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Ethical Considerations in Corporate Takeovers
Copyright © 1990 Woodstock Theological Center. All rights reserved. Published by Georgetown University Press (ISBN 0-87840-500-3).
TABLE OF CONTENTS
"Ethical Considerations in Corporate Takeovers" is the product of two years of study and two major conferences with members of the financial industry, government, and academia. Rev. Timothy S. Healy, S.J., then President of Georgetown University, chaired the conferences. This report distills highlights of those conversations and offers an evaluation and recommendations for ethical conduct in the financial industry.
Those whose names appear above were participants in the process. Not every member of the group subscribes to every sentence in this report, but all support its basic contents and sentiments, deeming its distribution within the financial industry and beyond to be useful. Their support does not involve any organization with which they are affiliated. They hope that their shared experience and insight may help others who face ethical questions in financial decisions.
This project was conceived in the Fall of 1987, when the media were dramatizing the ethical problems confronting the financial industry. People in that industry were deeply concerned about the origin and extent of these problems. In response, the Woodstock Theological Center decided that a project on ethics in the financial industry would be valuable. The Center was established at Georgetown University in 1974 by the Society of Jesus to study the interaction between moral values and problems facing contemporary society.
Besides our gratitude to Father Healy for chairing our meetings and to Henry Owen for helping to conceive and guide this project, we are indebted to Dr. Margaret M. Blair, its rapporteur. Not only did Dr. Blair draft the original working paper, she also organized the ensuing discussion material, giving greater coherence to this collaborative monograph. We also thank Rev. John P. Langan, S.J., who contributed an initial paper and gave continuing assistance; Mr. Lloyd N. Cutler, who gave wise advice at key points in the process; and Dr. E. Eugene Carter for his economic expertise.
We are happy to acknowledge our gratitude to Chemical Bank, The Chase Manhattan Bank, American Security Bank, and the Anne S. Richardson Fund for financial support of this project.
Beyond publication of this seminar statement, Woodstock will continue to study and publish reports on ethical issues in corporate life. The role of corporate leaders in setting the ethical tone of a firm is one such topic under discussion. What can corporate leaders do to create and maintain a climate in which ethical values are respected? Through the Seminar in Business Ethics, the Woodstock group hopes to reach consensus on concrete procedures and systems of accountability that will guarantee ethical consciousness.
James L. Connor, S.J.
The corporate sector of the U.S. economy appears to be undergoing a massive restructuring as a consequence of an unprecedented number of mergers, acquisitions, takeovers, leveraged buyouts, spin-offs, and recapitalizations. These transactions have raised ethical and moral questions which some individuals and institutions in the financial industry that are parties to the transactions or brokers or agents for other participants have considered worth studying. The ethical considerations are made more complex by the fact that the transactions themselves are sometimes controversial. Some thoughtful observers believe that the increased pace of turnover and restructuring of corporations is sapping the economic strength of the corporate sector, while other equally thoughtful people believe that it is indicative of the dynamism and responsiveness of the sector to changing economic conditions. Moreover, we do not fully understand what social and economic forces are causing this institutional upheaval, nor are we able to predict what its full effects are likely to be.
Troubling ethical questions regarding corporate takeovers and related transactions have been raised on two levels:
First, at the level of process, questions have been raised about the appropriateness and fairness of the behavior of parties involved in the transaction itself. In particular, questions have arisen about the changing role of financial institutions, about evolving standards and expectations regarding the responsibilities of these institutions to their clients, and about the way in which existing fee and compensation structures affect the incentives and behavior of parties to the transactions.
Second, at the level of outcomes, questions have been raised about the harm or benefits of the transaction to all parties directly and indirectly affected, and about the fairness or social desirability of these outcomes. Debate about these issues often comes down to questions about the social role of corporations, their responsibilities to constituencies other than their shareholders, and, by extension, the social role and responsibilities of the institutions that are called upon to act as agents or intermediaries for corporations.
The Woodstock Theological Center Seminar in Business Ethics brought together members of the Congress, executives from the financial industry, officials from the international development banks, regulators, and academic specialists in philosophy, economics, finance, management, and business ethics to address these issues in a series of seminars. Although the following report reflects a general consensus among project participants about the ethical considerations facing professionals in the financial industry who are involved in merger and takeover transactions, not every statement reflects the views of each participant in all respects. It is intended to serve as a point of reference for them and other members of the financial community who are concerned that their individual decisions, actions, and norms of behavior, as well as those of their industry, should reflect the highest values of the society they serve.
