In new research, Carl T. Bogus uses General Electric as a case study to argue that regulators should prohibit companies that have reached a certain size from growing through mergers and acquisitions due to more common inefficiencies and their outsized harms to stakeholders and society.
Once a corporation reaches a certain size, it should be prohibited from growing larger through mergers or acquisitions due to increasing likelihoods of diseconomies of scale, risks to innovation, and the disproportionate harm from irrational behavior. Where to place a merger cap is a matter of judgment, not science, but it might apply to companies with revenues exceeding 0.5% of the gross national product. Currently, that would include about 325 firms in the United States.
This is a radical proposal. It flies in the face of current antitrust doctrine, which holds that firm size is irrelevant and that mergers should be permitted unless the new firm will have sufficient market power to raise prices. That depends on the market share of the new firm and the number of rivals with which it will compete.
Modern merger policy assumes that companies know what they are doing. If a merger is competitively permissible because it will not give the new firm sufficient market power to raise prices, and the merging parties want to pursue the merger nonetheless, then the parties must have determined that the merger will create efficiencies that will make the new firm more profitable and create wealth for shareholders and customers through lower costs. But studies show this assumption is wrong. Most mergers do not create efficiencies. But if companies do, in fact, know what they are doing, how can that be?
An evaluation of the merger history of General Electric Company from 1981 to 2017 helps answer that question. It also illustrates why a merger cap makes sense. During those years, GE’s CEOs were Jack Welch and Jeff Immelt. GE was considered the best managed company in America; some believed it had transformed management into “something resembling a hard science.” If there was a company capable of making smart acquisitions, it should have been GE.
During those 36 years, GE acquired nearly 1,380 other companies. Almost all of those acquisitions failed; that is, they did not make GE more efficient, more innovative, or more profitable. In fact, GE’s acquisitions all but destroyed what had been one of the nation’s most revered companies.
Let’s examine three of GE’s most important acquisitions to see what we can learn.
In December 1985, GE agreed to purchase RCA Corporation for $6.28 billion. On paper, the merger seemed sensible: GE made land-based radar; RCA made ship-based radar. GE made military satellites; RCA made civilian satellites. Both companies made semiconductors and televisions. But the merger was not about any of that. GE acquired RCA for only one reason: RCA owned the NBC television network. GE sold its semiconductor business in 1988 and all defense-related businesses in 1992. By 1998, GE had shed all remaining vestiges of RCA except for NBC.
If a television network seems like an odd acquisition for an industrial corporation, it is because it was an odd acquisition. Jack Welch simply wanted to own a television network. He became interested in RCA only after both CBS and ABC had become unavailable. The consensus today is that NBC was a vanity purchase. Welch relished appearing as a guest on CNBC’s Business Center and NBC’s Tonight Show, playing golf with NBC celebrities and having them at home for dinner parties, and personally participating in contract renegotiations with stars like Jerry Seinfeld.
When GE acquired it, NBC was riding high. But GE knew nothing about running a television network, and it put its own managers at the head of the network. By 1992, NBC was in last place and hemorrhaging tens of millions of dollars per year.
Lesson 1: Corporate acquisitions can have more to do with the personal motivations and foibles of corporate leaders than with sound business strategy. While this can happen to a company of any size, the potential magnitude of socially harmful behavior is greater with giant firms that can afford more and larger acquisitions.
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In 1986, GE acquired the securities trading and investment banking firm Kidder Peabody. Welch wanted to bring in house the investment-banking work for GE’s enormous volume of mergers. As Welch explained, “We were getting tired of putting up all of the money and taking all of the risk while watching the investment bankers walk away with huge up-front fees.” GE settled on Kidder Peabody only after more prominent investment banks rebuffed its advances. Kidder needed the merger because it was undercapitalized.
GE knew no more about securities than it knew about television. Kidder’s CEO, Ralph DeNunzio, outmaneuvered GE into ultimately paying $1.15 billion for a firm that earned $43 million in the year preceding the acquisition. Following an insider-trading scandal, Welch replaced DeNunzio with a series of GE managers unschooled in securities. The last executive in the series rewarded a Kidder trader who had racked up a truly unbelievable number of trades by naming him Kidder’s “Man of the Year” and giving him a $9 million bonus—only to discover that a vast number of the trades were fraudulent and $350 million was missing. In 1994, GE threw in the towel and sold Kidder. Welch later said, “It was a classic case of hubris….I thought I could make anything work.”
Lesson 2: The larger the firm, the greater its complexity and the more top management will not understand the operations of various divisions and subsidies.
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When he retired in 2001, Welch was widely acclaimed as the greatest CEO of his time. Under his watch, GE stock rose from $1.20 to about $50 per share. Fortune pronounced Welch “Manager of the Century.” But Welch’s handpicked successor, Jeff Immelt, knew better. The once great industrial giant had become a hodgepodge of unrelated businesses. GE acquisitions— averaging four per month, sustained over twenty years—had mesmerized Wall Street. Yet nearly all of Welch’s nearly 1,000 mergers failed to provide their predicted benefits. GE’s acquisition assembly line had been something of a Ponzi scheme, with new mergers financed by breaking up and selling off parts of prior mergers. There was a disjunction between short-term profitability (and activity that, with the help of creative accounting, appeared profitable) and long-term company health and profitability.
