STORYTELLING AND ETHICS IN FINANCIAL ECONOMICS

Critical Perspectives on Accounting (1997) 8 , 605 – 632

STORYTELLING AND ETHICS IN FINANCIAL ECONOMICS SARA ANN REITER School of Management , Binghamton University , NY USA Examination of financial economic stories told at a conference on hostile takeovers demonstrates the power of stories to frame thinking about issues and to compel and convince listeners. Assumptions of financial economic stories include ethical properties ascribed to market forces, primacy of shareholder wealth maximization, and presumption that managers are the enemy. When market efficiency and agency theory assumptions are questioned, financial economic stories fail to provide a convincing response to the concerns of economic justice. Ethical shortcomings of financial economic theory are relevant since financial economic theory underlies accounting practice and research. Accountants’ ability to portray performance and value becomes critical if market prices do not adequately represent this information. If the social benefits of shareholder wealth maximization are questioned, accounting must be expanded to adequately meet the needs of stakeholders other than shareholders and accounting researchers must investigate the wealth distribution effects of financial reporting. ÷ 1997 Academic Press Limited

Introduction In this paper, I analyze stories told at a conference on the impact of hostile takeovers. Critical examination of these stories leads to identification of financial economic ethical precepts and paves the way for evaluating their adequacy in terms of economic justice. An understanding of the ethics of financial economics is important to accountants in the U.S. since, as Williams (1995) notes, ‘‘the discourse of positivist economics has come to be the language of accounting’’ (p. 16). Williams adjures that ‘‘(w )e must recover ethics as a central preoccupation of what we are and what we do’’ (p. 17). This will not be easy since accountants often have a limited understanding of the ethics of financial economic theory and how these ethics have been incorporated into accounting thought and practice. When accounting researchers are trained in financial economic theory, the training is of a highly technical and statistical nature. The predominance of mathematical-technical discourse is typical of the field of economics and examination of storytelling is one way of breaking through the technical complexity to the underlying narratives which express the ethical framework of financial economics. Knights, Raiders , and Targets (CCC: Coffee et al., 1988) contains the papers Address correspondence to: Sara Ann Reiter, Associate Professor, School of Management, Binghamton University, Binghamton, New York 13902-6015, USA. Email: Sreiterê bingvmb.cc.binghamton.edu Received 6 February 1996; revised 31 October 1996; accepted 27 November 1996. 605 1045 – 2354 / 97 / 060605 1 28 $25.00 / 0 / pa960117

÷ 1997 Academic Press Limited

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from the Columbia Law School’s Center for Law and Economic Studies’ 1985 ‘‘Conference on Takeovers and Contests for Corporate Control’’ (hereafter Conference).1 The volume also contains discussants’ comments and summaries of the discussions by conference partcipants. This conference provides a rich source of storytelling in financial economics. First, since the papers are prepared for verbal presentation, they are more likely to tell stories than papers prepared as journal articles. Verbal presentations in economics often involve explicit discussion of the story motivating the study (McCloskey, 1985). Also, unlike conversations conducted through publication in scientific journals, the authors, discussants, and participants at the converence confront each other’s views directly in real time. This, and the presence at the conference of several competing ideological points of view, generates a much richer discourse than can be derived from analysis of published articles. Several of the elite figures of financial economic theory, such as Michael Jensen and Richard Roll, present inaugural versions of new stories at the conference, and there are also counter-stories tendered by other economists, legal scholars, and corporate CEOs such as Warren Buffet and Harry Gray. Analyzing the stories told at the Conference is a form of discourse analysis which elucidates the ethical arguments made by participants in the conversation about the impact of hostile takeovers and need for regulatory intervention. The stories told at the Conference are particularly revealing because the hostile takeover movement of the 1980s posed serious empirical and ethical challenges to financial economic theory. What do market prices mean when the market price of a company can change so drastically during the course of a takeover battle? If market prices of companies before takeovers accurately reflect their value, what is the source of the gains that fund the enormous control premiums and transactions costs? Who gained and who lost in the takeover battles? The efficiency of the securities markets, the meaning of market prices, and the source and disposition of the gains from acquisition activity were the principal issues discussed at the Conference. These issues are at the heart of the ethics of financial economics and at the heart of debates about the necessity for regulation in the financial markets. These issues are also essential to understanding the ethics of financial accounting at the macro level. Market prices are central to our financial accounting system and we need to understand what they do and do not represent. The meaning of the market price of a firm is central to current debates on accounting for goodwill and for merger activities. In a larger sense, accountants’ ability to portray how well companies are doing becomes fundamentally important if we begin to believe that market prices do not adequately represent this information. If we do not adequately account for risk and long-term performance potential, accounting itself may have been a contributory factor in the takeover movement of the 1980s. If we become uncomfortable with the ethical validity of financial economic stories, changes in accounting practice may be necessary. For example, if we question the social benefits of shareholder wealth maximization, we may need to expand the scope of accounting to adequately meet the needs of stakeholders other than shareholders.

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In the first section of this paper, I talk about storytelling practices in economics and explain why stories are laden with hidden ethical meaning. I also discuss the role of stories in developing and communicating ideology. Next, I review the Conference and the basic ideological conflict between the beliefs of the owners and the managers. Two ethical frameworks for evaluating hostile takeovers, welfare economics and economic justice, are introduced. In the third section, I analyze stories about markets and managers told by Jensen and Roll and recall the foundational stories and assumptions of classical economic thinkers. I explore the ways that metaphor is used in conversation about markets and managers and note how the stories work to help construct the ideological position of financial economics. The financial economists’ ethical (welfare economics) analysis of hostile takeovers is summarized. In the fourth section, I present counter-stories to those of the financial economists about how the markets may not work efficiently and how managers should act to develop future value. The economic justice evaluation of hostile takeovers is summarized. Next, I draw links between financial economic ethical issues and accounting practice, particularly in relation to accounting for acquisitions and long-term corporate performance. Finally, I present recommendations that accounting research and practice break away from the accounting’s current (hidden) role as a partisan for agency theory and owners’ interests. Storytelling Practices In his commentaries on rhetoric and narrative in economics, McCloskey (1985, 1990) explains that economic conversation, like all human conversation, has strong rhetorical content. The elements of rhetoric are fact, logic, narrative, and metaphor. Social scientists, like other scientists, tend to think that their conversations are about facts and logic. Many of the participants at the Conference probably thought that the conversation was about empirical facts, how they are generated, and how they do or do not support various hypotheses. However, the conversation at the Conference was also very much about ideologies, or systems of belief2. The two main opposing points of view at the Conference are presented by the financial economists (taking the side of the owners) and the corporate executives (taking the side of the managers). Even though neither owners’ nor managers’ ideology has established clear dominance in the larger discourse about corporate America, the owners’ ideology is developed most fully at the Conference by the financial economists. Labelling a system of beliefs an ideology does not indicate that its tenets are necessarily false. It does, however, lead to the suspicion that fact, logic, narrative, and metaphor are being used to present a coherent system of belief in which conclusions may be overstated, beliefs may be universalized and naturalized, and social conflicts may be suppressed. To a great extent, the ideological arguments are presented in the form of stories. Stories have considerable power to frame thinking about issues and to compel and convince others. By discussing the stories told at the Conference, I emphasize the narrative and metaphorical aspects of financial economic discourse rather

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than the technical aspects. Once the discourse is de-mystified of its technical authority, it is easier to see the ethical implications. Storytelling Practices in Economics The stories told by elite economic storytellers like Jensen and Roll are not generally subjected to critical or ethical scrutiny. In fact, such questioning is soundly discouraged in many economics classrooms as students learn early on that it is considered bad form to question fundamental assumptions (Strassmann, 1994; Strassmann & Polanyi, 1992). Emphasis on analogic reasoning leads students to view the core material as the ‘‘valuable and unchallengeable consensus of experts’’ (Strassmann, 1993b, p. 152). As Strassmann suggests, ‘‘(t)he inability of economics to give much credence to issues of values, power, and social construction may be due to the way practitioners have been selected and socialized to discount the role of such factors, and to give excessive credence to stories based on core assumptions and models’’ (Strassmann, 1993a, p. 57). Meanwhile, the mathematicaltechnical aspects of economic discourse predominate to the extent that students are not even consciously aware of the core narratives. When economic theory is imported into other fields, such as accounting, the dearth of critical attention to core theory and assumptions carries over along with many other aspects of economic style. Examination of the stories told at the Conference and their ethical implications is a starting point for critical inquiry into the ethics of financial economics. Examining storytelling in financial economics, rather than expressing financial economic concepts in economic jargon, makes it more difficult for criticism to be captured or defused by the traditional economic mantras that students (including ourselves) are taught to ward off doubts about economic theory. Critiques of neoclassical economic thought often get bogged down in arguments about whether the theory predicts well in spite of unrealistic underpinnings, or about how critical each assumption is to the workings of the theory. Problems with the big picture remain unaddressed. The Power of Stories Stories are very powerful, and their ethical and conceptual underpinnings are often hidden. Witten (1993) asserts that ‘‘narrative is a singularly potent discursive form through which control can be dramatized, because it compels belief while at the same time it shields truth claims from testing and debate’’ (p. 100). This ‘‘unique power’’ of stories derives from the rules of storytelling. The storyteller uses emotionally compelling language and is allowed to speak without interruption or critique. Listeners habitually suspend critical response and judge stories in terms of internal consistency and relevance rather than external validity. The storyteller conveys ‘‘ ‘ready made’ knowledge . . that takes on the status of presumption . . and is shielded from testing or debate’’ (pp. 106 – 107). The moral presumption of stories allows financial economic storytellers to tell tales whose ethical underpinnings are seldom questioned or examined. Stories are also one of the ways that ideologies advance their ideas and their hidden agendas. Thompson (1984) explains that ‘‘ideology, in so far

