers' power and potentially subjects them to monitoring by the capital markets.” Michael C. Jensen, “The Takeover Controversy: Analysis and Evidence,” in Coffee, Lowenstein, and Rose-Ackerman, eds., Knights, Raiders and Targets, 321. For a technical discussion of this topic and how to evaluate net present value projects, see Rappaport, Alfred, Creating Shareholder Value: The New Standard for Business Performance (New York, 1986)Google Scholar.

¹⁴ Manne, Henry, “Mergers and the Market for Corporate Control,” journal of Political Economy 73 (1965): 110–20.CrossRefGoogle Scholar

¹⁵ See Kaufman and Zacharias, “From Trust to Contract.”

¹⁶ See the testimony of Stanley A. Kaplan and Robert H. Mundheim, in Full Disclosure of Corporate Equity Ownership in Corporate Takeover Bids, hearings before the Committee on Banking and Currency, U.S. Senate, 90th Cong., 1st sess., 1967, 132-39. Also, Manne, Henry G., “Tender Offers and the Free Market,” Mergers & Acquisitions 2 (1966): 91–95.Google Scholar

¹⁷ Manne, “Mergers and the Market for Corporate Control.” Manne's criticisms were later followed by similar critiques by economists of the Chicago School. For a review of this literature, see Davidson, Megamergers, 315-20; Garvey, George G. and Garvey, Gerald J., Economic Law and Economic Growth (Westport, Conn., 1990), 103–20Google Scholar; Tollison, Robert D., “Public Choice and Antitrust,” in Economic Liberties and the Judiciary, ed. Dorn, James A. and Manne, Henry G. (Fairfax, Va., 1987), 289–300Google Scholar; Waters, Timothy J. “Antitrust Law and Policy: Rule of Law or Economic Assumptions?” in Economics and Antitrust Policy, ed. Lamer, Robert J. and Meehan, James W. Jr., (Westport, Conn., 1985), 157–78.Google Scholar

¹⁸ For example, see Hawley, Ellis W., The New Deal and the Problem of Monopoly (Princeton, N.J., 1966)CrossRefGoogle Scholar, especially 404-19 and 456-71.

¹⁹ See Davidson, Megamergers, 109–12; Gaughan, Patrick A., Mergers and Acquisitions (New York, 1991)Google Scholar; Eisner, Marc Allen, Antitrust and the Triumph of Economics (Chapel Hill, N.C., 1991)Google Scholar.

²⁰ See U.S. House Antitrust Subcommittee of the Committee on Judiciary, Investigation of Conglomerate Corporations, Committee Print, 7 June 1971.

²¹ See Berg, Norman, “Corporate Role in Diversified Companies,” in Chandler, Alfred D. Jr., and Tedlow, Richard S., The Coming of Managerial Capitalism: A Casebook on the History of American Economic Institutions (Homewood, Ill., 1985), 756–65.Google Scholar

²² For a summary of these findings, see Ravenscraft and Scherer, “Mergers and Managerial Performance,” 194-210; Caves, Richard E., “Effects of Mergers and Acquisitions on the Economy: An Industrial Organization Perspective,” in The Merger Boom, ed. Browne, Lynn E. and Rosengren, Eric S. (Federal Reserve Bank of Boston, Oct. 1987)Google Scholar.

²³ This new learning had worked tirelessly to find theoretical and empirical flaws in the reigning structure/performance paradigm. For a summary of the debate see Davidson, Megamergers, 117-22. For an introduction to the new learning see, Eisner, Antitrust, and Adams, Walter and Brock, James W., Antitrust Economics on Trial: A Dialogue on the New Laissez Faire (Princeton, N.J., 1991)CrossRefGoogle Scholar. F. M. Scherer offers the standard structure-performance argument in his Industrial Market Structure and Economic Performance, 2d ed. (Chicago, Ill., 1980)Google Scholar. Perhaps the best single work synthesizing the advances in antitrust law was written by a managerial economist, Oliver Williamson. See his Markets and Hierarchies (New York, 1975)Google Scholar, particularly 155-233. See Stigler, George J., “The Theory of Economic Regulation,” Bell Journal of Economics and Management Science 2 (1971): 3–21.CrossRefGoogle Scholar

²⁴ House Committee on the Judiciary, Investigations of Conglomerate Corporations: Reports by the Staff of the Antitrust Subcommittee, 91st Cong., 1st sess., 1971, 5; Manne, “Mergers and the Market for Corporate Control,” 112-14.

²⁵ These arguments about the act's detrimental effects on the market for corporate control were raised during the Senate hearings. See U.S. Senate, Committee on Banking and Currency, Subcommittee on Securities, Full Disclosure of Corporate Equity Ownership in Corporate Takeover Bids, 90th Cong., 1st sess., 1967.

²⁶ There were two stages in state anti-takeover laws. In the first, in the late 1960s–early 1970s, states passed laws that required information disclosure by corporations operating within their boundaries. Courts found these laws unconstitutional, and they were replaced by corporate governance legislation that applied to firms either incorporated in or having a substantial business presence in a state. The courts have continually left such governance legislation to the jurisdiction of individual states. Commentators have equated this ubiquitous state legislation as a de facto national anti-takeover law. See Grundfest, Joseph A., “Subordination of American Capital,” Journal of Financial Economics 27 (1990): 89–114.CrossRefGoogle Scholar

²⁷ Chernow, Ron, The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance (New York, 1990).Google Scholar The 1907 congressional Pujo Hearings focussed on the “money trust” and warned of bankers' domination of American industry; see Richard H. K. Vietor, “Regulation and Competition in Commercial Banking,” in Vietor, Strategic Management, 397.

