Teen Pregnancy (2423 words) Essay Example For Students

Teen Pregnancy (2423 words) Essay Teen PregnancyTeen PregnancyThesis statement:Teenage pregnancy is a major concern in todays society; there are many ways to prevent teen pregnancy, many people to get advice from, and many decisions that a teen parent must make. Outline:I. IntroductionII. Teenage PregnancyA. Concerns about Teenage PregnancyB. What helps prevent Teen PregnancyC. Source of Advice and SupportIII. Stages of PregnancyA. First TrimesterB. Second TrimesterC. Third TrimesterIV. Challenges of Teenage ParenthoodA. Parenthood OptionsB. Continuing EducationC. Financial ProblemsV. ConclusionTeenage pregnancy is a major concern in todays society; there are many ways to prevent teenage pregnancy, many people to get advice from, and many decisions a teenage parent must make. The statistics tell that the U.S. has the highest rate of teen pregnancy and births. We will write a custom essay on Teen Pregnancy (2423 words) specifically for you for only $16.38 $13.9/page Order now More than 4 out of ten young women become pregnant at least once before they reach the age of 20-nearly one billion a year(Teen Pregnancy Facts and Stats 1). Teenage pregnancy has declined slowly but steadily. These recent declines reverse the 24-percent rise in the teenage birth rate from 1986 to 1991 (Teen Pregnancy Facts and Stats 1). Usually only one-third of teenage mothers receive a high school diploma. The rest of the mothers usually end up on welfare. A majority of both boys and girls who are sexually active wish they had waited. Eight in ten girls and six in ten boys say they wish they had waited (Teen Pregnancy Facts and Stats 1). Many people are concerned about the problems teenage parents and their children face. The health risks for a teenage girl who becomes pregnant increase sharply. One of the concerns of teenage mothers is the health risk. Usually young women have more complications in pregnancy than older women. The most hazardous complication is low birth weight. One out of seven babies born to teenage mothers have a low birth weight (Hildebrand 88). Poor eating habits, smoking, or using alcohol or drugs, cause low birth weight. Premature babies and babies with low birth weights often have organs that havent fully developed, such as lungs, heart and brain. These babies get sick easier than normal weight babies. As a result from what was motioned above, teenage mothers are considered to be in the high-risk health category. They need good prenatal care as soon as they find out they are pregnant. A doctor, nurse, or other medical practitioner gives most of the information about nutrition. Prenatal care can help prevent pregnancy complications and improve ones chances of having a healthy baby. The best way to prevent teenage pregnancy, which is 100% effective, is abstinence. Most teenagers have a whole life ahead of them and having a child will cause a lot of complications in your goals. Its no t impossible for teenage mothers to complete high school, or try to reach their goals in life, but having a child could very well interfere with these goals. Another way of protection is condoms. There are a lot of protections out there, but these protections are not 100-percent reliable. There are a lot of places and people to go to for support and advice. In addition there are many organizations and hotlines a teenage mother can contact for advice and assistance. Parents and family are one alternative. There are a lot of teenagers that are afraid of their parents reactions. However, most parents are calmer and more supportive than teenagers expect. Most parents are shocked when the teenager comes and tells them that they are pregnant. Just give the parents time and they will try to give their teenager the best advice that they know. The school nurse or counselor is another place to get advice. The counselor usually can gather up pamphlets and brochures about pregnancy. The counsel or can also help the teenager remain in school. They are very supportive and understanding. Doctors and clinics are very important for a teenage parent to go to. There are a lot of home pregnancy tests available, but the doctor is a lot more reliable and gives a more accurate answer. Family planning counselors are also very professional people who can explain various options and discuss the community resources available to teenagers. They also help arrange for financial assistance and recommend support groups. Since teenagers need a lot of prenatal care, the counselor also offers advice on prenatal care, nutrition information, childbirth classes, and parenting skills. These mentioned are just a few place or people you can go to for advice. Dont ever think that there isnt anyone out there to ask for advice. Teenager mothers would feel a lot more comfortable knowing what was going on with their bodies and how the baby is developing. The next part of this paper is going to explain the first through the third trimester of pregnancy. .u5fdccf2fb2b7abfe1a49545600f2927a , .u5fdccf2fb2b7abfe1a49545600f2927a .postImageUrl , .u5fdccf2fb2b7abfe1a49545600f2927a .centered-text-area { min-height: 80px; position: relative; } .u5fdccf2fb2b7abfe1a49545600f2927a , .u5fdccf2fb2b7abfe1a49545600f2927a:hover , .u5fdccf2fb2b7abfe1a49545600f2927a:visited , .u5fdccf2fb2b7abfe1a49545600f2927a:active { border:0!important; } .u5fdccf2fb2b7abfe1a49545600f2927a .clearfix:after { content: ""; display: table; clear: both; } .u5fdccf2fb2b7abfe1a49545600f2927a { display: block; transition: background-color 250ms; webkit-transition: background-color 250ms; width: 100%; opacity: 1; transition: opacity 250ms; webkit-transition: opacity 250ms; background-color: #95A5A6; } .u5fdccf2fb2b7abfe1a49545600f2927a:active , .u5fdccf2fb2b7abfe1a49545600f2927a:hover { opacity: 1; transition: opacity 250ms; webkit-transition: opacity 250ms; background-color: #2C3E50; } .u5fdccf2fb2b7abfe1a49545600f2927a .centered-text-area { width: 100%; position: relative ; } .u5fdccf2fb2b7abfe1a49545600f2927a .ctaText { border-bottom: 0 solid #fff; color: #2980B9; font-size: 16px; font-weight: bold; margin: 0; padding: 0; text-decoration: underline; } .u5fdccf2fb2b7abfe1a49545600f2927a .postTitle { color: #FFFFFF; font-size: 16px; font-weight: 600; margin: 0; padding: 0; width: 100%; } .u5fdccf2fb2b7abfe1a49545600f2927a .ctaButton { background-color: #7F8C8D!important; color: #2980B9; border: none; border-radius: 3px; box-shadow: none; font-size: 14px; font-weight: bold; line-height: 26px; moz-border-radius: 3px; text-align: center; text-decoration: none; text-shadow: none; width: 80px; min-height: 80px; background: url(https://artscolumbia.org/wp-content/plugins/intelly-related-posts/assets/images/simple-arrow.png)no-repeat; position: absolute; right: 0; top: 0; } .u5fdccf2fb2b7abfe1a49545600f2927a:hover .ctaButton { background-color: #34495E!important; } .u5fdccf2fb2b7abfe1a49545600f2927a .centered-text { display: table; height: 80px; padding-left : 18px; top: 0; } .u5fdccf2fb2b7abfe1a49545600f2927a .u5fdccf2fb2b7abfe1a49545600f2927a-content { display: table-cell; margin: 0; padding: 0; padding-right: 108px; position: relative; vertical-align: middle; width: 100%; } .u5fdccf2fb2b7abfe1a49545600f2927a:after { content: ""; display: block; clear: both; } READ: Alcohol abuse EssayThe average biological length of human gestation, from conception to delivery, is 266 days. Due to the difficulty in assessing the exact date of conception, however, the clinical length of pregnancy is considered to be 280 days or 40 weeks, calculated from the last normal menstrual period before the cessation of menses, or menstrual flow. This calculation assumes that ovulation occurs 14 days after the last menstrual period. Human gestation is further divided into trimesters, each of which lasts slightly more than 13 weeks (Pregnancy and birth 1). In the first trimester the mother experiences nausea and vomiting, morning sickness, in the first 8 weeks. Breast soreness or tingling often occurs due to hormonal stimulation. Fatigue is also a common complaint. The baby is developing organs in the first trimester. The fetus heart begins to beat after 4 weeks. By 8 weeks, the eyes, ears, nose, mouth, fingers, and toes are easily recognizable, and male and female reproductive systems have diffentiated. By 12 weeks all of the organs have developed. During these first weeks, the mother should be very careful because the fetus is most vulnerable to potential teratogenic, birth-defect inducing drugs, radiation, and viruses. All of those factors are very dangerous to the fetus. During the second trimester the mother has increasing abdominal girth and pressure from the growing uterus. Braxton-Hicks contractions may occur. The mother may experience lightheadedness and may even faint due to the effects of the hormones on the blood vessels and the amount of blood diverted to the uterus, placenta, and fetus. There are many discomforts associated with pregnancy, most complained about is heartburn. Despite this discomfort, women are generally more comfor table during the second trimester than the first. During the second trimester the babys thin-walled skin develops, organs begin to function, and blood begins to be formed in the bone marrow. Scalp hair appears, fat increases, and bones begin to harden. About 20 weeks along, the mother can feel the precise movements of the baby. In the third trimester, the last weeks of pregnancy become increasingly uncomfortable. Headaches, shortness of breath, and swelling of legs are the common complaints. False labor pains, or contractions of the uterus that do not lead to progressive dilation, or opening of the cervix, can be particularly uncomfortable. The baby gains weight in the third trimester. Ear lobes begin to develop cartilage, testes begin to descend into the scrotum, nails begin to grow over the tips of the fingers, and creases develop over the soles of the feet. Also, the fetus begins to demonstrate coordinated patterns of behavior that are similar to the cycles of activity and sleep of a newborn. The things mentioned are just an overall view of the trimesters. A womans body undergoes a variety of changes to prepare for the growth, nourishment, and birth of a child. The teenage parent has a lot of challenges that must be overcame and decided, such as parenthood options, continuing education, and financial problems. These mentioned are just a few of the challenges a teenager faces. There are three options parents must decide if they become pregnant. The parents can marry and raise the child together. The mother or father can raise the child as a single parent. The parents can put the baby up for adoption. These are three options that are going to be very hard to decide. Whatever the teenager decides will have a consequence on the baby and the parents. When teenagers become pregnant, the first thing they want to do is rush into marriage. The parents may have talked about marriage but this would be the real thing. Only one-third of the teenagers who become pregnant before the age of 18 are married (Gutman 25). Babies need a lot of attention. They need to be fed, burped, diaper changes, bathe and cuddled. Having someone around to help with these tasks can be very helpful and rewarding for parents and the baby. Most teenage marriages dont last long. The teenagers may think they will have more freedom when they are married. Wrong, you will not have as much freedom. Teenagers are taking on a big responsibility when they marry. Think about it before you rush into marriage. When teenagers marry, they have to make decisions about where to live and how to pay the bills. These are just things you have to decide on. Trying to adjust to parenthood and having a marriage partner will be challenging and overwhelming. As a result, four out of five teenage couples divorce within six years (Hildebrand 94). The marriages that are successful receive support from friends and family. Another option would be singe parenthood. Single parenthood is either the mother or father deciding to raise the child alone. Usually when this happens, the mother is the one to keep the child. Both mother and child usually live with the mothers parents. Money concern plays a major role in teenage marriage, but is a greater problem for single parents. Being a single parent, trying to work, finish school, you must arrange for childcare services. Childcare services can be very expensive for a single parent. Usually if a single parent is balancing school, work, and taking care of a child, the teenager have a lot of support from parents, friends, and relatives. Parents can be big support for a teenage parent. The last option is adoption. To make this decision, the parents would have thought long and hard about the babys needs and their future. Adoption is not bad it may be best for the child if the couple isnt able to provide everything that a baby needs. If the parents werent able to gi ve the baby the good start in life it needs, adoption would be the best option. .u32c2e5af6ecdb596b22783330496a11f , .u32c2e5af6ecdb596b22783330496a11f .postImageUrl , .u32c2e5af6ecdb596b22783330496a11f .centered-text-area { min-height: 80px; position: relative; } .u32c2e5af6ecdb596b22783330496a11f , .u32c2e5af6ecdb596b22783330496a11f:hover , .u32c2e5af6ecdb596b22783330496a11f:visited , .u32c2e5af6ecdb596b22783330496a11f:active { border:0!important; } .u32c2e5af6ecdb596b22783330496a11f .clearfix:after { content: ""; display: table; clear: both; } .u32c2e5af6ecdb596b22783330496a11f { display: block; transition: background-color 250ms; webkit-transition: background-color 250ms; width: 100%; opacity: 1; transition: opacity 250ms; webkit-transition: opacity 250ms; background-color: #95A5A6; } .u32c2e5af6ecdb596b22783330496a11f:active , .u32c2e5af6ecdb596b22783330496a11f:hover { opacity: 1; transition: opacity 250ms; webkit-transition: opacity 250ms; background-color: #2C3E50; } .u32c2e5af6ecdb596b22783330496a11f .centered-text-area { width: 100%; position: relative ; } .u32c2e5af6ecdb596b22783330496a11f .ctaText { border-bottom: 0 solid #fff; color: #2980B9; font-size: 16px; font-weight: bold; margin: 0; padding: 0; text-decoration: underline; } .u32c2e5af6ecdb596b22783330496a11f .postTitle { color: #FFFFFF; font-size: 16px; font-weight: 600; margin: 0; padding: 0; width: 100%; } .u32c2e5af6ecdb596b22783330496a11f .ctaButton { background-color: #7F8C8D!important; color: #2980B9; border: none; border-radius: 3px; box-shadow: none; font-size: 14px; font-weight: bold; line-height: 26px; moz-border-radius: 3px; text-align: center; text-decoration: none; text-shadow: none; width: 80px; min-height: 80px; background: url(https://artscolumbia.org/wp-content/plugins/intelly-related-posts/assets/images/simple-arrow.png)no-repeat; position: absolute; right: 0; top: 0; } .u32c2e5af6ecdb596b22783330496a11f:hover .ctaButton { background-color: #34495E!important; } .u32c2e5af6ecdb596b22783330496a11f .centered-text { display: table; height: 80px; padding-left : 18px; top: 0; } .u32c2e5af6ecdb596b22783330496a11f .u32c2e5af6ecdb596b22783330496a11f-content { display: table-cell; margin: 0; padding: 0; padding-right: 108px; position: relative; vertical-align: middle; width: 100%; } .u32c2e5af6ecdb596b22783330496a11f:after { content: ""; display: block; clear: both; } READ: PLate Tetonics EssayAdoptions can be arranged by local, state, religious, and even private agencies. These agencies have a list of couples that wants kids but are unable to have them. The couples background is checked to be certain that they would be the best parents for the baby. Teenage parents who put their child up for adoption can be assured that the child will be taken care of. If the parents decide to give the baby up for adoption before its born, it can be arranged before birth. Adoption laws vary from state to state. An open adoption can be made. This adoption allows the birth and adoptive parents to share information about themselves and the child. The birth moth er usually meets the adoptive parents during the pregnancy or after the birth. The adoptive parents send photographs and letters letting the birth mother know how the child is doing. This is an advantage for the birth mother. The birth parents will know a little about his/her biological background. The adoptive parents can answer most of any questions the child asks about the birth parents. Continuing education is also a major decision when you become a teenage parent. Pregnant teenagers have the right to finish their education. It may be hard, but it is not impossible. In some schools they stay in their regular classes, but in others they are placed in special classes for pregnant teenagers. These classes can be helpful because they help parents learn about pregnancy, prenatal care, and parenting skills. Some schools even have childcare. This would help out a lot of teenage parents trying to finish their education. It is important for teenage parents to complete high school. A lot of jobs require high school diplomas. How can teenagers support their baby with no job?The statistics show that teenagers who dropout usually qualify for the lowest-paying jobs in the community, if even that. That is why having an education will help out a teenage mother or father. Having a high school diploma enables them to have more career choices. The most important challenge of a teenage parent is financial problems. Teenagers face more financial problems than older parents. Even if both parents work, they lack the education or skills needed to obtain a job that can support a family. This is why many teen mothers rely on welfare. Some 63% of teen parents depended on public programs for medical needs and daily living expense in 1992 (Programs that Work Now 1). Aid to families with Dependent Children (AFDC) provides financial support to eligible parents and children. Government assistance is minimal, however, and not always available. This probably wont change in the future becau se of the tax burden of these programs. Because of these programs, it helps prevent teenage mothers living in poverty. Before you become sexually active think of the consequences you face. Teen pregnancy isnt just it, there are many problems such as STDs, AIDS, and HIV. These are all associated with sex. If you are sexually active get on some kind of birth control and always use a condom. Think about the consequences you as a teenager would have to face if you risk getting pregnant. Think about the consequences it would put a baby through. Its tough to be a teenage parent and people will have to sacrifice a lot of things that they used to do now that theres a baby with you. Just remember, dont start having sex just because everybody else is or because someones pressuring you into it. Think about everything, including your future, school, friends, freedom, and your life. WORK CITEDGutman-Bowe, Sonia. Teen Pregnancy. Minneapolis: 1987. Hildebrand, Verna. Parenting: Rewards and Responsibilities. New York: 1988Pregnancy and birth. Grolier, INC. 1996 ed. Programs that work now. AFDC. 1995 online. Internet. 18 November 1999. Available http://www.intac.com/~jdeck/tahra/programstext.html. Teen Pregnancy Facts and Stats. NCPTP. 1999. Online. Internet. 11 November 1999. Available http://www.teenpregnancy.org/factstats.html. Social Issues Essays

Discipline in High School Class

Discipline in High School Class Free Online Research Papers Subject: Discipline Topic: Use some ideas from Kounin or Skinner to solve a classroom problem One of my classes is made up for the most part of good students. The class is not large, although the room is tiny and crowded. Some of the students are excellent, always having the answers ready. Others listen for the most part, and learn. Two students, who we will call Amit and Gal, are different. They don’t seem to take the class seriously, and like to laugh and joke, even when nothing is funny. Amit doesn’t always pay attention, but when his behavior in class is commented on by the teacher, he always makes a big argument and defends himself. â€Å"Why me? I’m not the only one talking. And anyway, I wasn’t disturbing the class. I work hard to assimilate the material, see how my grades have come up since the beginning of the year. Why do you pick on me? I wasn’t fooling around at all. â€Å" He never admits anything. You would think he was being interrogated by the police and was afraid to admit even one thing, because it will be held against hi m What advice can Skinner and Kounin give me? How can I control this student’s behavior, or get him to control himself? I think I would try Skinner’s successive approximations and positive reinforcement. If Amit doesn’t disturb for a half an hour, make a positive comment even if he doesn’t listen. When he listens attentively make another positive comment. (These students are too old for stickers or Smileys). After a few days of this, discuss with him his improvement but insist in the future on no disturbances and also attentiveness. I would also try and keep up the Kounin student accountability pressure on Amit by peppering him with questions more frequently than other students. I would do this even though he will resent it. Gal’s problem is very similar. I once told of a humorous comment of the Ibn Ezra, at which Gal laughed uproariously. Gal constantly refers to this comment and laughs, even though it’s not that funny the tenth repetition. He also talks in class much too much, and is called to task frequently. I and using Kounin’s student accountability, but that has only limited effectiveness. I think I should try a schedule of reinforcement if Gal does not disturb, and note and praise his positive (or really non-negative) classroom behavior. Research Papers on Discipline in High School ClassStandardized TestingTrailblazing by Eric AndersonHip-Hop is ArtUnreasonable Searches and SeizuresThe Relationship Between Delinquency and Drug UseBook Review on The Autobiography of Malcolm XPersonal Experience with Teen PregnancyWhere Wild and West MeetQuebec and CanadaMarketing of Lifeboy Soap A Unilever Product

International business management----- E-business Essay

International business management----- E-business - Essay Example The organizations must re-evaluate their business strategy to incorporate business plans so that the potential of the internet, which is fast emerging as a most power tool of communication, can be exploited for business purposes. The popularity of internet has been one of the most promising instruments of advancing one’s business base. As per the article â€Å"E-commerce is an economic solvent. It dissolves old business models and changes the cost structure, and rearranges links among buyers, sellers, and everyone in between. The impact of e-commerce is happening in phases† (Kalakota, Robinson, 2002). Internet, used as a potent communication tool, would provide a vast scope of income generation avenues through increased opportunities. The internet presence of the business through interactive module of the website would facilitate and encourage usage of ecommerce for a win-win situation and help exploit the vast potential of the internet to benefit business through the huge database of customers that internet provides at the click of a mouse. Case study of Tesco is an excellent example of using ecommerce to gain the popularity and trust of the people and the prospective customers. We would be using the case study to evaluate and analyze the methodologies and approach to ecommerce activities to develop and increase customer database. Tesco realized the vast potential of internet early and has been the first business enterprise to introduce e-commerce activity in UK. The interactive communication between the client and the business house has been utilized to develop a professional relationship between the two, that not only provides opportunity to improve and improvise the quality as per customer’s requirement and demand while at the same time, customer gets the best deal because of the competitive nature of internet, as a medium of business promotion

Medicalization of Deviance Essay Example | Topics and Well Written Essays - 1000 words

Medicalization of Deviance - Essay Example One of the main reasons there has been a much stronger focus on medicalizing deviance is because the offenders who are in this category need a specific type of help to refrain them from continuing to break the law and behaving outside of what is considered to be the social norm. Without medical intervention their behavior is uncontrollable and will continue to escalate unless they are placed on medication to control their specific cognitive problems. So, based on this assumption, when the terminology of medicalization is placed with deviance or deviant behavior it is understood that what is actually being implied is that those of deviant character need specialized medical treatment such as certain neuro-chemical stabilizers to control their behaviors. Sociologists claim that by defining deviance in this way it will allow for an ability to be able to maintain order far better in societies than simply following a traditional pattern of law and placing all of those of a disorderly character in a certain legal framework without proper labeling of the adversity being given. Furthermore, when certain criminal activities are taken out of the main legal framework and analyzed it will be perceivable that for some there are medical reasons for their behavior while for others they simply are prone to violent actions and engage in crime because they want too and for no other reason. For other's it is quite the opposite, which is why there is a strong point for labeling some offenders under medical deviance. Conrad (1992, pg. 210) points out that it was in the mid 1970's when the concept of medicalization and activities of a deviant background were first were introduced, although there was not much headway in labeling offenders into this grou p at that time. However, now in present times the terminology has become quite common and even more pronounced, gaining precedence in claiming that many crimes have a medical reason and therefore claiming medicalizing many deviant behaviors is not only arbitrarily conceivable, but it is quite logical to do. In Conrad's article (1992) there is an emphasis on the fact that medicine can control deviant actions and many characteristics of it, which has been hinted at in this research. By applying the proper treatment regimen to those offenders who are engaging in deviant acts, the chemicals that are not reacting correctly in the brain can be adjusted by various pharmaceutical prescriptions. By counseling and regulating the medications, psychologists can monitor these previous offenders and almost guarantee that their actions won't be repeated as long as they stay on the treatment prescribed to them. The definition of medicalization in itself shows, "it is a process where more and more of everyday life has come under medical dominion, influence, and supervision" (Conrad 1992, pg.210). Of course, as this research is showing even legal problems in society are now beginning to be associated with medicine and it's treatments to maintain control. To extend this reasoning further, many psychiatrists, sociologists, and psychologists believe that a person who is committing deviant

Bank Julius Baer Case Essay Example for Free

