Corporate Takeovers, Fairness, and Public Policy
Zalewski, David A., Journal of Economic Issues
A defining characteristic of the 1980s was the wave of corporate takeovers that introduced many Americans to the colorful world of greenmail and golden parachutes. Andrei Shleifer and Robert Vishny (1997, 98) estimated that acquisitions during this decade involved $1.3 trillion in assets and 28 percent of the 500 largest US-based corporations. Although takeover activity slowed by the early 1990s, its recent resurgence in the United States and increasing popularity in Europe justify a reexamination of its consequences. 
Mainstream economists support an institutional environment that encourages acquisitions by arguing that a vibrant market for corporate control improves allocative efficiency by helping resolve agency problems.  Paradoxically, another strategy to address agency conflicts--compensating managers with shares of stock or stock options--may reward substandard performance in the event of a hostile takeover. This results from the premium paid by many acquiring firms for the undervalued shares of mismanaged firms. Since many executives benefit financially from these transactions, I argue in this paper that the market for corporate control often fails on ethical grounds because the burdens of takeovers are unfairly distributed. 
Like many types of market failure, ethical shortcomings in the market for corporate control result from power, which many executives exploit to negotiate contracts that reward them even if they perform poorly. As Salary.com vice president William H. Coleman observed: "Almost everyone understands that executives get paid a lot because they're entrusted with the responsibilities of a multimillion dollar corporation. But what they don't comprehend is that a CEO doesn't suffer when a company's fortunes take a turn for the worse."  Because nonexecutive employees and other stake-holders disproportionately bear the risk of poor corporate results, one-sided employment contracts are unfair.
Because recent changes in the executive labor market have increased the negotiating power of CEOs, it is unlikely that corporate boards will voluntarily resolve this problem soon. For this reason, the federal government should address the unethical consequences of corporate takeovers by revising current tax policy.
Executive Power and Compensation
Proponents of agency theory argue that the market for corporate control disciplines executives by threatening their jobs if they perform poorly. Although takeovers have cost many managers their jobs, many of them negotiate contracts that limit their financial risk. The following examples illustrate two of the most popular ways to accomplish this objective--option repricing and golden parachutes.
The Price Is Right
One common method of shielding executives from the consequences of poor performance is to change the exercise price of their stock options. For example, North Face Inc. became a leveraged-buyout target in September 1998 after its stock price fell from $26 to $9 per share amid financial irregularities. Soon after negotiations began, the board of directors repriced the stock options held by the top three executives from $21 to $9 per share. When the deal closed on February 27, 1999, at a price of $17 per share, Kathleen Morris (1999) estimated that CEO James G. Fifield gained $3 million from this adjustment.
Some of the most popular takeover defenses are golden parachutes, which provide large contingent payments to executives who lose their jobs after an acquisition. A particularly egregious example was the package granted to three senior executives at insurance giant Conseco Inc. According to Debra Sparks (1998), the stock options held by these managers had no exercise price. Thus, the entire share price paid by an acquiring firm would be a capital gain. Moreover, because these managers were to receive five times their annual salaries and bonuses following a takeover, Sparks estimated that an acquisition would have resulted in a $590 million windfall. …