²⁸ Roe, “Political and Legal Restraints,” 11, 12-13; and McCraw, Thomas K., Prophets of Regulation: Charles Francis Adams, Louis D. Brandeis, James M. Landis, Alfred E. Kahn (Cambridge, Mass., 1984), 169–81Google Scholar; Vietor, “Regulation,” 411.

²⁹ Roe, “Political and Legal Restraints,” 12-13. Also, see Pateman Report, 1968, House Committee on Ranking and Currency, Subcommittee Staff Report, Commercial Banks and Their Trust Activities: Emerging Influence on the American Economy, 90th Cong., 2d sess., 1968; and U.S. Senate Committee on Governmental Affairs, Structure of Corporate Concentration: Institutional Shareholders and Interlocking Directorates among Major U.S. Corporations, Committee Print, 96th Cong., 2d sess., 1980, 1-20. Similar prohibitions exist for insurance companies. For example, New York regulations do not allow New York life insurers to put more than 2 percent of their assets into a single stock, while property and casualty insurers are prohibited from controlling a noninsurance company. Such laws appear to be typical for the industry. See Roe, “Political and Legal Restraints,” 14.

³⁰ A. A. Rerle made this case in his testimony before the House Committee on Banking and Currency. In it he recounted how banker control had periodically threatened democratic rule and how Congress has responded. Specifically, he warned that current laws would allow a zaibatsu system to emerge. “That means a feudal control of huge industrial combinations plus banks, analogous to what they have in Japan. It may be all right for Japan. I do not undertake to say. Here I think it is dangerous.” See, “Statement of A. A. Berle, Professor Emeritus, Columbia University,” House Committee On Banking and Currency, Bank Holding Company Act Amendments: Hearings, 91st Cong., 1st sess., 15-18, 21-25 April 1969, 9; for his summary of finance capital's threat to the economy and democracy, see p. 10. Also see Vietor, “Regulation,” 413.

³¹ Drucker, Peter F., “Reckoning with the Pension Fund Revolution,” Harvard Business Review 69 (March–April 1991): 106Google Scholar; and Blasi, Joseph Raphael and Kruse, Douglas Lynn, The New Owners: The Mass Emergence of Employee Ownership in Public Companies and What It Means to American Business (New York, 1991), 2.Google Scholar

³² These collective action problems arise out of “the vulnerability of voting rights, emptiness of shareholder proposal rights, liability of controlling persons, freezing stockholding, the forfeiture of short term gains and group filing requirements.” From Monks, Robert A. G. and Minow, Neil, Power and Accountability (New York, 1991), 279n3Google Scholar.

³³ Roe, “Political and Legal Restraints,” 15; Senate Subcommittee on Oversight of Government Management of the Committee on Governmental Affairs, The Department of Labor's Enforcement on Governmental Affairs, 99th Cong., 2d sess., Committee Print, 1986.

³⁴ Baker, George P., “Beatrice: A Study in the Creation and Destruction of Value,” Journal of Finance 47 (1992): 1081–1119, at 1105CrossRefGoogle Scholar.

³⁵ Ibid., 1105; Anders, Merchants of Debt, 119, 73.

³⁶ For a detailed discussion of how LBOs are arranged, see Congressional Research Service, Pensions and Leveraged Buyouts Prepared for the Subcommittee on Labor-Management Relations of the House Committee on Education and Labor, Committee Print, Feb. 1989, 36-39; and Gaughan, Mergers and Acquisitions, 269-99.

³⁷ Burrough, Bryan and Helyar, John, Barbarians at the Gate: The Fall of RJR Nabisco (New York, 1990), 133–34Google Scholar. In 1965 Kohlberg put together his first deal, which involved a $9.5 million acquisition of Stern Metals, a dental manufacturer. In this case, Kohlberg found a group of investors who, using other people's money, bought the firm from the seventy-two-year-old founder. The new owners left the family with a substantial equity holding and let them run the business. The family was so successful that when the investors sold their $500,000 investment to the public four years later, they garnered $4 million. KKR buyouts of family firms included Norris Industries (1981), Fred Meyer (1981), Dillingham Corporation (1983), and Cole National (1985).

³⁸ Linn, Scott C. and Rozeff, Michael S., “The Corporate Sell-Off,” in The Revolution in Corporate Finance, ed. Stern, Joel M. and Chew, Donald H. Jr., (Oxford, England, 1986), 428–36Google Scholar; Bartlett, Sarah, The Money Machine: How KKR Manufactured Power and Profits (New York, 1991), 78Google Scholar; Gaughan, Mergers and Acquisitions, 461.

³⁹ Burrough and Helyar, Barbarians, 134.

⁴⁰ Eccles, Robert G. and Crane, Dwight B., Doing Deals: Investment Banks at Work (Boston, Mass., 1988), 100–109Google Scholar.

