The Decade of Greed

Revisiting RJR Nabisco and the 1980s

We can think of valuing a company in two steps. First, forecast the future earnings of the company. Next, decide how much to pay for those future earnings. This is true conceptually, but in practice it is difficult to know which factor is at work, because we do not know what investors expect for earnings in the indefinite future. We can only look at the ratio of the stock price to earnings today, or the ratio of price to earnings projected for next year.

Since 1980, all of the major stock price indexes have been on a strong upward trajectory. Some of that has come from higher earnings. But most of it comes from either an increase in the estimate of future earnings growth or, more likely, a willingness of investors to pay more for a given level of expected future earnings.

I would argue that this began in the 1980s, the “decade of greed.” I have been re-reading Barbarians at the Gate, a 1989 best-seller by journalists Bryan Burrough and John Helyar about the takeover fight for RJR Nabisco.¹ This was the climactic leveraged buyout of the period. In the book’s epilogue, the authors write,

The Roaring Eighties were a new gilded age, where winning was celebrated at all costs. “The Casino Society,” Felix Rohatyn dubbed it. The investment bankers… conjured up wild schemes, pounded out new and more outlandish computer runs to justify them, then twirled their temptations before executives… RJR will go down as either the high point of the low point of an era.

It wasn’t an accident that RJR Nabisco should provide that moment. In its final decade Reynolds had become less a great company than a great dream machine. Its torrent of tobacco money allowed egos to run wild and fantasies to become true…

What did this all have to do with doing business?

The main characters in the book were Ross Johnson, the CEO of RJR Nabisco, and Henry Kravis, of KKR and company, the Wall Street firm that ultimately won the battle to take over the giant corporation. There is a movie based on the book that you can find on YouTube. Johnson is portrayed as a lovable rogue, and Kravis is portrayed as an ice-cold villain of the sort one would find in a James Bond film.

The book depicts neither Johnson nor Kravis favorably. Johnson’s main skill seems to have been manipulating corporate boards to maneuver himself to the top management position. He lavishly spent corporate money on perks for himself, board members, and other top executives. His management style is described as restlessness, constantly re-arranging businesses and moving executives around. For better or worse, he seems to have been more decisive and less bureaucratic than other executives of that period.

Reynolds tobacco made cigarettes and Nabisco made cookies, both of which were profitable. But Johnson’s decision as head of Nabisco to buy Reynolds destroyed shareholder value, as investors soured on the tobacco industry. In effect, he turned Nabisco into a tobacco stock. The expected future earnings of RJR Nabisco were high, but the price that investors would pay for those earnings was low.

In the 1980s, KKR and its imitators looked for companies that had potentially higher value. Sometimes, the firms were being run inefficiently, carrying excess cost. Or, like RJR Nabisco, they were undervalued by investors. KKR came up with the idea of a leveraged buyout (LBO), in which KKR would finance a takeover of the firm by management, using massive debt financing. To pay off the bonds, the firm would sell off business assets and cut costs. After a few years, when they had demonstrated the higher value of the firm, KKR and the management team would sell the company at a profit, either to a new corporate buyer or by reissuing stock to the public.

Some business school professors praised LBO’s and other corporate restructuring activities. They came up with the phrase “the market for corporate control” to describe the financial contests that took place. The professors argued that competition for the control of a company was a good thing, leading to better management and better allocation of capital.

I am sympathetic to the case that the financial manipulations of the 1980s were beneficial for the economy. Corporate America needed a shakeup. If you want to see what stakeholder capitalism looks like, you can go back to the 1970s: lazy managers, inefficiency, and economic stagnation.

In this interview, Burrough points out that before the 1980s, corporations were not run to maximize shareholder value. Ross Johnson, for all his flaws, was in the vanguard of executives who cared about the share price.

But there was a lot of public backlash to the LBOs. What was more efficient to the economists meant layoffs, insecurity, and instability. And the large fees and extraordinary profits that accrued to Wall Street and to top management provoked resentment.

In the case of RJR Nabisco, Johnson could have left things alone. This would have allowed him to continue to use corporate money to fund his lavish lifestyle. But unless he was a better manager than the book portrays, it would have meant that RJR Nabisco would have produced sub-optimal earnings results.

Prior to the 1980s, most CEOs would have put more effort to staying in their position than in boosting the stock price. But Johnson was dissatisfied with the low stock price, so he attempted an LBO backed by Shearson Lehman. For a stock that was languishing in the 40s, Johnson and Shearson offered $75 a share.

Their offer would have left him in charge. But making the offer put the company “in play,” and KKR swooped in and won the takeover battle, resulting in Johnson’s ouster. They paid $109 a share. In hindsight, it seems that KKR overpaid, so it was not one of their financial success stories.

For some time now, I have thought that the investing public is doing with stocks what KKR did with RJR Nabisco. That is, they are overpaying for future earnings. To me, it looks unsustainable. But I should note that those of us issuing Jeremiads against the “casino society,” “irrational exuberance,” “excess debt,” and so on have so far not been vindicated.

On paper, Americans’ individual and collective wealth has far surpassed what we had in the 1980s. Viewed from the perspective of the present moment, we might as well call what seemed like the excesses back then as The Decade of Rounding Error.

1. One of the minor figures in the book is Bruce Wasserstein. He received $25 million for attending some meetings and offering advice. This was a small fraction of the fees paid to investment bankers involved in the transaction. His appearance in the book interests me because he was a relative of my father-in-law. The older generation of cousins, first-generation immigrants who arrived in this country about 100 years ago and have all passed away, were very close. They would gather on family occasions, including at our wedding. At these occasions in the 1980s and 1990s, I met many of them, including Wasserstein’s parents. The next generation were not as devoted to the extended family, so I never met Bruce himself.