The way people talk about the need for new regulation of business, you’d think it was 1930. Have we not already lived through the New Deal with its pervasive regulation of corporations? Have we not lived through the regulatory explosions of the 1970s, 1980s, and 1990s? Are not the transgressions of a few businessmen already illegal? Something is wrong with this picture.
Maybe government isn’t the answer after all. This is distinctly the minority view. But many truths began that way. Maybe it’s time to think outside the box, or connect the dots, or whatever the vogue saying is this week.
If a little poison is bad for you, then a lot is worse. Maybe government regulation is a poison. In broadest terms, it certainly lulls everyone into a state of unwariness about crooked businessmen. Why be wary? Government watchdogs are on the case. Right. Wanna buy a bridge?
The truth is that the government pulled the teeth out of the best corporate watchdog there is: the hostile takeover. Beginning with Adam Smith, economists have been concerned that the corporation suffers from what is called the principal-agent problem. Stockholders own a firm, but they don’t manage it. Instead they hire managers. But the owners don’t have a strong incentive to monitor the managers closely. So the managers are able to get away with things that the owners wouldn’t tolerate if they knew what was going on. Even if the typical stockholder gets wind of problems, he might find it more to his interest to dump the stock than to try to change things.
This indeed is a problem. But as usual, the marketplace generated its own solution: the corporate takeover. If managers are misusing a corporation’s assets, there will be profit opportunities for the alert investor who figures it out, buys up a controlling share of stock, and replaces the managers with better ones. This is a hostile takeover. But notice that the only people who would be hostile are the inefficient or corrupt managers. The stockholders who freely sell their shares at attractive prices surely have no hostility.
The takeover is a key tool in what Henry Manne, the great economist and former dean of the George Mason University Law School, long ago dubbed the market for corporate control. As Manne wrote recently in the Wall Street Journal, “New scandals will continue until we bring back the most powerful market mechanism for displacing bad managers: hostile takeovers.”
So why hasn’t this check on bad managers worked? Because the federal and state governments have done all they could to prevent corporate takeovers. In 1968 the federal government enacted a law forcing anyone who acquires a specified amount of a corporation’s shares (today it’s 5 percent) to disclose his intentions to the Securities and Exchange Commission. Obviously, if someone announces that he intends a takeover, the stock price will rise, wiping out the profit in the takeover. That was the point.
Why did the government pass such a law? Because managers who feared losing their jobs lobbied Congress and the president. It was special-interest, protectionist legislation all the way. It hurt the public, as we can see today.
In the 1980s the states and state courts enacted even harsher anti-takeover measures. The result? “The number of hostile tender offers dropped precipitously and with it the most effective device for policing top managers of large, publicly held companies,” Manne writes.
Have you heard anyone in public office call for repeal of all laws inhibiting takeovers? Of course not. The politicians’ reflex is to call for more government (surprise, surprise), even though that is what got us into this mess in the first place.
And don’t fool yourself. Republicans are no different from Democrats. Look at what President Bush said in his high-profile speech on Wall Street. “From the antitrust laws of the 19th century to the S&L reforms of recent times, America has tackled financial problems when they appeared. The actions I’m proposing follow in this tradition.”
But those problems were created by government intervention in the first place. The real solution back then was to repeal the interventions, not to pile more on the old ones.