Bloodsport

Chapter One

ADOLF BERLE AND THE DEBATE OVER TAKEOVERS

MANHATTAN, 1956. THE trip uptown wasn’t long but it was heavy with meaning. Newly minted New York University law grad Martin “Marty” Lipton clattered north on the IRT to meet—to work with—Columbia University Law School’s Adolf A. Berle, Jr. This was a big moment for the then-lanky Lipton.¹ At twenty-five he was bright, ambitious, if unknown—the son of a garment-factory manager from Jersey City and a graduate of that “Jewish” law school, New York University, with hopes of an academic legal career. Berle, on the other hand, at sixty-three, was an intimate of presidents, a commanding figure of the Protestant and liberal establishment: short, slim, fast-talking, dapper in a double-breasted suit. The son of a Congregationalist minister, he had been a legendary prodigy who went off to Harvard College at the age of fourteen in 1913 and received his law degree from Harvard Law School at twenty-one—the youngest in the school’s history. He had been at ivied Columbia since the late ’20s. He struck many as too smart, too arrogant, for his own good; in law school, he made a lifelong enemy of Harvard law professor and later Supreme Court justice Felix Frankfurter when he took his class and muttered sarcastic comments from the back row.²

Nonetheless, Berle had long been considered a master—the master—of corporate law, the field Lipton was interested in entering. Berle, remarkably, saw himself as a kind of Karl Marx of capitalism.³ There was something elusive about him, a refusal to be pinned down, to subordinate himself to mere mortals or to one activity; or perhaps he was just too glib, too self-regarding, for his own good. For three decades, he had taught at Columbia, all the while operating a law office downtown, on Wall Street. A registered Republican, he had been an original member of Franklin Roosevelt’s Brains Trust, with fellow-Columbians Rexford Tugwell and Raymond Moley. He and his wife had written Roosevelt’s New Individualism speech, which led to the National Industrial Recovery Act, considered by many to be the high tide of the New Deal’s impulse to manage a corporate economy. Typically, he refused to leave Columbia or his law practice for a Washington job, choosing to try to influence Roosevelt directly without actually joining the administration. In the years since the New Deal, Berle had moved into the higher realms of the establishment: consulting on New Deal projects like the Reconstruction Finance Corp. and the International Civil Aviation Board and serving as ambassador to Brazil, as a member of a Kennedy task force on Latin America, and as chairman of the 20th Century Fund. He wrote regularly, prolifically: law articles, speeches, book after book.

Lipton never took a class from Berle, but he spent a lot of time talking to him. “He was a storyteller,” Lipton recalls. “He was as interesting as could be.”⁴ Berle wanted Lipton to write a dissertation on the impact of institutional investors on corporate law, but Lipton, who left Columbia for a clerkship, then a job at a firm, never got around to it. “He was prescient,” Lipton admits. “At this time, only about 5 percent to 6 percent of shares of public companies were held by institutions. Not much in the way of mutual funds. Pension funds were just getting started. But he saw that the institutions would come to dominate.”

Little did either man realize it at the time, but Berle had met a disciple who, for the next half-century or so, would labor to revive key aspects of the Columbia professor’s vision of how corporations fit into the great American commonwealth.

BERLE WAS, IN many ways, everything Lipton dreamed about as a lawyer who could do, as he later said, “great things.”

Still, for all his accomplishments, Berle was best known in 1956—as he is today—for one book he co-authored with Columbia economist Gardiner Means: The Modern Corporation and Public Property, which the pair began in the late 1920s but published at the height of the Great Depression, 1932.⁵ The book, an uneasy blend of Berle’s theories and commentary on the nature and role of the public corporation and Means’s statistics—with page after page of tables exploring the increasingly concentrated structure of the American corporate economy—is not an easy read, and was probably mostly unread, but it was a book that literate Americans felt responsible to buy and retain in their libraries. It was, everyone said, generationally important, like Keynes’s General Theory or, more recently, Thomas Picketty’s Capital in the Twenty-First Century. (At the time of publication, Means’s facts about corporate concentration—that 180 companies owned 47 percent of US corporate assets—was considered the sexy takeaway, not Berle’s musing on the separation of ownership and control.) And so it became a best seller and an iconic text. Today, Means is frequently passed over; the book is about Berle and his views, although it remains a text more often referred to than carefully read. At a minimum, the book embodied a partnership between law and economics that would later play a major role in rationalizing an unrestrained merger regime. Few books in American history have had a more winding path, or produced more argument about meaning and context, than The Modern Corporation and Private Property.

