A Hubris Of Managers: when Corporate Takeovers Go Bad

Listener 17 November, 2001.

Keywords Business & Finance; Governance

Why should New Zealanders be abused when a Singapore owned company closes down its Australian operations? That is what happened when Air New Zealand shut down Ansette Australia. Yet, when the New Zealand government privatized the company in 1989, nobody mentioned that there would still be such ongoing attachments. They were certainly ignored in the 1984 Treasury paper setting out the case for privatization of all government trading activities. That paper had a very narrow focus, justifying private ownership using a theory without empirical content and ignoring the practicalities of the real world. Like that Ansette workers disregarded that it was a mainly Singapore owned airline dumping them, and picketed the New Zealand prime minister.

The theory’s idealization that a good company would run each state owned enterprise better than the government leapt over some rather obvious difficulties. The hubris theory of company takeovers (I first saw it published in 1982), suggests there is a tendency for acquisitor-companies to pay too much. Company managers are over-optimistic about their ability to add value to a new company. The takeover increases their company’s debt. Instead of being concerned about managing the taken-over company well, the acquisitors concentrate on extracting as much cash as possible to service the debt. Profits are not reinvested, but paid out as dividends to the shareholder company. (“Herald” business columnist, Brian Gaynor argues that New Zealand companies have a bad record of paying too high a proportion of profits in dividends.) Investment, research and development, marketing, human resources development crucial for its long term survival are cut back. Takeovers, rather than succeeding, are more often failures.

(Other means by which a significant shareholder can extract cash from a partly owned company include selling it an overpriced assets, extracting an excessive management fee, and overcharging for services (say insurance) by an associate, all of which damage the company and its small shareholders.)

In the Air New Zealand case, one of its major Singaporean shareholders, Brierleys, owns a substantial portion of the British Thistle Hotels chain, which it acquired in extremely unsatisfactory circumstances (the hubris theory again), and which has been a financial albatross. To service its debt, Brierleys has been pressing the other companies it owns (or partially owns, but has a representative on the board of directors) for dividends. The Air New Zealand disaster may be one consequence.

Directors – especially those who think they do not need to know anything about the businesses of the boards they sit on – also illustrate the hubris theory. One of the Air New Zealand directors excused the board’s ineptitude saying they could only operate as well as the advice they were given. Given the fees they were paid (the 13 directors received $900,000 a year between them) one might hope for some competence in their selection of advisers.

But why participate in takeovers, if about three out of four are going to be a disaster? There are few rewards for the director who counsels common sense – director’s fees generally go up after an acquisition. (Do they come down when the ruin occurs?) There are even fewer rewards for cautious advisers. Their fee for a deal is often around 1.5 percent of the cost. (That would be in excess of $1.3m on the Air New Zealand bailout, although Treasury probably screwed it down a bit.) So takeovers generate positive incentives for directors and those who make the deals, even if small shareholders suffer. Recall Business Roundtable ex-chairman, Douglas Myers, who said a lot of ‘old farts’ lost money on the share market. Above is a list of some of the ways they have.

One might argue that shareholders – old farts and others – are there by choice. But there are others with less choice who also depend upon the company who also suffer: customers, workers, suppliers. Sometimes the entire economy can – hence the need to re-nationalise Air New Zealand. The 1984 Treasury report said good quality ‘cornerstone’ shareholders can result in good company performance. But not all such shareholders are good quality.

In the 17 years the extremist theory of privatisation has been tested. There is a good study by Alan Bollard and Ian Duncan that corporatisation of state owned enterprises led to better business efficiency (but this must in part be that they were told to pursue only that efficiency and no other – social – objectives). However, compelling evidence on inevitably superior performance by privatised companies does not exist. That which existed by the 1980s was equivocal, and the new research remains so, with examples of successes and failure, quite unlike the prediction of the theory-based fact-ignoring 1984 paper.

This does not necessarily mean that enterprises should be re-nationalised in order to keep the businesses out of the hands of incompetent directors and cornerstone shareholders. Some of the criticisms against government ownership remain valid. But now the argument is one of pragmatic judgement of the relative merits of public and private ownership, not of extremist rhetoric. Meanwhile small shareholders need to avoid being gulled into believing in naturally superior company directors acting in their and their company’s interests.