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as it seeks to sustain relations of domination by representing them as ‘legitimate’, tends to assume a narrative form’’ (p. 11). Stories play a vital role in the strategies used by ideologies to legitimate their beliefs. Ideologies seek to promote congenial beliefs and values, naturalize and universalize beliefs as self-evident, denigrate challenging ideas, exclude rival forms of thought, and obscure social reality in convenient ways (Eagleton, 1991, pp. 5 – 6). The Conference on Takeovers and Contests for Corporate Control The Conference was sponsored in November 1985 by Columbia Law School’s Center for Law and Economics to provide a forum for a broad range of participants—including practitioners, investment bankers, business executives, and scholars—to debate the issues surrounding hostile takeovers. As the Conference organizers explain, there is considerable disagreement about the nature of the underlying forces and longer-term consequences associated with the hostile takeover movement of the 1980s. The popular press story about hostile takeovers goes as follows: ‘‘The ABC Company issues ‘golden parachutes’ to its executives and pursues a ‘scorched earth’ policy by selling its ‘crown jewels’ and issuing a ‘poison pill’ to its shareholders, all in an attempt to foil a takeover bid by Mr. Z, a well-known ‘shark’ and ‘greenmailer’ who floats junk bonds with abandon. When Mr. Z persists, a white knight, otherwise known as Company X, arrives to fend off the hostile attack’’ (CCC: Coffee et al ., 1988, p. 3)3.

This is a colorful story, filled with metaphors of warlike pillage and destruction, which reflects a certain public unease about the ethics of hostile takeovers. At the Conference, participants tell stories and present arguments and evidence to explain and reconcile hostile takeover events. Participants seek to answer the questions, ‘‘Why do takeovers occur, and are takeovers good or bad?’’ (Weiss, 1988, p. 360). The underlying question is whether there is anything sufficiently wrong with the U.S. market for corporate control to require regulatory intervention. Therefore, participants seek to explain ‘‘why takeovers occur and where the gains come from’’ (CCC: Ruback, 1988, p. 355) and who the gains go to. The Basic Conflict The basic conflict at the Conference is between the stories of corporate owners (represented by the financial economists) and corporate managers (represented by the CEOs). Roll (CCC: 1988, p. 241) explains that numerous financial economic theories about takeovers have arisen over time. These explanations are not mutually exclusive—some may apply in some, and others in other situations. However, ‘‘(m)ost takeover hypotheses make the natural presumption that economic benefits will flow from the corporate combination’’ (p. 243). The source of the gains differs between explanations. Potential sources of gains for shareholders from takeovers include: monopoly power, information effects, synergies of combination, elimination of inferior management of the target firm, and financial motivations such as utilization

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of tax shields or reduction of bankruptcy costs (p. 243). The financial economists maintain that hostile takeovers can be described within this framework of economic efficiency. Taking the corporate executive side, Harry Gray of United Technologies distinguishes between mergers of the past designed to strengthen existing businesses and current takeovers being accomplished with junk bonds which are really designed ‘‘to break apart companies as opposed to putting them together’’ (CCC: Gray, 1988, p. 12). In the junk bond takeovers, some parties win and some parties lose. Shareholders in target firms can profit, the raiders profit hugely, ‘‘(b)ut everyone else, in our opinion—including the company— loses’’ (p. 12): ‘‘The junk bond takeover restricts the ability of the affected business to grow or to provide increased productivity and employment. It encourages management to focus on the short term to avoid becoming a takeover target via the junk bond, which uses your own assets to finance the takeover. It results in defensive measures to ward off actual or anticipated threats’’ (p. 12).

It is this story, widely believed in the business community, that leads to doubts about the economic benefits of takeovers, to ‘‘strong pressure on regulators and legislatures to enhance restriction that could curb activity in the market for corporate control’’ (CCC: Jensen, 1988, p. 314), and to the Conference. At the time of the Conference, the takeovers and leveraged buyout transactions of the 1980s were attracting considerable regulatory attention. ‘‘In the spring of 1985 there were over twenty bills in Congress that proposed new restrictions on takeovers’’ (CCC: Jensen, 1988, p. 314). The neoclassical view of the relationship between economics and policy (law) is that regulations should encourage and not hinder maximization of shareholder wealth: ‘‘. . . the underlying policy aim of the law is the facilitation and encouragement of an economic system that promises to deliver goods and services in the most efficient manner, thereby maximizing national wealth. The maximization of shareholder wealth is often a means toward that end, because legal standards that maximize shareholder wealth serve to hold managers to an efficiency objective and to promote continuing infusions of capital into the equity market. Furthermore, if shareholders invest in the justified expectation that managers will act to maximize shareholder wealth, the law should take that expectation into account as a matter of fairness. And all other things being equal, the creation of shareholder wealth is obviously a good thing in itself’’ (CCC: Eisenberg, 1988, p. 155).

Ethical Issues Questions of regulation are closely related to evaluation of the ethics of hostile takeovers. If the hostile takeover situation were found ethically wanting, a regulatory solution would be proposed. I propose that two ethical frameworks, welfare economics and social justice, are appropriate for evaluating the stories told at the Conference. Financial economists have been trained to think and present their ethical case for hostile takeovers in the welfare economics framework. Regulators and policy-makers use justice criteria and it is appropriate to evaluate the financial economic stories by those criteria as well.

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Wilson (1991b) points out that ‘‘(t)he neoclassical model of economics behavior is not totally devoid of ethical considerations . . . The ethical version of the neoclassical model is utilitarianism’’ (p. 201). As Sen (1987) explains, ‘‘the traditional welfare economic criterion used to be the simple utilitarian one, judging success by the size of the sum total of utility created . .’’ (p. 30). Comparisons of outcomes in economics are made using the criterion of Pareto optimality (that some party is better off while none are worse off) ‘‘which is sometimes also called ‘economic efficiency’ ’’ (p. 31). Sen explains that Pareto optimality ‘‘deals exclusively with efficiency in the space of utilities, paying no attention to the distributional considerations regarding utility’’ (p. 34). In other words, neither inequity in initial endowments nor inequity in distribution is of ethical concern as long as total value is created by an act. Sen notes that ‘‘the . . . ‘Fundamental Theorem of Welfare Economics’ . . . relate(s) the results of market equilibrium under perfect competition with Pareto optimality’’ (p. 34). This explains the financial economists’ concern with demonstrating that total value is created by hostile takeovers. This also explains why it is so important to maintain that stock markets are efficient. Using this ethical framework, the financial economists are seeking to demonstrate that efficient markets are operating in the hostile takeover environment and value is being created by hostile takeovers. If the system is working in this way, it is ethically sound according to welfare economic criteria. Wilson (1991b), however, contends that welfare economics ‘‘cannot tell us whether the activities of Wall Street in general are to be judged as ‘unjust’ from a social point of view. To address [justice] concerns we must turn to a far broader moral model . . .’’ (p. 202). Wilson suggests using a contractual model of social justice which ‘‘involves three different conditions that permeate all stages of the economic system: commutative justice, productive justice, and distributive justice’’ (p. 204). Commutative justice implies equivalence of exchange. Several elements of just exchange are that there is ‘‘neither ‘excessive profit’ nor ‘undue loss’ ’’ (p. 204) and that the exchange is just, fair and voluntary. This condition implies equally competent and informed buyers and sellers. Productive justice ‘‘relates to the fairness of participation by individuals in the economic system’’ (p. 205). Distributive justice ‘‘concerns the allocation of the benefits of an economic system among all the members . . .’’ (p. 207). Economic justice concepts are presented in Figure 1. For an entire economic system, ‘‘(i)f the original distribution of certain fundamental rights is fair, and all subsequent exchanges are fair, then the final distribution is just’’ (p. 207). While one may be concerned about how exactly to define ‘just’ and ‘fair’, ethicists propose that people have a widely shared ‘moral sense’ about concepts such as fairness (Wilson, 1993). Evaluating the hostile takeover movement from a social justice perspective examines different issues than those highlighted by welfare economics. The issue of who wins and who loses matters in a justice framework. From the perspective of commutative justice, one must ask whether the hostile takeover events represent a fair and voluntary economic exchange. Are the profits made by the raiders, and to a lesser extent by the target firm shareholders,