Why is this book important? Both the book and Berle’s long career were focused on control of the single greatest source of American wealth: the corporation. By the time he came of age, the American economy, dominated by a relatively small number of large, sophisticated corporations, was the world’s largest. But who really owned the corporation? Who controlled its massive cash flows and accumulated capital? Was it Wall Street and the bankers, such as the formidable J. P. Morgan and his powerful House of Morgan? Was it executives, overseen by boards of directors? Was it shareholders? Or, most provocatively, was it the government, acting as an instrument of a broader public, what Berle called “the community”? These were fascinating questions, even in the 1920s; but they became compelling in the chaos and uncertainties of the next decade with its devastating economic breakdown that exposed so much of the underlying skeleton of the system. By the ’50s and ’60s—decades of enormous growth and prosperity—these issues submerged again in the warm glow of consensus, at least on corporate matters. By the time Lipton met the by-now sage-like Berle, there was a general consensus that corporations were run for stakeholders—workers, shareholders, customers, communities—which effectively put managers, overseen by the government, in control. Berle championed this approach.

But the concept of stakeholders and government oversight had not always been quite so universally accepted, even by Berle himself. The Modern Corporation and Private Property, for all its fame, is an elusive and ambiguous text. Berle’s clearest message—that as American companies grew larger and more complex, they needed to sell shares to larger numbers of investors—did not actually originate with him. Inevitably, the founder-owners surrendered control to a broader diversified shareholder base. The result was a separation of ownership and control, a kind of original sin of the public corporation. The primary movers within corporations shifted from “owners,” the shareholders, to managers, those most deeply involved in operations. As a result, managers developed a degree of independence from shareholders; they felt that the company was theirs, and they acted autonomously, even plutocratically—in a later popular phrase, they entrenched themselves.

This is the message that has sifted down through the decades. Over the years it gradually dovetailed with other, often contentious ideas, many coming from law and business schools, but nearly all of them beginning with the snake in the garden: the separation of ownership and control. Over the last forty years or so, the separation of ownership and control has emerged as the central message of The Modern Corporation and Private Property, particularly for those who never actually read the book, and Berle has been elevated posthumously to the status of “the father of shareholder governance.” This is, at best, half right. Advocates of shareholder governance argue that the managerial assumption of autonomy is both illegitimate and inefficient; that shareholders are the sole “owners” of corporations and the source of their power; and that “governance” implies that the primary end of the corporation is not to generate jobs, or to help customers, or to provide concert halls for local communities, or even to create prosperity for the masses: it is to maximize the value of shareholders’ investment. Shareholders thus become a kind of proxy for the common good. And good corporate governance shifted from a form of republicanism (the political system, not the party), in which managers juggle a variety of interests or stakeholders, to democracy, in which shareholders rule absolutely.

Berle, who died in 1976, did not live to see this transition, but he would almost certainly have been surprised by how quickly and abruptly it occurred. However, he had never been a slave to consistency. His mind was supple, his instincts pragmatic and political. And so his ideas about the one set of preoccupations that he dwelled upon for most of his adult life—the role of the corporation in American life—shifted with the times.⁶ His treatment of the separation of ownership and control both in The Modern Corporation and Private Property and in later years reflected a deeper ambiguity in how Americans broadly viewed corporations. In the late ’20s, when times were good and he was beginning to work on the book, Berle did focus on the separation of ownership and control, and he argued for the idea of managers as “trustees” for shareholder interests and for greater “market regulation” that would empower shareholders. But by the time the book was nearing publication, the global economy had crashed and Berle was angling for a spot as an adviser to the Roosevelt campaign. His views changed. More drastic measures were necessary. Despite the self-evident concentration, large corporations needed to be more aggressively regulated for the larger good by the government. Managers were still trustees, but for a shifting constellation of interests that reflected the larger community. That point of view found its way into the pro-planning mentality of Roosevelt’s New Individualism speech.

