Corporate Restructuring and Industrial Research and Development (1990) / Chapter Skim
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Afternoon Session, October 12, 1989
Afternoon Session, October 12, 1989
Pages 80-120
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From page 80... ...
It examines the impacts of technological change, internationalization, and deregulation on the structure of the computer and communications industries. Ken is a recognized expert on technology policy in the United States and is also the author of the background paper that was distributed prior to the symposium, which gave us a very good context for our discussion.
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From page 81... ...
Thirdly, I would like to point out some of the major issues that came out of venous studies on the impact of takeover activity on research and development, pointing particularly to a couple of subtleties that are not always evident to the naked eye. Finally, I would like to make some brief remarks on capital costs, a subject that has come up over and over again, as linked to this entire discussion.
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From page 82... ...
But to make a long story short, there is not a great deal of evidence to suggest a steep decline associated with the rise in takeover activity, although obviously these data are very limited. The second thing I wanted to point out is that when we are tattling about how the Federal Government can influence research and development activity in this country, clearly one avenue is policy aimed at regulating or restricting takeover activity.
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From page 83... ...
If one wanted to look at the impact of hostile takeover activity on research and development, one would want to distinguish between hostile takeovers and non-hostile takeovers. Again, it is not clear that all merger and acquisition activity is equal if you are looking at the arguments which lie behind the assertion that takeovers are either good or bad.
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From page 84... ...
These two seemingly intractable and contradictory propositions can in fact be reconciled. A third subtlety which is important, very difficult to grapple with, and in some sense the crux of the matter, is that those who argue that takeover activity has basically served a positive function, argue that much of the positive function has been exercised through what you might call demonstration effects.
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From page 85... ...
Presumably research would be especially impacted particularly more basic kinds of research because of the long-term nature of that kind of activity. According to this scenario—and here is where it ties in with Michael Jensen's arguments on the salutary effects of takeover activity if we are coming from a world of relatively low capital costs, into a world of relatively high capital costs, one would expect pressures on companies to adjust, that is, to cut back on the longer-term projects and to divert more of their attention to shorter-term projects.
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From page 86... ...
You can say hostile takeovers are causing a decline in research; strictly speaking, you would be correct, because they were the vehicle by which demonstration effects influenced everyone else in industry and got them to cut back on research and development. Or you can say that real capital cost, the macroeconomic environment, was the culprit, because it was causing this diversion away from long-term projects toward shorter end projects, and you would also be right.
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From page 87... ...
I have argued today that the empirical record is far less certain than some would have you believe, in part due to subtle effects that are not really measured in these studies, and more important, because of the distinction between research intensity and the aggregate level of research.
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From page 88... ...
The Almanac of American Politics has said, and I think rightly so, that his major assets are his rare ability to come up with original and defensible solutions to complex and seemingly insoluble problems, his openness and his intellectual honesty. That is why we are particularly pleased that the Majority Leader has agreed to join us today to tell us how his colleagues view the wave of corporate restructuring that we have been talking about, and what we need to do in a broader sense to ensure U.S.
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From page 89... ...
We got off the elevator, they took one of my aides to the side and were talking to him, and he came over to me afterwards and he was laughing wildly and I said, what did they say? He said, they said, you know, Dice President Quayle looks in person just like he does on TV.
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From page 90... ...
We cannot and should not construct barriers to all takeovers in corporations, but we should examine whether we can remove those tax subsidies that exist that artificially encourage takeover activity. Second, the trend toward takeovers and leveraged buyouts and reduced emphasis on basic research supported by industry puts an even higher importance on increasing the level of federal support for basic research.
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From page 91... ...
The bill establishes a permanent statutory position for the Assistant to the President for Science and Technology. Our bill restructures traderelated federal agencies, including reforming the Commerce Department into a streamlined Department of Industry and Technology, beefing up the foreign commercial service and creating an export strike force.
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From page 92... ...
The bad news is it has changed for the worse. In 1980, the division between federal dollars for military research versus civilian research was about dollar for dollar, about where it had been for the previous 20 years.
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From page 93... ...
I foresee people like yourselves taking an active role in places such as the Board of Directors and on various ACTA projects. You know where the action is, or where it should be in the next 20 years, but for various reasons, a given company or companies together cannot or will not go it alone.
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From page 94... ...
CONGRESSMAN GEPHARDT: The Advanced Civilian Technology Agency.
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From page 95... ...
You may be interested to know that in some of the earlier panels, particularly our corporate panel, there was a rather, I would say, cruel view of the capital gains cut. I think you might have been surprised by that.
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From page 96... ...
We would put up with getting rid of industrial development bonds and the investment tax credit and lots of other things that a lot of us really thought were pretty keen ideas, in order to get capital gains at the same rate as ordinary income, and to get the whole rate down to about 30 percent, which we thought was real progress. Now people could invest, people could make decisions based on how they thought they could make money, not by some attractive gimmick in the tax code.
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From page 97... ...
I would lye to thank Ed Abrahams for the invitation. I would like to thank Stu Eizenstat for the introduction, and I would like to thank my old friend, Commissioner Joe Grundlest, for essentially giving my speech last night at dinner.
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From page 98... ...
I do not know who is right and who is wrong, but there do seem to be tremendous differences. I come from the University of Rochester where the business school is called the William Simon Business School, named after Bill Simon who was our former Secretary of the Treasury.
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From page 99... ...
I mean, if you do not believe in stock markets, you probably do not make much out of it, but it does indicate that there is something more than just debt that is going on here. The debt is not the entire story; leverage is not the entire story.
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From page 100... ...
Free cash flow is a result of having past successes in business. Businesses that have had past successes have investments and projects that are doing well.
