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Building Empires, or Building the Economy?

The CAW has merged with about 35 smaller unions since we were formed in 1985.  That doesn’t stop me, however, from questioning the economic usefulness of Canadian corporate mergers.  M&A activity last year reached an incredible $270 billion.  That’s 20 percent of our GDP.  And what good actually comes from it?  At best, the M&A boom is a sideshow.  At worst, it’s a portent of trouble ahead.  It is the dual, I argue, of the weakness in corporate investment: CEOs are sitting on mountains of idle cash, and they want to spend it on something.  So why not buy something that someone else built — instead of taking on the difficult job of building it themselves.

Here’s my take on this scandalous abuse of economic power, as published in the Globe and Mail:


            Just when you thought that corporate Canada would run out of profligate, economically useless ways to waste vast sums of money, along comes the latest data on mergers and acquisitions (M&A).  According to Thomson Financial, the combined value of takeovers involving Canadian companies almost doubled in 2006, to an awesome $230 billion (U.S.).  (For those who follow the quaint, old-fashioned practice of valuing Canadian companies in our own currency, that’s $270 billion Canadian.)

            Let’s put that in perspective.  A sum equivalent to one-fifth of our GDP was allocated last year to acquire and merge Canadian companies: building corporate empires.  In contrast, Canadian business spent a mere $170 billion on capital investment: building the real economy.

            I have been complaining loudly about the inadequacy of business investment – relative to our economic needs, and relative to record profits.  Now we know what the titans of business have been up to, instead.  For each dollar they spent building the economy last year, they spent $1.60 building their own empires.

            Sure, every time a new deal is announced, the marrying executives boast about impressive “synergies,” savings, and efficiencies.  These promises rarely amount to more than an accountant’s hill of beans.  In reality, the M&A action is a corporate shell game, with few if any real economic effects.

            Some important patterns are visible in the M&A report.  The biggest deals involve resource companies – including six of the top ten takeovers.  Many deals involve foreign takeovers, like last year’s buyouts of Inco, Falconbridge, and Fairmont Hotels.  These takeovers represent a huge capital inflow to
Canada, but one that does next to nothing to actually develop our real economic potential.  (I have nothing against foreign investment, as long as it actually does something useful.)

            The current M&A boom is reminiscent of a similar binge in the late 1990s, just before the dot-com meltdown.  At its peak in 1999, Nortel Networks paid $3 billion for a software start-up (Qtera) with no revenues and 170 employees.  We all know what happened to Nortel.  Back then, intoxicated buyouts were justified on the basis of the internet’s awesome value-creating potential.  Replace the word “internet” with the word “mineral,” and you could sing the same hymn today.

            Somewhere around the corner, however, a price will once again be paid – when resource prices tumble, and the bullish spreadsheets which underline today’s inflated valuations suddenly turn to slag.  The
Toronto Stock Exchange hits new highs almost daily, with rumours of still more takeovers (aluminum could be next) fuelling the fire.  Just don’t bet your RRSP that this frenzy will produce any lasting value on which to retire.

            I’ve always been curious why business leaders (juiced on cheap finance and idle cash) are given free reign to drive up the prices of the stuff they buy with such wild abandon.  Consider the biggest deal of 2006: the takeover of Inco by Brazil’s CVRD.  The deal cost $20.3 billion (U.S.).  Yet Inco’s tangible assets (including property, plant, and equipment; inventories; and cash) were worth barely half that, according to its last annual report.  The remaining premium is just a huge bet that Inco profits will remain sky-high thanks to inflated global commodity prices.

            If workers’ wages grow by more than 2 percent, the Bank of Canada clamps down hard.  But in business, nobody questions an “inflation rate” of 100 percent or more in the market for corporate control.  What does this say about our economic priorities?  And why don’t we take away the CEOs’ punch bowls, when their partying starts to overwhelm our whole economy?

            In reality, the takeover binge reveals the bankrupt business leadership of uncreative executives who’ve been given way too much money to play with.  Rather than inventing something new, expanding our capacity, or investing in real productivity, they pay outrageous prices for companies that others built.  Bottom-line earnings appear to “grow,” and so might share prices (for a while, anyway, until the debt comes home to roost).  Every marrying CEO – whether hunter or hunted – gets a golden parachute, assuaging any lingering regrets over lost empires.  And Bay Street, as usual, takes a juicy cut of every pointless deal.

            But from the perspective of our real economic potential and productivity, at best this shell game is a sideshow.  At worst, it’s a portent of trouble ahead.

Enjoy and share:


Comment from Stephen Gordon
Time: February 18, 2007, 6:57 pm

Actually, I blame a lot of this on the tax system. Since dividends are taxed and capital gains are (for the most part) not, managers have little incentive to find profitable investment projects (shareholders don’t want to pay the tax on distributed earnings), and every incentive to play silly games to jack up the stock price.

Comment from Darwin O’Connor
Time: February 19, 2007, 9:12 am

I find that CEOs run companies in their own interest to maximize the money that they make, to the detriment of the employees, customers and shareholders.

The reason they like to merge is being CEO of a bigger company mean the can justify a bigger salary and bonus, even if they distroy the company in the process.

Comment from travisfast
Time: February 20, 2007, 1:07 pm

Stephen, if you change the rules so that distributed earnings are taxed on par with capital gains all that will do is cause the cash to flow to shareholders and not back into improving the value of the underlying asset.

If increased productivity or employment or both is what is wanted then the problem is that the existing tax system prioritizes equity price first, shareholder wealth second, productivity growth third and employment a very distant fourth. Changing the taxation of distributed earnings will only change the order of the first two priorities.

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