the leveraged buyout of RJR Nabisco by Kohlberg Kravis Roberts (KKR) for. $23 billion reflects the geographical dominance of the arbitrage economy: as a.
Environment and Planning A, 1989, volume 21, pages 997-1000
Commentary
Remaking the map of corporate capitalism: the arbitrage economy of the 1990s If the notion of deindustrialization broadly described the spatial consequences of corporate strategy during the 1960s and 1970s, and if restructuring could be thought to describe corporate strategy of the late 1970s and 1980s, how are we to characterize the emerging map of corporate capitalism of the late 1980s and 1990s? Deindustrialization had drastic consequences for the levels and locations of employment, involving plant closings, relocations, and the emergence of industrialization in the third world. Restructuring was aimed at increasing the productivity of labor, reducing the work force, and decreasing the producers' real wages paid to labor by means of rationalizing production around fewer, more valuable locations (Clark, 1989). Leveraged buyouts (LBOs), mergers, and acquisitions involve these policy options, plus one more: the transformation of the literal form of the corporation. The current wave of LBOs, mergers, and acquisitions has signaled the emergence of a new era where whole corporations are bought and sold for their asset value, whereas in the past corporate managers bought and sold businesses, plants, and even communities as parts of their production networks. In this new economy, corporations are valued for their disassembled worth whereas, even in restructuring, the management valued the assets for their functional worth (or opportunity cost). What we are witnessing is the emergence of a new form of corporate capitalism which may be described by the notion of arbitrage—the conversion of corporate assets into financial capital, and the redeployment of those assets into other sectors, businesses, and other corporate entities. The arbitrage economy in this sense is an economy fueled by the process of converting productive assets into financial assets and other corporate forms. The geographical consequences of this kind of corporate capitalism are manyfold. It is readily apparent that arbitrage centers (New York City, London, Hong Kong, Tokyo, etc) have grown extraordinarily over the last five years, and, notwithstanding the October 1987 stock market crash, these centers and their hinterlands are likely to grow even more in the next few years as the biggest deals of this century are played out away from the traditional production centers. Symbolically and literally, the leveraged buyout of RJR Nabisco by Kohlberg Kravis Roberts (KKR) for $23 billion reflects the geographical dominance of the arbitrage economy: as a merged conglomerate, the headquarters of RJR Nabisco had already been moved from Winston-Salem to Atlanta. With the leveraged buyout, the headquarters was moved from Atlanta to New York City. In essence, the logic of centralized control and decentralized production (so fundamental to textbook treatments of the geography of corporate management) has been taken over: centralized control in other centers is now necessary for the efficient conversion of assets, and decentralized production networks are assets to be sold rather than managed. The geographical consequences of arbitrage are more profound than suggested by the relocation of headquarters, but at present there is little research that can guide our analysis. Nevertheless, a couple of examples of processes of asset conversion can be sketched that bear upon the spatial structure of production. Take for example the LBO of Safeway Stores around the years 1987/1988. After fending off a takeover attempt by the Dart Group of Maryland (by paying a premium
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to Dart for their shares and purchase rights), management, in conjunction with KKR, took Safeway private. As a consequence of its LBO debt ($4.1 billion), Safeway sold many of its marginal and peripheral businesses—it sold 141 stores in Texas and the southwest, its Kansas City and Arkansas divisions were sold, and it closed a number of its stores in smaller mid-Atlantic communities. In all, some 9500 jobs were affected. A similar takeover attempt and then LBO (again involving the Dart Group and KKR) of Stop and Shop in 1988 affected 3000 jobs. This is another way of describing the transformation of the retail-service economy (see Wrigley, 1989). Generally speaking there appear to be three different ways in which an LBO affects the spatial organization of production. Assuming that the LBO results in a new operating corporation (not its whole liquidation of productive capacity), a vital ingredient of any LBO is the sale of assets to finance the deal. Thus Safeway sold assets in other states and other communities not essential to its core businesses. Inevitably there is a certain geography of divestiture which at present is largely undocumented but which must have vital implications for the concentration of competition in different geographical markets. A second consequence is the spatial rationalization of production and capacity. On the sellers' side, rationalization is vital to reduce the costs of servicing given markets. On the buyers' side rationalization is often necessary to fit acquired facilities into existing networks of plants and outlets. Again we know little or nothing about the spatial consequences of rationalization except for well-publicized plant-closures. And third, LBOs appear to put greater pressure on existing and surviving units to produce more efficiently relative to the debt burden assumed by management. The financing of LBOs is now almost entirely through junk bonds, but there have been instances where LBOs were financed by the management terminating and stripping off the excess assets of workers' pension funds. This process, known as pension reversion, was very important in the buyout by Texaco of Getty Oil in 1984. In addition, there is no doubt that pension reversions have been a way for the management of financially troubled corporations to become instant owners with little or no down payment. On the other hand, since their peak in 1985, pension terminations have dramatically declined in number and real value (see table 1). Although data are unavailable for 1989, it is likely that there were fewer reversions than in 1988 and that there will be even fewer reversions in 1990. The federal courts and the Internal Revenue Service have made it very difficult to terminate Table 1. Completed (1980 to 1988) and pending pension reversions (31 December 1988), by number, size, and value. Source: Pension Benefit Guaranty Corporation, unpublished data. Year