Bank Julius Baer Case Essay Before the arrival and leadership of Stuart Adam (â€Å"Adam†), Bank Julius Baer, North America (â€Å"BJB-NA† or the â€Å"Company†), the largest independently-owned European private bank in the United States, faced financial difficulties. By mid-2001, a worldwide market downturn caused a significant decline in Julius Baer Group’s (â€Å"JB† or the â€Å"Parent†) performance. In 2001, JB’s stock price was down by over 40% while the Parent experienced a 39% decline in net profits, 9% increase in operating expenses and an increase of 14% in employee headcount. BJB-NA, the â€Å"crown jewel† of JB, was barely profitable but no one inside the Company knew its true financial condition. JB had always been led by a member of the Baer family until January 2001. Despite significant family ties at JB, BJB-NA did not have a strong leader to drive the company. There was a lack of clear vision or direction for the Company. BJB-NA did not focus on profitability as a measurement of success. The attitude around BJB-NA was more about â€Å"keeping the peace† than creating any conflict or hostility. Even with a passive work environment, employee morale was low. Employees tended to blame other parts of the Company for their problems. The competitive environment in the High Net Individual (â€Å"HNI†) private banking sector increased dramatically during the 1990’s. BJB-NA was a boutique private bank in a business where bulge bracket firms dominated the competitive landscape. As such, the key factors for success in the HNI market were now recognized as differentiation (not cost leadership), improved client relationship management, broad product range and strong client-responsiveness. BJB-NA strived to be a partner organization that differentiated itself from the competition by satisfying the needs of its clients. The existing organization structure consisted of BJB-NA organized into four regionally-based â€Å"teams. † Poor communication existed throughout the Company as the staff didn’t know what was going on and there was little cohesion among units. BJB-NA operated on a â€Å"need to know† basis. Team leaders were not responsible for their own budgets, as it was not known if their teams were profitable or not. To further support the lack of accountability at BJB-NA, the Company did not have a systematic performance valuation system and lacked a compensation system tied to customer growth and returns. Bonuses were virtually guaranteed and all bonus decisions were made by Bank’s top leadership. Most likely, there were employees who â€Å"flew under the radar† if they underperformed since the Company never laid anyone off. Adamà ¢â‚¬â„¢s Changes and Evaluation Adam arrived at BJB-NA and immediately laid out an action plan to turn around the Company. One of Adam’s best early moves was his selection of Denise Downey to head the Segmentation Study Team. Downey was well respected by the employees that she led and was able to thoroughly evaluate the organization and deliver results to the Company and Adam. Based on the Segmentation Study, Adam wanted BJB-NA to really stand-behind its promises to be a partner organization. He encouraged full transparency and a strong focus on measurable results and accountability. Specifically, he focused on the following three initiatives: Refocus the Company strategy: Adam emphasized that BJB-NA shift its focus to Europeans, Asians, Canadians and Latin Americas who live outside the U. S. who had U. S. based asset management needs. By targeting specific geographic and customer segments, it allowed the Company to specifically focus its strategy and resources rather than spread itself too thin to satisfy a larger, diverse customer base. In addition, he asked some longstanding personal clients who were not profitable to close their accounts. Not only did this change the Company’s customer focus, but also, it signaled to employees that Adam had confidence and high expectations for BJB-NA. Establish new performance expectations: Adam developed productivity assumptions that would hold employees more accountable. He established measurable criteria related to book value, relationships and accounts. Previously, Company employees truly did not know their clients. As a result, it was difficult for management to identify top and low performers. Adam’s established criteria that pushed Relationship Managers past their comfort zone. Before Adam took the helm at BJB-NA, almost everyone received bonuses regardless of their performance. Tying a bonus program with a structure performance evaluation system incentivizes those who bring success and growth potential to the Company. Modify the organization structure: Adam slightly altered the structure of BJB-NA by having a client-segment focus within existing geographic areas. As such, the decision making processes were now decentralized to each of the regional teams. Previously, the advisory and product services departments worked with all regions. After Adam took charge, he assigned advisory teams to each of the different regions to further strengthen customer relationships. Recommendations BJB-NA recognizes that its future success hinges on one important factor: its clients. Our consulting firm wants the Company to further expand and impact its clients beyond what Adam has already planned. Our approach is a client-centric strategy that focuses on two key initiatives: (1) Aggressively recruiting top talent to enhance client acquisition and performance (2) Overhauling the compensation scheme and performance measures. Each initiative, accompanied by supporting tactics, will align to elevate the client experience, resulting in deepening wallet share, increasing warm referrals, and building the BJB-NA brand in supreme customer service. I. Recruiting the Right Talent. Recruiting the right people to manage and advise BJB-NA’s clients will be critical to sustaining long-term growth and increasing assets-under-management. Recruiting will align with the Company’s geographic approach to segmentation by adopting three tactics:  · Local talent recruitment – a successful private banker needs an outgoing, service-orientated personality, and the ability to connect with potential and existing clients. In connecting with clients, it becomes mandatory that future private bankers will be recruited from local regions. This strategy will generate bankers who know the local customs and cultures, speak the language, and are involved in the community. As a result, it creates comfort and familiarity for potential clients.  · Recruit from bulge bracket private banks –Company acquisition is not a feasible option at this time. However, employee/talent acquisition is an even better method to help improve the Company. Bulge bracket private banks are typically a part of much larger conglomerates, often weighed down high-level corporate strategies and â€Å"red tape. To attract bulge bracket private bankers, BJB-NA should promote an entrepreneurial environment that offers autonomy and flexibility while still offering resources found at larger firms. Recruit from ultra-boutique private banks – BJB-NA should actively target private bankers from smaller, boutique firms that have larger books, but have a need for a more global reach. Private bank clients are becoming more global, and with that, have a specific need for banks that have an international presence. BJB-NA provides a solution with offices in Asia, Western Europe, Eastern Europe, and the United States. At the same time, by aggressively recruiting boutique bankers, BJB-NA will be able to expand its presence by acquiring the books of these bankers who may have a strong presence in untapped markets within the targeted regions. II. Restructuring Compensation and Performance Measures BJB-NA should introduce a compensation scheme that will not only be more beneficial for keeping clients’ interests first, but also offer higher potential incentives for the Company’s bankers. First and foremost, bankers will be paid based on client portfolio performance. No one will be paid on the basis of commission. While this tactic may seem counter-intuitive in the short-term, especially in the midst of a struggling economy, it acknowledges BJB-NA’s long-term commitment to its clients. Other positive externalities resulting from a new compenstation structure include: differentiation from competition, potential referrals from clients, and attention to BCB-NA’s innovative thinking. In short, BJB-NA’s message is: â€Å"We make money only when our clients make money†. Second, standard annual bonuses will be foregone. Employees would be accountable for their performance and compensated accordingly. BJB-NA will incentivize bankers by the value they add to their clients and related portfolio performances. This compensation structure ultimately rewards bankers who take of their clients and strive to grow their assets under management. Finally, BJB-NA should revise the position title of its company leaders. To accurately reflect the duties of the position, the title †Team Leader† should be changed to â€Å"Managing Director (MD)†. MD’s would have full PL and people-management responsibilities of his/her respective branch. In addition, MD’s could receive an additional bonus based on the branch’s bottom-line performance. This change will push decision-making down to MD level, promoting entrepreneurship and autonomy. III. Management and Leadership Since Adam decided to resign from his position as the leader of BJB-NA, it is vital for the Board of Directors to select a successor that will be able to implement the changes initiated under Adam’s tenure. As discussed, BJB-NA needs to aggressively put its clients before anything else in its business. The new successor should be an experienced professional who deeply understands the Company’s clients and industry. Taking these requirements into consideration, we recommend that the Board of Directors pick Adam’s successor from a list of internal candidates only. Currently, the firm is in a state of fragility. Employees are stressed and morale is low. With the initial round of layoffs that included six people, any move will be highly scrutinized and may have a long-term impact on the organization. Employees were already caught off guard with Adam’s resignation, especially after he led the restructuring efforts at an off-site meeting that seemed to build positive momentum. To replace Adam’s with an external candidate may put the Company in a state of flux. An external candidate would not have attended the restructuring meetings and participated in the Segmentation Study. He/she may have different views of how the organization should be changed. In addition, the HNI private banking industry is built around relationships. To bring on a new leader who hasn’t built a strong rapport with a majority of the Company’s clients would make the leadership transition a difficult process. One potential internal candidate BJB-NA should consider is Denise Downey. Downey is currently the Head of U. S. Domestic Clients, but more importantly she led the Segmentation Study that evaluated areas of improvement needed at BJB-NA. Employees viewed Downey as a strong, effective leader who always delivers results. As a sign of trust, Adam gave Downey significant autonomy during her time leading the study. Elevating Downey to the C-suite level would be a fairly seamless transition. Downey has significant experience understanding the clientele of BJB-NA since she already leads U. S. client group. With all of the â€Å"client-focused† changes that need to be implemented by Adam, Downey will be best candidate to effectively communicate the steps needed during the transition period. For example, during her time as the Segmentation Study leader, Downey took the initiative to send updates to the entire bank. Alternate Approaches Deviating from a client-centric strategic plan could negatively impact BCB-NA’s future success. Nonetheless, two other alternate approaches were considered. The first approach considered a compensation system where bankers would be paid variable commissions based on fee-based transactions. The variable in commissions would depend on the type of investment vehicles clients would invest in. This viable approach guarantees cash flows from transactions with no dramatic culture change. However, after careful consideration, this alternative was rejected since bankers would be incentivized more by selling a diversity of investment vehicles to clients rather than working for clients’ best interests. The second approach considered but rejected involved an overhaul of the organization structure. After the Segmentation findings, Adam seemed adamant about moving away from the geographic-focused organizational structure of the Company. As such, an alternative approach considered was to eliminate geographic departments and implement an organizational structure focused on client-type. One of the key success factors for companies in the private banking industry is to customize services based on the needs of customers. A BJB-NA client-focused structure based on client characteristics (such as wealth, age, income level) may be more advantageous, especially with raised expectations now required by Adam on bankers’ book of clients. Additionally, within a geographic organization, conflict may occur between local regional management and the executives at corporate. As such, this may hurt the opportunity for knowledge sharing and collaboration, values emphasized by the Baer family. However, as much as a client-focused structure might have its advantages, a geographic organizational structure still is the most effective for BJB-NA. Communication is much more personal in geographic organizational structures. Instead of calling or videoconferencing with olleagues across the globe, it forces employees to sit next to each other to form collaborative teams, values preached by the Baer family. In addition, it allows employees to understand each other’s personalities and work styles. Besides the human capital element, geographic work teams allow BJB-NA to hire leaders familiar with the local business environment, something vital for the relationship-focused private banking industry. Not only will employees understand the client better but the clients will be more comfortable around employees who share similar interests and culture.

