Hostile
takeovers, insider trading, cold calling, investment
banking, information asymmetries --- the language of
so-called high finance permeates the world depicted in
Wall Street. The film has come to epitomize the culture
of that center of financial transactions in the United
States called by the same name. The activities depicted in
Wall Street were based upon financial news stories
from the early to mid 1980s. The well publicized financial
shenanigans of Ivan Boesky and David Levine were important
source materials, as were the activities of Drexel, Burnham,
Lambert and their wunderkind Michael Milken. The rivalry
between Sir James Goldsmith (whose takeover of the paper
company, Crown Zellerbach, may have been inspiration for
Teldar Paper) and Carl Icahn (who won the battle for Trans
World Airlines, which may have been inspiration for Bluestar
Airlines) was an important inspiration for the rivalry
between Gordon Gekko and Sir Larry Wildman in Wall Street.
The processes
engaged in by financial institutions and the individuals who
do the work of the financial markets are sexy precisely
because of the relatively large sums of money involved,
resulting sometimes in spectacular accumulations of
financial wealth for certain players (such as Gordon Gekko)
or the equally spectacular, although perhaps not as
inspiring, falls from financial grace when a player makes
the wrong moves (as we saw with Bud Fox and, to some extent,
Gordon Gekko). Such dramatic transformations in financial
status can be quite exciting, although the processes and
instruments involved have rarely been captured on the big
screen and perhaps never better than with Oliver Stone's
1987 classic. But if all the financial markets did was move
money from "weak" hands to "strong" hands, then it would be
little more than the casino that many have claimed it to be.
What is the
relationship of the financial sector to the so-called
real economy (the world of Bluestar Airlines and Teldar
Paper)? This is an important macroeconomic question. In
Wall Street, Lou Mannheim tries, implicitly, to answer this
question when he says to Bud Fox that "the money you make
for people creates science and research jobs." How exactly
does this work?
In fact, most
of the trading in the financial markets has no direct
effect on the capital available to industrial corporations
(those producing tangible products, like Teldar Paper, for
instance), for building new plants, buying equipment, or
hiring new workers (including those engaged in research and
development). Trading in existing equity and bonds simply
moves money from one portfolio investor's hand to another
such portfolio holder with no direct impact on the
underlying firm that issued the stocks and bonds. The only
time there is a direct connection between the capital
available for productive investment and the activities on
Wall Street (and in the larger financial community) is when
the firm in question issues new equity or bonds.
In the case
of both new and existing enterprises, there are three
potential sources of financing: equity, debt, and grants.
Equity is contributed by owners of the firm's assets. Debt
is obtained by borrowing from individuals (including the
owners of the firm, family members, strangers) or
institutions (banks, insurance companies, governments,
etc.). Grants are contributions to the firm that come with
no ownership stake or claim on enterprise cash flow.
Governments sometimes make such gifts to corporations,
although gifts could also come from private parties (and, in
the case of non-capitalist enterprises, gifts often come
from relatives as a result of kinship obligations and
reciprocity). Because capitalist firms are organized around
the hiring of wage laborers, and typically a large number of
such wage laborers, then such firms often have a large
appetite for capital: large sums of money are needed to
provide the facilities and equipment wage workers need to
produce the final output desired by firm management. Thus,
growth in capitalism has often required sizable sums of
capital, capital far in excess of the ability of individual
firms to generate internal cash flow available for
investment (retained earnings) or the ability of private
owners and their bankers to raise funds. The need for
expanded capital accumulation (described in the Resnick and
Wolff text and elsewhere) has been facilitated by the
development of the publicly traded corporation and financial
markets in the buying and selling of ownership, as well as
the trading of existing debt contracts (in the form of
publicly traded corporate bonds).
Thus, one of
the most important institutional inventions to be tapped by
capitalism has been the corporation (or, more specifically,
the equity-issuing for-profit corporation). The corporation
is a legal institution, incorporated according to state
laws, that has the right to commodify the ownership of
corporate assets by issuing shares of stock. Initially,
these shares are held privately: the equity shares are not
yet fully commodified (tradeable on the public financial
markets, rather than only in private transactions). By
taking the corporation public, the firm's board can
authorize the sell of shares to the general public (anyone
who is in a position to buy shares on the relevant exchange
or in the relevant trading system). This initial public
offering (IPO) is typically made through an
intermediary, a merchant or investment bank. The sums
raised in this initial public offering (minus the
merchanting fees required by the investment bank) are
available to corporate management and can be used to fund
productive investment, including, as Lou Mannheim indicates,
research and development expenditures. Indeed, many biotech
companies have financed their research and development
primarily through the issuance of equity. In Wall Street,
there is a reference to Darien (played by Daryl Hannah)
taking her interior decoration business public, although it
is unclear why she would need to raise additional funds for
a business that is most likely organized around
self-employment (the labor system in the ancient class
process) rather than wage labor (the labor system in the
capitalist class process), although I suppose she might
follow in the footsteps of Martha Stewart (who, in her
current identity as lifestyle guru, started out as
self-employed caterer but is now a capitalist corporation,
Martha Stewart Living Omnimedia, with publicly traded
shares).
