The last time that CEOs were routinely kept awake at night was during the merger wave of the mid-1960s.
The frothy ’50s turned out to be high tide for American industrial dominance, a time when we were rebuilding the world after a devastating war. CEOs had it pretty cozy then. As the tide began to recede, investors began to notice the accumulated waste made possible by a decade of easy growth. A few of them saw advantage in taking over the worst governed companies in order to restructure them. At that time, they could do so without warning, which is what made this environment so frightening to CEOs. Imagine never knowing when you might get a phone call telling you that you are out. This is like going trick-or-treating and fearing the “tricks” all year long.
Corporate executives of that period had grown up in a world where being a leader meant getting along with everybody, and knowing how to use the corporate treasury to buy allegiances, including labor, business partners, and politicians. These new people on the scene—called “raiders”—were after the whole treasury, in part to prevent it from being used as the CEO’s relationship kitty. The governance mechanisms of the day gave them access to it by simply taking advantage of the stock being cheap after years of neglect.
Worried incumbent CEOs reacted by contacting their congressmen, who also knew a thing or two about incumbency. This unholy partnership took control of the narrative. Instead of investors identifying bloated companies in order to restructure them and return excess funds to remaining shareholders, the incumbents claimed that:
“In recent years we have seen proud old companies reduced to corporate shells after white-collar pirates have seized control with funds from sources which are unknown in many cases, then sold or traded away the best assets, later to split up most of the loot among themselves.” (Sen. Harrison Williams, 1965)
The media bought it. The legend of the “corporate raider” was born. The off-hand mention of “unknown” funding sources added a hint of nefariousness. (Who did they think provided the funds? Why did it matter?) The media didn’t consider that any mechanism that made the sum of the parts worth so much more than the whole might actually be socially useful. Instead, they played on the conservative discomfort of seeing old line, industrial firms disappearing at the hands of destabilizing (and generally non-WASP) upstarts, and the liberal discomfort of “money men” involved in unregulated financial activities.
Thus, in the fall of 1968, Congress passed the Williams Act. This law prevented investors from making a tender offer for shares without giving incumbent boards and management a chance to “present their case” for continued control of the company—as if they hadn’t already had years to make their case.
Now comes the weird part. Many people think that golden parachutes were concocted by managers who were worried about losing their jobs in a corporate takeover. If that were the case, though, we would have expected to see golden parachutes gaining traction before passage of the Williams Act, when the threat of takeover was higher, and then dropping off after passage of the Williams Act, when managers were better protected.
In fact, the opposite happened. Before the Williams Act, there was little reason for a board to grant a CEO a golden parachute, or for an acquirer to honor it. Sure, CEOs would have lobbied furiously for golden parachutes if they had thought about it during the pre-Williams era. But what would they do if they didn’t get their way? Leave the company?
No. The golden parachute became popular after passage of the Williams Act because the Act effectively gave CEOs a veto over the acquisition of their firm. In other words, golden parachutes became the bribe to get CEOs to go along with a deal that might displace them. For example, it now made sense for current shareholders who were getting a $400 million premium in a takeover offer, and for prospective shareholders who thought that they could make a billion dollars by turning the company around, to pay the incumbent CEO a few million extra dollars to go away, if that’s what it took to get the deal done.
It was like trick-or-treating the way children experience it, i.e., treats no matter what. Under-performing CEOs were no longer haunted by the specter of a ghoulish investor eying his candy. The fear of corporate raiders would reawaken in the 1980s, but by then the golden parachutes had been handed around, so even if CEOs were pushed out, it would be on their own terms. Note that this “rent extraction,” as it’s termed by economists, was not the result of managerial power granted by a lazy or corrupt board to a greedy CEO. This was managerial power created by law.
The Williams Act was the first step in a long dance of Congress unintentionally enhancing managerial power, and then trying to contain that power through other legal constraints that, in turn, had their own unintended consequences. In fact, the long history of governance regulation in general, especially compensation governance, has been a nightmare of unintended consequences, leaving a complex tangle of rules that benefits no one but lawyers and consultants.
Today, managers are only slightly less entrenched than they used to be due to a wholesale shift in power from the CEO toward more independent boards–a shift that had more to do with growing institutional power than to any regulations. But managers (and boards) are nowhere near as accountable in the current, convoluted regime of enhanced disclosure, tax constraints, and “Say on Pay” as they would be in a truly vigorous market for corporate control.
If we were serious about getting rid of the extra leverage that CEOs have over their boards and shareholders, then we should return to the “scary” environment we abandoned forty-five years ago, when underperforming CEOs really had something to fear.