Oh, For the Love of Thought :: Philosophy Plato The Allegory of the Cave Essays

Oh, For the Love of Thought Many thinkers have existed throughout history. These thinkers were called philosophers because they literally loved knowledge. In fact, the root phil means love, and the root soph means knowledge. These lovers of knowledge have always looked for ways to spread both their knowledge and their way of constantly thinking to other people. One of these attempts was Plato's The Allegory of the Cave. Plato's The Allegory of the Cave describes, through a conversation between Socrates and his student Glaucon, cave dwellers who see only shadows of puppets on a wall. Socrates emphasizes to Glaucon: To them, the truth would be literally nothing but the shadows of the images. Socrates continues his supposition by rhetorically asking: What will follow if the prisoners are released and disabused of their error?. It turns out, says Socrates, that the experience will be painful at first. Once a liberated cave dweller leaves the cave and goes to see the sun, he will see a greater truth than those in the cave. Socrates and Glaucon continue to discuss the cave and determine a set of possibilities: The cave dweller who does not leave the cave will be ignorant; he will not know nor want to know the truth. The cave dweller who leaves the cave and returns will be considered heretical; while he knows a greater truth, he must suffer for it. The cave dweller who leaves the cave and does not return w ill be cause for the cave dwellers to consider the sun, enlightenment, or the ultimate truth to be dangerous; it will be reason for the cave dweller not to leave the cave. The allegory, continued in a reader's mind to a deeper level at which visible reality is an unraveling ball of infinite size with ultimate truth at its core and layers of illusion surrounding it, shows that there will always be a deeper truth. No one person can be fully enlightened and see ultimate truth just as no one person can see the whole of a sphere. It takes the perspectives of all to even begin to see the ultimate truth. Plato begs man in general not to consider the ideas of other men to be heretical because the ideas force people out of their comfort zone and do not make immediate sense to them. People must be continually open-minded. Man may find a new insight into something shedding a layer from the aforementioned ball of reality, but that just means that there are infinitely more insights to gain before the layers of illusion are shed.

A Financial Perspective on Mergers and Acquisitions

The Free Cash Flow Theory of Takeovers: A Financial Perspective on Mergers and Acquisitions and the Economy Michael C. Jensen Harvard Business School [email  protected] edu  © Michael C. Jensen, 1987 â€Å"The Merger Boom†, Proceedings of a Conference sponsored by Federal Reserve Bank of Boston, Oct. 1987, pp. 102-143 This document is available on the Social Science Research Network (SSRN) Electronic Library at: http://papers. ssrn. com/ABSTRACT=350422 The Free Cash Flow Theory of Takeovers: A Financial Perspective on Mergers and Acquisitions and the Economy Michael C.Jensen* Harvard Business School [email  protected] edu From, â€Å"The Merger Boom†, Proceedings of a Conference sponsored by Federal Reserve Bank of Boston, Oct. 1987, pp. 102-143 Economic analysis and evidence indicate the market for corporate control is benefiting shareholders, society, and the corporate form of organization. The value of transactions in this market ran at a record rate of about $ 180 billion per year in 1985 and 1986—47 percent above the 1981 record of $122 billion.The number of transactions with purchase prices exceeding one billion dollars was 27 of 3300 deals in 1986 and 36 of 3000 deals in 1985 (Grimm, 1985). There were only seven billion-dollar plus deals in total, prior to 1980. In addition to these takeovers, mergers, and leveraged buyouts, there were numerous corporate restructurings involving divestitures, spinoffs, and large stock repurchases for cash and debt. The gains to shareholders from these transactions have been huge.The gains to selling-firm shareholders from mergers and acquisition activity in the period 1977-86 total $346 billion (in 1986 dollars). 1 The gains to buying-firm shareholders are harder Estimated from data in Grimm (1986). Grimm provides total dollar values for all merger and acquisition deals for which there are publicly announced prices amounting to at least $500,000 or 10 percent of the firm and in which at least on e of the firms was a U. S. company. Grimm also counts in its numerical totals deals with no publicly announced prices that it believes satisfy these criteria.I have assumed that the deals with no announced prices were on average equal to 20 percent of the size of the announced transactions and carried the same average premium. *Professor of Business Administration, Harvard Business School, and Professor of Finance and Business Administration, University of Rochester. The author is grateful for the research assistance of Michael Stevenson and the helpful comments by Sidney Davidson, Harry DeAngelo, Jay Light, Robert Kaplan, Nancy Macmillan, Kevin Murphy, Susan Rose-Ackerman, Richard Ruback, Wolf Weinhold, Toni Wolcott, and especially Armen Alchian.This research is supported in part by the Division of Research, Harvard Business School, and the Managerial Economics Research Center, University of Rochester. The analysis here draws heavily on that in Jensen (forthcoming 1988). 1 M. C. Je nsen 2 1987 to estimate, and to my knowledge no one has done so yet, but I estimate that they would add at least another $50 billion to the total. These gains, to put them in perspective, equal 31 percent of the total cash dividends (valued in 1986 dollars) paid to investors by the entire corporate sector in the past decade. Corporate control transactions and the restructurings that often accompany them can be wrenching events in the lives of those linked to the involved organizations: the managers, employees, suppliers, customers and residents of surrounding communities. Restructurings usually involve major organizational change (such as shifts in corporate strategy) to meet new competition or market conditions, increased use of debt, and a flurry of recontracting with managers, employees, suppliers and customers.This activity sometimes results in expansion of resources devoted to certain areas and at other times in contractions involving plant closings, layoffs of top-level and mi ddle managers and of staff and production workers, and reduced compensation. Change due to corporate restructuring requires people and communities associated with the organization to adjust the ways they live, work and do business. It is not surprising, therefore, that this change creates controversy and that those who stand to lose are demanding that something be done to stop the process.At the same time, shareholders in restructured corporations are clear-cut winners; in recent years restructurings have generated average increases in total market value of approximately 50 percent. Those threatened by the changes argue that corporate restructuring is damaging the U. S. economy, that this activity damages the morale and productivity of organizations and pressures executives to manage for the short term. Further, they hold that the value that restructuring creates does not come from increased efficiency and productivity; rather, the gains come from lower tax payments, broken contract s withTotal dividend payments by the corporate sector, unadjusted for inflation, are given in Weston and Copeland (1986, p. 649). I extended these estimates to 1986. 2 M. C. Jensen 3 1987 managers, employees and others, and mistakes in valuation by inefficient capital markets. Since the benefits are illusory and the costs are real, they argue, takeover activity should be restricted. The controversy has been accompanied by strong pressure on regulators and legislatures to enact restrictions to curb activity in the market for corporate control.Dozens of congressional bills in the past several years have proposed new restrictions on takeovers, but as of August 1987, none had passed. The Business Roundtable, composed of the chief executive officers of the 200 largest corporations in the country, has pushed hard for restrictive legislation. Within the past several years the legislatures of New York, New Jersey, Maryland, Pennsylvania, Connecticut, Illinois, Kentucky, Michigan, Ohio, Indi ana, Minnesota and Massachusetts have passed antitakeover laws.The Federal Reserve Board implemented new restrictions in early 1986 on the use of debt in certain takeovers. In all the controversy over takeover activity, it is often forgotten that only 40 (an all-time record) of the 3,300 takeover transactions in 1986 were hostile tender offers. There were 110 voluntary or negotiated tender offers (unopposed by management) and the remaining 3,100-plus deals were also voluntary transactions agreed to by management. This simple classification, however, is misleading since many of the voluntary transactions would not have occurred absent the threat of hostile takeover.A major reason for the current outcry is that in recent years mere size alone has disappeared as an effective takeover deterrent, and the managers of many of our largest and least efficient corporations now find their jobs threatened by disciplinary forces in the capital markets. Through dozens of studies, economists have accumulated considerable evidence and knowledge on the effects of the takeover market. Most of the earlier work is well summarized elsewhere (Jensen and Ruback (1983); Jensen (1984); Jarrell, Brickley and M. C.Jensen 4 1987 Netter (1988)). Here, I focus on current aspects of the controversy. In brief, the previous work tells us the following: †¢ Takeovers benefit shareholders of target companies. Premiums in hostile offers historically exceed 30 percent on average, and in recent times have averaged about 50 percent. †¢ Acquiring-firm shareholders on average earn about 4 percent in hostile takeovers and roughly zero in mergers, although these returns seem to have declined from past levels. †¢ Takeovers do not waste credit or resources.Instead, they generate substantial gains: historically, 8 percent of the total value of both companies. †¢ Actions by managers that eliminate or prevent offers or mergers are most suspect as harmful to shareholders. †¢ Golden pa rachutes for top-level managers do not, on average, harm shareholders. †¢ The activities of takeover specialists (such as Icahn, Posner, Steinberg, and Pickens) benefit shareholders on average. †¢ Merger and acquisition activity has not increased industrial concentration.Over 1200 divestitures valued at $59. 9 billion occurred in 1986, also a record level (Grimm, 1986). †¢ Takeover gains do not come from the creation of monopoly power. Although measurement problems make it difficult to estimate the returns to bidders as precisely as the returns to targets,3 it appears the bargaining power of target managers, coupled with competition among potential acquirers, grants a large share of the acquisition benefits to selling shareholders. In addition, federal and state regulation of 3See Jensen and Ruback (1983, pp. 18ff). M. C. Jensen 5 1987 tender offers appears to have strengthened the hand of target firms; premiums received by target-firm shareholders increased substanti ally after introduction of such regulation. 