In order for
these primary markets in securities to work properly, most
portfolio investors must be confident that the market is,
for the most part, fair. Gordon Gekko might not care that
the market is not fair, but in order for Gekko to make
extraordinary gains in the market he needs someone on the
other side of the trades (and, therefore, someone who
necessarily has less information than he does, but does not
realize the magnitude and/or significance of this
information asymmetry). Who would trade with Gekko if
they knew that Gekko had inside information? Thus,
if most portfolio investors believed the market to be
unfair, they might severely restrict their participation in
the market. This would reduce the money in the market for
new issues of securities and therefore make it more
difficult for companies to raise necessary investment funds
through initial public offerings. This is precisely why the
Securities and Exchange Commission (SEC), the primary
regulatory agency that watches financial market transactions
and seeks prosecution of those who violate the securities
laws, exists and plays such a critical role in the entire
process of channeling savings from individual portfolio
holders to young corporations in need of sizable amounts of
financing (or older companies seeking to raise additional
funds through what are called seasoned offerings of
stock or bonds).
Oliver Stone,
screenwriter and director, placed his (intended-to-be)
heroic characters in the background. Bud Fox's father,
Carl, the epitomy of the hardworking laborer, who has toiled
on BlueStar's planes for years, rising to be a leader in the
Mechanics Union local, and Lou Mannheim, the honest broker,
were admittedly drawn from Lou Stone, Oliver Stone's
father. In the foreground, we are supposed to see the
seedier side of finance capital: Gordon Gekko, the
Mephistopheles-like manipulator who "creates nothing" but
takes everything, and his sidekick Bud Fox, the naive but
greedy young man, whose inner struggle becomes a focal point
for the film. However, once a film is created, it becomes
the malleable object of the culture(s) into which it is
thrust and the culture of Wall Street, particularly the
hip-hop culture of the young traders, analysts, and
wanna-be-Gekkos (many older Wall Street professionals
responded negatively to the film, at least initially),
reversed the polarity of the morality of the tale. The cult
status of Wall Street and the morality reversal was
best depicted in another film about finance, Boiler Room,
where the young wanna-be-Gekkos even memorize the lines of
their hero. Indeed, in the hip-hop culture of young Wall
Streeters, "greed is good," as Gekko said. Whereas, Oliver
Stone tried to embue the film with a sense of the negative
consequences of the naked pursuit of material wealth by
financial manipulation and related shenanigans (with no
regard for the real economy or the productive workers
who power that economy), the wanna-be-Gekkos could only see
in the film a boiler plate for achieving their own vision of
success. Thus, Oliver Stone's depiction of the struggle
between good and evil (both in the external world --- Gekko
against Carl Fox, for example, and in the internal world ---
within Bud Fox) was turned into a parable of how to get
rich the Gekko way while reducing the probability of
getting caught by the evil SEC.
For the
hip-hop Wall Streeters, Gordon Gekko was the hero of the
film and Bud Fox was his Judas, the ungrateful disciple.
Gekko represented possibility (of rise from rags to riches,
of using one's wits to overcome obstacles, of overcoming the
banality of love and morality in favor of a neoclassical
logic of naked and boundless self-interest). The
wanna-be-Gekkos, the foot soldiers of money manipulation and
deal-making could see themselves in his shoes, as Gekko the
Great. They could not identify or sympathize with Carl Fox,
the mechanic and labor leader, or the pathetic figure of Lou
Mannheim. Ironically, the reshaping of Wall Street
from morality tale (of an old fashioned variety) to
neoclassical tale of possibility may be precisely in accord
with the logic and inner needs of capitalism. Capitalism
needs Gordon Gekko if it is to work properly. It turns out
that Gordon Gekko, at least in his persona as corporate
raider, solves a problem for capitalism, a problem that, if
left unsolved, would cause the capitalist process to lose
some of its dynamism and run the risk of falling into
stagnation.
The early to
mid 1980s was a period of virtual warfare within the market
for corporate control. The extensive commodification of
corporate ownership in the United States and the liquidity
of the equity markets provided a foundation for sometimes
vicious struggles over control of the corporate assets.
