Organization Theory and the Market for Corporate Control: A Dynamic Analysis of the Characteristics of Large Takeover Targets, 1980-1990

Davis, Gerald F., Stout, Suzanne K., Administrative Science Quarterly

banks or other firms had no such effect. Having an executive of a large bank on the board of directors also failed to save firms from takeover.(4) These results fail to support the predictions of bank control theory; moreover, they suggest that commercial banks are not particularly effective either at preventing managerial discretion or at protecting from takeover the firms to which they are connected. Thus, there is little evidence that a regime of more active bank participation in corporate governance would yield substantial benefits, contrary to the claims of recent commentators (e.g., Thurow, 1992).

Firms that were well connected in the interlock network were Corporate takeovers became perhaps the most significant events on the organizational landscape during the 1980s. Due to a confluence of factors--including the availability of large supplies of debt financing, innovations in financial instruments, and a climate of relaxed antitrust enforcement--top managers of large corporations previously thought invulnerable to unwanted takeovers abruptly faced a challenge to their control unlike any in the postwar era. Thus, between 1980 and 1990, 144 members of the 1980 Fortune 500 (29 percent) were subject to at least one takeover or buyout attempt. While most of these attempts (77) were hostile--publicly resisted by management--the vast majority ultimately led to a change in control, including 59 of the hostile bids and 125 bids overall, By decade's end, due to mergers and takeovers, roughly one-third of the largest industrial corporations in the United States no longer existed as independent organizations, indicating a degree of tumult at the top unparalleled in recent times (Faltermeyer, 1991).

Despite the importance of this trend, relatively little research on takeovers has appeared in the organization theory literature, and the relevance of the market for corporate control for theories about the dynamics of change in organizational populations has gone largely unrecognized. Organization theory, informed by a biotic evolutionary metaphor of organizations, has focused primarily on adaptation--internally generated organizational change--or selection--the death of organizations that fail to adapt (Aldrich and Pfeffer, 1976). Takeovers do not readily map onto either of these abstract notions. Takeovers are not internally generated, yet acquired firms typically undergo substantial organizational change under their new ownership. While death through business failure is not unheard-of among the largest corporations, it is exceptionally rare--several Fortune 500 firms sought protection through bankruptcy during the 1980s, but fewer than 1 percent of this population ultimately failed--while takeovers are quite common. Moreover, takeover targets almost always remain going concerns after the acquisition, operating in the same industry (or industries), with most of the same employees (Bhagat, Shleifer, and Vishny, 1990). Thus, while takeovers contain elements of both adaptation and selection, they do not easily fit either of these categories.

We argue that the operations of financial markets provided a potent motor of organizational change in the 1980s that challenges the metaphors of adaptation and selection that have dominated organization theory. Researchers on organizations and environments have catalogued the adaptive strategies that organizations can use to reduce uncertainty and increase autonomy (e.g., Thompson, 1967; Pfeffer and Salancik, 1978). Yet these theories are implicitly premised on a conception of the large corporation that takes the managerial revolution as the status quo: Stockholders are dispersed and effectively powerless, large firms are immune from takeover, and thus the largest corporations are run by a self-perpetuating class of professional managers who seek growth and greater environmental certainty with little constraint from shareholders (cf. Meyer, 1991). But as Herman and Lowenstein (1988: 215) pointed out, "The former stability of corporate control and irrelevance of shareholder ownership and voting rights to corporate power has been badly shaken and weakened" due to the construction of a takeover market for the largest corporations. As a result, the most prominent approaches to organizations and environments have themselves fallen out of sync with the realities of corporate control even as takeovers came to represent perhaps the dominant form of organizational transformation among large capitalist firms.

