<br><h3> Chapter One </h3> <b>The Modern Deal <p> <p> I</b> begin with a short deal story. <p> In 1868, Cornelius Vanderbilt, the railroad baron, went to war against the Erie Gang-Jay Gould, Daniel Drew, and James Fisk. The dispute's genesis was the rather reprehensible conduct of the Erie Gang with respect to the hapless New York & Erie Railroad. The three men had acquired a majority interest in the company, treating it as their personal piggy bank. Not content with the millions in profit reaped through outright theft, the gang further took advantage of Erie's public shareholders by manipulating Erie's stock to their benefit. The gang's machinations so financially weakened the Erie that it defaulted on its debt payments. <p> Meanwhile, Vanderbilt coveted the Erie railroad for its railroad line out of New York and to Lake Erie. The combination of the line with his routes would provide Vanderbilt with a stranglehold over much of the railroad traffic out of New York. Vanderbilt began to build a position in Erie by purchasing the stock sold by the Erie Gang. When the Erie Gang discovered this activity, they quickly acted to their own advantage. The gang arranged for Erie to issue out bonds convertible into Erie stock to sell to Vanderbilt, thereby diluting Vanderbilt's position. <p> Vanderbilt soon became aware of the stock issuance and arranged for his lawyers to obtain a court injunction halting them. This was easy for Vanderbilt's counsel as the judge issuing the injunction was on Vanderbilt's retainer. The Erie Gang responded by arranging to have their own kept judge issue a competing injunction restraining Vanderbilt's conduct. Meanwhile, Vanderbilt kept buying, and the Erie Gang circumvented the injunction by arranging for third parties to sell stock to the unknowing Vanderbilt. Fisk purportedly said at the time that "if this printing press don't break down, I'll be damned if I don't give the old hog all he wants of Erie." <p> Vanderbilt then upped the ante and arranged for an arrest warrant to be issued for all three of the Erie Gang, who promptly fled from New York to New Jersey. They smartly, but illegally, took over $7 million of Erie's funds and yet more unissued Erie stock. The fight then became physical as Vanderbilt sent armed goons to attack the Erie Gang. Vanderbilt's henchmen were repelled by the gang's own hired men, and Fisk even went so far as to have 12-pound cannons mounted on the docks outside Erie's New Jersey refugee headquarters. Ultimately, the war was resolved when the Erie Gang succeeded in bribing the New York legislature to enact legislation validating the trio's actions. Vanderbilt was forced to cut his losses and settle, leaving the Erie Gang in control of the Erie Railroad, now forever known as the Scarlet Woman of Wall Street, and Vanderbilt was out an amount alleged to be over $1 million. <p> A modern-day observer of corporate America may dismiss this well-known story as an interesting and well-cited relic of long-ago battles from a wilder age. The rule of law has grown stronger since the Gilded Age, and machinations like those of the Erie Gang and Vanderbilt are no longer a part of battles for corporate control. But before you agree, compare the war over Erie with a thoroughly modern dispute. <p> In August 2004, eBay Inc. acquired 28.5 percent of craigslist. The facts surrounding eBay's acquisition are a bit hazy, but it appears to have occurred due to a break among the prior owners of craigslist, Craig Newmark, James Buckmaster, and Phillip Knowlton. But for whatever reason, and no doubt in pursuit of money, Knowlton arranged to sell his interest to eBay for a rumored $16 million. The sale placed Newmark and Buckmaster in an awkward position. Adamantly proclaimed anticorporatists, the two assert craigslist to be a community service and have publicly rejected the idea of selling any part of craigslist to the public or a third party. Nonetheless, perhaps because Newmark and Buckmaster had no choice, they acquiesced in eBay's purchase. At the time, the reason cited by the two for accepting the sale was that they believed that eBay would not interfere in the core mission of craigslist. "They have no interest in asking us to change that in anyway," Buckmaster stated. "They're happy with us having our full autonomy. They recognize us as experts at what we do." <p> The parties' honeymoon was short. A dispute among them soon arose over eBay's decision to launch its own free classifieds service, Kijiji. Apparently, eBay didn't think the craigslist people were as expert as they thought. The business competed with craigslist and therefore triggered certain provisions in the shareholders agreement among eBay and the other two craigslist shareholders. Specifically, eBay lost its right of first refusal to purchase equity securities sold or issued by craigslist or to purchase Newmark's or Buckmaster's shares, should either attempt to sell them. <p> Newmark apparently thought this prenegotiated penalty was insufficient. He e-mailed Meg Whitman, eBay's CEO at the time, and stated that he no longer desired eBay as a craigslist shareholder. Whitman responded with a polite no, instead expressing eBay's own interest in buying