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Criteria

Commutative Justice

Fair price in economic exchange Sanctity of contractual obligations

Productive Justice

Equal opportunity to participate in economic system Ability to satisfy basic human needs Participation respects individual dignity and sense of fairness

Distributive Justice

To To To To

Justice

each each each each

according to merit according to rank according to essential needs the same

Adapted from Wilson (1991a, p. 245)

‘excessive’? In terms of productive justice, questions can be raised about the effects of hostile takeovers on workers and communities, and on the long-run welfare of American business. Consideration of distributive justice leads to questioning the distribution of the takeover gains and losses to the various stakeholders. Conference participants from institutional and legal backgrounds raise these issues about hostile takeovers in their responses to financial economic stories. Organization of the Conference The Conference was organized as a series of panel sessions with papers, comments, and open discussion. The kick-off for the conference was an informal panel of Corporate Executive Officers presenting their views that acquiring firms pay excessive prices in hostile takeovers leading to large profits for target shareholders and that stock market prices often undervalue firms, setting them up as takeover targets (CCC: Coffee et al., 1988 , pp. 3 – 4). The first panel, ‘‘Capital Markets, Efficiency, and Corporate Control,’’ focused on issues of stock market (in)efficiency and over / undervaluation. The second panel, ‘‘Managerial Behavior and Takeovers’’, was concerned with issues of managerial motives and long-term benefits of hostile takeovers. The third panel, ‘‘Evidence on the Gains from Mergers’’, presented results of empirical studies and drew the sharpest debate (p. 6). The fourth panel, ‘‘Mergers and Takeovers: Taxes, Capital Structure and the Incentives of Managers’’, presented evidence on tax incentives, but it was generally agreed that tax incentives play a minor role in the hostile takeover phenomena. The remainder of the conference focused on legal rules and discussed institutional regulations surrounding takeover activity in different countries and issues related to shareholder voting and dual class capitalization. The corporate executives put their issues on the table and the next four panel sessions were forums for the financial economists to present their opposing views and evidence. Institutional economists, law professors, and managerial theorists also participated in panels 1 – 4 and there was a sharp debate between the financial economists and these groups. The Appendix

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lists the disciplinary areas and institutional affiliations (as of 1985) of all participants at the conference who are quoted in this paper. As the conference organizers note in summary, ‘‘(a)s usual, important issues have not been finally resolved, and few conference participants behaved like Saul on the road to Damascus’’ (p. 8). It is primarily the discussion in the first three panels that provides the raw material for my analysis of Conference stories and revisitation of old tales from classical economics. I organize the stories into two main categories— stories about markets and managers and counter-stories. The principal stories that I retell are Roll’s story about managerial hubris (panel 3), Jensen’s story about the hostile takeovers and the market for corporate control (panel 4), Shiller’s story about fads and bubbles in asset pricing (panel 1), Herman and Lowenstein’s institutional story about takeovers (panel 3), and Salter and Weinhold’s story about the managerial perspective on mergers and takeovers (panel 2). Throughout, the stories are augmented by comments from discussants and other authors. Occasionally I go outside the discourse of the conference to provide background material necessary to appreciate a story, however, most of the text comes from discussion by the participants. Markets and Managers Beliefs about markets and managers are central to the stories of financial economics. First I tell Roll’s story about managerial hubris and Jensen’s story about managers hoarding corporate cash flows. Following Jensen’s justification of hostile takeovers as a market regulatory mechanism, I revisit the classical stories on which the financial economic stories are based and the examine the role of metaphors in thinking about markets and the business environment. I also discuss the role of stories in constructing and communicating the owners’ ideology. Finally, I present the financial economists’ conclusions about the welfare economics of hostile takeovers. Roll’s and Jensen’s Stories Traditional explanations of takeover premiums as efficiency gains are severely tested by hostile takeovers in the 1980s. Bradley and Jarrell (CCC: 1988, p. 258) note that ‘‘(i)t is hard for us who advocate the neoclassical theory of takeovers to understand some of the recent acquisitions and particularly the enormous premiums often paid for target firms’’. Takeover premiums are often as much as 50% to 80% of pre-takeover market value, and this magnitude of gain is difficult to explain as expected efficiency gains or agency cost reductions. Roll and Jensen unveil new stories to account for these phenomena at the Conference. Their new stories play on old themes and beliefs about managers and markets. Roll tells a story about irrational behavior by managers as a possible explanation for some takeover events. His hubris theory is a ‘‘behavioral explanation for the takeover phenomena’’ (CCC: 1988, p. 244): ‘‘My argument is that bidding firm managers intend to profit by taking over other firms, possibly because they believe that synergy is present, that the

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S. R. Reiter target has inefficient management, etc. Their intentions are not fulfilled, however, because the market price already reflects the full value of the firm . . . Why, then, do bidding firms persist in their pursuit of the target? Because the individual decision makers in the bidding firm are infected by overweening pride and arrogance (hubris) and thus persist in a belief that their own valuation of the target is correct, despite objective information that the target’s true economic value is lower . . . The hubris explanation is heavily dependent on improper recognition of the ‘winner’s curse’ . . .’’ (p. 249).

In Roll’s story, the manager is a fool and market prices are assumed to be correct before bidding frenzy takes over. Regulatory intervention is not called for, however, because overbidding due to hubris is a rare occurrence and any regulation aimed against this situation would deter other beneficial merger transactions. Jensen introduces the free cash flow theory of takeovers at the Conference (CCC: Jensen, 1988, pp. 314 – 354). Jensen’s story combines narrative themes about problems with managers and benefits of markets. The basic theme of Jensen’s story is that managers can be motivated to behave in the interests of shareholder / owners and disgorge free cash flows4 by subjecting firms to the discipline of the managerial labor market or the discipline of debt, which in this case substitutes for market control. The source of takeover gains is seen as the reduction of agency costs resulting from reestablishing market control over managerial behavior. Jensen adheres to basic agency theory assumptions that while managers are agents of the shareholders, managers follow their own self-interest, creating serious conflicts ‘‘over the choice of the best corporate strategy’’ (p. 321). In Jensen’s story, managers are consumed with short-sighted self-interest and concerned with gaining and retaining power, even at the expense of survival of their firms. In some cases, Jensen asserts, ‘‘takeovers occur because incumbent managers are incompetent’’ (p. 318). If not incompetent, managers ‘‘often have trouble abandoning strategies they have spent years devising and implementing’’ (p. 318) or ‘‘dealing with the fact that some firms . . . have to go out of business’’ (p. 318). While Jensen concedes that there is little formal evidence that managers are often myopic, he believes this does occur when ‘‘managers hold little stock in their companies and are compensated in ways that motivate them to take actions to increase accounting earnings’’ and ‘‘when managers make mistakes because they do not understand the forces that determine stock values’’ (pp. 319 – 320). The champion in this story, protecting the interests of the shareholders as well as the interests of society, is the regulating mechanism (generally, of course, a ‘‘free’’ market) that supplies the discipline to keep the manager in check. Jensen notes, ‘‘The market for corporate control is best viewed as a major component of the managerial labor market. It is the arena in which alternative management teams compete for the rights to manage corporate resources. Understanding this point is crucial to understanding much of the rhetoric about the effects of hostile takeovers’’ (p. 317).

The usual market disciplining forces, product and factor markets, are not sufficient to control the actions of managers under certain circumstances. The

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takeover battles of the 1980s exemplify market forces in the form of the market for corporate control attempting to discipline managers who are not behaving in shareholders’ interests. Jensen summarizes: ‘‘In short, the external takeover market serves as a court of last resort that plays an important role in (1) creating organizational change, (2) motivating the efficient use of resources, and (3) protecting shareholders when the corporation’s internal controls and board-level control mechanisms are slow and clumsy or break down’’ (p. 319).

Managers of the largest firms had formerly been ‘‘protected from competition for their jobs by antitrust constraints that prevented takeover of the nation’s largest corporations . . .’’ (p. 317); however, the recent ‘‘development of innovative financing vehicles, such as high-yield noninvestment grade bonds (junk bonds), has removed size as a significant impediment to competititon in this market’’ (p. 318). Hostile takeovers and the defensive restructurings undertaken by firms to become less attractive targets are seen by Jensen as beneficial despite the obvious angst that these events often cause. Since hostile takeovers occur ‘‘in response to break-downs of internal control processes in firms with substantial free cash flow and organizational policies . . . that are wasting resources’’, they are ‘‘value-increasing’’ (p. 334). Taking on additional debt, even to the point of ‘‘over-leveraging’’ is sometimes desirable: ‘‘. . . levering the firm so highly that it cannot continue to exist in its old form yields benefit. It creates the crisis to motivate cuts in expansion programs and the sale of those divisions that are more valuable outside the firm . . . This process results in a complete rethinking of the organization’s strategy and structure. When it is successful, a much leaner, more efficient, and competitive organization results’’ (p. 335).

