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Randall Morck is Jarislowsky distinguished professor of finance and University professor, School of Business, University of Alberta. Vikas Mehrotra is A. F. (Chip) Collins professor of finance and Jarislowsky fellow, School of Business, University of Alberta.
Bids must meet corporate-governance standards. SOEs fall short
China-phobia is a bad idea. China will soon be the world’s largest economy, and Canadian consumers and businesses can benefit from China’s rise. Canada needs foreign-investment policies that apply evenly to all foreign companies, and that businesses can expect to remain the same over time. A two-track policy makes sense: an open door to private-sector foreign bidders but skepticism toward foreign state-controlled bidders, unless they make a compelling case.
Research into corporate takeovers shows that some are good and others bad — for the firms involved, their employees, consumers and the economy. In general, society benefits from takeovers that transfer control of a company from top managers who are running it poorly to top managers who will run it well. Unfortunately, many Canadian firms are indeed run by people who invest in white elephants, fail to invest in productivity improvement, or neglect their firms while enjoying the perks of being a CEO.
But many other takeovers feature poor managers, temporarily flush with cash, wresting control of a target firm away from its perfectly fine managers. An ideal takeover law would encourage the first kind of takeover and forbid the second kind. Unfortunately, making such a decision requires hugely expensive information and expertise that is often highly specific to a given industry. If government officials actually could decide what constitutes running a firm well versus badly, Soviet-style communism would have worked.
The collapse of the Soviet Union in the early 1990s revealed an economy of value-destroying state-controlled enterprises. The concept of value destruction takes a bit of work to grasp: These enterprises transformed inputs into outputs that were actually worth less than the inputs. A steel plant might have produced a billion rubles worth of steel from two billion rubles worth of iron ore, coal, power, machinery and wages — destroying a billion rubles a year. Post-Soviet reformers’ terror at the magnitudes of these losses largely explains the hasty privatizations that let crony capitalists take over.
Value destruction is wasteful, and economic efficiency is about minimizing waste. Minimizing waste, the value of inputs minus the value of outputs is the same as maximizing profits, the value of outputs minus the value of inputs. That is why economists connect profit maximization with efficiency. It’s not that profits are virtuous; it’s that profit-maximizing firms keep the economy from wasting resources. Central planning, by disconnecting enterprise management from profit maximization, ultimately allowed so vast a waste of resources that the Soviet economy simply collapsed under its mounting weight.
While most state-controlled enterprises today, including many in China, India and other emerging economies, are a far cry from such Soviet-era catastrophes, most are vulnerable to political meddling. If the Canadian government is doing the meddling, some Canadian public-policy goal might justifiably trump economic efficiency. But in a foreign-government controlled firm, political meddling would waste Canadian resources to advance a foreign public-policy agenda. All this suggests that state-controlled foreign firms’ takeover bids be discouraged as a matter of general policy. This should apply equally to foreign bidders from everywhere — Albania through Zimbabwe.
The richness of the takeover premium shouldn’t matter if the bidder is state controlled. If one private firm takes over another, the bidder that can make the most of the target firm’s assets can afford to offer the highest takeover premium. That is why private-sector takeovers that create more shareholder value are likely to transfer control to better management. We use shareholder value as an albeit imperfect thermometer showing how well a firm is run.
For the rest of this column, please go to the National Post website: http://opinion.financialpost.com/2012/10/25/the-case-against-soes/