⁴¹ See Hirschman, Albert O., Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States (Cambridge, Mass., 1970), 46Google Scholar.

⁴² Monks and Minow, Power and Accountability, 214.

⁴³ Ibid., 169; and Gaughan, Mergers and Acquisitions, 283-88.

⁴⁴ This description relies heavily on Jensen, Michael, “Eclipse of the Public Corporation,” Harvard Business Review 67 (Sept.-Oct. 1989): 68–70Google Scholar.

⁴⁵ See, for example, “Prospectus,” Safeway, Inc., 9 April 1991, 25-26; “Prospectus,” Duracell International, Inc., 1 April 1991, 24-25; “Prospectus,” AutoZone, Inc., 1 April 1991, 23-24. KKR delegates the monitoring of individual company financial progress to associates and junior partners who are each assigned one or two companies. This monitoring includes at least weekly conversations with company officials. Anders, Merchants of Debt, 178.

⁴⁶ For a discussion of how LBOs may lessen the cost of bankruptcy, see Jensen, “Eclipse of the Public Corporation,” 61-74; and “The Ebb Tide,” The Economist, 23-27. Kester, W. Carl, Japanese Takeovers: The Global Contest for Corporate Control (Boston, Mass., 1990), 69–75Google Scholar, describes how debt and interlocking directorates have provided incentives and a mechanism for Japanese banks to monitor a firm's financial situation carefully and to resolve difficulties promptly.

⁴⁷ For a discussion of the relative advantages of implicit as opposed to explicit contracts, see Milgrom, Paul and Roberts, John, Economics, Organization & Management (Englewood Cliffs, N.J., 1992), 132-33, 332–33Google Scholar. Oliver Williamson provides a similar framework in his analysis of transaction costs. See, in particular, his The Economic Institutions of Capitalism (New York, 1985), 68–84Google Scholar. For a game theoretic approach on the cost-saving advantages of trust, see Frank, Robert T., Passions with Reason: The Strategic Role of the Emotions (New York, 1988)Google Scholar.

⁴⁸ For a vertically integrated firm, internal pricing has been a consistent problem. Johnson, Se H. Thomas and Kaplan, Robert S., Relevance Lost: The Rise and Fall of Management Accounting (Boston, Mass., 1987), 125–46Google Scholar. Presumably, an LBO association ameliorates these cost accounting problems. Some vertically integrated firms have explored ways of creating internal markets to resolve cost accounting problems; Cypress Semiconductor provides an extreme case. See Richard Brandt, “The Bad Boy of Silicon Valley,” Business Week, 9 Dec. 1991, 64-70.

⁴⁹ Anders, Merchants of Debt, 51.

⁵⁰ “Presentation on Leveraged Buy-outs, by Kohlberg Kravis Roberts & Co.: Updated 1991” (mimeo), 1-1.

⁵¹ “Luring Banks Overboard?” Forbes, 9 April 1984, 39-42; Hayes, Samuel L. III and Hubbard, Philip M., Investment Banking: A Tale of Three Cities (Boston, Mass., 1990), 108–10Google Scholar; and Whitley, “The Transformation of Business Finance,” 180-83.

⁵² For a list of the holdings of the top ten banks in 1988 and their effect on the firm's financial vulnerability see Gaughan, Mergers and Acquisitions, 319; for a general discussion of the commercial bank role in placing highly leveraged debt, see ibid., 318-20. See also “The Anatomy of a Bank Syndication Deal,” Banker's Monthly, 21 Nov. 1989, 29-32, and “Bank Lending: Sobering Up,” The Economist, 21 Nov. 1989, 91-92.

⁵³ Congressional Research Service, Pensions and Leveraged Buyouts: Prepared for House of Representatives, Subcommittee on Labor-Management Relations of the Committee on Education and Labor, Committee Print, Feb. 1989, 24. The CRS found that there was no regular statistical reporting service providing data on pension fund LBO investments and no government requirements to do so on the financial forms that these funds must file with the Department of Labor. By 1989, private pension funds held $666.7 billion in equity, while state and local government pension funds held equity in excess of $290 billion, Monks and Minow, Power and Accountability, 183. Peter Drucker reports that pension funds held 40 percent “of the medium-term and long-term debt of the country's bigger companies.” See Drucker, “Reckoning,” 106.

⁵⁴ Monks and Minow, Power and Accountability, 187-88. For a discussion of the fiduciary standard in the law and its applicability to state investment funds, see Krikorian, Betty Linn, Fiduciary Standards in Pension and Trust Management (Stoneham, Mass., 1989), 1–11Google Scholar; for a discussion of tax incentives, see p. 38.

⁵⁵ For a discussion of ERISA's tax advantages see, Krikorian, Fiduciary Standards, 38; for a discussion of ERISA's fiduciary standards, see 11-34. ERISA also protected employees by establishing the Pension Benefit Guaranty Corporation, which ensured defined benefit pension plans—that is, plans in which the sponsor promises to pay the beneficiaries a certain income; see 46-49.

⁵⁶ Congressional Research Service, Pensions, 24; Drucker, “Reckoning,” 106; and Blasi and Kruse, The New Owners, 36. Of the twenty largest pension funds, which own approximately one-tenth of corporate America's equity, thirteen were public funds, providing benefits for state, municipal, or nonprofit employees. Drucker, “Reckoning,” 106. Of the total stock outstanding, state and local government retirement funds owned 6.8 percent.