Widespread concerns about hostile takeovers are ascribed to self-interested lobbying by high level corporate executives: ‘‘Although economic analysis and the evidence indicate that the market for corporate control is benefitting shareholders, society, and the corporation as an organizational form, it is also making life more uncomfortable for top-level executives. This discomfort is creating strong pressures at both the state and federal levels for restriction that will seriously cripple the workings of this market . . . This political activity is another example of special interests using the democratic political system to change the rules of the game to benefit themselves at the expense of society as a whole’’ (p. 348).

Foundations of Financial Economic Stories To understand the convention in financial economic stories that the market is the superhero and profit maximization and shareholders’ interests are championed, it is necessary to reflect on the underlying story of financial economics. The famous Adam Smith quotation, ‘‘It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest’’ (Grapard, 1993), is from Smith’s story

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of how self-interested behavior by individual business owners leads to optimal allocations of resources in society through the operation of the ‘‘invisible hand’’ of market forces. This story is retold as the meta-narrative of neoclassical economics and explains the magical properties ascribed to market forces and the overriding focus on business owners’ interests. Werhane (1991) asserts that the invisible hand story does not accurately represent Adam Smith’s meaning. Interpretations of the claim that ‘‘under Smith’s invisible hand, a perfectly competitive market is ‘a morally free zone’, that is, ‘the market satisfies the ideal of moral anarchy’ . . . form the philosophical basis of some contemporary economic and political theories, in particular, the Chicago schools represented by George Stigler and Milton Friedman’’ (Werhane, 1991, p. 6). But Smith would hardly recognize his own work as interpreted in financial economic theory. Wolfe (1989) explains that ‘‘the market as a metaphor for a process of exchange that would serve as a moral model for all of society’s interaction would have been a foreign idea to Adam Smith’’ (p. 30). For one thing, there was no concept of market as we know it today in Smith’s time—Smith refers instead to exchange in a physical sense within a community governed by explicit and implicit moral understandings. Furthermore, Smith believed that ‘‘the laws of justice are the essential feature of any political economy’’ (Werhane, 1991, p. 179). Other concepts of early neoclassical economic theorists are called upon by conference participants. Herman and Lowenstein explain that ‘‘Manne . . . focused attention on the stock market as providing the only ‘objective standard of managerial efficiency’ . . . For Manne, a low stock price is a reflection of managerial efficiency, and the difference between the actual price and the price under efficient management is the relevant capital gain . . .’’ (CCC: p. 212) or ‘‘Manne opportunity value’’ released through merger activity. The financial economic theory of mergers ‘‘is nothing more than a simple extension of the neoclassical notion that there are mutual gains from voluntary trade—that through the process of voluntary exchange, resources will flow to their highest-value use’’ (CCC: Bradley & Jarrell, 1988, p. 253). The issue of who gains and who loses is not important in this framework—what is important is ‘‘whether or not these transactions create total value . . . the total gains realized by both stockholder groups’’ (p. 256). Neoclassical theory assumes that when ‘‘the gains exceed the losses, the transaction is ‘efficient’ (i.e. Pareto superior) and should be encouraged, on the rationale that the losers can be compensated by some other means (such as by the State)’’ (CCC: Coffee, 1988, p. 114). If markets are the superheroes of financial economic stories, managers are cast as the villains. The centrality of the conflict between stockholders (owners) and managers comes from the branch of agency theory that Williamson (CCC: 1988, p. 161) calls ‘‘informal agency theory’’. Informal agency theory is principally concerned with the nature of the contracting process. The ‘‘nexus-of-contract’’ view of the firm is featured and the theory examines how bonding, monitoring, and other devices (like Jensen’s market for control and the discipline of debt) can be used to perfect contracting relationships. Individual owners and managers, are assumed to have bounded rationality and self-interested motives.

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Roll’s and Jensen’s stories (CCC: 1988, pp. 241 – 252, 314 – 354) are heavily grounded in the narrative of agency theory which emphasizes conflicts of interest between owners and managers and takes sides emphatically with the owners. In the process of developing financial economics, the early microfinancial theorists elevated the profit maximization assumption of classical economics to be ‘‘the cardinal postulate of modern financial economic theory . . . that the central objective of the business corporation is (or should be) to maximize the wealth position of its shareholders’’ (Findlay and Williams, 1985, pp. 2 – 3). Therefore, the interests of the owners are singlemindedly championed in finance theory and measuring wealth effects of events from the viewpoint of common shareholders is the principal interest of finance researchers. These presumptions guide the empirical work undertaken by financial economists to evaluate hostile takeovers and explain the concern with demonstrating market efficiency and shareholder wealth effects. Metaphors, Markets, and Managers Beliefs about managers and markets, which are central to the stories of financial economics, are reinforced through the use of metaphor. Lakoff and Johnson (1980) explain that ‘‘(o)ur ordinary conceptual system, in terms of which we both think and act, is fundamentally metaphorical in nature’’ (p. 3). Adam Smith’s story draws heavily on the metaphors of natural science to ascribe power to the ‘‘invisible hand’’. Clower (1988) explains the contributions of Adam Smith’s work: ‘‘What has given the book lasting significance, however, is the cogent case Smith made for believing that the economic activities of individuals could be more effectively coordinated through the indirect and impersonal action of ‘natural forces’ of competition and self-interest than through the direct and often ill-conceived action of government authorities. In effect, Smith opened the eyes of humankind to the existence of a ‘grand design’ in economic affairs similar to that which Newton had earlier shown to exist in the realm of physical phenomena. . . . . . Common sense to the contrary notwithstanding, therefore, the economic system is an essentially self-regulating mechanism that, like the human physiological system, tends naturally towards a state of ‘equilibrium’ (homeostasis) if simply left to itself’’ (pp. 95 – 96).

Financial economic stories employ metaphors from Newtonian physics, such as efficient markets, market forces, and equilibria, and use ecological concepts such as survival of the fittest and competition. The use of terms such as ‘‘efficient’’ to describe capital markets is important in establishing the power of markets. As Shubik explains, ‘‘(w)e invoke the magic of an institution-free, anonymous, perfect competition complete with delicious phrases such as efficient markets, perfect foresight, rational expectations , and perfect equilibrium . . .’’ (CCC: 1988, p. 32). If markets can be seen as forces of nature, unimpeded by human agency, arguments that market prices supply efficient means of distributing resources are strengthened, and the status of the economic storytellers is enhanced. Furthermore, natural ecological forces such as competition are seen as the imperative of economic activity. Tinker

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(1988) provides examples of the concepts of social darwinism and survival of the fittest in the writings of 19th century philosophers and business apologists who used the concept to attack state aid to the poor and defend predatory business practices. He concludes that these ‘‘examples show how scientific theory may be used to naturalize (and thus authenticate) the prevailing social order . . . corporations thrive in their natural habitat of free markets without the hindrances of ‘unnatural’ state intervention’’ (p. 177). Creating an identity between market forces and natural forces is the way that financial economic storytellers connect with powerful narratives about the science of nature. The belief that market forces represent natural forces with beneficial powers is also the central ethical claim of financial economics. In an unregulated setting, where market forces are allowed to work, resources are allocated in an optimal manner and the system is ethically in balance. Financial economic stories also use the nature metaphors to connect with ideals of personal freedom and liberty: ‘‘In the popular free-enterprise mythology the freedom of markets and the impersonal discipline and justice of the price system take on a virtue associated with freedom and justice for the individual in general, as though the major purpose of government laws were to thwart the free play of the market. Yet rather than being an artifact of nature, the free-exchange market is clearly a product of society and its laws’’ (CCC: Shubik, 1988, p. 33).

The view of markets as a regulating and disciplining force in Jensen’s story is typical of visualization of the economy as an organism that works in everyone’s best interest through natural mechanisms resembling the forces of nature. And yet, as Frankfurter and McGoun (1993) point out, the ‘‘market for corporate control’’ metaphor is misleading: ‘‘A physical ‘market for corporate control’ per se is nowhere to be found. There is no place where exchange would take place, no indication that those who vie for such control perceive it as a market and no two-sided transactions’’ (p. 125).

Frankfurter and McGoun contend that the ‘‘market for corporate control’’ metaphor ‘‘becomes a necessary fiction to the true believers of the paradigm. It is the logical consequence of the underlying theory according to which value cannot exist without a market . . . In order to justify valuing corporate control, it is necessary to hypothesize a market for it’’ (p. 125).

Similarly, Shubik (CCC: 1988) maintains that the ‘‘theory of competitive markets has proved to be of great worth in providing insight and guidance concerning the overall functioning of mass markets, but it offers no intellectual basis for our understanding of the different markets for the paper, the real assets, and the control of a corporation . . .’’ (p. 34). Closely allied to beliefs about the benefits of competition are beliefs about the naturalness of self-interest. Jensen (CCC: 1988) scoffs at the altruistic model of the corporate board used by courts in legal decisions. The altruistic model presumes that the board of directors acts solely in the interests of the shareholders. For Jensen, this violates what we know of human nature:

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‘‘The altruistic model of the board . . . is incorrect as a description of human behavior. In the end, people are self-interested, and board members do not always have incentives to act in the shareholders’ interests’’ (p. 342).

