Sep 22, 2019

This merger frenzy is exciting, but is it really good for society?

written by Lisa Eason

Occasionally a book title can encapsulate an important truth in just a few words. The new work by Nicholas Lemann, Transaction Man: The Rise of the Deal and the Decline of the American Dream, does just that.

It tells the story of how, since the 1970s, the US economy has become ever more dominated by transactions rather than institutions. The same process has happened in this country.

The book uses Morgan Stanley as an example to explain how things shifted. Historically, the merchant bank focused on underwriting stock and bond issues for big corporations and institutions. In 1974, it developed a specialist mergers and acquisitions department. Then it opened a sales and trading operation. Meanwhile, the rest of Wall Street took advantage of deregulation and expanded their activities, embracing high-powered new forms of capitalism, such as derivatives, leveraged buyouts, hostile takeovers and private equity.

Subsequently, the country’s institutional structure was reorganised at an increasingly rapid rate. Other factors have played a part — the inflation of the 1970s, the growth of new technology, globalisation, the rise of institutional investors and so forth.

Old oligopolies were broken up and competition in many industries increased dramatically. Shareholder returns became more important, capital gains trumped dividend income, and the complacent managerialism of the 1960s was shaken up. In many respects, this corporate disruption delivered benefits to the consumer and society — more choice and lower prices, new inventions and the computer revolution, but it also exacerbated financial instability, showered the public with debt, and destroyed the traditional concept of a job for life in the private sector.

The business culture in Britain and the US focuses to a high degree on deals — the buying and selling of companies — rather than long-term stewardship and organic investment and growth. Consequently, the Masters of the Universe at banks such as Morgan Stanley occupy the commanding heights of the system, as opposed to the founders and those who run companies.

Meanwhile, most stock market investors are relatively short-term and encourage an extractive approach to business. Capitalism has never been a charitable endeavour, but the triumph of transactions has caused collateral damage. The City of London has benefited to an enormous degree thanks to the vast rivers of fees that flow to intermediaries and advisers, but frequent changes of ownership and relentless consolidation have not necessarily helped local workers or even boosted the British economy as a whole.

Over the decades, previously conservative investment banks, such as Morgan Stanley, dramatically increased their capital and appetite for risk. This backfired horribly during the financial crisis of 2008. The bank was bailed out by the US government, which loaned it $107bn. Morgan Stanley’s rise and near-death experience was promoted by transaction men, intent on winning their bonuses at almost any cost.

I am a transaction man of sorts, although I’m a principal, not an adviser, and I like to own companies for the longer term, but deals are exciting, and can sometimes be transformational.

In this arena it is easy to be a hypocrite. In countries such as Italy and Germany, family owned firms dominate, and wheeler-dealers have never enjoyed the same influence as here or in America. Generally, I would say more conservative capital structures, funded with patient capital, are healthier than the merger frenzy that is so common in the Anglo-American business scene.

When I was a stockbroker in the 1980s, institutional funds were already in the ascendant but the invasion of the hedge funds had not begun. They are the ultimate hit-and-run traders, with a devil take the hindmost philosophy and extraordinary rake-offs for those who do well. Their supremacy peaked about five years ago — perhaps their retreat signifies a new phase.

Unfortunately, institutions take a long time to build, yet can be ruined quickly. As Martin Vander Weyer recently noted, only 27 of the original constituents of the founding FTSE 100 in 1984 remain in the index today.

That turnover of huge organisations at the top suggests dynamism but also impermanence. Transactions tend to generate transient rewards — enduring success is more boring, and elusive, but surely creates a stronger society.