March 27, 1980, Washington, D.C.
Published by the U.S. Department of Commerce in
Mergers and Economic Efficiency, Volume 1,
Proceedings and Supplementary Papers, November 1980.
... introductory remarks ...
... summary of the state of the literature on mergers ...
Thank you very much, Fred. The Department of Commerce appreciates your work in attempting to summarize a wide range of literature.
I know that a number of you will not agree with all of Fred's interpretations of the literature, and there those who would argue that the economic value created by mergers is not as great as Fred claims or is non-existent. You will each get your chance to state your views, and after we finish, there will be opportunity for an open discussion.
I want to turn next to Walter Measday for comments on the points that Fred Weston has made and for his own comments on the economic aspects of conglomerate mergers. Walter?
My comments are going to be very brief. My problem is that I think in terms of anecdotal evidence which always comes up to confuse a theory.
First, I think Fred Weston has done his usual magnificent job in reviewing the literature, but I think his review tends to exhibit one side of two schools of thought on the conglomerate problem. In the first place, just about everybody—and I think one could get this from Fred's paper—would agree with Jerry's initial comment that the evidence on the economic effects of conglomerates is not particularly persuasive, one way or the other. Fred looks at this and says there's no sound economic evidence that conglomerates do any great harm and, therefore, there isn't any reason to restrain them. We should look upon conglomerate acquisitions as simply one form of legitimate business strategy.
Dennis Mueller, on the other hand, reviews substantially the same literature and comes out with a conclusion that is similar but not quite the same. He says there's no sound evidence—economic evidence—that conglomerate mergers do any good. I think Mueller's position, which I support certainly, is that since there are political and social problems that we are just starting to examine, it might be a good idea to hold off on conglomerate mergers for a while until we can address some of these problems. If there is not strong evidence that conglomerate mergers do a great deal of good for society, rather than for the firm, I think we can see that a policy based on Mueller's approach will be almost cost-free.
Those of you who know me know that I have been involved on one side of this debate; as a result of my job perhaps, I may have certain biases.
Now, I want to emphasize the difference between what is good for the firm and what is good for the economy. Looking at mergers in terms of the companies' situations is one approach to the subject; looking at mergers in terms of what is good for the public is something else. Charlie Wilson's remark that what's good for the economy is good for General Motors and vice versa, is, I think, probably generally correct, but there may be a lot of exceptions. Even General Motors is beginning to wonder whether what is good for the economy in terms of foreign car imports is necessarily good for General Motors.
I'm not surprised that we find that shareholders of the acquiring company may benefit as a result of conglomerate mergers. If the acquired firms are more profitable than the acquiring firm, you raise the average profitability of the acquiring firm and it's beneficial to the owners. Let me get down to anecdotes. For an extreme example, look at LTV's acquisition of Jones and Laughlin. Add up Jones and Laughlin's net income from 1968 to 1977; it's considerably larger than the consolidated net income of LTV. This appears to be an example of a deep-pockets theory in reverse; basically J&L was carrying the rest of the operation. I assume that this was extraordinarily beneficial to LTV's stockholders. No question about it! However, I am concerned because I don't think that it necessarily demonstrates any real improvement in efficiency as far as the economy is concerned. I don't think this result proves the point that Fred believes it proves.
There are a couple of questions relating to mergers that still have to be answered. We must determine from the standpoint of the economy, not from the standpoint of the individual firm, whether a conglomerate merger is a sterile operation. If, for example, we are worried about declining productivity, the reduced rate of economic growth, stagflation etc., to what extent does heavy corporate investment in mergers rather than in real plant and equipment help us? Let's not worry about the relative values or anything like that. I'm not saying the corporations here are behaving irrationally; they may be behaving perfectly rationally. But is their behavior good for the economy? To what extent does acquiring another corporation, assets in place, substitute for actual real investment in new plant and equipment and new productive capacity?
Let me give you another example. Mobil bought General Crude Oil from International Paper in 1979 for $800 million. General Crude, as as I could tell, was a well run firm when it was acquired by International Paper in 1975 for $489 million. It had an excellent rate of return, an active exploration program and so forth. Mobil ended up getting itself some very nice crude oil reserves and about 350 billion cubic feet of natural gas. Maybe Mobil got these reserves for a lot less money than it would have cost the company to develop its own reserves. However, I submit that the public is no better off; we are no closer to a solution of energy problems because Mobil now has reserves which were formerly owned and developed by General Crude.
A further question is, what happened to the $800 million spent by Mobil? Since International Paper was buying Bodcaw Co. (for $805 million) at about the same time it was selling General Crude, I suspect that the Bodcaw stockholders ended up with a good bit of Mobil's cash. I haven't any idea what the former stockholders of Bodcaw are doing with that money. But there should be some research into what ultimately happens to these transfers of funds—do they end up financing real investment at some point, or do they simply spin around in a circle, bidding up the values of existing assets? If the latter is the case, I submit that it's pretty hard to show that there are any economic or social benefits from the current wave of merger activity.
My second concern is that I suspect that when you get these chains of mergers, you may tend to get upward pressure on prices, given that we start with something less than perfect competition. Again, let's get back to the anecdotal. In March 1979, Reliance Electric purchased Federal Pacific Electric from UV Industries. UV's investment in Federal Pacific, as far as I can judge on the basis of its 10 K reports and so forth, was about $180 million. On that, UV was making a very nice rate of return in 1978, $57 million in pre-tax earnings. Reliance paid $345 million for Federal Pacific. It's clear that to earn a rate of return equal to the return that UV had earned on its investment, Reliance, from those same assets, would have to earn approximately $108 million a year. To produce such a return, prices would have to be pushed up.
However, as we all know, Exxon turned around and offered $72 a share for Reliance stock which was worth $34.50 on the market. Exxon bought Reliance for $1.2 billion, and it's very hard to trace what happened to Federal Pacific's assets in this. Nonetheless, I would suggest that Exxon will either end up with a much lower rate of return on these assets—a rate of return that will be unsatisfactory to Exxon's stockholders—or if Exxon is going to try to earn perhaps four times as much from the assets as UV had been making, it will have to see if the electrical equipment industry will tolerate some price increases.
Now, it may be that this is revaluing the assets to reflect market conditions, but I'm not sure that it is. I don't see that it's particularly helpful to the economy and I think there should be some investigation in this area.
Thank you very much, Walter. I must say it's refreshing for someone in this town to admit at the beginning that he has any bias on any of these questions.
...
... and later in the discussion ...
... We also looked at industries, such as materials handling, that in the early 1960s were backward technologically, and found that it made a lot of sense to bring together complementary managerial capabilities.
The Exxon-Reliance example reminds me of that. In reading the hearings on the Exxon interest in Reliance, I found considerable evidence that Exxon had devoted substantial resources to developing capabilities in the creation of energy and the use of electricity in the motor field and saw some potential for new product developments in these areas. Reliance had experience with motors. If the acquisition of a company like Reliance provided an effective marketing organization to that segment of the economy, then it's clear that the acquisition stimulated, supported, and brought to fruition a substantial amount of internal investment.
Hindsight provides a somewhat different perspective. Shell had this to say circa 1998: "... some oil companies entered and later exited non-oil businesses ... Exxon [went] into electric motors via Reliance Electric ... All these large diversifications were later abandoned." In Exxon's case, 1986 to be exact, according to a brief history of Kato Engineering, a division of Reliance Electric.