Jensen maintains that the courts must stop relying on fiduciary duty and trust and rely instead on the agency theory remedy of ‘‘a complex set of contractual and market forces’’ (pp. 342 – 343). However, non-economists may be concerned with this narrow view of human nature: ‘‘Yet the student of history and society confronted with many of the models of micro-economic theory can become uneasy, with some justification. Is loyalty to one’s country, friends, or partners best explained by short-term utility maximization? In the search for economic explanation, is there an efficient market for charity or the very punctilio of honor? Are tradition, custom, and codes of ethical behavior little more than institutionally imperfect realizations of the principle of short-run maximization in an efficient market? Or could it be that much fiduciary behavior is based on longer-term concepts of codes of honesty not easily (or uniquely) explained by nonsocialized, noninstitutional, consciously short-term optimizing economic individuals?’’ (CCC: Shubik, 1988, p. 44).

Stories and the Owners’ Ideology As noted previously, the stories promoting owners’ interests told by the financial economists can be considered as part of an ideology or belief system (Eagleton, 1991, p. 4). The stories about markets and managers have a number of characteristics of ideology, which does not mean that they are necessarily false or irrational. As Eagleton (1991) notes, ‘‘to claim that a belief is functional for social interests is not necessarily to deny that it is rationally grounded’’ (p. 55). Ideologies ‘‘attend to the promotion and legitimation of the interests of . . . social groups in the face of opposing interests’’ (p. 29). The stories are powerful advocates for the interests of shareholder / owners against the interests of managers and labor. Ideologies are unifying, action-oriented, rationalizing, legitimating, universalizing, and naturalizing (Eagleton, 1991, p. 45). The financial economists’ stories present a unified point of view that leads to definite prescriptions for how markets should be organized and managers should be held in check. Eagleton explains how ideologies are mixtures of analytic and descriptive statements and moral and technical prescriptions which blend beliefs and disbeliefs, moral norms, factual evidence, and technical prescriptions. Jensen’s story fits this description very well. Ideologies are rationalizing, providing ‘‘plausible explanations and justifications for social behavior which might otherwise be the object of criticism’’ (p. 52). Both Roll’s and Jensen’s stories are told to rationalize hostile takeovers. Their stories are also legitimating in that they present stockholders’ interests as supreme. Ideologies achieve ‘‘legitimacy . . . by universalizing . . . interests which are in fact specific to a certain place and time . . . as the values and interests of all humanity’’ (p. 56). This is done partly by ‘‘suppressing the historical relativity of their own doctrines’’ (p. 58) and by rendering ‘‘their beliefs natural and self-evident’’ (p. 58). The use of natural and scientific metaphors is an example of this process. The financial economists’ stories exhibit several traits of a theoretical ideology in that ‘‘(p)ublic policy advocacy, based on a theoretical position, typically exceeds the authority warranted to it

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by empirical data . . . [and] (c)ertain unarticulated assumptions permit a theory to advance some social interests at the expense of others’’ (Tinker, 1988, p. 168).

Welfare Economics Evaluation Financial economists at the conference interpret the substantial share price gains to shareholders of acquired firms as evidence of efficiency gains (Manne opportunity value) or reductions in agency costs. They also conclude that shareholders of bidding firms are slightly better off or at least no worse off. This is a Pareto optimal finding (one party better off and no party worse off) and validates hostile takeovers from the welfare economics point of view. As Magenheim and Mueller note, ‘‘. . . this interpretation of the evidence, if valid, would appear to vindicate a liberal antimerger policy’’ (CCC: 1988, p. 171) of noninterference. However, the validity of this view depends critically on the validity of the previously discussed underlying tenets of neoclassical economic theory about the efficiency of capital markets, meaning of share prices, exclusive focus on shareholder wealth, villainy of managers, and necessity for competition. Social benefits are defined purely in terms of shareholder’s interests but actions that benefit shareholders (like payouts from corporations) are also assumed to be of more general benefit since they place the firm under the beneficial regulation of market forces and ‘‘increase efficiency and thereby promote the national interest’’ (CCC: Jensen, 1988, p. 315). In contrast to the popular press version, Jensen’s story explains how all of the seemingly threatening elements of hostile takeovers are actually beneficial. McCloskey explains that these soothing stories are typical of economic storytellers: ‘‘If even economics can be shown to be fictional and poetical and historical its story will become better. Its experts will stop terrorizing the neighborhood and peddling snake oil. Technically speaking the economist’s story will become, as it should, a useful comedy—comprising words of wit, amused tolerance for human folly, stock characters colliding at last in the third act, and, most characteristic of the genre, a universe in equilibrium and a happy ending’’ (McCloskey, 1990, p. 162).

Counter-Stories The optimistic view of hostile takeovers as a market regulatory mechanism is challenged when one questions the basic assumptions of the financial economists. Whether markets work in real life the way they do in financial economic stories became a critical question at the Conference. I present Shiller’s story about how fads and bubbles play havoc with the meaning of market prices and Herman and Lowenstein’s story about takeovers in a world without valuation-efficient markets. Another critical issue in evaluating hostile takeovers concerns assumptions about the role of competition and what it takes for business to succeed. Managerial theorists approach the problem

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with a different conception of managers and the firm and suggest that hostile takeovers take business in a very wrong direction. Finally, appraisal of hostile takeovers from an economic justice point of view is contrasted to the welfare economics analysis. Market Prices Stock market prices are important in evaluating hostile takeovers. At the Conference, most of the empirical evidence discussed is stock market reaction to restructuring and takeover events. It is assumed that positive stock market reactions indicate events that are favorable for the shareholders and that stock market reactions express the efficiency and desirability of various events. Shareholders’ interests play the central role in financial economic theory and stock returns are the principal form of evidence in financial economic stories5. However, several conference participants question the validity of stock price reactions in this context. What is the meaning of market prices if one does not believe that the market for corporate control is efficient? ‘‘If, in contradistinction to the adherents of the single, efficient market, we suggest that there are several more or less imperfect markets involving the market for a few shares, the market for control, the market for goingbusiness assets, and the market for assets in liquidation, then we have a structure for interpreting what is going on in terms of arbitrage among these different markets’’ (CCC: Shubik, 1988, p. 33).

Shiller (CCC: 1988) tells a story about fads and bubbles which questions whether market prices accurately reflect value, as the neoclassical model assumes. Shiller notes that ‘‘(f)or hundreds of years, it has been commonly accepted that prices in speculative markets are influenced by capricious changes in investor sentiments, changing fashions, fads, or bubbles’’ (p. 56). Market fads are like consumer fads, and a ‘‘fad is a bubble if the contagion of the fad occurs through price; people are attracted by price increases’’ (p. 61). The story behind fads and bubbles is psychological rather than economic: ‘‘Modern psychology does not reduce human behavior to a simple model like the expected utility model that underlies theoretical finance. The literature on gambling behavior shows the plausibility of the claims made in the usual anecdotes that there is sometimes excessive enthusiasm for certain financial assets and thus that other financial assets are sometimes ignored. The literature on salience and human judgment makes plausible the claims in the anecdotes that popular attention to certain speculative assets was capricious. The literature on group polarization of attitudes adds some further plausibility to the claim in the anecdotes that groups of individuals may tend to act together, reaching the same decisions around the same times’’ (p. 65).

Shiller believes that sometimes market prices do reflect fundamental values, while at other times market prices may seriously overvalue or undervalue firms. Stock market prices may not reflect rational expectations about the future: ‘‘The stock market may be over- or under optimistic about the future consequences of acquisitions at different points in time’’ (CCC:

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Magenheim & Mueller, 1988, p. 190). Therefore, it is difficult to know, a priori, whether gains to shareholders related to takeovers are due to efficiency increases, wealth transfers between groups of shareholders and others, or exploitation of market inefficiencies. What if Markets Don’t Work? Law (CCC: 1988) tells the ‘‘well-known anecdote in the history of the Royal Society’’: ‘‘Charles II proposed this question: ‘Why does a vessel of water not weight more if a dead fish is put in it, but does weigh more if the fish is alive?’ Solutions of great ingenuity were proposed, objected to, and defended. In the end, of course, someone thought to conduct an experiment, and the royal hypothesis was disproved’’ (p. 260).