⁵⁷ “Where All the Money Comes From,” Fortune, 2 Jan. 1989, 76-80.

⁵⁸ See Congressional Research Service, Fiduciary Responsibility Requirements of the Pension and Retirement Plans for State Employees, 8 Aug. 1988; National Conference of State Legislatures, Public Pension Funds' Investment Practices, Legislative Finances Paper no. 72, Feb. 1990; Congressional Research Service, Pensions; and Congressional Research Service, Public Pension Plans: The Issues Raised over Control of Plan Assets, Subcommittee on Labor-Management Relations, May 1990.

⁵⁹ See U.S. General Accounting Office, PENSION PLANS: Public Plans in Four States Have Generally Similar Policies and Practices, Report to the Subcommittee on Labor-Management Relations, Committee on Education and Labor, House of Representatives, U.S. Congress, July 1990.

⁶⁰ Our discussion summarizes Rartlett, The Money Machine, 99-134. James L. McGoffin, director, Oregon Public Employees Retirement System, testimony, joint hearing of the Subcommittee on Labor-Management Relations of the Committee on Education and Labor, U.S. House of Representatives, Public Employee Pension Benefit Plans, 98th Cong., 1st sess., 15 Nov. 1983, 372. Krikorian, Fiduciary Standards, reviews the doctrine of prudence and the “prudent man” rule in common law, 8-11, and its inclusion in ERISA, 11-13. See Whitley, “The Transformation of Rusiness Finance,” for a discussion of the effects of ERISA's incorporation on the behavior of financial institutions, 184.

⁶¹ Bartlett, The Money Machine, 123.

⁶² Anders, Merchants of Debt, 39, 276.

⁶³ Perhaps as much as this human network, KKR's financial experts also took full advantage of the emerging computer technologies of the decade, purchasing their first Apple II in 1980 and upgrading to IBM PCs in 1982. Anders, Merchants of Debt, 39-41.

⁶⁴ Congressional Research Service, The Role of High Yield Bonds [Junk Bonds] in Capital Markets and Corporate Takeovers: Public Policy Implications: A Report prepared by the Congressional Research Committee for the Use of the Subcommittee on Telecommunications, Consumer Protection and Finance of the Committee on Energy and Commerce, U.S. House of Representatives, Committee Print, Dec. 1985, 4, 24, and Taggart, Robert A. Jr., “‘Junk’ Bond Market's Role in Financing Takeovers,” in Mergers and Acquisitions, ed. Auerbach, Alan J. (Chicago, Ill., 1988), 13Google Scholar.

⁶⁵ Gaughan, Mergers and Acquisitions, 338-39. Drexel Burnham Lambert was able to place junk bonds with insurance companies, mutual funds, pension funds, corporations, foreign investors, savings and loans, private individuals, and security dealers. Of these, insurance companies, mutual funds, and pension funds were the largest customers. Ibid., 380, 379.

⁶⁶ John C. Coffee, Jr. “Shareholders Versus Managers: The Strain in the Corporate Web,” in Coffee, Lowenstein, and Rose-Ackerman, eds., Knights, Raiders and Targets, 116n2.

⁶⁷ These included those of Oregon, Washington, New York, Wisconsin, Illinois, Iowa, Massachusetts, Montana, Michigan, Minnesota, and Utah. The Wall Street journal, 25 Nov. 1983, 10; 11 April 1986, 1; 10 July 1987, 8; and 26 Oct. 1988, A3.

⁶⁸ For a discussion of this fallout in the popular literature, see Burrough and Helyar, Barbarians at the Gate, 141-45; Bartlett, The Money Machine, 213-26; and Anders, Merchants of Debt, 133-35.

⁶⁹ KKR took a 4.9 percent position in Texaco in March 1987 as the oil company was being threatened with a takeover bid by Carl Icahn. KKR spoke with Texaco management about arranging a LBO, but when these discussions broke down, KKR sold its shares for a profit. The Wall Street journal, 10 July 1989, 8; “King Henry,” Business Week, 14 Nov. 1988, 125.

⁷⁰ Gaughan, Mergers and Acquisitions, 461-62, 37.

⁷¹ Davidson, Megamergers.

⁷² Mergers & Acquisitions, May–June 1991, 52, and March–April 1990, 116.

⁷³ Jensen, “The Takeover Controversy,” 316-17; Gaughan, Mergers and Acquisitions, 37-38. Also, see “Oil: Hunting for Bargains,” National Journal, 31 March 1984, 598-601.

⁷⁴ Blair, Margaret M. and Litan, Robert E., “Corporate Leverage and Leveraged Buyouts in the Eighties,” in Debt, Taxes, and Corporate Restructuring, ed. Shoven, John B. and Waldfogel, Joel (Washington, D.C., 1990), 64Google Scholar, and “LBO Special Section,” Mergers & Acquisitions, July–Aug. 1989, 46. There are significant difficulties in analyzing LBOs by industry, because the few industry-based analyses use different measures of takeover activity.

⁷⁵ Gaughan, Mergers and Acquisitions, 34-35.

⁷⁶ “The New J. P. Morgans,” Fortune, 29 Feb. 1988, 44; Jensen, “Eclipse.”