Berle, in short, had become a stakeholder advocate. This issue became confusing when in 1932 Berle found himself tangled up in a debate with Harvard Law School professor E. Merrick Dodd that reverberated around the legal community for decades.⁷ Dodd believed that corporations had responsibilities to many constituencies or stakeholders. He was not aware that Berle had changed his views. Berle, feeling constrained by his campaign responsibilities, chose to defend his old position, one that made him to this day the patriarch of shareholder governance, despite the fact that he was already recanting that position in the soon-to-be-published The Modern Corporation and Private Property. Even as he was debating Dodd, Berle was growing more committed to an approach that featured heavy state regulation—even planning and administration—of large, powerful, technologically sophisticated and, in his view, necessary industrial corporations. In 1968, he revisited the debate, which had taken on legendary proportions, in a law article and declared Dodd, who died in 1951 in a car crash, the winner. “The late Professor E. Merrick Dodd of Harvard insisted, and history seems to have vindicated him, that they [large corporations] are also stewards for employed personnel, for customers and suppliers, and indeed for that section of the community affected by their operation,” he wrote.⁸

By then, the issue had grown obscured, like the motivations of characters in a particularly tangled spy novel. Dodd, repulsed by the activism of the New Deal, had long since abandoned his old views and embraced Berle’s early shareholder-centric stance, even as Berle had moved to assume Dodd’s old stakeholder position. Once the Great Depression passed and new federal regulations appeared, Dodd turned to markets to resolve the problem of separation of ownership and control, while Berle embraced managers and regulation.

By the mid-’50s, however, Berle appeared triumphant, and the stakeholder approach carried the day. There were critics, but they were marginal. A new, free-market zeitgeist associated with Friedrich Hayek and Ludwig von Mises, Austrian economists who had both made their way to the United States, was percolating at the University of Chicago where Hayek taught. In the mid-’60s, Berle tangled over the matter with Henry Manne, forty-eight, a University of Chicago Law School graduate then teaching at George Washington University Law School. Manne believed that separation of ownership and control was a major problem and challenged Berle by focusing on “the market for corporate control”—that is, the ability of companies to freely buy and sell each other and thus establish accountability through the market, not ultimately through the government.⁹ Given high industrial concentrations, antitrust laws were tight, and after the chaos of depression and war, and the anxieties of the Cold War, the powers-that-be saw no reason to encourage the disruption brought by large-scale dealmaking. In fact, there were relatively few mergers, particularly among the largest companies, which resembled autonomous kingdoms. As Manne acknowledged, “Mergers among competitors would seem to have no important saving grace. The position has gained considerable legal currency that any merger between competing firms is at best suspect and perhaps per se illegal. The latter result seems especially likely when one of the combining firms already occupies a substantial portion in the relevant market.”¹⁰ Manne identified managerial efficiency with a high share price and argued that the best way to discipline managers in a world where ownership and management were separate is the threat of a takeover, with buyers hungrily drawn to a bargain share price.

Berle swatted Manne away. In an arch reply, he suggested that the younger Manne hadn’t been around for World War I, the 1920s, or the Great Depression, or “experienced a world without the safeguards of the Securities and Exchange Commission,” systematized accounting, aggressive regulation of conflicts of interest, or a Federal Reserve.¹¹ In other words, Manne was a babe in the woods. He accused Manne of taking refuge in a nineteenth-century set of ideas that did not fit the “industrial system” with its technologically sophisticated corporations. Berle defended that system in a long, stem-winding paean of praise (he had a weakness for rhetorical overkill): “The American industrial system, under guidance and control, has done more for more people, has made possible a higher standard of living for the vast majority of a huge population in a huge country, has preserved more liberty for self-development, and now affords more tools (however unused or badly used) from which a good society can be forged so far as economics can do so, than any system in recorded history.” He added, “It is eons from perfection. It has, nevertheless, empirically arrived at results that relegate both the communist economics of Karl Marx and the classic economics of his contemporary, John Stuart Mill, and of the modern expositor, Ludwig von Mises, to a museum of 19th-century thought.”¹²

Berle was no more impressed with the wisdom of shareholders and markets. “In practice,” he wrote, “the rise and fall [of stock] has a vague relation to the success or failure of the corporation in its operations (a sweepstakes ticket has a similar unpredictable relation to the speed of the horse).”¹³ Most shares, he argued, were traded on secondary markets, between individuals or firms, transactions that had nothing to do with the company in question. This stock, he wrote, is not an “investment” in a company at all. The stock market is less an allocator of capital than of wealth, mostly to the financial crowd. And even if the market closed, as it had in 1914 during World War I, large corporations could easily get by on their own internally generated capital. In Berle’s worldview, which he shared with Harvard economist John Kenneth Galbraith, only large corporations really mattered; entrepreneurs and start-ups were far too small and far too weak to matter very much. America’s large corporations were thus too important, too central to capitalism, to leave to the speculative forces of chaotic markets.