Thus, this study attempts to fill some of the gap in our understanding of corporate takeovers by taking an organizational approach to the market for corporate control. Our intention is not to propose a new general theory of change in organizational populations--the fact that takeovers came in a wave that has substantially run its course indicates that such a theory would be inappropriate. Rather, we hope to provide an assessment of the significance of takeovers for existing organizational theories and to suggest avenues for improvement by examining the factors that made firms vulnerable to takeover during the 1980s. We cannot claim that other forms of change were absent during this period: Self-restructurings, sell-offs, and more mundane changes undoubtedly occurred on a day-to-day basis, and these might be assimilated by adaptive organizational theories, if not by selection approaches. Yet a takeover represents both an undeniably significant change and one that is alien to most organization theory and, thus, most in need of exploration.

THE RISE OF THE MARKET FOR CORPORATE CONTROL

The notion that mergers could be conceived as transactions in a market for corporate control was forcefully articulated by Manne (1965), providing the theoretical foundation for most subsequent research on corporate takeovers. Manne argued that the stock market provides the only objective evaluation of management performance through the price it places on a firm's equity. If those in control of a public corporation do a bad enough job, the firm's share price will dip so low as to create an incentive for more competent managers to take control and drive the firm's value back up. The worse a firm is managed, the lower its share price and, therefore, the greater the potential capital gains to outsiders who buy the firm's stock and run the firm more efficiently. Although takeovers can be costly, as long as the cost of the takeover is outweighed by the gains to be made by ousting inefficient managers, they will be attractive to potential acquirers.

Control changes can be accomplished in several ways, including proxy fights and negotiated mergers, but tender offers are the most effective way to take control of an unwilling target. A tender offer differs from other forms of merger in that, rather than negotiating a business combination with the target firm's managers, outsiders take their case directly to the shareholders and bypass management and the board. In a typical tender offer, outsiders offer target shareholders a premium over the target's current share value in order to buy an ownership position sufficient to exercise influence or control (up to 100 percent of the target's outstanding shares).(1) When tender offers are made without the approval of the target's board, they are considered hostile takeover attempts. Top managers typically leave the firm following successful hostile bids (Walkling and Long, 1984). Stockholders are the judges in these contests for control, choosing to support incumbent managers or to sell out to the takeover team. Because they allow outsiders to bypass incumbent managers, tender offers are the most effective way to bring about a change in control, and as the leading edge of the market for corporate control, they are argued to be perhaps the only serious force for limiting managerial opportunism or inefficiency. Moreover, according to some commentators, when a successful tender offer allows a more efficient management team to oust a less efficient one, virtually everyone except the displaced managers benefit: Target shareholders that sell out get their premium, the new managers gain from the increased value of the firm they now manage more effectively, and society benefits from a more efficient allocation of resources (Gilson, 1981).

Given these enthusiastic descriptions of the hypothetical social benefits to be derived from an active takeover trade, the scene was set for the developments that brought about the biggest wave of large corporate takeovers in history during the 1980s. Several factors came together to promote large takeovers: innovations in financing techniques, which lessened the effectiveness of size as a barrier to successful takeover; the elaboration of a takeover industry with sophisticated information technologies, as well as financial and legal advisors adept at deal making; and the free-market ideological climate provided by the Reagan administration, which worked against any regulation of takeovers and encouraged the gutting of antitrust enforcement (Brooks, 1987). Additionally, the Supreme Court invalidated most state laws limiting takeovers with the Edgar v. MITE decision in 1982.

Facilitating these developments was an underlying shift in the dominant conception of the corporation toward a financial model. The public corporation is now widely viewed not as a complex social organization but as a bundle of assets, a source of cash flows (Fligstein, 1990; Meyer, 1991). Few events illustrate this commodification of the corporation as dramatically as a takeover: Takeovers highlight the fact that public corporations are not only commodities but that they are always for sale, at least in principle, regardless of the wishes of the individuals who work in them. This institutional transformation was driven in …

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Publication information: Article title: Organization Theory and the Market for Corporate Control: A Dynamic Analysis of the Characteristics of Large Takeover Targets, 1980-1990. Contributors: Davis, Gerald F. - Author, Stout, Suzanne K. - Author. Journal title: Administrative Science Quarterly. Volume: 37. Issue: 4 Publication date: December 1992. Page number: 605+. © 1999 Cornell University, Johnson Graduate School. COPYRIGHT 1992 Gale Group.

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