Section I places the specific ethical issues addressed by this project in the context of the ethical climate of the business community and of society at large. In particular, it discusses concerns expressed by project participants that the ethical problems they observe in the financial sector are but one small piece of a widespread pattern of social problems bearing on the moral climate of society. This section further provides some perspective on these fears by reviewing possible reasons for the apparent moral upheaval, and identifying some assumptions and competing values underlying the concerns.
Any attempt to develop ethical guidelines for the financial community must begin with a sense of the values which are worth preserving. Accordingly, Section II presents a statement of values which the conference participants believe provide a basis for ethical decision-making, particularly in business transactions.
Section III offers a set of questions and procedural suggestions to which financial industry professionals involved in merger and takeover transactions may wish to refer for guidance in identifying the ethical issues that may arise in such transactions, and in deciding how to respond to those issues. These questions are thus intended to help these professionals translate the values identified in Section II into practical choices and actions.
Section IV addresses the ethical responsibilities of players outside the financial industry, and suggests ways in which the questions in Section III can be adapted for use by these other players. This section also comments on the role of public policy and offers some concluding thoughts and directions for future study.
In the last decade, dramatic changes have taken place in the way the financial industry operates to mobilize capital for productive enterprises and in the way it rewards the entrepreneurs, institutions, and "financial engineers" who direct the movements of capital. High-speed technology for information processing and communications has made it possible to transfer resources around the world in minutes, and to transform the contractual terms on which those resources are transferred via complex conditionality clauses and multilayered arbitrage, portfolio, and swapping arrangements. New forms of securities have been developed and new institutional arrangements have arisen which make it possible for even small and mid-sized corporations to bypass traditional financial relationships and raise money through new channels. Investors, both large and small, can now invest in a wide range of new securities, the risks and rewards of which are only partially understood. And corporations are being bought, sold, taken apart, put back together again, and reorganized at an unprecedented pace.
In this context of growing complexity, a few individuals have been able to amass large profits from transactions which, even if they are not illegal or deceptive, have aroused suspicion and distrust among some observers. Rapid shifts in power and wealth, together with the breakdown of old institutional arrangements and the public suspicion of foul play by some players, have aroused fears that the moral underpinnings of the financial sector of industrial economies may be weakening.
Some participants expressed concern that the notion of loyalty in business relationships has been devalued. Some employees no longer feel a commitment to the organization for which they work, and some organizations now display less loyalty to their employees than was thought to be the case in the past. "Client" relationships have changed as lenders, borrowers, agents, and brokers move from deal to deal, seeking the best terms without regard to long-standing relationships. Concern arises in some quarters from the fear that this weakening of loyalty, together with the increasing complexity and depersonalization of financial transactions, will undermine even more fundamental values of honesty, fairness, and responsibility to society's larger purposes.
Some project participants viewed changing values and ethical standards in the financial community as a reflection of broader changes in the moral fiber of society at large, which have expressed themselves in the crumbling of family structures, widespread use of drugs, and fear that cheating and corruption in both government and the private sector are increasing. Although addressing these larger societal issues exceeds the intended scope of the present project, participants felt strongly that the ethical problems in the financial sector should not be viewed as isolated -- that many of the broader ethical problems in society have common roots in several social and economic trends.
The growing complexity of Western social structures and economies has led to a world in which individuals are often isolated from the nuts-and-bolts, flesh-and-blood consequences of their individual economic actions and decisions. Widespread social and economic mobility has also, to some extent, deprived individuals of a sense of community and rootedness that beget loyalty and allegiance to group values. The combination of complexity and mobility, both of which also have socially and economically desirable effects, has sometimes left responsible individuals morally confused. Traditional standards of behavior may become muddled or seem to be irrelevant when it ceases to be clear who is acting on behalf of whom, who owes what allegiance to whom, and who has what legitimate property rights in which assets. Accountability for the consequences of decisions and actions is diminished when those actions are taken by groups whose memberships and constituencies are changing frequently, and when the consequences may be so far removed in space or time from the decision or action as to be invisible to the actor. Partly as a result of these changes, our society has come increasingly to stress the rights, claims, and happiness of individuals over their responsibilities to the community and, in some cases, to value instant gratification over concern for future generations.
