Threat of takeover

    Even if all the above measures fail, the threat of takeover acts as one further disciplineon management. If management persistently underutilises the company’s resources, the threat of a takeover by another management team will be accentuated,with potentially adverse consequences for incumbent executives. While

even the best-run companies can become a takeover target, the probability of this

unpleasant outcome can be minimised by earning high profits. This raises the

share price and makes the firm too expensive for predators.

    The takeover threat is particularly relevant to countries with a highly developed

stock market culture, such as the US and the UK. Of course, management

has devised many ingenious ways of reducing the potency of this threat. Among

the more familiar schemes are greenmail, white knights and poison pills. Poison

pills refer to provisions whereby, in the event of a merger_takeover, shareholders

can acquire shares in the surviving firm at a substantial discount from market

price. This acts as a disincentive to such takeovers by making them more expensive.

Executives are aware that these measures offer no foolproof defence.Replying to a question about a possible takeover of the company, the chief executiveof a major materials multinational, CRH  commented:

    A company is always vulnerable if it performs badly. A good performance is the best protection against acquisition. It means that someone else has to prove to shareholders that they can run your business even better._4

    Market forces, in the form of both the ‘carrot’ of incentives and the ‘stick’ of the

takeover threat, impose a discipline on management and penalise the systematic

neglect of profit maximisation. However, the threat of takeover, like executive

compensation, is not foolproof against abuse. Good performance does not

provide immunity against takeover. Often takeovers are motivated by personal

egos of chief executives rather than objective pursuit of profit, as the dismal performance of most large mergers demonstrates. At the limit, however, there is the

threat of bankruptcy, a real danger for an underperforming firm. Even in the

public sector, state-owned commercial enterprises can be given an incentive to

act like a profit-maximising firm through the imposition of ‘hard budget constraints’

linked to a targeted return on capital.

    In recent years, the power of institutional investors has risen relative to that of

individual investors, giving greater weight to shareholder interests over those of

corporate executives. Large pension fund and mutual fund investors are more

able to wield power and are better organised than traditional small private shareholders. Investment managers are themselves under pressure to perform well.

Investment and pension fund trustees compare the performance of different fund

managers and are more prepared to shift their funds from one manager to

another than are small private investors. Thus, while the volume of capital available

to investment managers has reached unprecedented heights, so too has the

competition for managing it. This makes fund managers more demanding in

terms of shareholder returns.

    Alternatives to the assumption of profit maximisation have been explored, for

example, that executives try to maximise sales, subject only to a minimum level

of profit to keep shareholders happy. This assumption is plausible in certain circumstances, but as a generalisation it is hard to argue its superiority over profit

maximisation. Unless long-run profits are maximised, the forces of competition

threaten not only the jobs of management, but the survival of the firm.

    Besides, profit maximisation does not necessarily conflict with the objective of

keeping or expanding market share. The firm making the largest sustained profits

will be best equipped to survive in the long term. Of course firms will continue to

emphasise factors such as product quality, but this preference for product quality

might reflect a contrasting management style and time horizon, rather than deviation

from the long-run objective of profit maximisation. The contemporary  profit-maximising firm may have a sophisticated agenda. A former chief executive

of the Bank of Montreal explained that:

    In rating my bank’s performance, I assign only 40 per cent weight to the bottom line.Customer satisfaction, employee competence and public image count for 60 per cent for they are the indicators of future profit and future shareholder value._5

    Thus, most firms remain profit maximisers. Some just place more weight on

future profits than others.