Law draws a parallel between the neoclassical view of takeovers and the dead fish hypothesis and notes that ‘‘(t)he interesting question is why anyone ever believed in the dead-fish theory of takeovers in the first place. The answer, of course, is the efficient-market syndrome—the belief that because one can’t beat the stock market, the market must know the intrinsic value of a firm’’ (p. 260). Freed from the constraints that prices must be efficient and regulation must be unnecessary, several conference participants provide descriptive stories about merger activity. These stories are complex and indeterminate reflecting the legal point of view that ‘‘(t)he law is messy, institutional, historical and evolutionary’’ (CCC; Schubik, 1988, p. 32). In Herman and Lowenstein’s story, there is no single systematic explanation of hostile tender offers over time. In the 1970s, bidding firms appeared to find some underperforming targets, but over time targets adjusted their behavior and the bidder’s situation changed. Ravenscraft and Scherer (CCC: 1988, p. 197) assert that ‘‘acquisition activity in the United States, at least during the late 1960s and 1970s, was characteristically a search for gold nuggets, not for dross that could, by some managerial alchemy, be transformed into gold’’. In the 1980s, bids were more speculative and often involved taking on considerable debt. Acquisitions designed to profit from operations did poorly while acquisitions designed for short-term speculation did well (CCC: Herman & Lowenstein, 1988, p. 230). Recent changes in economic and institutional circumstances, most notably the advent of the junk bond, ushered in the era of the ‘‘bust-up’’ takeover where the driving force is the perceived disparity between the target’s liquidation and stock market values. The Managerial Perspective The story at the Conference told by management theorists, for whom managers rather than shareholders are the critical actors, reflects a different point of view from agency theory where ‘‘the relation of owner-managers to third parties remains primarily reactive and adversarial’’ (Steidlmeier, 1992, p. 170). A more proactive and cooperative perspective is taken as Salter and

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Weinhold (CCC: 1988) consider the ways in which mergers can create value. Three sources of value, refinancing assets, renegotiating contracts, and reconfiguring asset portfolios, are seen as short-term value-added strategies. These strategies can be undertaken following a hostile takeover, but they tend to be ‘‘one-shot improvements . . . that lead to higher, but not increasing, returns’’ (p. 137). Long-term value creation comes solely from recombining businesses into more competitive entities (p. 141). The irony is that ‘‘increased effectiveness and efficiency is based upon shared goals and a willingness to cooperate among managers of merged enterprises’’ (p. 146). ‘‘. . .(T)he major source of value creation, represented by the integration of operations and coordination of systems . . . is severely threatened by most hostile takeovers’’ (p. 148): ‘‘When a business recombination requires the support of a disenfranchised management group—such as that arising in any unfriendly takeover—many of these activities stop dead in their tracks. Critical information is lost as the losing managers leave, compliance costs jump as unwilling managers refuse to cooperate, and control costs skyrocket as functional activities no longer smoothly coordinate themselves’’ (p. 148).

Therefore, under this view, it is unlikely that hostile takeovers create long-term value for society. Economic Justice Evaluation As noted previously, the financial economists conclude that hostile takeovers are pareto optimal and, therefore, beneficial to society. Other Conference participants, however, do not believe that ethical issues surrounding takeovers can be resolved simplistically by examining returns to bidding and acquired firm shareholders. Referring to the Wilson’s (1991a) economic justice framework presented in Figure 1, concerns are raised on issues related to commutative justice, productive justice, and distributive justice. The principal concerns of commutative justice in this situation are whether prices are fair and contractual obligations are maintained. Legal scholars at the conference are concerned about whether bid outcomes in takeover contests are distorted by pressure to tender. If shareholders of target firms perceive that their share values will decrease after a successful takeover attempt and tender their shares, not because they believe that better management will result but because they believe that they will lose if they do not, they have not made an undistorted choice. Only if the majority of shareholders view the offer price as higher than the real value of the firm will the takeover benefit shareholders and produce social gains (CCC: Bebchuck, 1988, pp. 371 – 372). The pressure to tender problem could be averted by, for example, separating the vote on control from the tender of the shares. De Mott (CCC: 1988, p. 423) explains that while U.S. bidders have more freedom than in other countries, U.S. managers have more tools for resisting takeovers as well. Ideological beliefs are important in deciding whether more regulatory controls are needed to make the control and bidding process fair or whether more rules would mean that market forces cannot do their optimizing work:

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S. R. Reiter ‘‘If one believes that the hostile tender offers are for the most part bred in hell and are inflicting grievous harm on the body politic and economic, and if one is exasperated at the seeming unwillingness of the Congress and the commission to take action to stem them, leaving beleaguered managements to fend for themselves, then certainly a recapitalization that vests voting control in management is seen as a means of accomplishing a social good—the frustration of efforts to take over control of the company. On the other hand, of course, those like Professor Dan Fischel, SEC Chief Economists Gregg Jarrell, and Judge Frank Easterbrook, who see in tender offers a lubricant to assist in the most effective allocation of resources, believe that anything which hinders tender offers is the enemy of such an allocation’’ (CCC: Sommer, 1988, p. 527).

Conference participants also question whether returns to stockholders provide sufficient evidence to evaluate the societal benefits of hostile takeovers. They are demonstrating a concern with productive justice which asks whether the economic and social systems benefit from this activity, even though individuals, in the short-term, may be harmed. Shubik (CCC: 1988) does not think that the financial economists’ evidence resolves this question because ‘‘. . . on questions such as mergers, buy-outs, or tender offers, current finance theory has little to say of any value because its models are not rich enough to capture the essence of the process in the struggle for corporate control’’ (p. 32). Edwards (CCC: 1988) points out that ‘‘. . . it is too naive an approach to simply look at stock prices and companies’ equity value to determine whether a takeover is or is not in the public interest—or whether it enhances social welfare’’ (p. 69). The increase in the target firm’s value could be caused by the effects of speculative bubbles and fads or by substantial undervaluation as suggested by Shiller and Shubik. Herman and Lowenstein (CCC: 1988) point out ‘‘that takeovers rooted in a market undervaluation of corporate assets are not designed to prune managerial deadwood or improve asset utilization—on the contrary, they reflect a flaw in the market machinery and valuation process’’ (p. 215). Furthermore, even supposing that the ‘‘increase in share value indicates that shareholders benefit . . . (w)hether or not society as a whole benefits depends on whether the increase in shareholder value comes at the expense of some other group (the U.S. Treasury, bondholders, employees, consumers) or is due to efficiencies’’ (CCC: Salinger, 1988, p. 73). Again, this question is answered by ideological beliefs about whether takeovers lead to efficiency gains. If simple financial economic tenets do not hold, the ethical situation surrounding hostile takeovers requires far deeper study and consideration: ‘‘. . . Coffee’s propositions about the role of management vis-a-vis either stockholders or employees raises complex problems of social psychology and organization theory that transcend the takeover phenomenon and indeed go beyond privately owned enterprise—how to stimulate and how to constrain management in order to induce optimal performance. His references to the state or society as the ultimate bearer of the losses resulting from management disaffection suggest the need for a much broader inquiry . . . ‘‘(CCC: Brudney, 1988, p. 153).

Even if a total gain is produced by takeover activity, the distribution in society could be inequitable. This is the concern of distributive justice.

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Edwards (CCC: 1988) asserts that ‘‘(t)he impact on bondholders, creditors, long-run managerial incentives, financial market stability, and even local communities (because of plant closings) may all enter the social welfare equation’’ (p. 70). Financial economic theory persists in seeing the ‘‘. . . shareholder, as the critical actor who has alone accepted the entrepreneurial role, is entitled to appropriate the full takeover premium . . . (T)his analysis is flawed because managers and others also share in the residual risk and are not protected fully by the external market’’ (CCC: Coffee, 1988, p. 79). Financial economists’ concern with total gains, focus on shareholders’ interests, and dismissal of management’s concerns as self-seeking has precluded substantive study of the distributive wealth effects of hostile takeovers. Therefore, no direct evidence on distribution of wealth effects was presented at the Conference.

Implications for Accounting Practice and Research Ethical questions about financial economic theory are relevant to accountants. First, I illustrate how assumptions of financial economics, such as the ethical properties ascribed to market forces, the primacy of shareholder wealth maximization, and the assumption that managers are the enemy, have been incorporated into financial accounting practice. Then, I ask questions about accounting practice and research from the economic justice framework. Financial economic theory underlies accounting theory, both implicitly and explicitly. Tinker (1980) shows how financial economics has ‘‘provided guidelines for income definition, asset valuation and . . . financial standard setting’’ (p. 149). For example, in accounting for acquisitions, the belief that transactions must have value or they would not have occurred translates into the presumption that goodwill has future value. U.S. accountants capitalize the merger premiums (the difference between the purchase price and the value of underlying assets) as goodwill which is amortized over periods as long as 40 years. The clear presumption is that the takeover premiums have present and continuing future value. Accountants also assume that market prices are the strongest form of evidence, overriding all other valuations. When market prices fall below replacement values of firms, acquisitions are recorded at the market prices, creating negative goodwill. In these valuation practices related to acquisitions, accounting rules reflect financial economic assumptions. Accounting practice has eschewed concern with developing accounting representation of value, relying instead on market prices for valuation6. But what if market prices are not valuation efficient? Can accounting numbers provide an alternative source of information about corporate performance and value? Herman and Lowenstein (CCC: 1988, p. 217) note that recent financial economic studies of mergers focus on immediate and long-term stock price reactions rather than profitability measured by accounting data as did merger studies of the past. They note that the correlation of accounting data with economic rates of return has been well demonstrated in the past and that ‘‘(a)ccounting data are relied on heavily by those who are in the marketplace’’