The ethical confusion caused by this estrangement and rootlessness pervades most social and economic arenas, although it is expressed somewhat differently in each arena. In the financial sector, judgments about the character of colleagues and partners and about the impact of changes on the various overlapping communities in business and society which would be affected by business decisions have become increasingly difficult to make in a financial world in which stable relationships with long-term clients have been weakened by a greater emphasis on the cost-effectiveness of individual transactions. Trust has been undermined in some segments of public opinion by transactions or endeavors which do not seem to create anything new of value, and to which some of the participants do not appear to have a long-term personal commitment. Concern has been expressed in the media and in some political quarters about the nature and social consequences of a financial system which delivers large short-term gains from these transactions. Such a system is seen by some as rewarding the uncommitted at the expense of the committed, exacerbating the sense of estrangement, and speeding the breakdown of institutions which bind people together and encourage them to adopt a vision which extends beyond their own self-interest.
Short-term gains from financial transactions which are not perceived as improving production or productivity are viewed as running counter to a deeply rooted cultural belief that wealth ought to be earned by creating something, and that property ought to belong only to those who expend energy developing it, or who exercise some judicious stewardship of it. Our history as a nation of immigrants who came to this country with their pockets empty to start over and rebuild explains the strength of this notion. Property-right claims by homesteaders who settled large parts of the country, for example, were honored by the courts only if the settlers were living on the tract or cultivating it. Hence, in a contest over the division of gains from a corporate enterprise, some cultural sympathies will tend to be with the employee who has been with the firm for twenty years rather than with the "raider" who joined the enterprise the previous week. Likewise, there is suspicion of transactions which enable some parties to profit enormously from a very small investment in time or resources, even if no parties who suffered losses from those transactions have been identified.
But perhaps the most disturbing to public opinion is the growing perception of an attitude among some members of the financial community that familiar moral standards are no longer really applicable, that they are likely to be invoked primarily by those who are no longer able to compete successfully in the rapidly changing market, and that they put those who attempt to live by them at an impossible disadvantage in responding to new opportunities. There is fear that the normative convictions that people bring into the financial marketplace from their families, schools, synagogues, and churches are dismissed as relics of tradition and are not used as meaningful points of moral reference.
Corporate takeovers and contests for corporate control often dramatize the consequences of the estrangement and disconnectedness between those who pull the levers of power and those who are affected on the other end. Decision-makers and profit-takers in these deals may sometimes seem to have no real connection to the enterprise at stake, and the rank-and-file workers, loyal customers, or suppliers who do feel connected to the enterprise may appear to be cut away from the center of power, authority, and responsibility.
Ambivalence and confusion about corporate takeovers also arises from another set of culturally based and deeply felt values about how power and authority are to be allocated, controlled, and held accountable. While the public will have no sympathy for the get-rich-quick artist with little personal investment in the firm, it will also be suspicious of institutional arrangements which tend to entrench existing management or foreclose new ideas or new leadership. At bottom are two widely held, yet sometimes conflicting values, one which would like to encourage innovation and change, and the other which would like to reward hard work, stability, and long-term personal commitment.
It should perhaps come as no surprise that corporate mergers and takeovers have become a focal point for concern over the conflict between these two values, as well as over the breakdown of institutions and the ethical consequences of rootlessness, mobility, and complexity. The widely held, limited-liability corporate structure, by its very nature, gives institutional form to mobility and complexity, even as it sometimes serves to sever the connections between individual economic actors and the consequences of their behavior. The corporation is not a person, but has legal standing similar to that of a person; it is made up of persons who have a variety of different claims against the proceeds of the whole enterprise, but who, individually, cannot be held legally responsible for all of the actions or obligations of the enterprise.