craigslist. Clearly there was a communication gap among the parties. Newmark and Buckmaster, both directors of craigslist, responded by adopting (1) a share issuance plan under which any craigslist shareholder who granted craigslist a right of first refusal on their shares received a share issuance and (2) a poison pill preventing any current shareholder from transferring their shares other than to family members or heirs. <p> The poison pill effectively prevented eBay from transferring its shares, except in discrete blocks below a 15 percent threshold, to any single person. Moreover, Newmark and Buckmaster agreed to the right of first refusal and received the authorized share issuance; eBay did not, probably because it wanted to reserve the right to freely sell its position. The result was to dilute eBay's ownership of craigslist to 24.85 percent. This action was important, because under the parties' shareholder agreement if eBay falls below the 25 percent ownership threshold, craigslist's charter can be amended to eliminate cumulative voting. <p> Cumulative voting provides minority shareholders the ability to concentrate their votes by allowing them to cast all of their board-of-director votes for a single candidate rather than one vote per candidate. So if, for example, there are three directors up for election, eBay would have three votes and could cast all of them for one candidate. In the case of craigslist, this right had enabled eBay to elect one director to the three-member craigslist board. But Newmark and Buckmaster now acted to amend craigslist's charter to eliminate this right, and eBay thus lost its board seat. Moreover, the poison pill effectively prevented eBay from selling its shares. Who would want to buy a minority position in a company where the other shareholders did not want you and you were effectively without any control rights? The amendment and the poison pill thus combined to lock eBay into a voiceless minority position. <p> So eBay sued craigslist, Newmark, and Buckmaster in Delaware, the place of craigslist's incorporation, for breach of fiduciary duty and to have their actions nullified. Meanwhile, craigslist countersued eBay in California State Court for false advertising and unfair and unlawful competition. The parties remain in litigation at the time of this writing, with the two craigslist directors still firmly in control of the company. Given the tremendous dollar amounts at stake, whether the craigslist founders will succeed or desire to keep their grip remains to be seen. <p> Approximately 140 years separate these two events, but the story of craigslist and eBay shows that in deals, companies and the people running them are still not above fighting to the figurative death, employing every available tactic. The big difference is that these fights largely play out in the courts, the regulatory agencies, or the plains of shareholder and public opinion rather than as brawls in the street or bribery. Microsoft Corporation and Google Inc. will battle over relevant acquisitions in the halls of their antitrust regulator, the Federal Trade Commission, or in the marketplace. The CEO of Google Inc., Eric Schmidt, is hopefully not about to attempt to send armed men to assault Steve Ballmer, Microsoft Corp.'s current CEO. They both will work within the rules, perhaps even stretching them, to fulfill their goals. <p> The strengthening of the rule of law and the immense economic and social changes of the past century and a half have placed lawyers in a primary role. The structure and manner of takeovers has not remained static over the years. Nonetheless, as illustrated in these two stories, central tenets of deal-making have emerged and remained. Deals are still in large part about money, earning a return on invested capital commensurate with the risk, but like so many things in life, it is not all about the money. Other factors come into play and skew the process. These include: <p> The personality element-individuals often determine the outcome of deals, sometimes by acting outside their company's and shareholders' economic interests. In doing so, these individuals act in their own self-interest and with their own psychological biases to affect deals, sometimes acting to overtly enrich themselves or more subtly aggrandize themselves and build empires. <p> The political and regulatory element-Congress, state legislatures, and other political bodies can take direct and indirect action to determine the course of deals, particularly takeovers. Meanwhile, deals have steadily become more regulated and impacted by regulation, whether by the federal securities laws or antitrust or national security regulation. <p> The public element-popular opinion and the constituencies that are affected by deals increasingly matter. <p> The adviser element-deals have become an institutionalized industry; advisers and the implementation of their strategic, legal, and other advice now affect the course of transactions. <p> The game theory element-tactics and strategy continue to matter in deals and deal-making, as these disputes show. As I discuss in Chapters 8 and 9, structuring deals within (and sometimes) outside the law and the tactics and strategy used