Since the board of directors serves the modern role of
capitalist (the first receiver and distributor of cash flow
or, in Marxian terms, surplus value) within capitalist
corporations, the struggle was first and foremost over
control of the board: win the board of directors and you
control the corporate assets. I describe these struggles as
warfare (also implied by Oliver Stone in Wall Street
--- for example, there were frequent references to Sun Tzu's
The Art of War) because despite the absence of
martial combat the conflicts usually involved two hostile
parties willing to use every legal (and sometimes a few
illegal) means for gaining or retaining control over the
board of directors. Typically, these conflicts were between
outsiders, called raiders, and insiders, in the
persons of the existing top level corporate managers and
boards of directors. In Wall Street, both Gordon
Gekko and Sir Larry Wildman were raiders, although Wildman
becomes a white knight in the Bluestar conflict (a
white knight is defined as a raider who comes to the
assistance of existing management and directors against a
hostile raider).
The
successful conquest of an existing firm by a raider, such as
Gekko or Wildman, usually resulted in the restructuring
of the firm. This could mean the selling off of major
corporate assets, sizeable layoffs of employees, raiding
overfunded pension funds (the funds held by the corporation
to meet retirement obligations of existing and former
employees), and/or spinning off existing subsidiaries and/or
divisions into independent corporate entities (raising cash
flow for the raider by the IPO of the subsidiary and/or
division now independent corporation).[1] Even if the
raider is unsuccessful, the battle for corporate control may
have left existing management with no choice but to
restructure the firm. Perhaps, for example, they took on
sizeable debt in order to buy back stock or simply to
overleverage the firm to the extent that bondholders and
banks would not be interested in providing the raiders with
financing for the takeover of a firm that has become too
high a default risk. Either of these aggressive strategies
might both keep the company out of the raiders hands and
force corporate restructuring, such as selling assets and
laying off or firing employees. The firm's managers may have
to cut their own perquisites in a further effort at
generating the cash flow necessary to meet new debt
obligations, precisely the sort of action that Gekko
indicated was needed in the case of Teldar Paper (more on
this in a moment).
Indeed, as a
defense against being raided, an increasing number of
corporate managers cut deals with buyout specialists, like
Kohlberg, Kravis, Roberts, & Company (KKR), to borrow huge
sums of money from banks and in junk bond offerings to buy
controlling interest in their companies. These insider
takeovers are called management buyouts (MBOs) and because
they are financed by debt, they are also referred to as
leveraged buyouts (LBOs). LBOs are not restricted, however,
to insider takeovers. In Wall Street, we saw two
examples of LBOs used in hostile takeovers by Gordon Gekko.
Gekko referred to significant subordinated debt involved in
his takeover of Teldar Paper and we witnessed a meeting
between Gekko's attorneys and bankers in an effort to
arrange financing of the takeover and liquidation of the
assets of Bluestar Airlines.
In the 1980s,
the total value of the corporate assets that changed hands
as a result of takeovers was unprecedented, far in excess of
anything that had been seen before. In addition, many large
corporations merged as a way of protecting existing
management's continued control. The bigger the fish, the
harder it is to swallow and the more likely it will be the
predator, rather than the prey. It was the time of the
corporate raiders, such as Ronald Perelman, who seized
control of Revlon and came close to seizing control of the
investment banking house of Saloman Brothers, Saul Steinberg
who greenmailed Disney to the tune of $32 million more than
the market value of his holdings (plus an additional $28
million for "out of pocket expenses"), just to keep him from
gaining control, and Robert Campeau, who took control over
Bloomingdales, Brooks Brothers, Filenes, I. Magnin, and 29
other department store chains. Among the less hostile
takeovers and mergers that occurred during this period
were: General Electric's takeover of RCA, which had already
taken control over the NBC television network; General
Motors acquired Electronic Data Systems from Ross Perot, as
well as Hughes Aircraft (Howard Hughes' old operation),
which has extensive satellite communications systems; U.S.
Steel bought Marathon Oil; Chevron Oil paid $13.3 billion
for Gulf Oil; Sony took control over CBS Records and
Columbia Pictures, and that is only a sampling of the wide
ranging consolidations of corporate power during the decade.
In one of the
most remarkable speeches in film history, Michael Douglas
qua Gordon Gekko explains (in a speech that is understood on
the street as largely taken from one given by Ivan Boesky)
why the practice of corporate raiding is a positive
phenomenon for American capitalism:
"Today
management has no stake in the company. Altogether the men
sitting here own less than 3% of the company. Where does
Mr. Cromwell (the CEO) put his million dollar salary? Not
in Teldar stock. He owns less than 1%. You own the
company. That's right, you, the stockholders. You are
being royally screwed over by these bureaucrats with their
steak luncheons, hunting and fishing trips, their corporate
jets, and golden parachutes."