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From page 101... ...
So in order to be talking about the free cash flow theory, you must talk about a firm that has free cash flow. If the firm has got a free cash flow discount, you are really talking about a firm where the stock market does not have a lot of faith in management's ability to follow that simple Finance 101 rule.
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From page 102... ...
But this theory, in and of itself, implies that it is certainly not for all firms. It is only for those that are suffering from this free cash flow disease.
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From page 103... ...
There Is also a tremendous amount of capital. Some have referred to it as predatory pools of capital we heard that earlier today enormous pools of capital looking for profitable outlets.
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From page 104... ...
The data are that the Flamm overview and the Grundfest tank and the work that Bronwyn Hall and others have done indicate that it is very, very tough to find any support at the aggregate data level for the notion that R&D is suffering at the hands of the restructuring community. I was moved when I heard both gentlemen from the corporate community this morning refuse to condemn restructuring activity per se.
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From page 105... ...
Boone Pickens, Jr., who is the famous would-be takeover specialist. He was a villain when he was taking over American oil companies or attempting to take over American oil companies and now he is a hero because he aimed his guns at a Japanese firm.
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From page 106... ...
I must say that in listening to your description of the free cash flow theory and the limits that it puts on management, it reminds me on the public policy side of a policy some allege the Reagan Administration participated in, in which taxes were cut so deeply it created a deficit so large that it constrained members of Congress from spending anything that they wanted to spend. Whether that is actually a public policy analog I do not know, but it sounds at this hour about as close as I can come.
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From page 107... ...
I am going to agree and say I do not think we can say anything that is very definite, and I am not going to really talk about that very much. Instead I want to talk about what I think ought to be our concern at a conference like this, namely more broadly based questions about corporate restructuring, again broadly defined to include mergers and acquisitions, hostile takeovers as well as LBOs and innovative activity.
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From page 108... ...
Had I been precocious enough, I would have even named what I was doing a free cash flow theory of mergers and gotten some of the accolades that Mike Jensen is now getting for that. We know that most of the active acquiring firms in the mid-1960s were based on mature, slow-growing industries: tobacco, textiles, paper, et cetera.
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From page 109... ...
I guess at least the two people from Wall Street this morning would still be in that camp, maintaining that wealth is created when companies are put together and wealth is created when companies are broken apart. Is it any wonder, therefore, that the criticisms of takeover activity heard from its champions, let us say, on Wall Street, are only that we have too little takeover activity, that the Williams Act slows up takeovers and thus stops this wealth-creating process and that, for example, section seven in the Clayton Act, when we used to enforce it, prevented too many synergy-enhancing, horizontal, and vertical acquisitions?
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From page 110... ...
On face value, it is hard to envisage why hostile takeovers would improve the innovative records of the companies involved. Certainly, the immediate effects of hostile takeovers and the restructurings that follow— and of leveraged buyouts, for that matter—and the pressure to increase immediate earnings, are unlikely to create a corporate environment that enhances the long-run commitment to R&D and investment and risk taking that the innovative activity requires.
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From page 111... ...
They moved heavily into machine tools and by the mid-197Os they were one of the leading machine tool manufacturers in the country. In 1979, as everybody now knows who was here this morning, they went through a leveraged buyout and in the next six years, their constant dollars sales dropped by over 70 percent.
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From page 112... ...
One has to, I think, ask the question how it is the Japanese seem to remain so innovative and efficient without the tight constraints on the market for corporate control, and the discipline on managements which we get through the much heavier and more intense merger and acquisition activity that we have in this country. (Here I might mention, on the point raised this morning, that the Japanese can engage in cooperative R&D but, of course, the diversification mergers that have taken place in this country are supposed to have a similar effect.
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From page 113... ...
They are not really terribly exciting, and the productivity has increased in precisely that area most subject to foreign competition, so you also could make the argument that it may not be the leveraged buyouts and restructuring so much as the downsizing of those industries and the requirement to mechanize and to have to compete with foreign competition and not have the luxury of having as many men and
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From page 114... ...
I do not find any evidence. I find a purely theoretical economic argument of the Chicago school.
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From page 115... ...
I think the next place to look is firms that leverage in order to avoid hostile takeovers or other types of attack, and that I cannot give you the answer on yet.
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From page 116... ...
My third comment is for Gregg Jarrell. He alluded to a result on leveraged buyouts which is not really a result.
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From page 117... ...
By their own admission, on the other hand, LBO candidates tend to be rather low-intensity R&D performers, and this may make a real analysis of the impact on R&D very difficult to come to. The corporate view is that the real villain is the short-term horizon, and that the short-term horizon forces corporations to make short-term decisions, to satisfy stockholders who want to know what the next quarter returns are going to be, and therefore take away from the necessary concentration on R&D, which is obviously a long-term interest.
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From page 118... ...
118 CORPORATE RESTRUCTURING view, LBOs are, if anything, essentially a negative to R&D because, again, they tend to force a short-term attitude of paying off the debt and then selling the company. Again, the data do not seem to support although anecdotally they might- the intuition one would have that higher debt levels for these LBOs would lead to less R&D.
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From page 119... ...
I think we got some extremely provocative and very interesting notions from our corporate panel and from others about possible tax policies to change the short-term horizon problem: taxing pension funds, a graduated capital gains tax, ways to reduce our capital costs. Perhaps until and unless we have the kind of empirical studies that will develop a consensus on restructuring, what we ought to be doing is focusing on those things where we have reached some form of consensus, which are: we need to spend a hell of a lot more on R&D than we are; there are serious reasons for the R&D decline; we do have short-term horizon problems; and we do have capital cost problems.
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