The Junk Was Gold
I should be calling for Glenn Yago’s pointy academic economist’s head. After all, he starts his new book, Junk Bonds: How High Yield Securities Restructured Corporate America (Oxford University Press), by declaring that recent management “fads” amounted to no more than “a way to rationalize a style of corpocracy that had long ceased to function properly.” However, Professor, I happen to agree with you. Too many of us were too optimistic about corporate renewal. So I am delighted to cheer you on.
Yago’s book is academic. Page after page of tables and charts. All numbers to two decimal points. Meticulous reviews of others’ studies. Yet it sparkles, chronicling the remarkable cleansing effect that the market for corporate control, as it came to be called, had on big business. Raiders and junk-bond buyouts terrified comfy managements. The threat of raiding had an even more pervasive effect.
Professor Yago begins with a look at overall performance of junk bond-supported firms. He analyzes all 1,175 companies that issued $113 billion in high-yield securities between 1980 (when the market hit high gear) and 1986 (the most recent year with complete data), and compares those companies to industry as a whole. Employment increased at 6.7 percent annually among the firms using junk, compared to 1.4 percent for the rest; in manufacturing, junk bond-financed firms lost 0.7 percent of their employment per annum, compared with a loss of 1.8 percent for the lot. (Junk-bond issuing firms accounted for 82 percent of total job growth among all publicly traded firms.) Sales per employee rose 3.1 percent yearly for the high-yield gang, vs. 2.4 percent the whole (in manufacturing it was 4.7 percent vs. 2.9 percent). And capital expenditures, thought to be the Achilles heel of junk-bond users, increased at 10.6 percent a year vs. 3.8 percent for the whole (9.7 percent vs. 2.1 percent in manufacturing).
In companies using junk bonds to support a leveraged buyout, the story is just as impressive. Yago examines the 43 major junk-financed LBOs that took place from 1984 through 1986. Before the deals, the average sales change for any year’s set of firms ranged from -7 percent to +5 percent per annum; after the LBO, sales increased at 40 percent a year. Productivity had been rising at 4 percent, then shot up to 17 percent after the buyouts. Operating income, down sharply before the LBO, surged to 30 percent per annum.
Yago also persuasively counters the most popular, anti-junk analyses. For example, in several studies where employment appeared to decline after an LBO, researchers had ignored whole business units that new management sold off after the deal; these liberated units usually went on to add jobs under a new, more appropriate parent. A ballyhooed National Science Foundation study showed post-LBO research and development expenditures plummeting; but the study again overlooked spun-off units.
There’s also an enlightening description of the re-emergence of the junk bond market. (Its origins date to Alexander Hamilton’s use of risky, high-yield paper to pay off America’s Revolutionary War debt.) Prior to the late 1970s, about 800 of 23,000 sizable, publicly traded firms (over $35 million in sales) access to “investment grade” corporate financing—i.e., had bond ratings greater than Ba or BB. Yet research dating back to late ’40s clearly demonstrates that bond buyers were “overinsured.” They focused on past performance and accounting measures of profitability, paying scant attention to potential growth and cash flow; moreover, they overemphasized risk and deemphasized reward. “The true revolution caused by junk bonds,” Yago writes, was comprehending “that a company should be judged on its potential, rather than what it has previously accomplished.”
Yago scrutinizes the political convulsion generated by junk bonds as well. The new offerings hardly caused a twitter until were used to underwrite “deconglomeration”—e.g., breaking up ponderous but politically powerful giants. Wall Street’s old-boy network trembled, too. “Sharp elbows and a working knowledge of computer spreadsheets,” wrote the New York Times’ Peter Passell, “suddenly counted more than a nose for dry sherry or membership in Skull and Bones.”
Recent doings in the high-yield market do come in for criticism. “Pressure to ‘do deals’ overrode discrimination,” Yago observes. Investment bankers, largely paid out of after-deal earnings in the early days, began to pocket huge front-end fees for doing business per se. Nonetheless, Professor Yago gives the junk-bond revolution a high grade overall. “Junk bonds have created access to capital for small and medium-sized companies had been economically disenfranchised from participating in the capital markets,” he concludes. “In a very real sense, the yield market democratized capital (and) eliminated many of the advantages of corporate size.”
Over the years I’ve pursued radical solutions for forcing change down corporate throats. Noxious diseases call for noxious medicine. The junk-bond/LBO tonic had nasty side effects. Yet the net impact, Michael Milken’s dark side notwithstanding, has been salutary: As Glenn Yago’s well researched book reveals, companies taking the medicine have sucked in their guts, focused their businesses and turned technocrat bosses into accountable owners.
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