1980 1981 1982 1983 1984 1985 1986 1987 1988 Pending Total
Plans number 9 35 82 166 329 582 258 270 166 28 1925
Participants number 22242 30512 123587 168549 379716 708 744 261769 232041 180298 20481 2127939
Assets (Sm) 58.5 341.6 1136.8 3431.7 7402.3 13652.1 8 912.6 4899.9 4974.9 314.2 45 124.6
Benefits ($m) 40.0 183.0 732.9 1823.4 3 845.0 7 547.7 4628.1 2960.2 3189.1 196.1 25145.5
Reversion ($m) 18.5 158.6 403.9 1608.3 3 557.3 6 104.4 4284.5 1939.7 1785.8 118.1 19979.1
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overfunded pensions. Also, legislation is pending in Congress which would impose heavy financial penalties upon the termination of such plans, so it is unlikely that pension-fund assets will be used to finance management-led LBOs. Now, there is a vital difference between pension-fund assets and pension-fund managers. That is, although it is now very difficult for corporate management to raid their pension funds to pay off LBO debt, pension-fund managers are very much involved in buying unrelated LBO-based junk bonds. The RJR Nabisco buyout was first put together with support from some university pension-fund managers who expected a net return of as much as 35% to 45% (to the embarrassment of their university presidents). According to Drexel Burnham Lambert, in 1986 mutual funds accounted for 32% of junk-bond holdings, insurance companies 30%, pension funds 10%, and savings and loan associations 7% (the balance being held by individuals and other investors) (GAO, 1988). At this point the crisis of the savings and loan industry intersects with the arbitrage economy in ways unanticipated by the deregulators of that industry. Indeed, a crucial part of the story to be told of the growth of the arbitrage economy and its geographical manifestations is how the savings and loan industry of the south and southwest became active in the asset conversion business. The fact that most LBOs are externally financed and created through increasing the debt burden of surviving corporate units must be included as a vital element in any geography of the arbitrage economy, because, after the sale of assets and the rationalization of capacity, the only sources of money to finance the continuing debt obligations of an LBO are the workers and their communities. And yet, this dependence upon workers and their communities comes at a high price: plant closures and rationalization lose jobs. The President of the AFL-CIO (Lane Kirkland) estimates that LBOs and takeovers cost as many as 100000 unionized jobs during the period 1984-88. ( 1 ) Given that so few US workers are unionized, the total job loss due to LBOs and takeovers could have been as much as one million jobs during this period. These are interesting figures, but there are other issues to be considered. Paradoxically, at a time when management need a very productive work force, this work force is more at risk than ever before. A cyclical downturn would have drastic effects on the financial solvency of highly leveraged firms. The debt burden is often so large that highly leveraged firms are unable to invest, or even protect their markets, and these same firms often face an increasingly hostile competitive environment as other corporations (perhaps foreign, financed by their own merchant banks at much lower rates of interest), not so leveraged, begin to penetrate local markets. Given the track record of such highly leveraged firms in abandoning other communities, their plants, markets, and businesses, it is doubtful whether workers and their communities will or can reasonably trust management, or even work for management. The map of the emerging arbitrage economy will contain many locations bound together in tension and dispute. There will be places abandoned and closed through rationalization and through sale of assets. These places will be sources of political mobilization against the new financial elites. There will be places that grow and expand, linked by public and private telecommunication networks to the world's money markets, thereby financing and planning the new corporations of the arbitrage economy. These places will be the supercities, the world cities of the 1990s. There will be places that will depend upon the continuing vitality of the W Testimony given to the Senate Finance Committee on 26 January 1989; available from AFL-CIO, Sixteenth Street North West, Washington, DC.
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new corporations and will pay, through their own productivity and sweated labor, the inherited debt burden imposed by managers located in the money-market capitals of the world. Yet again, corporate capitalism is about to be recast into a new geography of power, control, and production. Elements of the new economy will appear familiar if we look back over this century: at issue is the question, "How will the current wave of leveraged buyouts and mergers and acquisitions affect the geographical character and structure of the world economy?" G L Clark References Clark G L, 1989, "US regional economic transformation in the context of international competition", in Deindustrialization and Regional Economic Transformation Eds. L Rodwin, H Sazanami (Unwin Hyman, Winchester, MA) forthcoming GAO, 1988 Financial Markets. Insurers, Purchasers, and Purposes of High Yield, Non-investment Grade Bonds General Accounting Office GGD-88-55FS (US Government Printing Office, Washington, DC) Wrigley N, 1989, "Commentary. The lure of the USA: further reflections on the internationalisation of British grocery retailing capital" Environment and Planning A 21 283-288
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