Coronation Street’s Jack Duckworth had some good advice last night not only to Tyrone about marriage but also for investors in SBC and Procter and Gamble: “If you only want a pint of milk every now and then, there’s no point buying a cow.”
Jack is reminding us of Oliver Hart’s question: why does ownership of an asset matter?
Hart’s answer, in his crucial book, Firms Contracts and Financial Structure, is that “ownership is a source of power when contracts are incomplete.”
This tells us why we don’t usually need to buy a cow; we can contract easily to get milk when we want it.
But there are circumstances in which it would make sense to buy the cow – if you couldn’t contract to get milk of acceptable quality and price at the times you wanted it, buying the cow might be the best way of getting milk.
So, the question SBC investors should ask is: what can SBC get from buying AT&T that they couldn’t get from a contractual arrangement, such as a joint venture or a stake in AT&T? What exactly are the benefits of control? Why buy the cow?
It’s not good enough to speak of the “heritage and strength of the AT&T brand.” You can get these by buying a small part of AT&T.
Nor is it sufficient to speak of SBC and AT&T being complementary; you have to show how that complementarity can actually raise profits. And again, it’s not good enough to talk of the potential for cost-cutting. History shows that potential often goes unrealized.
What’s more, the superiority of control rights over contractual agreements is easily overstated. The theory is that management fiat gets things done quicker and cheaper than haggling over contracts. But this ignores the prevalence of rent-seeking and bounded rationality within a company. In practice, making the right and effective management decisions can be as difficult as writing or enforcing a contract. That’s one reason why so many mergers fail*.
I’ve no view on whether the SBC/AT&T or P&G/Gillette mergers will succeed or fail. All I’m saying is that, if you want a view, you’ve got to answer the Duckworth-Hart question.
* But just how many do fail? The conventional wisdom that most do so might not be as strong as sometimes thought. Much of the evidence is based upon studies showing that the acquirer’s share price falls after the merger. But these studies are open to criticism, for example from these guys.