4 Some have argued that the gains to shareholders come from wealth reallocations from other parties and not from real increases in efficiency. Roll (1986) argues the gains to target firm shareholders come from acquiring firm shareholders, but the data are not consistent with this hypothesis.While the evidence on the returns to bidding firms is mixed, it does not indicate they systematically suffer losses; prior to 1980 shareholders of bidding firms earned on average about zero in mergers, which tend to be voluntary, and about 4 percent of their equity value in tender offers, which more often are hostile Jensen and Ruback (1983). These differences in returns are associated with the form of payment rather than the form of the offer: tender offers tend to be for cash and mergers tend to be for stock (Huang and Walkling, 1987).Some argue that bondholders in acquired firms systematically suffer losses as substantial amounts of debt are added to the capital structure. Asquith and Kim (1982) do not find this, nor do Dennis and McConnell (1986). The Dennis and McConnell study of 90 matched acquiring and acquired firms in mergers in the period 1962-80 shows that the values of bonds, preferred stock and other senior securities, as well as the common stock prices of both firms, increase around the merger announcement. Changes in the value of senior securities are not captured in measures of changes in the value of common stock prices summarized previously.Taking the changes in the value of senior securities into account, Dennis and McConnell find the average change in total dollar value is positive for both bidders and target firms. Shleiffer and Summers (1987) argue that some of the benefits earned by target and bidding firm shareholders come from the abrogation of explicit and implicit longterm contracts with employees. They point to highly visible recent examples in the airline See Jarrell and Bradley (1980), Nathan and Oâ⠂¬â„¢Keefe (1986), however, provide evidence that this effect occurred in 1974, several years after the major legislation. M. C. Jensen 6 1987 industry, where mergers have been frequent and wages have been cut in the wake of deregulation. But given deregulation and free entry by low-cost competitors, the cuts in airline industry wages were inevitable and would have been accomplished in bankruptcy proceedings if not in negotiations and takeover-related crises. Medoff and Brown (1988) study this issue using data from Michigan. They find that both employment and wages are higher, not lower, after acquisition than would otherwise be expected; however, their sample consists largely of combinations of small firms.The Market for Corporate Control 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 (Jensen and Ruback, 1983). Understandin g this point is crucial to understanding much of the rhetoric about the effects of hostile takeovers. Takeovers generally occur because changing technology or market conditions require a major restructuring of corporate assets (although in some cases, takeovers occur because incumbent managers are incompetent).Such changes can require abandonment of major projects, relocation of facilities, changes in managerial assignments, and closure or sale of facilities or divisions. Managers often have trouble abandoning strategies they have spent years devising and implementing, even when those strategies no longer contribute to the organization’s survival, and it is easier for new top-level managers with no ties to current employees or communities to make changes. Moreover, normal organizational resistance to change commonly is lower early in the reign of new top-level managers.When the internal processes for change in large corporations are too slow, costly, and clumsy to bring about the required restructuring or change in managers efficiently, the capital markets do so through the M. C. Jensen 7 1987 market for corporate control. Thus, the capital markets have been responsible for substantial changes in corporate strategy. Causes of Current Takeover Activity A variety of political and economic conditions in the 1980s have created a climate where economic efficiency requires a major restructuring of corporate assets.These factors include: †¢ †¢ The relaxation of restrictions on mergers imposed by the antitrust laws. The withdrawal of resources from industries that are growing more slowly or that must shrink. †¢ Deregulation in the markets for financial services, oil and gas, transportation, and broadcasting, bringing about a major restructuring of those industries. †¢ Improvements in takeover technology, including more and increasingly sophisticated legal and financial advisers, and innovations in financing technology (for example, the strip financing commonly used in leveraged buyouts and the original issuance of high-yield non-investment-grade bonds).Each of these factors has contributed to the increase in total takeover and reorganization activity. Moreover, the first three factors (antitrust relaxation, exit, and deregulation) are generally consistent with data showing the intensity of takeover activity by industry. Table 1 indicates that acquisition activity in the period 1981-84 was highest in the oil and gas industry, followed by banking and finance, insurance, food processing, and mining and minerals. For comparison purposes, the table also presents data on industry value measured as a percentage of the total value of all firms.All but two of the industries, retail trade and transportation, represent a larger fraction of total takeover activity than their representation in the economy as a whole, indicating that the takeover market is concentrated in particular industries, not spread evenly throughout the corpo rate sector. M. C. Jensen 8 1987 Table 1 Intensity of Takeover Activity, by Industry, 1981-84 Percent Percent of Total of Total Takeover Corporate Industry Classification of Seller Market Valueb Activitya Oil and Gas 26. 13. 5 Banking and Finance 8. 8 6. 4 Insurance 5. 9 2. 9 Food Processing 4. 6 4. 4 Mining and Minerals Conglomerate Retail Trade Transportation Leisure and Entertainment Broadcasting Other a 4. 4 4. 4 3. 6 2. 4 2. 3 2. 3 39. 4 1. 5 3. 2 5. 2 2. 7 . 9 . 7 58. 5 Value of merger and acquisition transactions in the industry as a percentage of total takeover transactions for which valuation data are publicly reported. Source: W. T Grimm, Mergerstat Review (1984, p. 41). bIndustry value as a percentage of the value of all firms, as of 12/31/84 Total value is measured as the sum of the market value of common equity for 4,305 companies, including 1,501 companies on the New York Stock Exchange, 724 companies on the American Stock Exchange, plus 2,080 companies in the over-the -counter market. Source: The Media General Financial Weekly, (December 31, 1984, p 17) Many sectors of the U. S. economy have been experiencing slower growth and, in some cases, even retrenchment. This phenomenon has many causes, including substantially increased foreign competition.The slow growth has meant increased takeover activity because takeovers play an important role in facilitating exit from an industry or activity. Changes in energy markets, for example, have required radical restructuring and retrenchment in that industry, and takeovers have played an important role in accomplishing these changes; oil and gas rank first in takeover activity, with twice their proportionate share of total activity. Managers who are slow to adjust to the new energy environment and slow to recognize that many old practices and strategies are no longer viable find that takeovers M. C.Jensen 9 1987 are doing the job for them. In an industry saddled with overcapacity, exit is cheaper to accompl ish through merger and the orderly liquidation of marginal assets of the combined firms than by disorderly, expensive bankruptcy. The end of the competitive struggle in such an industry often comes in the bankruptcy courts, with the unnecessary destruction of valuable parts of organizations that could be used productively by others. Similarly, deregulation of the financial services market is consistent with the number 2 rank of banking and finance and the number 3 rank of insurance in table 1.Deregulation has also been important in the transportation and broadcasting industries. Mining and minerals has been subject to many of the same forces impinging on the energy industry including the changes in the value of the dollar. The development of innovative financing vehicles, such as high yield noninvestment-grade bonds (junk bonds), has removed size as a significant impediment to competition in the market for corporate control. Investment grade and high-yield debt issues combined were associated with 9. percent of all tender offer financing from January 1981 through September 1986 (Drexel Burnham Lambert, undated). Even though not yet widely used in takeovers, these new financing techniques have had important effects because they permit small firms to obtain resources for acquisition of much larger firms by issuing claims on the value of the venture (that is, the target firm’s assets) just as in any other corporate investment activity. Divestitures If assets are to move to their most highly valued use, acquirers must be able to sell off assets to those who can use them more productively.Therefore, divestitures are a critical element in the functioning of the corporate control market and it is important to avoid inhibiting them. Indeed, over 1200 divestitures occurred in 1986, a record level (Mergerstat Review (1986)). This is one reason merger and acquisition activity has not increased industrial concentration. M. C. Jensen 10 1987 Divested plants and asse ts do not disappear; they are reallocated. Sometimes they continue to be used in similar ways in the same industry, and in other cases they are used in very different ways and in different industries.But in both cases they are moving to uses that their new owners believe are more productive. Finally, the takeover and divestiture market provides a private market constraint against bigness for its own sake. The potential gains available to those who correctly perceive that a firm can be purchased for less than the value realizable from the sale of its components provide incentives for entrepreneurs to search out these opportunities and to capitalize on them by reorganizing such firms into smaller entities.The mere possibility of such takeovers also motivates managers to avoid putting together uneconomic conglomerates and to break up existing ones. This is now happening. Recently many firms’ defenses against takeovers appear to have led to actions similar to those proposed by th e potential acquirers. Examples are the reorganizations occurring in the oil and forest products industries, the sale of â€Å"crown jewels,† and divestitures brought on by the desire to liquidate large debts incurred to buy back stock or make other payments to stockholders.The basic economic sense of these transactions is often lost in a blur of emotional rhetoric and controversy. Managerial Myopia versus Market Myopia It has been argued that, far from pushing managers to undertake needed structural changes, growing institutional equity holdings and the fear of takeover cause managers to behave myopically and therefore to sacrifice long-term benefits to increase short-term profits.The arguments tend to confuse two separate issues: 1) whether managers are shortsighted and make decisions that undervalue future cash flows while overvaluing current cash flows (myopic managers); and 2) whether security markets are shortsighted and undervalue future cash flows while overvaluing ne ar-term cash flows (myopic markets). M. C. Jensen 11 1987 There is little formal evidence on the myopic managers issue, but I believe this phenomenon does occur.Sometimes it occurs when managers hold little stock in their companies and are compensated in ways that motivate them to take actions to increase accounting earnings rather than the value of the firm. It also occurs when managers make mistakes because they do not understand the forces that determine stock values. There is much evidence inconsistent with the myopic markets view and no evidence that indicates it is true: (1) The mere fact that price-earnings ratios differ widely among securities indicates the market is valuing something other than current earnings. For example, it values growth as well.Indeed, the essence of a growth stock is that it has large investment projects yielding few short term cash flows but high future earnings and cash flows. The continuing marketability of new issues for start-up companies with li ttle record of current earnings, the Genentechs of the world, is also inconsistent with the notion that the market does not value future earnings. (2) McConnell and Muscarella (1985) provide evidence that (except in the oil industry) stock prices respond positively to announcements of increased investment expenditures and negatively to reduced expenditures.Their evidence is also, inconsistent with the notion that the equity market is myopic, since it indicates that the market values spending current resources on projects that promise returns in the future. (3) The vast evidence on efficient markets, indicating that current stock prices appropriately incorporate all currently available public information, is also inconsistent with the myopic markets hypothesis. Although the evidence is not literally 100 percent in support of the efficient market hypothesis, no proposition in any of the social sciences is better documented. 