paid. Greenmail payment takes a target company “out of play” (i.e., it removes the immediate threat of takeover). Terminating the takeover process induces frantic selling by arbitrageurs. The market in the firm’s stock is equilibrating away from highly opportunistic clientele back toward long-term investors. Moreover, investors cannot know as much as managers about a firm’s prospects. The problem is essentially one of signaling or investor relations, which, by and large, firms do poorly. Even if management never talks to shareholders, however, and instead waits for intrinsic value eventually to become manifest in operating performance, paying greenmail still makes economic sense if the wealth transfer to the remaining shareholders is positive.
Conclusion
Should Disney pay greenmail to Saul Steinberg? Various perspectives would seem to support it. Focusing on shareholder welfare, assume that (1) the price paid by Walt Disney Productions per Steinberg share is less than the intrinsic value, (2) Disney makes realizing the intrinsic value for remaining shareholders a top priority (via operational changes and better investor relations), and (3) the effect on share price is superior to restructuring or other defenses; the result then is an economic gain for the remaining shareholders of Disney. What should the price be? It should be as low as possible, consistent with an incentive for Steinberg to sell—certainly no higher than the estimated intrinsic value. Raiders and arbitrageurs look for annualized rates of return above 50 percent. Assuming Steinberg bought his shares on March 1, 1984, his holding period to the date of the case was 103 days. Thus, he would seek an interim gain of 14 percent in order to achieve an annualized gain of 50 percent. Steinberg’s apparent cost basis was $63.25, suggesting a greenmail price of $72.11 (114 percent of cost).
The decision to pay greenmail is difficult because of the ambiguity and conflicting tugs of various arguments; but wrestling with these inenviable problems is what chief executives are paid to do. Although the economic analysis outlined here sheds light on the consequences of paying greenmail, nothing in the analysis should be construed as suggesting that the decision can be reduced to a simple rule.
Outcome
On June 12, 1984, Disney’s chief executive officer announced an agreement to buy Steinberg’s shares for $77.45 per share, yielding a 78 percent annualized return on investment to him. On that day, Disney shares closed at $49.00, down $5.25, or 9.7 percent, from the previous close. Two days later, the first of many shareholder lawsuits protesting the payment was filed.
Then, on July 17, Irwin Jacobs, another raider, mounted a hostile bid for Disney. The Bass family, wealthy investors who had gained a significant stake in Disney as a result of an earlier transaction with Disney, undertook a series of actions to defuse Jacobs. First, the Bass group purchased large blocks of stock from Michael Milken and Ivan Boesky, and then purchased Jacobs’ shares, in effect paying a second round of greenmail. With Jacobs’ departure, the directors could focus their attention on underlying problems at the company. Apparently sensing that the two raids indicated fundamental problems in management, the board of directors fired Ronald Miller as CEO; other senior managers soon left the company as well. A major management housecleaning took place following the raids.
More importantly, the focus of the firm’s strategy shifted from real property back to creative capital with the hiring of the new chief executive officer, Michael Eisner, from Paramount. While campaigning for the CEO position, Eisner is reported to have said to Sid Bass, “It’s going to take a creative person to run this company. Look at the history of American companies. They have always gotten into trouble when the creative people are replaced by the managers. Walt Disney Productions can’t allow that to happen to it.”21
Eisner’s strategy of returning to the creative core of the company was successful. For the next 10 years, Disney showed a ninefold increase in net income. The compound annual growth in stock price from June 1984 to May 1993 was 34 percent.
CONCLUSION
Analysis of ethical issues in M&A is important but not easy. Ethical issues pervade the M&A environment. And as I argued in Chapter 1, ethics is one of the pillars on which stands success in M&A. Therefore, the M&A deal designer must learn to identify, analyze, and act on ethical issues that may arise.
This chapter has sketched a framework of reflection that draws on the long literature of ethics. Consequences, duties, and virtues stand out as three important reference points for reflection. Nevertheless, the results of such analysis are rarely clear-cut. Indeed, the five cases outlined in the introduction to this chapter will find rational arguments on each side of the question and raise classic problems for further consideration:
1 Prettying up a firm for sale. In general, this book takes a strong stance against earnings management. Chapters 16 and 17 spell out why. As usually practiced, earnings management fails all three ethical tests: It breaks duties to shareholders and society; it hurts shareholders and employees; and it seems to corrupt those who practice it. In the mid-1980s, the CEO of CUC Inc. sought to prepare the firm for sale. Part of this entailed the use of aggressive accounting policies to improve the financial track record of the firm. Ultimately, the firm fraudulently booked nonexistent sales. After acquiring CUC in late 1997, Cendant Corporation discovered an estimated $500 million in fraudulent revenue booked at CUC over the previous three years. The CEO was indicted (and pleaded not guilty). The practice of prettying up a target company for sale in less dramatic ways is thought to be widespread. Is this unethical? One issue here is intent: Is it to clarify or deceive? Another issue is consequences: Who will be helped or hurt? A study by William Shafer (2002) found that materiality of the fraud would influence the likelihood of committing fraud by financial executives: The less material, the greater the likelihood.
2 Persuasion of growth prospects. Like the problem of prettying up, the ethical judgment on conveying growth prospects hinges significantly on questions of intent and consequences for the other party. Through the 1990s, Tyco International pursued an aggressive strategy of growth by acquisition that relied on creating the appearance of high growth, when in fact the companies acquired were mature and growing slowly. The appearance fueled expectations of prolonged growth, granting Tyco a high share price, and therefore a strong acquisition currency with which to do more deals. The limits to high rates of growth are obvious. (This kind of “momentum acquiring” is discussed in detail in Chapter 17.) Suddenly, in January 2002, Tyco announced that it would not only stop acquiring, but also split up the firm. This burst the bubble of growth expectations, leading ultimately to a collapse in the share price, investigations, indictment of the CEO and CFO, and write-offs for accounting errors. Tyco is a strong cautionary tale against momentum growth. Many companies aim to persuade investors of good growth prospects even when that growth is uncertain. Be cautious about how the effort to persuade investors affects others, how it ignores or respects duties, and how it corrupts or strengthens the persuader.
3 Selling at a low price and directors’ conflicts of interest. In 1980, the directors of Trans Union Corporation approved without much analysis or discussion a leveraged buyout proposal from the CEO at a relatively low price. A number of the directors were friends or affiliates of the CEO. Details of this case are given in Chapter 26 and in the excerpts of the court’s opinion, found on the CD-ROM. The core issue here is the directors’ faithfulness to their duty to shareholders. It may be that competing higher bids are unrealistic, not credible, or unlikely to gain financial backing, in which case a sure thing at a lower price may actually be in the shareholders’ best interests. But directors have a strong obligation