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(p. 219). Among financial economists, however, accounting data is viewed at best as poor secondary evidence. ‘‘While most financial economists would argue that stock market data are far superior to accounting data in assessing the economic effects of corporate events, most would also agree that examining the latter is not a fruitless exercise’’ (CCC: Bradley & Jarrell, 1988, p. 257). Jensen is more dismissive of accounting data, asserting that ‘‘studies . . . based almost entirely on accounting data . . . are of limited use in measuring the effects of mergers’’ (CCC: 1988, p. 337). Financial economists are biased against accounting data. However, if stock price reactions do not adequately portray the wealth effects and economic outcomes of events such as mergers, the potential role of accounting data is enhanced. The centrality of agency conflicts to financial economic theory is reflected in accounting’s predominant concern with shareholders’ interests. The systematic exclusion of parties, interests, and phenomena from financial economic theory is a political choice (Tinker et al., 1982 , Cooper & Sherer, 1984; Lehman & Tinker, 1987; Tinker, 1991). The importance of these omissions becomes clear when we consider that economic models are often read literally and the partiality, selectivity, and political bias underlying the models are ignored in framing policy recommendations (Longino, 1993). In addition, the partial nature of financial economic stories limits the domain studied and structures the questions that can be asked. For example, financial economic stories preclude serious examination of the effect of the takeover movement on American workers and communities. This leads to many invisibilities, such as issues relating to employees or the environment, and to inadequate and unrealistic explanations of investor, managerial, and corporate behavior. In much of mainstream financial accounting research, investigations of the consequences of accounting information are framed in terms of share price reactions to events7. Even if share price reactions are valid, they represent only shareholder wealth effects or a partial equilibrium (Cooper & Sherer, 1984). The effects of accounting information on nonshareholder groups is largely unexplored. Accounting researchers should consider whether accounting information can be used to develop evidence on the wealth effects of takeovers and other events on non-shareholder parties such as creditors, employees, and governments. Another effect of agency theory assumptions is an automatic distrust of management’s representations. The AICPA’s Special Committee on Financial Reporting concludes, however, that ‘‘business reporting must . . . (b)etter align information reported externally with the information reported internally to senior managers to manage the business’’ (Jenkins, 1994., p. 40). The Committee calls for more and better soft disclosure and forward-looking information8. The future of external reporting is seen as moving away from the dominance of agency theory conflicts toward increased reliance on management’s representations. Furthermore, and perhaps most importantly, the fundamental character of accounting as a social construction and the accountant as a social actor is suppressed in the financial economics view of accounting9. If we admit ‘‘social—not just economic—reality . . . ’’, we admit to the ‘‘possibility of their being conflicting social welfares, and that accounting—inevitably—

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preferences some, and not others . . .’’ (Tinker, 1991, pp. 304 – 305). In other words, the accountant is always a partisan because accounting practice has already taken sides in social conflicts surrounding economic events. This partisan nature of accounting is often hidden from us in daily practice, but can be revealed, in part, through understanding the stories of financial economists. Morgan and Willmott (1993) use the term ‘‘New Accounting Research’’ (NAR) to describe the growing project of accounting research based on recognition of the social and reflexive nature of accounting and re-discovery of the moral nature of accounting practice. Morgan and Willmott see the ‘‘cumulative nature of the new accounting research . . . as a series of attempts from different perspectives to make visible some of the conditions and consequences of accounting practices’’ (1993, p. 5). A number of studies in this NAR tradition have addressed the partisan nature of financial reporting in the context of social conflict; however, there have been few empirical investigations of the consequences of financial reporting for stakeholders other than shareholders10. In order to reconstitute accounting as an ethical practice, investigations need to be undertaken from a point of view skeptical of the stories of the financial economists. Cooper and Sherer (1984) recommend that accounting researchers ‘‘recognize power and conflict in society’’ and treat ‘‘value as essentially contested’’ in a domain where accounting reports operate ‘‘in specific interests’’ (p. 217). Further, accounting researchers must take into account the ‘‘specific historical and institutional environment’’ (p. 218) of society and promote the potential for accounting to operate as an agent of change and ‘‘reflect differing interests and concerns’’ (p. 219). Lehman and Tinker (1987) explain that ‘‘(i)nvestigations of the nature of interests, and the manner in which these interests are implicated in accounting practice, highlight the problematic character of accounting—its mutability in different social and organizational contexts’’ (p. 504). The framework of economic justice gives the accounting researcher questions to ask in a number of situations. Is the process fair to all participants? Are the benefits received by various parties proportionate to their investment and effort? Do gains reflect real value added or wealth transfers from other constituent groups? Where do the gains come from and who do they go to? Does accounting information encourage an economic system that delivers goods and services in the most efficient manner? Does accounting information stimulate and constrain managers toward optimal performance? Do market forces result in socially desirable allocations and does accounting perpetuate inequities? Are accounting models sufficiently rich in social and institutional detail? Do accounting gains represent increases in value or flaws in the valuation process? Do accounting presentations discriminate transactions that create long-term value from one-time effects? Does accounting information allow us to evaluation the effects of transactions on stakeholders other than shareholders? These are appropriate questions if we take ‘‘a notion of social welfare that focuses on society as an aggregate . . . , an emphasis on distributive as well as exchange (allocative) dimensions of wealth and power and a concern with socially necessary rather than market determined production’’ (Cooper & Sherer, 1984, p. 207.

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Acknowledgements I would like to acknowledge helpful comments received from participants at the Rochester Institute of Technology ethics conference in April 1995, the American Accounting Association meeting in August 1995, the Critical Perspectives Conference in April 1996, and the Alternative Perspectives on Finance Conference in July 1996. I would like to particularly recognize the helpful comments of David Cooper, Dean Neu, and Paul Williams. Any remaining errors, and all opinions, are my own.

Notes 1. References from the Corporate Control Conference are identified by the letters CCC preceding the author’s name to help the reader identify which quotes and ideas come from the conference. 2. I use the term ideology in its neutral meaning of a system of thought and belief. A more critical conception of ideology emphasizes its role in the process of sustaining asymmetrical power relations and maintaining domination (Thompson, 1984, p. 4) and carries a ‘‘whole array of negative notions from false consciousness to fanaticism, mental blockage to mystification’’ (Eagleton, 1994, p. 1). 3. Coffee et al. (CCC: 1988) provide a translation of this story for the non-initiate: ‘‘The ABC Company seeks to fend off a hostile takeover by giving its executives generous severance agreements, selling highly profitable divisions, and issuing a security that will permit shareholders other than Mr. Z to exchange their shares for a package of securities at a very favorable exchange ratio that may deter a takeover bid. The aggressive Mr. Z finances his bid by issuing high-risk debt backed by the assets of the firm he is trying to acquire. He is known as a person who sometimes buys a substantial part of a company and then lets himself be bought out at a higher price by a friendly bidder such as Company X’’ (p. 9). 4. ‘‘Free cash flow is cash flow in excess of that required to fund all projects that have positive net present values when discounted at the relevant cost of capital. Such free cash flow must be paid out to shareholders if the firm is to be efficient and to maximize value for shareholders’’ (CCC: Jensen, 1988, p. 321). 5. An underlying premise of financial economics is that aggregate behavior, evidenced through market reactions, is the only valid form of evidence, superseding the perceptions of individuals involved in economic events or observers recounting ‘‘anecdotal evidence.’’ Ironically, much of the ‘‘evidence’’ presented in Jensen’s Chapter is anecdotal and is taken very seriously. This is an example of the power of elite storytellers. 6. Chambers (1993), for example, speaks bitterly about accounting researchers’ abandonment of concern with representation of value in order to follow the informational perspective as represented by positive accounting research. Accounting researchers have measured the value relevance of accounting numbers in relation to market prices (see, for example, Barth, 1991). Recently, Ohlson (1991) and others have returned to considerations of how accounting numbers may reflect fundamental values. 7. The accounting research literature using stock price reactions to evaluate the effects of accounting information is vast (see Watts & Zimmerman, 1986 and Bernard, 1989 for partial summaries). Several articles that critique this practice are Merino et al. (1987) and Frankfurter and McGoun (1993). 8. Baruch Lev (1994) criticizes the Committee for not taking into account ‘‘the strategic role of managers’’. ‘‘The committee appears to believe that all that is required is for managers to be informed about users’ needs and they will wholeheartedly provide for those needs. But we know that managers have their own objectives and preferences regarding financial reporting and sometimes even window-dress the reports’’ (p. 46). Lev asserts that ‘‘the crucial issue is how to elicit from managers high-quality, relevant and objective information’’ (p. 46). This issue would be approached differently by financial economic theorists, with their emphasis on conflict and discipline, and theorists with a managerial orientation. 9. Tinker et al. (1982), Tinker (1980, 1988, and 1991), Cooper and Sherer, (1984), Neimark and

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Tinker (1986), and Lehman and Tinker (1987) develop the social nature of accounting in opposition to the financial economic view. 10. An example of such studies can be found in Reiter and Omer (1992) and Tinker and Ghicas (1993) which use accounting data to explore wealth expropriation from employees associated with accounting for pensions and terminations of pension agreements.