⁷⁷ Eccles and Crane, Doing Deals, 97.

⁷⁸ Hayes and Hubbard, Investment Banking, 107-8. Surveys done by Donaldson, Luflkin & Jenrette document the growing sophistication of corporate financial officers. For example, in 1967 only 11 percent of corporate financial officers in the survey were involved in choosing a new underwriter; by 1986 the figure had grown to 72 percent. As the corporation's financial capabilities expanded, investment bankers found their old advisory relationships to corporate clients giving way to competitive pressures. See Eccles and Crane, Doing Deals, 74.

⁷⁹ For years, the securities industry had been able to maintain fixed brokerage fees. Although institutional discounts were regularly given during the 1970s, academic writers complained that the industry convention unduly increased transaction costs, making for less efficient markets. Hayes and Hubbard, Investment Banking, 108-9. Rule 415 under the Securities Act of 1933 permitted frequent and well-documented issuers to use the act of registration (“shelving”) statement for listing a securities offering to a certain maximum during any point in a period of two years. Usually, during this period, the issuer will receive calls from investment bankers to purchase the securities, thus creating, in effect, a competitive bidding process. Ibid., 111. In large part, this rule emerged as issuers and regulators acknowledged that regulatory inefficiencies had led corporations to offshore outlets and had forced them to engage in interest-rate and currency swaps as alternatives for U.S. debt placements. For a detailed discussion of Rule 415 and its effect on the investment banking industry, see Joseph Auerbach and Samuel L. Hayes III, “Underwriting Regulation and the Shelf Registration Phenomenon,” in Hayes, ed., Wall Street, 127–56.

⁸⁰ “Shaking Billions from Beatrice,” The New York Times, 6 Sept. 1987, sec. 3, 1; “The New J. P. Morgans,” Fortune, 44-53; Hayes and Hubbard, Investment Banking, 129-33; Robert A. Miller and Lawrence E. Fox, “Are Bankers Too Eager to Arrange LBOs?” Journal of Commercial Bank Lending, Feb. 1987, 19–26; Christopher J. Arts and George C. Lodge, “Senator Riegle and U.S. Corporate Restructuring,” Harvard Business School Case, N9-390-031 (12 Oct. 1989), 8-9.

⁸¹ Stein and Kaplan depict the period in the following way: 1) the ratio of buyout price to company cash flow moved upward in the latter part of the 1980s; 2) buyout premiums also rose, nearly doubling from 25.7 percent in 1985 to 48.1 percent in 1988; 3) banks offering senior debt demanded quicker payback schedules after 1986, even though the proportion of the debt for LBOs remained steady throughout the decade. Steven N. Kaplan and Jeremy C. Stein, “The Evolution of Buyout Pricing and Financial Structures in the 1980s,” Journal of Financial Economics [forthcoming].

⁸² In particular, Burrough and Helyar, Barbarians at the Gate; also see “Deal of the Century,” Newsweek, 12 Dec. 1988, 40-44. But, although the RJR buyout has come to be a popular symbol for the overpriced purchases that occurred in the latter part of the decade, this symbol seems, to contain more myth than fact. Only two years after it bought out RJR, KKR was able to bring RJR public again, earning a 59 percent compound annual rate of return for its original equity investors. Jensen, “Corporate Control,” 14.

⁸³ Baker, “Beatrice,” 1106-8; also see “Has the Beatrice LBO Gone PFFT?” Fortune, 31 July 1989, 113-18; and “Beatrice Investors Will Just Have to Sit Tight,” Business Week, 12 March 1990, 104. Eventually, KKR cashed out of Beatrice with its sale to ConAgra in June 1990 on favorable terms, with a 50 percent annual return on its original 1986 investment. See “KKR Is Doing Just Fine—Without LBOs,” Business Week, 30 July 1990, 56.

⁸⁴ The drama of this struggle to control RJR is skillfully told by Burrough and Helyar, Barbarians at the Gate. A summary of the rivalry between KKR and Shearson Lehman Hutton can be found in “And in This Corner Wearing White Trunks,” Business Week, 14 Nov. 1988, 130-31.

⁸⁵ Rappaport, Alfred, “CFO's and Strategists: Forging a Common Framework,” Harvard Business Review 70 (May–June 1992): 84–91Google Scholar; “Corporate Strategy for the 1990s,” Fortune, Feb. 1989, 34-42. For more detail, see Rappaport, Creating Shareholder Value; and Blyth, Michael L., Frisky, Elizabeth A., and Rappaport, Alfred, “Implementing the Shareholder Value Approach,” Journal of Business Strategy 6 (1986): 48–58CrossRefGoogle Scholar.

⁸⁶ Equity carve-outs are another technique open to firms intent on selling off parts. Here the firm may decide to sell off only a partial interest in the business, thereby keeping some position in the new stand-alone company. See Gaughan, Mergers and Acquisitions, 479-80. For a statistical examination of restructuring, see James A. Brickley and Leonard D. Van Drunen, “Why Firms Restructure: An Empirical Analysis,” Managerial Economics Research Center, Working Paper Series, MERC 88-08. Gordon Donaldson presents a fascinating story about how one company came to a voluntary decision to restructure in his “Voluntary Restructuring: The Case of General Mills,” Journal of Financial Economics 27 (1990): 117–41CrossRefGoogle Scholar.