5For an introduction to the literature and empirical evidence on the theory of efficient markets, see Elton and Gruber (1984, Chapter 15, p. 375ff), and the 167 studies referenced in the bibliography. For some anomalous evidence on market efficiency, see Jensen (1978). For recent criticisms of the efficient market hypothesis see Shiller (1981a; 1981b), Marsh and Merton (1983; 1986) demonstrate that the Shiller 5 M. C. Jensen 12 1987 (4) Recent versions of the myopic markets hypothesis emphasize increases in the amount of institutional holdings and the pressure funds managers face to generate high quarterly returns.It is argued that these pressures on institutions are a major cause of pressures on corporations to generate high current quarterly earnings. The institutional pressures are said to lead to increased takeovers of firms, because institutions are not loyal shareholders, and to decreased research and development (R&D) expenditures. It is hypothesized that because R&D expenditures reduce current earnings, firms making them are more like ly to be taken over, and that reductions in R&D are leading to a fundamental weakening of the corporate sector of the economy.A study of 324 firms by the Office of the Chief Economist of the SEC (1985a) finds substantial evidence that is inconsistent with this version of the myopic markets argument. The evidence indicates the following: †¢ Increased institutional stock holdings are not associated with increased takeovers of firms. †¢ Increased institutional holdings are not associated with decreases in R&D expenditures. †¢ †¢ Firms with high R&D expenditures are not more vulnerable to takeovers. Stock prices respond positively to announcements of increases in R&D expenditures.Moreover, total spending on R&D is increasing concurrent with the wave of merger and acquisition activity. Total spending on R&D in 1984, a year of record acquisition activity, increased by 14 percent according to Business Week’s annual survey. This represented â€Å"the biggest gain since R&D spending began a steady climb in tests depend critically on whether, contrary to generally accepted financial theory and evidence, the future levels of dividends follow a stationary stochastic process. Merton (1985) provides a discussion of the current state of the efficient market hypothesis and concludes (p. 0), â€Å"In light of the empirical evidence on the nonstationarity issue, a pronouncement at this moment that the rational market theory should be discarded from the economic paradigm can, at best, be described as ‘premature’. † M. C. Jensen 13 1987 the late 1970’s. † All industries in the survey increased R&D spending with the exception of steel. In addition, R&D spending increased from 2 percent of sales, where it had been for five years, to 2. 9 percent. In 1985 and 1986, two more record years for acquisition activity, R&D also set new records.R&D spending increased by 10 percent (to 3. 1 percent of sales) in 1985, and in 1986, R &D spending again increased by 10 percent to $51 billion (3. 5 percent of sales), in a year when total sales decreased by 1 percent. 6 Bronwyn Hall (1987), in a detailed study of all U. S. manufacturing firms in the years 1976-85, finds in approximately 600 acquisitions that firms that are acquired do not have higher R&D expenditures (measured by the ratio of R&D to sales) than firms in the same industry that are not acquired.Also, she finds that â€Å"firms involved in mergers showed no difference in their pre- and post-merger R&D performance over those not so involved. † I know of no evidence that supports the argument that takeovers reduce R&D expenditures, even though this is a prominent argument among many of those who favor restrictions on takeovers. Free Cash Flow Theory More than a dozen separate forces drive takeover activity, including such factors as deregulation, synergies, economies of scale and scope, taxes, managerial incompetence, and increasing globalization of U. S. markets. 7 One major cause of takeover activity, the gency costs associated with conflicts between managers and 6 The â€Å"R&D Scoreboard† is an annual survey, covering companies that account for 95 percent of total private-sector R&D expenditures. The three years referenced here can be found in â€Å"R&D Scoreboard: Reagan & Foreign Rivalry Light a Fire Under Spending,† Business Week, (, July 8, 1985, p. 86 ff. ); â€Å"R&D Scoreboard: Now, R&D is Corporate America’s Answer to Japan Inc. ,† Business Week, (, June 23, 1986, p. 134 ff. ); and â€Å"R&D Scoreboard: Research Spending is Building Up to a Letdown,† Business Week, (, June 22, 1987, p. 39 ff. ). In 1984 the survey covered 820 companies; in 1985, it covered 844 companies; in 1986, it covered 859 companies. 7 Roll (1988) discusses a number of these forces. M. C. Jensen 14 1987 shareholders over the payout of free cash flow,8 has received relatively little attention. Yet it has pla yed an important role in acquisitions over the last decade. Managers are the agents of shareholders, and because both parties are selfinterested, there are serious conflicts between them over the choice of the best corporate strategy.Agency costs are the total costs that arise in such cooperative arrangements. They consist of the costs of monitoring managerial behavior (such as the costs of producing audited financial statements and devising and implementing compensation plans that reward managers for actions that increase investors’ wealth) and the inevitable costs that are incurred because the conflicts of interest can never be resolved perfectly. Sometimes these costs can be large, and when they are, takeovers can reduce them.Free Cash Flow and the Conflict Between Managers and Shareholders Free cash flow is cash flow in excess of that required to fund all of a firm’s projects that have positive net present values when discounted at the relevant cost of capital. Suc h free cash flow must be paid out to shareholders if the firm is to be efficient and to maximize value for shareholders. Payment of cash to shareholders reduces the resources under managers’ control, thereby reducing managers’ power and potentially subjecting them to the monitoring by the capital markets that occurs when a firm must obtain new capital.Financing projects internally avoids this monitoring and the possibility that funds will be unavailable or available only at high explicit prices. Managers have incentives to expand their firms beyond the size that maximizes shareholder wealth. 9 Growth increases managers’ power by increasing the resources This discussion is based on Jensen (1986a). Gordon Donaldson (1984), in a detailed study of 12 large Fortune 500 firms, concludes that managers of these firms were not driven by maximization of the value of the firm, but rather by the maximization of â€Å"corporate wealth. He defines corporate wealth as â€Å" the aggregate purchasing power available to management for strategic purposes during any given planning period†¦. this wealth consists of 9 8 M. C. Jensen 15 1987 under their control. In addition, changes in management compensation are positively related to growth. 10 The tendency of firms to reward middle managers through promotion rather than year-to-year bonuses also creates an organizational bias toward growth to supply the new positions that such promotion-based reward systems require (Baker, 1986);.The tendency for managers to overinvest resources is limited by competition in the product and factor markets that tends to drive prices toward minimum average cost in an activity. Managers must therefore motivate their organizations to be more efficient in order to improve the probability of survival. Product and factor market disciplinary forces are often weaker in new activities, however, and in activities that involve substantial economic rents or quasi-rents. 1 Activities yielding substantial economic rents or quasi-rents are the types of activities that generate large amounts of free cash flow. In these situations, monitoring by the firm’s internal control system and the market for corporate control are more important. Conflicts of interest between shareholders and managers over payout policies are especially severe when the organization generates substantial free cash flow. The problem is how to motivate managers to disgorge the cash rather than invest it below the cost of capital or waste it through organizational inefficiencies.Myers and Majluf (1984) argue that financial flexibility (unused debt capacity and internally generated funds) is desirable when a firm’s managers have better information about the firm than outside investors. Their arguments assume that managers act in the best interest of shareholders. The arguments offered here imply the stocks and flows of cash and cash equivalents (primarily credit) that management can u se at its discretion to implement decisions involving the control of goods and services† (p. 3, emphasis in original). In practical terms it is cash, credit, and other corporate purchasing power by which management commands goods and services† (p. 22). 10 Where growth is measured by increases in sales. See Murphy (1985). This positive relationship between compensation and sales growth does not imply, although it is consistent with, causality. 11 Rents are returns in excess of the opportunity cost of the permanent resources in the activity. Quasirents are returns in excess of the opportunity cost of the short-lived resources in the activity. M. C.Jensen 16 1987 that such flexibility has costs; financial flexibility in the form of free cash flow (including both current free cash in the form of large cash balances, and future free cash flow reflected in unused borrowing power) provides managers with greater discretion over resources that is often not used in the shareholder s’ interests. Therefore, contrary to Myers and Majluf, the argument here implies that eventually the agency costs of free cash flow cause the value of the firm to decline with increases in financial flexibility.The theory developed here explains (1) how debt-for-stock exchanges reduce the organizational inefficiencies fostered by substantial free cash flow; (2) how debt can substitute for dividends; (3) why â€Å"diversification† programs are more likely to be associated with losses than are expansion programs in the same line of business; (4) why mergers within an industry and liquidation-motivated takeovers will generally create larger gains than cross-industry mergers; (5) why the factors stimulating takeovers in such diverse businesses as broadcasting, tobacco, cable systems and oil are essentially identical; and (6) why bidders and some targets tend to show abnormally good performance prior to takeover.The Role of Debt in Motivating Organizational Efficiency The a gency costs of debt have been widely discussed (Jensen and Meckling (1976); Smith and Warner (1979)), but, with the exception of the work of Grossman and Hart (1980), the benefits of debt in motivating managers and their organizations to be efficient have largely been ignored. Debt creation, without retention of the proceeds of the issue, enables managers effectively to bond their promise to pay out future cash flows. Thus, debt can be an effective substitute for dividends, something not generally recognized in the corporate finance literature. 12 By issuing debt in exchange for stock, Literally, principal and interest payments are substitutes for dividends. Dividends and debt are not perfect substitutes, however, because interest is tax-deductible at the corporate level and dividends are not. 12 M. C. Jensen 17 1987 anagers bond their promise to pay out future cash flows in a way that simple dividend increases do not. In doing so, they give shareholder-recipients of the debt the ri ght to take the firm into bankruptcy court if they do not keep their promise to make the interest and principal payments. 13 Thus, debt reduces the agency costs of free cash flow by reducing the cash flow available for spending at the discretion of managers. These control effects of debt are a potential determinant of capital structure. Managers with substantial free cash flow can increase dividends or repurchase stock and thereby pay out current cash that would otherwise be invested in low-return projects or wasted.This payout leaves managers with control over the use of future free cash flows, but they can also promise to pay out future cash flows by announcing a â€Å"permanent† increase in the dividend. 14 Because there is no contractual obligation to make the promised dividend payments, such promises are weak. Dividends can be reduced by managers in the future with little effective recourse available to shareholders. The fact that capital markets punish dividend cuts wit h large stock price reductions (Charest (1978); Aharony and Swary (1980)) can be interpreted as an equilibrium market response to the agency costs of free cash flow. Brickley, Coles and Soo Nam (1987) find that firms that regularly pay extra dividends appear to have positive free cash flow. In comparison with a control group they have significantlyRozeff (1982) and Easterbrook (1984b) argue that regular dividend payments can be effective in reducing agency costs with managers by assuring that managers are forced more frequently to subject themselves and their policies to the discipline of the capital markets when they acquire capital. 14 Interestingly, Graham and Dodd (1951, Chapters 32, 34 and 36) in their treatise, Security Analysis, place great importance on the dividend payout in their famous valuation formula: V=M(D+. 