The very definition of property was in flux, declared Berle, and “classical economic logic did not apply.”¹⁴ The notion that shareholders owned companies no longer applied: “For the fact is that purely passive property—that is, property divorced from any responsibilities of ownership, whose value grows or shrinks in the owner’s hands without any relationship to his risk-taking, work, or effort—has outlived most of the economic justifications that gave it birth.”¹⁵ Remarkably, Berle blithely ignored Manne’s emphasis on the disciplinary benefits of change of control. Instead, he viewed the large company as a kind of public utility, with a self-legitimating importance not to the market but to the community and to itself. “Not that ‘control’ or the managements have become thieves; quite the contrary,” he wrote. “Rather they have come to recognize (perhaps as ‘business statesmen’) that first claim in accumulated profits is the claim of the enterprise itself—that, for example, the first duty of a steel company is to make steel, and have it there in sufficient quantity to meet the existing or foreseeable future requirements of the community. These needs take precedence over the dividend desires of any body of passive shareholders—as indeed they should.”¹⁶

In the years ahead, nothing would take precedence over Berle’s “dividend desires.” Berle’s reply to Manne sums up an entire worldview forged in the New Deal and World War II that within a decade would crumble and wash away. Berle’s Olympian attitude was partly a product of his personality and partly the liberal articulation of a by-now long-established set of ideas, made all the more potent by American economic preeminence and power. But by the early 1970s that prosperity would crash, undermining the ideas that underpinned it. Manne would prove far more prescient than Berle gave him credit for. As new free-market ideas increasingly became orthodoxy, the markets grew to supersede concerns about community. And the most contentious arena of struggle for control turned out to be exactly what Manne had predicted: mergers and acquisitions.

All this occurred a decade after Lipton briefly studied with Berle. Lipton went on to clerk for a federal judge in 1956, then took a job as an associate at a ten-person firm, Seligson, Morris & Neuberger. (Seligson was a longtime New York University law professor and bankruptcy specialist.) There he worked with two other recent NYU grads, Leonard Rosen and George Katz, while lecturing at NYU in corporate law. In 1965, around the time Manne and Berle were going at it, Lipton, Rosen, and Katz teamed up with Herbert Wachtell, another former NYU law review editor, to open their own firm, Wachtell, Lipton Rosen, Katz & Kern. (Kern was a friend of Wachtell and left to become an investment banker, taking his name with him.) One of the firm’s specialties was bankruptcy, a field that top firms avoided—a “Jewish” field. Another was mergers and acquisitions, Lipton’s interest, which in those years was also viewed as “beneath” the grand calling of the established firms.

Over the next five decades the firm, run by Lipton, would go on to become a remarkable success: elite, small, immensely influential, and far more profitable than any of the old white-shoe firms. More importantly, in the years ahead, as Berle’s notion of a corporate community came under attack (particularly after the explosion in M&A), Lipton became the most rigorous and effective defender of Berle’s mature vision of stakeholders and the prerogatives of managers. He became, in a sense, a figure as large, and certainly as controversial, as Berle himself.

BY THE TIME Berle died, his world had changed in ways large and small. The hegemony of the White Anglo-Saxon Protestant was ending. The American dominance in the world economy began to wane, not only as a result of reviving economies in Europe and Japan but also because oil-rich countries were banding together to hold the rest of the world hostage. Unions struggled as industrialization peaked and began a long decline. The American economy staggered under Lyndon Johnson’s attempt to fund the Vietnam War and the Great Society without raising taxes—pushing Keynesian policies into the realm of dysfunction. Inflation merged with stagnation. Liberal pieties shattered. The government seemed feckless, corrupt, and stifling. The large corporations that Berle had celebrated appeared sclerotic and risk-averse, their CEOs bureaucratic and self-interested. Wall Street itself was a sleepy den of cartels, inbred, ethnically divided and technologically anachronistic.