⁸⁷ Gaughan, Mergers and Acquisitions, 462 and 464.

⁸⁸ Ibid., 195–96. In fact, recapitalization frequently gives managers greater control than they formerly had because in recapitalizing management may either issue shares of stock to an employee stock ownership plan or create stock options that enhance management's voting power. For a discussion on how stock ownership may enhance management's position, see Blasi and Kruse, The New Owners, 38, 45-46.

⁸⁹ “The Ebb Tide,” The Economist, 17. Interestingly, cyclical and stable industries both climbed sharply at the end of the 1970s; however, whereas the cyclical industry debt-service ratio declined precipitously in 1982, the stable industry ratio continued upward.

⁹⁰ Anti-takeover defenses have become an industry in itself, scrutable only to the initiated. But general descriptions of these various gambits do exist. A poison pill refers to securities issued by a target firm that give the shareholders the right to purchase the stock of an acquiring firm at a discount. Supermajority provisions require a majority greater than 50 percent to approve mergers; fair-price provisions modify the corporate charter to require the buyer to pay minority shareholders a fair market price for their shares; and dual capitalization restructures the corporation's equity into two classes with different voting rights. For a general discussion on these various anti-takeover tactics see Gaughan, Mergers and Acquisitions, 154–219, and Richard Ruback, “An Overview of Takeover Defenses,” in Auerbach, ed., Mergers, 49-67.

Recently, economists and financial economists have attempted to evaluate these various tactics. For a summary of this writing, see Jarrell, Gregg A., Brickley, James A., and Netter, Jeffrey M., “The Market for Corporate Control: The Empirical Evidence since 1980,” Journal of Economic Perspectives 2 (1988): 58–66.CrossRefGoogle Scholar Some examples of this writing are Malatesta, Paul H. and Walking, Ralph A., “Poison Pills Securities: Stockholder Wealth, Profitability and Ownership Structure,” Journal of Financial Economics 20 (1988): 347–76CrossRefGoogle Scholar; James Brickley, Ronald Lease, and Clifford Smith, “Ownership Structure and Voting on Antitakeover Amendments,” ibid., 267-92; Pound, John, “The Effect of Antitakeover Amendments on Takeover Activity,” Journal of Law and Economics 30 (1987): 353–67CrossRefGoogle Scholar; Jarrell, Gregg and Poulsen, Annette, “Dual Class Recapitalization as Antitakeover Mechanisms,” Journal of Financial Economics 20 (1988): 129–52.CrossRefGoogle Scholar

⁹¹ See CTS Corporation v. Dynamics Corporation of America, 481 U.S. 69 (1987). A general introduction to state anti-takeover laws can be found in Gaughan, Mergers and Acquisitions, 83-90. For more detailed discussions, see Thompson, Robert B., “Tender Offer Regulation and the Federalization of State Corporate Law,” in Public Policy Toward Corporate Takeovers, ed. Weidenbaum, Murray L. and Chilton, Kenneth W. (New Brunswick, N.J., 1988), 78–105Google Scholar; Rosenbaum, Robert D. and Parker, L. Stevenson, The Pennsylvania Takeover Act of 1990: Summary and Analysis (Englewood Cliffs, N.J., 1990)Google Scholar; Johnson, Lyman and Millon, David, “Misreading the Williams Act,” Michigan Law Review 87 (1990): 1862–1923CrossRefGoogle Scholar; and Romano, Roberta, “The Political Economy of Takeover Statutes,” Virginia Law Review 73 (1987): 111–99CrossRefGoogle Scholar.

⁹² Securities and Exchange Commission, Report on Tender Offer Laws, prepared for the Use of the Senate Committee on Banking, Housing and Urban Affairs, 99th Cong., 2d sess., Committee Print (Washington, D.C., 1980), 1–6Google Scholar. In 1984 the SEC issued an Advisory Committee Report that contained fifty proposals for reforming the ways corporate takeovers were to be fought out. “Merger Wars—Congress, SEC Take Aim at Hostile Corporate Takeover Moves,” National Journal, 23 July 1987, 1538-40.

⁹³ House Committee on Energy and Commerce, Corporate Takeovers: Public Policy Implications for the Economy and Corporate Governance; A Report for the Chairman of the Subcommittee on Telecommunications, Consumer Protection and Finance, 99th Cong., 2d sess., Dec. 1987, 3.

⁹⁴ For example, are two-tier bid offers fair or coercive? Are managerial defenses against hostile bids fair to shareholders? See House Committee on Energy and Commerce, Corporate Takeovers, 85-89, 104-05.

⁹⁵ For example, see Joint Committee on Taxation, Federal Income Tax Aspects of Corporate Financial Structures: Scheduled for Hearings before the Senate Committee on Finance on January 24-26, 1989 and the House Committee on Ways and Means on January 31 and February 1–2, 1989, Committee Print, 18 Jan. 1989; House Committee on Ways and Means, Tax Policy Aspects of Mergers and Acquisitions: Hearings, Part I, 101st Cong., 1st sess., 31 Jan., 1, 2 Feb., and 14, 15 March 1989.