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Law, W. A., ‘‘Comment’’, in J. C. Coffee, Jr., L. Lowenstein & S. Rose-Ackerman (eds) Knights, Raiders, and Targets , pp. 260 – 263 (New York: Oxford University Press, 1988). Lehman, C. & Tinker, T., ‘‘The ‘Real’ Cultural Significance of Accounts’’, Accounting, Organizations & Society, Vol. 12, No. 5, 1987 pp. 503 – 522. Lev, B., ‘‘Focus on: Recommendations of the Special Committee on Financial Reporting’’, Journal of Accountancy, October, 1994, pp. 41 – 46. Longino, H., ‘‘Economics for whom?’’, in M. Ferber & J. Nelson (eds) Beyond Economic Man : Feminist Theory and Economics, pp. 158 – 168 (Chicago: The University of Chicago Press, 1983). Magenheim, E. B. & Mueller, D. C, ‘‘Are Acquiring-firm Shareholders Better Off After an Acquisition?’’, in J. C. Coffee, Jr., L. Lowenstein & S. Rose-Ackerman (eds) Knights, Raiders, and Targets, pp. 171 – 193 (New York: Oxford University Press, 1988). McCloskey, D. N., The Rhetoric of Economics (Madison, Wisconsin: The University of Wisconsin Press, 1985). McCloskey, D. N., If You ’re So Smart (Chicago: The University of Chicago Press, 1990). Merino, B., Koch, B. S. & MacRitchie, K. L., ‘‘Historical Analysis—A Diagnostic Tool for ‘Events’ Studies: The Impact of the Securities Acts of 1933’’, The Accounting Review, October, 1987, pp. 748 – 762. Morgan, G. & Willmott, H., ‘‘The ‘New’ Accounting Research: On Making Accounting More Visible’’, Accounting Auditing & Accountability Journal, Vol. 6, No. 4, 1993, pp. 3 – 36. Neimark, M. & Tinker, T., ‘‘The Social Construction of Management Control Systems’’, Accounting, Organizations & Society, Vol. 11, No. 4 / 5, pp. 369 – 395. Ohlson, J., ‘‘The Theory of Value and Earnings, and an Introduction to the Ball-Brown Analysis’’, Contemporary Research in Accounting, Vol. 8, 1991, pp. 1 – 19. Ravenscraft, D. J. & Sherer, F. M., ‘‘Mergers and Managerial Performance’’, in J. C. Coffee, Jr., L. Lowenstein & S. Rose-Ackerman (eds) Knights, Raiders, and Targets, pp. 194 – 210 (New York: Oxford University Press, 1988). Reiter, S. A. & Omer, T., ‘‘A Critical Perspective on Pension Accounting, Pension Research and Pension Terminations’’, Critical Perspectives on Accounting, Vol. 3, 1992, pp. 61 – 85. Roll, R., ‘‘Empirical Evidence on Takeover Activity and Shareholder Wealth’’, in J. C. Coffee, Jr., L. Lowenstein & S. Rose-Ackerman (eds) Knights, Raiders, and Targets, pp. 241 – 252 (New York: Oxford University Press, 1988). Ruback, R. S., ‘‘Comment’’, in J. C. Coffee, Jr., L. Lowenstein & S. Rose-Ackerman (eds) Knights, Raiders, and Targets , pp. 355 – 357 (New York: Oxford University Press, 1988). Salinger, M. A., ‘‘Comment’’, in J. C. Coffee, Jr., L. Lowenstein & S. Rose-Ackerman (eds) Knights, Raiders, and Targets , pp. 71 – 73 (New York: Oxford University Press, 1988). Salter, M. S. & Weinhold, W. A., ‘‘Corporate Takeovers: Financial Boom or Organizational Bust?’’, in J. C. Coffee, Jr., L. Lowenstein & S. Rose-Ackerman (eds) Knights, Raiders, and Targets, pp. 135 – 149 (New York: Oxford University Press, 1988). Sen, A., On Ethics and Economics (New York: Basil Blackwell, 1987). Shiller, R. J., ‘‘Fashions, Fads, and Bubbles in Financial Markets’’, in J. C. Coffee, Jr., L. Lowenstein & S. Rose-Ackerman (eds) Knights, Raiders , and Targets, pp. 56 – 68 (New York: Oxford University Press, 1988). Shubik, M., ‘‘Corporate Control, Efficient Markets, and the Public Good’’, in J. C. Coffee, Jr., L. Lowenstein & S. Rose-Ackerman (eds) Knights, Raiders , and Targets, pp. 31 – 55 (New York: Oxford University Press, 1988). Sommer, A. A., Jr., ‘‘Comment’’, in J. C. Coffee, Jr., L. Lowenstein & S. Rose-Ackerman (eds) Knights, Raiders , and Targets, pp. 524 – 529 (New York: Oxford University Press, 1988). Steidlmeier, P., People and Profits: The Ethics of Capitalism (Englewood Cliffs, NJ: Prentice Hall, 1992). Strassmann, D. L., ‘‘Not a Free Market: The Rhetoric of Disciplinary Authority in Economics’’, in M. Ferber and J. Nelson (eds) Beyond Economic Man: Feminist Theory and Economics, pp. 54 – 68 (Chicago: The University of Chicago Press, 1993a). Strassmann, D. L., ‘‘The Stories of Economics and the Power of the Storyteller’’, History of Political Economy Vol. 25, 1993b, pp. 148 – 165. Strassmann, D. L., ‘‘Feminist Thought and Economics: Or, What Do the Visigoths Know?’’, American Economic Review, Vol. 84, No. 2, 1994, pp. 153 – 158. Strassmann, D. & Polanyi, L., ‘‘Shifting the Paradigm: Value in Feminist Critiques of Economics’’, working paper, Rice University, 1992. Thompson, J. B., Studies in the Theory of Ideology (Cambridge: Polity Press, 1984). Tinker, A. M., ‘‘Towards a Political Economy of Accounting: An Empirical Illustration of the Cambridge Controversies’’, Accounting, Organizations & Society, Vol. 5, No. 1, 1980, pp. 147 – 160. Tinker, T., ‘‘Panglossian Accounting Theories: The Science of Apologising in Style’’, Accounting, Organizations & Society, Vol. 13, No. 2, 1988, pp. 165 – 189.

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Appendix: Conference Participants and Affiliations in 1985 Bebchuck, Lucian A., Harvard Law School Bradley, Michael, Associate Professor of Finance and adjunct Associate Professor of Law, University of Michigan. Brudney, Victor, Weld Professor of Law, Harvard Law School. Coffee, John C. Jr., Adolf A. Berle Professor of Law, Columbia Law School. De Mott, Deborah A., Duke University School of Law Edwards, Franklin R., Director of Columbia University’s Center for the Study of Futures Markets and Professor, Graduate School of Business, Columbia Eisenberg, Melvin A., Koret Professor of Business Law, University of California at Berkeley Gray, Harry J., Chairman and Chief Executive Officer of United Technologies Herman, Edward S., Professor of Finance, Wharton School, University of Pennsylvania Jarrell, Gregg A., Chief Economist of the U.S. Securities and Exchange Commission Jensen, Michael C., LaClare Professor of Finance and Business Administration at the Graduate School of Management, University of Rochester and Professor of Business Administration at the Harvard Business School Law, Warren A., Edmund Cogswell Converse Professor of Finance at the Harvard Business School Lowenstein, Louis, Professor of Law, Columbia University Magenheim, Ellen, graduate student in economics, University of Maryland Mueller, Dennis C., Professor of Economics at the University of Maryland Ravenscraft, David J., research economist for the Federal Trade Commission’s Line of Business Program Roll, Richard, Allstate Professorship of Finance at UCLA Graduate School (on leave) and Vice President of the Mortgage Securities Department of Goldman, Sachs & Company Rose-Ackerman, Susan, Professor of Law and Political Economy, Columbia University and Director of Columbia Law School’s Center for Law and Economic Studies Ruback, Richard S., Associate Professor of Finance at the Alfred P. Sloan School of Management, Massachusetts Institute of Technology Salinger, Michael A., Assistant Professor of Economics at Columbia Business School Salter, Malcolm S., Faculty Chairman of the International Senior Managers Program and member of the Faculty of the John F. Kennedy School of Government Scherer, F. M., Joseph Wharton Professor of Political Economy at Swarthmore College

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Shiller, Robert J., Professor of Economics, Cowles Foundation and School of Management, Yale University Shubik, Martin, Seymour H. Knox Professor of Mathematical Institutional Economics at Yale University Sommer, A. A., Jr., partner in Morgan, Lewis & Bockius in Washington, D.C., former Commission of the Securities and Exchange Commission Weinhold, Wolf A., President of Wolf Weinhold & Company Weiss, Elliott J., Professor of Law at the Benjamin N. Cardozo School of Law, Yeshiva University Williamson, Oliver E., Gordon B. Tweedy Professor of Economics of Law and Organization, Yale University