January 9, 2019 / 2:26 PM / 8 months ago

Breakingviews - Hadas: Big mergers show capitalism’s bad side

LONDON (Reuters Breakingviews) - Anyone who believes that prices should be fair would agree that Celgene needs a corporate shake-up – just not the one the U.S. pharmaceutical company is about to get. From that perspective, the proposed $74 billion shares-and-cash takeover by Bristol-Myers Squibb announced last week looks like a reward for unjust behaviour.

Logo of global biopharmaceutical company Bristol-Myers Squibb is pictured on the blouse of an employee in Le Passage, near Agen, France March 29, 2018. REUTERS/Regis Duvignau

For a student of corporate ethics, Celgene’s biggest problem is certainly not that it is too small. Rather, the company is too profitable. After making some reasonable adjustments to the reported numbers, the cancer specialist’s operating profit margin in the most recent quarter was a stunning 55 percent. That is the money left after paying research and development costs. The drug prices which generate that sort of profitability for shareholders are almost certainly unjustly high.

Now investors who have already been generously rewarded are set to gain even more. The proposed takeover values Celgene at roughly 50 percent more than its share price before the deal was announced. The historical experience of big deals suggests that Bristol-Myers Squibb shareholders should worry the price is too high for their good. Studies consistently suggest that the target company’s equity holders typically receive a disproportionate share of any benefits from a large merger.

Yet even though there are good reasons for investors to be wary, this is unlikely to be the last big deal. Executives like the prestige that comes with scale, and they almost always think that they can do better than average. Besides, it is easy to sketch out cost savings – Bristol-Myers Squibb is predicting a 10 percent reduction in the combined companies’ cost base – and also easy to ignore what could go wrong. Smooth-talking and extremely well-rewarded advisers can usually assuage any doubts.

The explicit goal of such large company combinations is to increase shareholder value. While such gains often prove elusive, the losses suffered by many other constituencies are all too predictable.

To start with, some workers lose their jobs. Those who stay on suffer the upheaval of merging differing procedures, computer systems and corporate cultures. Differences are rarely smoothed over by adopting best practices. More often the result is the lowest common denominator.

Top managers do not escape the internal wars. Though they are usually rewarded with big pay increases, mergers inevitably bring distractions and frequently come with unpleasant surprises. A loss of corporate momentum is hard to avoid.

Big deals also hold a more subtle danger when they are motivated by the desire to fight limited growth possibilities or chronic underperformance. Combinations can make an average situation bad, and a bad one worse. Hewlett-Packard, the computer and equipment maker which first bought Compaq and then Autonomy in successive fits of strategic desperation, is a case study in how it can all go wrong.

Bosses sometimes say that well-conceived and well-executed big mergers can help their companies overcome strategic weaknesses. Few mergers are actually sensible and effective enough to test the thesis, but there is something wrong with the attempt. The economy is likely to suffer when healthy companies are used to support ailing ones. The common good is better served by letting successful enterprises develop their own cultures.

Whether or not merged companies do well, the increase in scale can inflict social harm. As my colleague Clara Ferreira Marques explained in a recent book review (here), takeovers remove competitors and give large companies too much power over prices, regulators and politicians.

This power typically favours shareholders over all other stakeholders. That encourages economic inequality, as higher returns for shareholders amount to cash transfers from generally poorer customers and workers to already-wealthy equity investors.

Corporate power and unjust shareholder enrichment is not inevitable. For example, authorities could require Bristol-Myers Squibb to pass on any reduction in operating costs from the Celgene deal in the form of lower drug prices for cancer-sufferers. The shareholder-first world view regards such a proposal as heretical. However, there are good ethical arguments for changing this culture. Companies are supported by the whole society in innumerable ways, from the protection of law to the provision of educated workers. Also, many companies are large enough to have a significant impact on broader society. It is therefore right for corporations, especially large ones, to substitute service of general public for shareholder value as their overriding goal.

Such a change would be extremely unpopular with today’s equity investors. They are not happy with merely fair returns, and often encourage managers to push up prices and chase market power. However, in a more just regime, shareholders in large companies would not enjoy such privilege over other stakeholders.

There are almost no current signs of a loss of faith in the cult of shareholder value, or of a slowdown in big mergers. Tougher enforcement of competition rules is gaining some support, but probably not enough to change the pattern. Bristol-Myers Squibb’s managers are likely to get the opportunity to maintain or increase Celgene’s already high earnings. Even if the deal succeeds on its own terms, though, it will show capitalism’s bad side.


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