Do workers have as valid a legal or moral claim to their jobs and associated compensation and benefits, for example, as bondholders have to their interest payments? Do customers who buy and use products made by the firm have as valid a right to low-cost, high-quality products as shareholders have to profits from the sale of those products? Should we as a nation be allowed to insist that corporations make investments which may not be profitable to them, or avoid certain lucrative activities, because it is in the national interest for them to do so? The answer depends on the social role we assign to corporations, and much of the controversy over corporate mergers and takeovers arises from the fact that there is no moral or legal consensus on this question. Hence it is doubly hard to determine what constitutes a fair or ethical outcome in transactions in which conflicting claims to the proceeds of the productive enterprise embodied in the firm may be at stake.
Although it is perhaps open to question whether ethical norms and standards have deteriorated faster in the 1980s than at other times, it seems clear that economic mobility and complexity have increased markedly and, with them, the rootlessness and disconnectedness that undermine ethical standards. It also seems clear that these changes are at least partially responsible for the wave of corporate restructuring now under way. The decline of strong institutional loyalties and the associated collapse of clubby affiliations and implicit rules and codes of behavior in the financial community have made many types of transactions socially acceptable and financially feasible which would not have been so in previous decades.
But the move to restructure organizations may also be a reaction to the lack of accountability that can result from mobility and complexity. In a small, but perhaps growing, number of cases the restructurings may restore accountability by putting in place managers who are also the owners of, or at least major shareholders in, the corporations. In many takeovers, a large premium is paid to shareholders of the target firm, and there is evidence that this extra value may come, at least in part, from improvements in the efficiency with which the new owners manage the firm's assets. Hence, there may be a sense in which takeovers serve to restore accountability and correct or reverse some consequences of the trend toward separation of economic actors from the effects of their actions.
It is, in part, these conflicting views and possibilities about the economic and social roles takeovers are playing that make ethical decision-making about them so difficult. Nonetheless, the ethical questions are inescapable. To attempt to ignore them and "let the chips fall where they may" is nonetheless to make a decision. It is unrealistic to think that the transformation under way in the corporate sector can be carried out without acknowledging its ethical dimension.
Any effort to examine the moral and ethical issues involved in corporate takeovers must begin with a clear statement of underlying values to which members of the financial community feel committed. This section presents the values identified by project participants as relevant to the kinds of ethical problems arising from mergers and takeovers. While the identified values may come in conflict with each other at times, choices and actions should reflect some consideration for balancing overall these selected values:
Most of the values outlined above are widely shared and uncontroversial, but one, in particular, deserves further discussion. The idea that the corporation is a social institution, and that numerous parties other than shareholders have legitimate moral claims to the gains from its productive activity, is not undisputed. A substantial legal question exists, for example, regarding the circumstances under which boards of directors can consider the interests of nonshareholder constituencies once a decision has been made that the corporation is for sale. If shareholder interests were always held predominant, many of the ethical issues raised by corporate takeovers would be greatly simplified. Fairness questions would not be eliminated, but would largely be reduced to questions about the impact of the deal on shareholders of the corporate entities involved.
But most participants in the Woodstock group tended to adopt a view of the corporation that, although less well defined, implies a wider social responsibility. That view recognizes that corporations do not exist in isolation, that they must be a constructive part of the larger society in which they operate, and that even shareholders who seek solely to maximize their own profits will, as a practical matter, have to take into account the interests of workers, customers, and communities, without whom the corporation could not exist.
If they are to be effective, ethical standards must be based on values that are accepted by most, if not all, members of the financial community. This is important for two reasons. First, the business environment facing most players in the financial markets is intensely competitive. If others have not adopted the standards, the individuals or firms who do chose to adhere to certain standards may be put at a severe competitive disadvantage. At best, ethical actors may decide it is futile to continue to adhere to their principles; at worst, they may be driven out of business, leaving only the unethical actors.
Second, if the financial community as a whole fails to discipline itself effectively, political pressures will mount for regulators to take action. Participants agreed the latter was not a desirable outcome.
But subscribing to a set of values does not, by itself, produce ethical behavior. Individual participants in a merger or takeover have to translate those values into practical choices regarding the procedures and practices of the transaction and, to some extent, the outcome of the transaction. This section outlines two tools that may help decisionmakers to make responsible choices that are consistent with their ethical values.
Early in the process of planning or negotiating a transaction, financial professionals can clarify some of the ethical issues that might arise by making a list of all the parties affected by the transaction. This would make it easier for each professional to think about and try to define his or her responsibilities to each of the parties on the list.