⁹⁶ President's Commission on Industrial Competitiveness, Global Competition: The New Reality, Jan. 1985. By so focusing its inquiries, the Democratic-controlled Congress was in fact examining whether corporate takeovers were proving themselves to be an effective alternative to the national development bank that Ronald Reagan's administration and others had promoted as a tool to make American manufacturing internationally competitive. Agency theorists and investment bankers testified that the burgeoning market for corporate control was an efficient alternative to a public reconstruction finance corporation.

In helping to provoke a corporate restructuring, in bringing new capital into a “bankrupt” industry, and in forging a new organizational form, KKR has certainly functioned as a “private reconstruction finance corporation,” as opponents of a national development bank claim. Yet, neither KKR nor the fourth merger wave of which it was a part has fulfilled all that was anticipated by proponents of a national development bank. The role envisioned for this public bank was to help finance investments in basic and specialized infrastructures, in job retraining, in local educational systems, in the upgrading of regional technical schools, and in the development ol regional research, development, and commercialization projects that would involve public and private participants. By providing these public goods, the national development bank was to assist American industry to compete internationally and to ensure that the costs of restructuring would be equitably handled. Certainly, the United States made little headway in these areas in the 1980s and faltered in most; for many, a national development bank still has much of the appeal that it had in the early 1980s. For a discussion of the relationship between failings in education and American economic decline, see MIT Commission on Industrial Productivity, Made In America: Regaining the Competitive Edge (Cambridge, Mass., 1989), 81-93, 156–65Google Scholar; for a description of the cost borne by workers, see Philips, Kevin, The Politics of Rich and Poor: Wealth in the American Electorate in the Reagan Aftermath (New York, 1990)Google Scholar.

⁹⁷ For example, see the statements of Michael Jensen, professor of business administration, Harvard Business School, and Harwick Simmons, chairman, Securities Industry Association, House Committee on Energy and Commerce, Management and Leveraged Buyouts: Hearings before the Subcommittee on Telecommunications and Finance, 101st Cong., 1st sess., 22 Feb. and 25 May 1989, 78-91 and 133-67, respectively.

⁹⁸ See Business Roundtable Ad Hoc Task Force, Analysis of the Issues in the National Industrial Policy Debate: Working Papers, Business Roundtable, revised 15 May 1984.

⁹⁹ For example, see the testimony of Thomas R. Donahue, secretary-treasurer, AFLCIO, in Senate Committee on Banking, Housing and Urban Affairs, Hostile Takeovers: Hearings, 100th Cong., 1st sess., 28 Jan., 4 March, and 8 April 1987, 261-70, 46-50.

¹⁰⁰ For testimony supporting Rohatyn's arguments, see William Lazonick's statement in House Committee on Banking, Finance and Urban Affairs, Oversight Hearing on Mergers and Acquisitions: Hearing before the Subcommittee on Economic Stabilization, 100th Cong., 1st sess., 12 May 1987, 98-107. For Felix Rohatyn's most recent call for a national development bank, see “The New Domestic Order?” New York Review of Books, 21 Nov. 1991, 6-10.

¹⁰¹ “LBO Backers Marshal Data to Fight Critics,” The Wall Street Journal, 23 Jan. 1989, C1. See House Committee on Energy and Commerce, Management and Leveraged Buyouts, 257–85. The document contains a critical review: see William F. Long and David J. Ravenscraft, “The Record of LBO Performance,” 203-27. For an update of the KKR report, see “Presentation on Leveraged Buy-outs by Kohlberg Kravis Roberts & Co.: Updated 1991” (mimeo).

¹⁰² For example, KKR partners contributed a total of $20,000 to eight members of the Senate Finance Committee for their 1988 re-election campaigns. We have examined Federal Election Commission documents, which detail KKR contributions in congressional and presidential elections since 1980. See, for example, “Mr. Forstmann Goes to Washington,” The Wall Street Journal, 9 Aug. 1989. For a general discussion of KKR's congressional strategy during these years, see Bartlett, The Money Machine, 257-70.

¹⁰³ “When Buyout Boutiques Find Little to Leverage,” The New York Times, 11 Dec. 1991, D7.

¹⁰⁴ For example, Campeau Corporation, a leading takeover firm in the retail industry, made an offer for $1.5 billion worth of junk bonds in 1989, only to find few takers. To sell its wares, Campeau had to ask for less funds at higher interest rates. Eventually, these additional funds were unable to save Campeau from financial ruin. Gaughan, Mergers and Acquisitions, 390-91.

¹⁰⁵ Revlon v. MacAndrews, 506 A.2d 173, Del. 1986; Paramount Communications v. Time, 571 A.2d 1140, Del. 1990 (written opinion in 1990; oral opinion in 1989).

¹⁰⁶ “Urgency of LBO Issue Fades, But Action Still Possible,” Congressional Quarterly, 18 March 1989, 571; “KO LBOs? Congress Turns a Cold Eye on Buyouts,” Barron's, 19 Dec. 1988, 15; “Taking on Takeovers,” National Journal, 9 Jan. 1988, 79-83; “Cool It, You Guys,” ibid., 4 March 1989, 523-26; “KKR Plays a Slower Game,” Business Week, 29 June 1992, 96-97; “Acquisition Boom Has Lost a Lot of Its Thunder,” ibid., 12 June 1989, 18; “There's Still Life in the Old LBO,” ibid., 21 Jan. 1991, 76.