33E). (See p. 454. ) V is value, M is the earnings multiplier when the dividend payout rate is a â€Å"normal two-thirds of earnings,† D is the expected di vidend, and E is expected earnings.In their formula, dividends are valued at three times the rate of retained earnings, a proposition that has puzzled many students of modern finance (at least of my vintage). The agency cost of free cash flow that leads to over retention and waste of shareholder resources is consistent with the deep suspicion with which Graham and Dodd viewed the lack of payout. Their discussion (chapter 34) reflects a belief in the tenuous nature of the future benefits of such retention. Although they do not couch the issues in terms of the conflict between managers and shareholders, the free cash flow theory explicated here implies that their beliefs, sometimes characterized as a preference for â€Å"a bird in the hand is worth two in the bush,† were perhaps well founded. 13 M. C. Jensen 18 1987 igher cash plus short-term investments, and earnings plus depreciation, relative to their total assets. They also have significantly lower debt-to-equity ratios. Th e issuance of large amounts of debt to buy back stock sets up organizational incentives to motivate managers to pay out free cash flow. In addition, the exchange of debt for stock helps managers overcome the normal organizational resistance to retrenchment that the payout of free cash flow often requires. The threat of failure to make debt-service payments serves as a strong motivating force to make such organizations more efficient. Stock repurchase for debt or cash also has tax advantages.Interest payments are tax-deductible to the corporation, that part of the repurchase proceeds equal to the seller’s tax basis in the stock is not taxed at all, and prior to 1987 tax rates on capital gains were favorable. Increased leverage also has costs. As leverage increases, the usual agency costs of debt, including bankruptcy costs, rise. One source of these costs is the incentive to take on projects that reduce total firm value but benefit shareholders through a transfer of wealth fro m bondholders. These costs put a limit on the desirable level of debt. The optimal debt/equity ratio is the point at which firm value is maximized, the point where the marginal costs of debt just offset the marginal benefits. The debt created in a hostile takeover (or takeover defense) of a firm suffering severe agency costs of free cash flow need not be permanent.Indeed, sometimes â€Å"overleveraging† such a firm is desirable. In these situations, leveraging the firm so highly that it cannot continue to exist in its old form yields benefits by providing motivation for cuts in expansion programs and the sale of divisions that are more valuable outside the firm. The proceeds are used to reduce debt to a more normal or permanent level. 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. M. C. Jensen 19 1987 The control hypothesis does not i mply that debt issues will always have positive control effects.For example, these effects will not be as important for rapidly growing organizations with large and highly profitable investment projects but no free cash flow. Such organizations will have to go regularly to the financial markets to obtain capital. At these times the markets have an opportunity to evaluate the company, its management, and its proposed projects. Investment bankers and analysts play an important role in this monitoring, and the market’s assessment is made evident by the price investors pay for the financial claims. The control function of debt is more important in organizations that generate large cash flows but have low growth prospects, and it is even more important in organizations that must shrink.In these organizations the pressure to waste cash flows by investing them in uneconomic projects is most serious. Evidence from Financial Transactions Free cash flow theory helps explain previously puzzling results on the effects of various financial transactions. Smith (Smith, 1986, tables 1 to 3) summarizes more than 20 studies of stock price changes at announcements of transactions that change capital structure as well as various other dividend transactions. These results and those of others are presented in table 2. For firms with positive free cash flow, the theory predicts that stock prices will increase with unexpected increases in payouts to shareholders and decrease with unexpected decreases in payouts.It also predicts that unexpected increases in demand for funds from shareholders via new issues will cause stock prices to fall. The theory also predicts stock prices will increase with increasing tightness of the constraints binding the payout of future cash flow to shareholders and decrease with reductions in the tightness of these constraints. These predictions do not apply to those firms with more profitable projects than cash flow to fund them. M. C. Jensen 20 1987 The predictions of free cash flow theory are consistent with all but three of the 32 estimated abnormal stock price changes summarized in table 2, and one of the inconsistencies is explained by another phenomenon.Panel A of table 2 shows that stock prices rise by a statistically significant amount with announcements of the initiation of cash dividend payments, increases in dividends and specially designated dividends, and fall by a statistically significant amount with decreases in dividend payments. (All coefficients in table 2 are significantly different from zero unless noted with an asterisk. ) Panel B shows that security sales and retirements that raise cash or pay out cash and simultaneously provide offsetting changes in the constraints bonding the payout of future cash flow are all associated with returns that are insignificantly different from zero.The insignificant return on retirement of debt fits the theory because the payout of cash is offset by an equal reduction in th e present value of promised future cash payouts. If debt sales are not associated with changes in the expected investment program, the insignificant return on announcement of the sale of debt and preferred also fits the theory. The acquisition of new funds with debt or preferred stock is offset exactly by a commitment bonding the future payout of cash flows of equal present value. If the funds acquired through new debt or preferred issues are invested in projects with negative net present values, the abnormal stock price change will be negative. If they are invested in projects with positive net present values, the abnormal stock price change will be positive.Sales of convertible debt and preferred securities are associated with significantly negative stock price changes (panel C). These security sales raise cash and provide little effective bonding of future cash flow payments; when the stock into which the debt is convertible is worth more than the face value of the debt, manageme nt has incentives to call the convertible securities and force conversion to common. M. C. Jensen 21 1987 Panel D shows that, with one exception, security retirements that pay out cash to shareholders increase stock prices. The price decline associated with targeted large block repurchases (often called greenmail) is highly likely to be due to the reduced probability that a takeover premium will be realized.These transactions are often associated with standstill agreements in which the seller of the stock agrees to refrain from acquiring more stock and from making a takeover offer for some period into the future (Mikkelson and Ruback (1985; 1986); Dann and DeAngelo (1983); and Bradley and Wakeman (1983);). Panel E summarizes the effects of security sales and retirements that raise cash and do not bond future cash flow payments. Consistent with the theory negative abnormal returns are associated with all such changes, although the negative returns associated with the sale of common t hrough a conversion-forcing call are statistically insignificant.Panel F shows that all exchange offers or designated use security sales that increase the bonding of payout of future cash flows result in significantly positive increases in common stock prices. These include stock repurchases and exchange of debt or preferred for common, debt for preferred, and income bonds for preferred. The twoday gains range from 21. 9 percent (debt for common) to 1. 6 percent for income bonds and 3. 5 percent for preferred. 15 The theory predicts that transactions with no cash flow and no change in the bonding of payout of future cash flows will be associated with returns that are insignificantly different from zero. Panel G of table 2 shows that the evidence is mixed; 15 The two-day returns of exchange offers and self-tenders can be affected by the offer.However, if there are no real effects or tax effects, and if all shares are tendered to a premium offer, then the stock price will be unaffecte d by the offer and its price effects are equivalent to those of a cash dividend. Thus, when tax effects are zero and all shares are tendered, the two-day returns are appropriate measures of the real effects of the exchange. In other cases the correct returns to be used in these transactions are those covering the period from the day prior to the offer announcement to the day after the close of the offer (taking account of the cash payout). See, for example, Rosenfeld (1982), whose results for the entire period are also consistent with the theory. M. C. Jensen 22 1987 he returns associated with exchange offers of debt for debt are significantly positive and those for designated-use security sales are insignificantly different from zero. All exchanges and designated-use security sales that have no cash effects but reduce the bonding of payout of future cash flows result, on average, in significant decreases in stock prices. These transactions include the exchange of common for debt or preferred or preferred for debt, or the replacement of debt with convertible debt and are summarized in Panel H. The two-day losses range from 7. 7 percent (preferred for debt) to 1. 1 percent (common for debt). In summary, the results in table 2 are remarkably consistent with free cash flow theory hich predicts that, except for firms with profitable unfunded investment projects, stock prices will rise with unexpected increases in payouts to shareholders (or promises to do so) and will fall with reductions in payments or new requests for funds from shareholders (or reductions in promises to make future payments). Moreover, the size of the value changes seems to be positively related to the change in the tightness of the commitment bonding the payment of future cash flows. For example, the effects of debtfor-preferred exchanges are smaller than the effects of debt-for-common exchanges. Tax effects can explain some of the results summarized in table 2, but not all.For example, the ex change of preferred for common, or replacement of debt with convertible debt, has no tax effects and yet is associated with price increases. The last column of table 2 denotes whether the individual coefficients are explainable by pure corporate tax effects. The tax theory hypothesizes that all unexpected changes in capital structure that decrease corporate taxes increase stock prices and vice versa. 16 Therefore, increases in dividends and reductions of debt interest should cause stock prices to fall, and vice versa. 17 Fourteen of the 32 coefficients are inconsistent with the corporate tax See, however, Miller (1977) who argues that allowing for personal tax effects and the equilibrium response of firms implies that no tax effects will be observed. 7 Ignoring potential tax effects due to the 85 percent exclusion of dividends received by corporations on holdings of preferred stock. 16 M. C. Jensen 23 1987 Table 23 Summary of Two-Day Average Abnormal Stock Returns Associated with th e Announcement of Various Dividend and Capital Structure Transactionsa Average Sample Size Average Abnormal Return (Percent) Free Cash Flow Theory Agreement with Tax Predicted Agreement Theory Sign with Theory? Type of Transaction A. Dividend changes that change the cash paid to shareholders Dividend initiation1 Dividend increase2 Specially designated dividend Dividend decrease2 3 Security Issued Security Retired 160 281 164 48 3. 7% 1. 0 2. 1 -3. 6 + + + – es yes yes yes no no no no B. Security sales (that raise cash) and retirements (that pay out cash) that simultaneously provide offsetting changes in the constraints bonding future payment of cash flows Security sale (industrial) 4 Security sale (utility) 5 Security sale (industrial) 6 Security sale (utility) Call8 7 debt debt preferred preferred none none none none none debt none none none common common common common 248 140 28 251 133 74 54 9 147 182 15 68 – 0. 2* -0. 1* -0. 1* -0. 