In addition, the Woodstock group discussed a general checklist of questions which individuals and institutions involved in merger and takeover transactions can ask themselves as they consider each case. These questions are intended as a help to decision-makers in considering how well their choices and actions support the values identified in Section II.
A. Conflict of Interest:
B. Information and Property Rights:
A. Cost vs. Benefit: Has adequate account been taken of the answers to these questions:
C. "Social" or "Institutional" Impact:
The attempt in this report to address the specific ethical issues facing financial industry professionals when they get involved in merger and takeover transactions should not be construed as implying that only members of the financial industry need worry about these problems. In fact, it would be unreasonable and inappropriate for financial institutions to be expected to serve as the only, or even the primary, locus of analysis or enforcement of what should be a broad social concern. Project participants stressed that the ethical issues raised by takeover transactions are the responsibility of all parties involved in the transaction, as well as of policy-makers at the state and national level. In particular, corporate executives and directors, institutional investors, financial industry regulators, and taxing authorities have a major responsibility to address the social and economic consequences of the takeover movement and to exercise moral leadership in determining their response to the trend in general, as well as to specific transactions in which they may be involved or over which they may have jurisdiction.
Although the checklist of questions in Section III was intended to be used by financial industry professionals, the same list could be applied with little modification to other involved parties. Virtually all of the questions would be appropriate for lawyers and, with the exception of some of the conflict-of-interest questions, for institutional investors and corporate officers and directors.
The "Outcome Questions" are of particular relevance for policy-makers and regulators. Indeed, while it is inappropriate to expect financial industry players to resolve the complex issues about the long-term consequences of the institutional transition under way in the corporate sector, this is the role of legislators and regulators. Project participants agreed that more research should be done in this area to determine the nature of these effects.
Although it was not one of the goals of the project to arrive at detailed public policy recommendations, participants did feel that increased regulation is not the answer to the problems treated in this paper. They suggested, however, that reforms in a few areas might help to counteract any economic and social tendency to focus on short-term gains at the expense of long-term vision.
The group felt that changes might be needed in the tax treatment of interest payments at the corporate level and capital gains at the personal level. In particular, some members of the group felt that personal and corporate tax rules should be changed so that debt and equity are given equal treatment, thereby eliminating the artificial, tax-induced incentives toward debt financing.
Secondly, the group discussed the possibility that the tax code should be used to reduce the profitability of short-term capital gains and to enhance that of long-term capital gains. The group acknowledged the legitimate role of short-term investors in making markets for certain securities, and ensuring the liquidity of financial markets in general. But the group felt that, properly designed, certain amendments to the tax code would discourage financial manipulation that amounts to little more than churning of assets for short-term gain, and encourage savings and investment in projects that have a longer-term payout.
The group also discussed the possibility of changing the rules governing corporate voting rights so that only those investors who hold corporate stock for some minimum amount of time would be allowed to exercise those voting rights. However, any such changes must carefully balance the need to provide incentives for long-term ownership against the need to maintain market discipline over corporate governance mechanisms.
Finally, there was some sentiment in the group that the wave of corporate restructuring transactions in the 1980s may be, in part, a response to competitive pressures put on U.S. firms by real interest rates and equity costs that are higher in the United States than in competitor nations. To the extent that large federal government budget deficits may be driving up the cost of financial capital, some members of the group felt that policy efforts directed at bringing those deficits down and increasing private savings should be intensified.
Beyond that, as indicated earlier, the group felt strongly that new regulations will not be needed, assuming existing regulations are effectively enforced.
Most importantly, the group acknowledged the complexity of the issues at stake and urged that debate and discussion on these issues continue. At the heart of the debate are fundamental questions about the appropriate social role of corporations, of the individual and institutional investors who provide the financial capital for them, and of the executives who manage them. If corporations are to survive and do their work well, they need to achieve a combination of stable continuity and flexibility, while still being responsive to the needs and goals of the larger society in which they operate.
The complexity and difficulty of balancing these goals and translating them into specific decisions and actions will require ongoing creativity, thoughtfulness, and commitment on the part of the leaders of the business community. Academic and religious leaders can also help by providing careful analysis and insight on issues to which their special expertise and perspective is relevant. The Woodstock Theological Center Seminar in Business Ethics plans to continue its study of special ethical problems facing people in business.