¹⁰⁷ Many of these LBOs have occurred only within the last decade, but early studies have reported favorable results in the area of productivity increases. See Lichtenberg, Frank, Corporate Takeovers and Productivity (Cambridge, Mass., 1992)Google Scholar.

¹⁰⁸ For the complete review of this period, see Graham, Otis L. Jr., Losing Time: The Industrial Policy Debate (Cambridge, Mass., 1992)Google Scholar. Graham also has some important insights on using recent history to guide policymakers.

¹⁰⁹ See, Coffee, “Shareholders Versus Managers,” 81-85, and Kaufman and Kaen, “Work of Managers.”

¹¹⁰ John Pound argues that this investor “political” activity will replace takeover activities as the fundamental threat to traditional corporate governance. “Beyond Takeovers: Politics Comes to Corporate Control,” Harvard Business Review 70 (March–April 1992): 83–93Google Scholar; Mark J. Roe, “Clearing Boardrooms Like GM's,” The Wall Street Journal, 27 Oct. 1992, and “Board Reform Replaces the LBO,” ibid., 30 Oct. 1992.

¹¹¹ “KKR Is Doing Just Fine,” 56-57.

¹¹² “The Ebb Tide,” The Economist, 17.

¹¹³ We could describe a fourth industrial group, one in consumer food products and supermarkets. Its members include RJR Nabisco, Safeway, and Stop & Shop.

¹¹⁴ Johnson and Kaplan, Relevance Lost, documents the cost accounting problems that vertical integration causes. See especially chaps. 6 and 7.

¹¹⁵ When KKR invests in solvent institutions, the expectations arise from projections about future performance; however, when KKR passively invests in failed institutions, these returns are in large measure dependent on the generosity of the Federal Deposit Insurance Corporation, which has responsibility for restructuring and recapitalizing the impoverished banking system.

¹¹⁶ Like most contemporary analysts, we do not have access to KKR's files. As a result, our history depends on public documents, which we tie together into a narrative by concepts taken from theoretical business disciplines. In particular, we make use of ideas in corporate strategy, agency theory, and transaction cost economics to explicate KKR's intentions and to account for its value-enhancing capabilities. For an example of how theory and narrative can be blended to analyze contemporaneous corporate strategic behavior, see Kaufman, Allen and Walker, Gordon, “The History-Strategy Connection,” The Public Historian 8 (1986): 23–39CrossRefGoogle Scholar.

¹¹⁷ For a review of different aspects of the role of keiretsu, see Dick K. Nanto, “Japan's Industrial Groups, the Keiretsu,” in Japan's Economic Challenge: Study Papers submitted to the Joint Economic Committee, Congress of the United States, October 1990; Abegglen, James C. and Stalk, George Jr., Kaisha, The Japanese Corporation (New York, 1985), 161–67Google Scholar; McCraw, Thomas K. and O'Brien, Patricia A., “Production and Distribution: Competition Policy and Industry Structure,” in America versus Japan, ed. McCraw, Thomas K. (Boston, Mass., 1986), 79–82Google Scholar; Yamamura, Kozo and Vandenberg, Jan, “Japan's Rapid-Growth Policy on Trial: The Television Case,” in Law and Trade Issues of the Japanese Economy: American and Japanese Perspectives, ed. Saxonhouse, Gary R. and Yamamura, Kozo (Seattle, Wash., 1986), 243–55Google Scholar; Okomoto, Daniel I., “Regime Characteristics of Japanese Industrial Policy,” in Japan's High Technology Industries: Lessons and Limitations of Industrial Policy, ed. Patrick, Hugh (Seattle, Wash., 1986), 45–50Google Scholar; Kester, Japanese Takeovers, 54-62. See also, Ferguson, Charles J., “Computers and the Coming of the U.S. Keiretsu,” Harvard Business Review 68 (July–August 1990): 55–70Google Scholar; “Learning from Japan: How a Few U.S. Giants Are Trying to Create Homegrown Keiretsu,” Business Week, 27 Jan. 1992, 52-60.

¹¹⁸ For an appreciation of the complex forces involved in the current debates over financial deregulation, see “Banking Overhaul's Fate,” The New York Times, 6 Nov. 1991, A1; “Cacophony of Lobbying Overwhelms Bank Bill,” ibid., D6.

¹¹⁹ Blasi and Kruse, The New Owners. Leading the way in the reorganization of U.S. industry is none other than IBM; for recent changes there, see “The New IBM,” Business Week, 16 Dec. 1991, 112-18; “Pulling One's Weight at the New IBM,” The New York Times, 5 July 1992, sec. 3, 1-6; “Breaking Up IBM,” Fortune, 27 July 1992, 44-58; and “Deconstructing the Computer Industry,” Business Week, 23 Nov. 1992, 90-100.

¹²⁰ On management's defensive retrenchment into its trustee rhetoric, see Monks and Minow, Power and Accountability, 79-84; on management's continued resistance to labor reform, see Weiler, Paul, Governing the Workplace: The Future of Labor and Employment Law (Cambridge, Mass., 1990), 29-37, 105–18CrossRefGoogle Scholar; and on management's financial as opposed to participatory use of ESOPs, see Biasi and Kruse, The New Owners, chap. 4.