Lesson 3: Perhaps the market cannot be fooled forever, but it can be fooled for a very long time. The complexity of larger firms can better hide irrational and unprofitable behavior from shareholders and regulators.
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Immelt needed to pull GE out of a tailspin without revealing it was in one. He decided to return GE to its industrial roots through a new acquisition strategy of divesting GE of some of its non-industrial businesses while acquiring new industrial holdings. The most important of Immelt’s 380 acquisitions—and the largest in GE history—was buying the power generation and transmission businesses of the French firm Alstom S.A.
GE and Alstom agreed on a $13.5 billion purchase price. But the French government—unhappy with losing the largest part of a national champion—tried to block the acquisition. EU and U.S. antitrust regulators also objected to the deal as originally structured. To win approval, GE repeatedly sweetened its offer. The purchase price rose to $13.8 billion while GE wound up buying considerably less. When the GE business development team crunched the final numbers, they concluded the acquisition no longer made sense. And it wasn’t even close. The team expected the GE officer to whom they reported to recommend that Immelt invoke a breakup clause and terminate the deal. Instead, that officer told them, “This is Jeff’s deal. We are not backing away.”
The merger was consummated but turned out to be a flop. Immelt later conceded he overpaid by $2 or $3 billion. Why had that happened? Organizational behaviorists have identified an “escalation of commitment” bias, which causes some administrators who become committed to course to escalate the commitment of resources toward that objective, even when confronted with evidence that they should back off.
Lesson 4: Business decisions can be irrational, even important ones by sophisticated companies. With larger companies, irrational decisions have more severe consequences.
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Research and development are expensive; researchers will reach many dead ends before exclaiming “Eurika!” It is more efficient for a corporate giant to divest in R&D and simply acquire other firms that make valuable discoveries. That is what GE did. In a 2009 speech, Immelt confessed, “While some of America’s competitors were throttling up on manufacturing and R&D, we deemphasized technology.”
Growing organically is hard work. Here, too, being big enough to buy others has advantages. In 1994, the Wall Street Journal reported: “Another way GE manages its earnings is by literally buying them—by acquiring companies or assets that are immediately profitable because they throw off more income than GE’s cost of financing.”
Lesson 5: It is too easy for giant companies to buy rather than earn success. This makes giant firms less creative and suppresses society-wide innovation.
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Back when Welch became CEO, GE employed 400,000 people. When he stepped down in 2001, it employed 300,000. GE’s workforce shrank by 25% even though it had absorbed nearly 1,000 other companies. In the main, GE’s acquisition program was not about making the firms it purchased, or itself, more efficient. GE behaved like a hedge fund: shuttering, offshoring, and selling off large portions of its acquisitions.
Wall Street loved GE for the same reasons it loves hedge funds. Other giant companies imitated GE, often hiring Welch acolytes as their CEOs. Countless people were thrown out of work while corporate cultures shifted from earning success to dazzling Wall Street.
Boeing was one such company. No longer content with making reasonable profits while building the world’s best airplanes, Boeing merged with aerospace manufacturer McDonnell-Douglas, whose CEO, Harry Stonecipher—a former Welch protégé—became CEO of the merged firm. Boeing’s board wanted Stonecipher to replicate at Boeing the soaring stock prices he had achieved at McDonnell. Stonecipher, like Welch, was all about prioritizing short-term shareholder value above all else. At McDonnell, he had spent precious funds to boost the company’s stock price through stock buyback programs while cutting R&D 60 percent. When a scandal forced Stonecipher to resign from Boeing, the board replaced him with another Welch disciple to continue the work making shareholder value, rather than quality, the company’s highest value.
Lesson 6: Firm merger strategy affects more than merging firms and their shareholders. The financial resources and complexity of giant companies make them better able to acquire more firms and more prone to decisions that negatively affect workers and customers.
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In 2000, GE’s stock price hit a high of $300 per share. But its aggressive acquisition strategy, which led it to buy and attempt to operate many businesses it did not understand while disinvesting in R&D, coupled with otherwise prioritizing short-term shareholder value over long-term company health, finally caught up with it. Investors realized something was wrong when Immelt twice failed to meet his own publicly announced earnings projections. Immelt was forced to resign in 2017, and a series of successors could not put Humpty Dumpty back together again, either. Simply too much damage had been done. GE’s storied history ended in 2021 when the 129-year-old firm split into three separate companies. It would be a mistake to think of GE as outlier. While few, if any, companies may have made as many acquisitions in the same period of time, many of today’s giants have grown to their present size through scores—even hundreds—of mergers. GE confirms what studies have shown: most mergers fail. The GE story illustrates some of the reasons mergers fail, how long failures can be concealed, and that damage resulting from mergers by corporate giants affects not only the merging firms and their shareholders but workers and society-at-large. Finally, GE shows why the benefits of a merger cap are likely to exceed its costs.
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