Gekko is
referring to the fact that in contemporary corporations, the
commoditization of ownership has resulted in shareholders
losing effective control over the board of directors and top
management. It is management, "these bureaucrats," who make
the key decisions about deploying corporate assets and
spending working capital. Top-level managers look after
their own interests, not those of the widely dispersed
shareholders. The board of directors is in a position to
fire top-level managers who abuse their power, but typically
these managers also sit on the board and/or have strong
influence over who does. Indeed, the board and top-level
managers are often closely allied, except in times of
serious threat to the corporation's viability or reputation,
when the board may turn against the top-level execs.
However, this is rare. Most of the time the board can relax
and simply rubber stamp the decisions of their chief
executive officer. And the board has little to worry about
from shareholders. The costs of monitoring top-level
management (agency costs) are very high and most
shareholders (owning a tiny fraction of the company) do not
even try. Typically, they sign over their votes to the board
in the form of proxies. By wielding proxy votes, existing
boards of directors can virtually guarantee their continued
control over the corporation. The Teldar board, according to
Gekko, has been complicit with management in wasting the
resources of the corporation (using working capital to
finance perquisites for managers and board members, e.g.
"steak luncheons, hunting and fishing trips, corporate jets,
and golden parachutes"), resources that ultimately belong to
the shareholders. And the board has, if Gekko is correct,
presided over the creation of a bloated bureaucracy that
burdens the corporation and drains cash flow (further
stealing from the shareholders):
"Teldar Paper
has 33 different vice presidents, each earning over $200,000
a year. I've spent the last two months analyzing what these
guys do. I still can't figure it out. One thing I do know
is that our paper company lost $110 million last year. I'll
bet half of that was spent in the paperwork going back and
forth between these vice presidents."
Gekko's
argument, which has many adherents within the corporate
finance establishment, is that his battle to wrest control
of Teldar Paper from the existing board of directors and
their managers is in the interest of the shareholders and
ultimately has beneficial effects on capitalism as a whole.
[2] The existing board and their managers have created an
inefficient, bloated bureaucracy that wastes corporate
resources. Gekko would put into place a new regime that
would eliminate many of these inefficiencies and squeeze
more shareholder value out of the corporate assets. Indeed,
the argument in favor of Gekko's analysis would point to the
fact that he can pay a much higher price for Teldar stock
than it was selling for before his takeover attempt and yet
still make a profit on the deal. This proves, according to
that argument, that Teldar's assets were simply being
mismanaged and that Gekko can take over the company, replace
the board, fire Cromwell and his 33 vice presidents,
eliminate the waste, and liberate shareholder value:
"Well, in my
book, you either do it right or you get eliminated. In the
last seven deals that I've been involved with, there were
2.5 million shareholders who have made a pretax profit of
$12 billion. I am not a destroyer of companies. I am a
liberator of them!"
The corporate
raiders and forced restructuring is understood as creating a
leaner, meaner, more shareholder friendly American
capitalism. If, in the process, long-term employees of the
restructured firms lose their jobs and factories or even
whole divisions may disappear, generating negative effects
on whole communities (see Michael Moore's documentary
Roger & Me) then so be it. That's the cost of progress:
"The point is
. . . that greed, for lack of a better word, is good. Greed
is right. Greed works. Greed clarifies, cuts through, and
captures the essence of the evolutionary spirit. Greed, in
all of its forms --- greed for life, for money, for love,
knowledge --- has marked the upward surge of mankind, and
greed . . . will not only save Teldar Paper but that other
malfunctioning corporation called the U.S.A."
The above
speech represents an application of the theory that the
market for corporate control provides an important mechanism
for transfering assets from the control of managers who, by
virtue of the widely dispersed pattern of corporate
ownership, have gained too much autonomy and have been using
that power in a manner inconsistent with maximizing
shareholder wealth. The ownership shift that results from
the takeover allows for the replacement of inefficient
managers with more efficient ones. This process, according
to Gekko, will not only solve the specific problems of the
inefficiently run corporation, in this instance, Teldar
Paper, but will ultimately make US capitalism, as a whole,
function more efficiently, i.e. generate economic growth.
NOTES
[1] Any fundamental
transformation in the asset base of a firm can be considered
a form of corporate restructuring, whether this results in
the expansion or contraction in the scope of the firm's
mission. For a more in-depth discussion of corporate
restructuring, see J. Fred Weston, Kwang S. Chung, and Susan
E. Hoag, Takeovers, Restructuring, and Corporate
Governance, 2nd edition, (Upper Saddle River, NJ:
Prentice Hall, 1998).
[2] For a discussion of
the negative effects of directors on corporate cash flow,
see E. S. Browning, "Wharton Study Connects Strengths and
Flaws of Directors to Companies' Financial Returns," The
Wall Street Journal, April 25, 1997, section C, page 2.
Leadership Focus