1* -0. 1* -2. 1 -1. 4 -1. 6 15. 2 3. 3 1. 1 -4. 8 0 0 0 0 0 – – – + + + + yes yes yes yes yes yes yes yes yes yes yes no b no no yes yes no no no no yes yes yes no b C.Security sales that raise cash and bond future cash flow payments only minimally Security sale (industrial) 4 conv. debt 7 Security sale (industrial) conv. preferred 7 Security sale (utility) conv. preferred D. Security retirements that pay out cash to shareholders Self tender offer 9 Open market purchase10 Targeted small holdings11 Targeted large block repurchase12 none none none none M. C. Jensen 24 1987 E. Security sales or calls that raise cash and do not bond future cash flow payments Security sale (industrial) 13 common none Security sale (utility)14 common none Conversion-forcing call15 common conv. preferred Conversion-forcing call15 common conv. debt F.Exchange offers, or designated use security sales that increase the bonding of payout of future cash debt common Designated use security sale16 Exchange offer 17 debt comm on 17 Exchange offer preferred common 17 Exchange offer debt preferred Exchange offer 18 income bonds preferred G. Transaction with no change in bonding payout of future cash flows Exchange offer 19 debt 20 Designated use security sale debt debt debt 215 405 57 113 flows 45 52 10 24 18 36 96 -3. 0 -0. 6 -0. 4* -2. 1 21. 9 14. 0 8. 3 3. 5 1. 6 0. 6 0. 2* -2. 4 -2. 6 -7. 7 -4. 2 -1. 1 – – – – + + + + + 0 0 – – – – – yes yes no yes yes yes yes yes yes no yes yes yes yes yes yes yes yes yes yes yes yes no yes yes no yes yes no yes yes yes H.Exchange offers, or designated use security sales that decrease the bonding of payout of future cash flows Security sale 20 conv. debt debt 15 Exchange offer 17 common preferred 23 17 Exchange offer preferred debt 9 20 Security sale common debt 12 Exchange offer 21 common debt 81 a Returns are weighted averages, by sample size, of the returns reported by the respective studies All returns are significantly different from zero unless noted otherwise by *. b Explained by the fact that these transactions are frequently associated with the termination of an actual or expected control bid. The price decline appears to reflect the loss of an expected control premium. Source: 1 Asquith and Mullins (1983). 2 Charest (1978); Aharony and Swary (1980). 3 From Brickley (1983). Dann and Mikkelson (1984); Eckbo (1986); Mikkelson and Partch (1986). 5 Eckbo (1986). 6 Linn and Pinegar (1985); Mikkelson and Partch (1986). 7 Linn and Pinegar (1985). 8 Vu (1986). 9 Dann (1981); Masulis (1980); Vermaelen (1981); Rosenfeld (1982). 10 Dann (1980); Vermaelen (1981). 11 Bradley and Wakeman (1983). 12 Calculated by Smith (1986), table 4, from Dann and DeAngelo (1983); Bradley and Wakeman (1983). 13 Asquith and Mullins (1986); Kolodny and Suhler (1985); Masulis and Korwar (Korwar and Masulis); Mikkelson and Partch (1986). 14 Asquith and Mullins (1986); Masulis and Korwar (1986); Pettway and R adcliffe (1985). 15 Mikkelson (1981). 16 Others with more than 50% debt Masulis (1980). 17 Masulis (1983).These returns include announcement days of both the original offer and, for about 40 percent of the sample, a second announcement of specific terms of the exchange 18 McConnell and Schlarbaum (1981). 19 Dietrich (1984). 20Eckbo (1986); Mikkelson and Partch (1986). 21Rogers and Owers (1985); Peavy and Scott (1985); Finnerty (1985). (Allen, 1987; Auerbach and Reishus, 1987; Biddle and Lindahl, 1982; Bradley, Desai, and Kim, 1983; Bradley and Rosensweig, 1986; Comment and Jarrell, 1986; 1986; Crovitz, 1985; Easterbrook, 1984a; Eckbo, 1985; 1985; Fama and Jensen, 1983a, b, 1985; Franks, Harris, and Mayer, 1987; Golbe and White, 1987; Herzel, Colling, and Carlson, 1986; Holderness and Sheehan, 1985; 1985; Jarrell, Poulsen, and Davidson, 1985; Jensen, 1985, 1986b; Jensen and Smith, 985; Kaplan and Roll, 1972; Koleman, 1985; Lambert and Larcker, 1985; Malatesta and Walkling, 1985; Mart in, 1985; Morrison, 1982; Mueller, 1980; Myers, 1977; Office of the Chief Economist, 1984, 1985b, 1986; Paulis, 1986; Ravenscraft and Scherer, 1985a, b; Ricks, 1982; Ricks and Biddle, 1987; Ruback, 1988; Ryngaert, 1988; Shoven and Simon, 1987; Sunder, 1975; You et al. ) Jensen 25 1987 hypothesis. Simple signaling effects, where the payout of cash signals the lack of present and future investments promising returns in excess of the cost of capital, are also inconsistent with the results-for example, the positive stock price changes associated with dividend increases and stock repurchases. If anything, the results in table 2 seem too good, for two reasons.The returns summarized in the table do not distinguish firms that have free cash flow from those that do not have free cash flow, yet the theory says the returns to firms with no free cash flow will behave differently from those which do. In addition, only unexpected changes in cash payout or the tightness of the commitments bonding the payout of future free cash flow should affect stock prices. The studies summarized in table 2 do not, in general, control for the presence or absence of free cash flow or for the effects of expectations. If free cash flow effects are large and if firms on average are in a positive free cash flow position, the predictions of the theory will hold for the simple sample averages. To see how the agency costs of free cash flow can be large enough to show up in the uncontrolled tests summarized in table 2, consider the graph of equilibrium firm M.C. Jensen 26 1987 value and free cash flow in figure 1. Figure 1 portrays a firm whose manager values both firm value (perhaps because stock options are part of the compensation package) and free cash flow. The manager, however, is willing to trade them off according to the given indifference curves. By definition, firm value reaches a maximum at zero free cash flow. The point (V*, F*) represents the equilibrium level of firm value and free ca sh flow for the manager. It occurs at a positive level of free cash flow and at a point where firm value is lower than the maximum possible. The difference Vmax – V* is the agency cost of free cash flow.Because of random factors and adjustment costs, firms will deviate temporarily from the optimal F*. The dashed line in figure 1 portrays a hypothetical rectangular distribution of free cash flow in a cross section of firms under the assumption that the typical firm is run by managers with preferences similar to those portrayed by the given indifference curves. Changes in free cash flow (or the tightness of constraints binding its payout) will be positively related to the value of the firm only for the minority of firms in the cross section with negative free cash flow. These are the firms lying to the left of the origin, 0. The relation is negative for all firms in the range with positive free cash flow.Given the hypothetical rectangular distribution of firms in figure 1, the majority of firms will display a negative relation between changes in free cash flow and changes in firm value. As a result the average price change associated with movements toward (V*, F*) will be negatively related to changes in free cash flow. If the effects are so pervasive that they show up strongly in the crude tests of table 2, the waste due to agency problems in the corporate sector is probably greater than most scholars have thought. This waste is one factor contributing to the high level of activity in the corporate control market over the past decade. More detailed tests of the propositions that control for growth prospects and expectations will be interesting. M. C. Jensen 27 1987Evidence from Going-Private and Leveraged Buyout Transactions Many of the benefits in going-private and leveraged buyout transactions seem to be due to the control function of debt. These transactions are creating a new organizational form that competes successfully with the open corporate form because of advantages in controlling the agency costs of free cash flow. In 1985, going-private and leveraged buyout transactions totaled $37. 4 billion and represented 32 percent of the value of all public acquisitions. 18 Most studies have shown that premiums paid for publicly held firms average over 50 percent,19 but in 1985 the premiums for publicly held firms were 31 percent (Grimm, 1985). Leveraged buyouts are frequently financed with high debt; 10:1 ratios of debt to equity are not uncommon, and they average 5. 5:1 (Schipper and Smith (1986); Kaplan (1987); and DeAngelo and DeAngelo (1986)). Moreover, the use of â€Å"strip financing† and the allocation of equity in the deals reveal a sensitivity to incentives, conflicts of interest, and bankruptcy costs. Strip financing, the practice in which investors hold risky nonequity securities in approximately equal proportions, limits the conflict of interest among such securityholders and therefore limits bankruptcy costs. T op managers and the sponsoring venture capitalists hold disproportionate amounts of equity. A somewhat oversimplified example illustrates the organizational effects of strip financing. Consider two firms identical in every respect except financing.Firm A is entirely financed with equity, and Firm B is highly leveraged with senior subordinated debt, convertible debt, and preferred as well as equity. Suppose Firm B securities are sold only in strips; that is, a buyer purchasing a certain percentage of any security must purchase the same percentage of all securities, and the securities are â€Å"stapled† together See W. T. Grimm, Mergerstat Review (1985, Figs. 29, 34 and 38). See DeAngelo, DeAngelo and Rice (1984), Lowenstein (1985), and Schipper and Smith (1986). Lowenstein also mentions incentive effects of debt but argues tax effects play a major role in explaining the value increase. 19 18 M. C. Jensen 28 1987 o they cannot be separated later. Security holders of both firms have identical unlevered claims on the cash flow distribution, but organizationally the two firms are very different. If Firm A managers withhold dividends to invest in value-reducing projects or if they are incompetent, the shareholders must use the clumsy proxy process to change management or policies. In Firm B, strip holders have recourse to remedial powers not available to the equity holders of Firm A. Each Firm B security specifies the rights its holder has in the event of default on its dividend or coupon payment; for example, the right to take the firm into bankruptcy or to have board representation.As each security above equity goes into default, the strip holder receives new rights to intercede in the organization. As a result, it is quicker and less expensive to replace managers in Firm B. Moreover, because every security holder in the highly leveraged Firm B has the same claim on the firm, there are no conflicts between senior and junior claimants over reorganization of the claims in the event of default; to the strip holder it is a matter of moving funds from one pocket to another. Thus, Firm B will not go into bankruptcy; a required reorganization can be accomplished voluntarily, quickly, and with less expense and disruption than through bankruptcy proceedings. The extreme form of strip financing in the example is not normal practice.Securities commonly subject to strip practices are often called â€Å"mezzanine† financing and include securities with priority superior to common stock yet subordinate to senior debt. This arrangement seems to be sensible, because several factors ignored in our simplified example imply that strictly proportional holdings of all securities is not desirable. For example, IRS restrictions deny tax deductibility of debt interest in such situations and bank holdings of equity are restricted by regulation. Riskless senior debt need not be in the strip because there are no conflicts with other claimants in the event of reorganization when there is no probability of default on its payments. M. C. Jensen 29 1987Furthermore, it is advantageous to have the top-level managers and venture capitalists who promote leveraged buyout and going-private transactions hold a larger share of the equity. Top-level managers on average receive over 30 percent of the equity, and venture capitalists and the funds they represent generally retain the major share of the remainder (Schipper and Smith (1986); Kaplan (1987)). The venture capitalists control the board of directors and monitor the managers. Both managers and venture capitalists have a strong interest in making the venture successful because their equity interests are subordinate to other claims. Success requires (among other things) implementation of changes to avoid investment in low-return projects in order to generate the cash for debt service and to increase the value of equity.Finally, when the equity is held by a small number of people, efficiencies in risk-bearing can be achieved by placing more of the risk in