In 1975, the first hostile bid for a New York Stock Exchange company occurred—a shock that reverberated throughout corporate America after Morgan Stanley, the epitome of the white-shoe investment bank, helped engineer the attack for an NYSE member. This marked the rise of what would become a bloodsport of American business—hostile M&A—and of a new, harsher, and much more powerful financial economy.

The deal ushered a new reality into corporate life that was more Manne and less Berle, more about the discipline of market power and, year by year, less about the needs of the community or the wisdom of “business statesmen.” Giant companies fell to unknown raiders. Uncertainty spiked. The liberal Berle died, replaced by selective memories of a dusty old book and an ancient cliché: separation of ownership and control. Corporations were now viewed not as organic entities but as conglomerations of self-interested agents and nexuses of contracts, monitored by shareholding proprietors. Results were measured by the daily “rational” judgment of share prices. Markets were “efficient” and replaced communities as standards of good and bad. Measurement and calculation swept away the balancing of qualitative interests. A new world dawned.

What emerged were new ways of viewing corporations, fueled by collisions of Hobbesian forces: managers and directors, shareholders, traders and bankers, and, of course, policymakers, politicians, regulators, judges, and that great protean beast, the public. All made their play: lawyers such as Joe Flom and Lipton; academics like Michael Jensen, Daniel Fischel, and Frank Easterbrook; Wall Street uber-advisors such as Felix Rohatyn, Michael Milken, and Bruce Wasserstein; Delaware judges like William Allen and Andrew G. T. Moore, economists like Frederic Scherer who dug deeply into the empirical reality (an elusive concept) of mergers; and many others. They were all swept up in a struggle for control—not just of corporate wealth in the heat of a takeover battle but of ideas that explain and interpret exactly what such a struggle was supposed to be all about. Berle understood that corporations were embedded in a democratic context of popular opinion, rules, regulations, and laws: politics. (He may, in fact, have discounted the market by overestimating the power of the political community.) The evolution of modern M&A proceeded in waves of excess and retrenchment, innovation and restraint, like markets themselves. Year by year, with the exception of recessions, M&A grew in frequency and size, buoyed by what in retrospect was a remarkable post-’70s bull market. Sunny economic times and M&A were self-reinforcing, in much the same way that the postwar boom justified stakeholder governance. After 1975, despite doubts, failures, and controversy, the ascendancy of the shareholder—the shareholder as owner—spread and congealed into popular belief, a kind of orthodoxy. This set of ideas eventually came to appropriate the phrase corporate governance, as if there were but one way to govern companies, with shareholders as owners. Like any ideology, corporate governance defined alternatives out of existence.

This is not to suggest that, as two prominent law professors declared in a 2000 paper, all the issues had been resolved and shareholder primacy was as inevitable as death and taxes.¹⁷ In fact, nothing is inevitable, the world keeps changing, and the future—as Keynes once noted—is irremediably uncertain. Views shift. There are no history-ending truths, which is why both markets and democracies work. Berle understood that the large public corporation is a relatively new phenomenon. The Founding Fathers were not omniscient. Even Alexander Hamilton, a promoter of manufacturers, never imagined a United States in which the most powerful, ubiquitous, and pervasive organizational form would be something called the corporation. They could not have imagined either the complexity of a mature corporate system or the deep, global markets that financed it. They never foresaw the challenge that corporations would pose to federal and state governments, to individual rights. They could not have seen the rise of byzantine administrative and regulatory functions within the government, the power of industrial and post-industrial technologies. Most importantly, they never paused to consider how these organizations would be controlled and governed, who would profit from them, and how they would fit into the American community.

Berle himself, who liked to speak prophetically, did not anticipate a global, post-industrial economy, with its decentralizing whirlwinds of information technologies, empowered entrepreneurs, consumers, dealmakers, and fierce global competition.

Today, after crises, recessions, and mounting inequality, questions proliferate more than ever. Who really matters when it comes to the fate of corporations: workers, shareholders, managers, communities? Who really owns corporations, and what rights and responsibilities does ownership entail? Are corporations republics or democracies, or are they something else—autocracies or bureaucracies, military units or sports teams—that operate under different rules? Should corporate oversight occur on a state or federal level, or should it be left to the markets? How should executives and directors behave in takeover battles? How rational, wise, and prescient are markets and shareholders? How does M&A affect the ability of corporations to grow, prosper,