to implement that plan can define the success or failure of a deal outside of economic drivers. <p> <p> But of these five noneconomic factors I would argue that personality, the psychological biases and foundation of individuals, has historically been the most underestimated deal-making force. <p> <p> <b>The Import of Personality</b> <p> The Erie story was as much about culture as it was about economics. Vanderbilt was self-made but also established money. He represented the period's dominant economic interests. The Erie group, and particularly Jay Gould, could best be characterized as new money, taking advantage of the emergent U.S. capital market to extract their own benefits. The intensity and length of the parties' dispute was no doubt enhanced by this cultural gap, which made each party want to win despite the benefits of compromise. Vanderbilt contemplated settling with these hooligans only when the New York legislature acted and he was left with no choice. The eBay-craigslist story is similarly one of stubborn will and cultural difference. The craigslist controlling shareholders have proclaimed that their opposition to eBay is moral. It is a desire to maintain an environment free from corporate influence in contrast to ex-eBay CEO Meg Whitman's seeming disbelief in Newmark and Buckmaster's expressed intentions and her and her successor's wish to exploit a very exploitable economic asset. <p> The cultural aspect to these disputes is not unique. Like many facets of our society, deals and takeovers in particular are often driven by culture, as well as other extrinsic factors such as morality, class, ideology, cognitive bias, and historical background. These affect not only whether deals succeed after they are completed but also whether they even occur. The epic battle for Revlon Inc. in the 1980s was likely as contentious as it was because of then Revlon Inc. CEO Michel Bergerac's deep hatred for Ronald O. Perelman, the hostile raider who controlled Pantry Pride Inc., the company that made a hostile bid for Revlon in competition against Teddy Fortsmann's Forstmann Little & Co. Perelman was described as an upstart Jew from Philadelphia, a corporate raider with a penchant for gruff manners and cigars. He was the antithesis of Bergerac's world; Bergerac could not see his prized company going to such a man and often referred to Perelman's bidding company as "Panty Pride." Bergerac's hostile reaction lost him not only his company but also the $100 million pay package Perelman had initially offered Bergerac to induce him to support the takeover. <p> Similarly, the battle over Paramount Pictures Corp. between Viacom Inc. and QVC, Inc. in the 1990s was as much about Barry Diller, the CEO of QVC, needing to prove that he had escaped the grasp of Martin Davis, CEO of Paramount, as much as it was about building an integrated media empire. Davis had previously been Diller's boss when Diller had been the head of Paramount. Diller had left the company after repeatedly clashing with Davis. The takeover of Paramount was his payback. <p> The reason for this bias is in part that takeovers are a decision-driven process helmed by men (and they have been almost uniformly men) who make these choices about when and what to pay or otherwise sell for assets. It was, after all, J. P. Morgan who single-handedly decided to purchase U.S. Steel and consolidate the steel industry in order to rein in price competition. As such, these are people driven by their own psychological considerations and backgrounds. It's not just about business. These biases can distort the deal process, most prominently injecting uneconomic or economically self-interested factors into takeover decisions. This has tended to be exacerbated by the increasing tendency of the media to personify corporations through the personality of their CEO: Microsoft becomes Bill Gates and then Steve Ballmer, Viacom becomes Sumner Redstone, JPMorgan Chase & Co. becomes Jamie Dimon, and so on. <p> The result has not been just a centrality in CEO decision making but the encouragement of CEO and individual hubris. In the 1960s, deal-making was about conglomerates-the idea was that management was a deployable resource and a company in diverse industries could resist a downturn in any single sector. But again it was about the individual who could ultimately control these empires. People like Charles Bluhdorn at Gulf + Western Inc., nicknamed Engulf and Devour for its acquisition practices, and James Joseph Ling at Ling-Temco-Vought were headline-making actors and stars of the business media. In the wake of the conglomerates, acquisition activity sharply rose from 1,361 acquisitions in 1963 to 6,107 in 1969. It created an atmosphere ripe for investment in these conglomerates, but it also set up spectacular failures, as many of these companies were built on the idea of an individual CEO's capability without sound financial underpinning. <p> Conglomerates have largely been buried by Wall Street, but hubris often masked by labels such as "vision" still persist: Perhaps the most spectacular failure and example of the later age is the merger of America Online, Inc. (AOL) and Time Warner Inc. orchestrated by Time Warner CEO Jerry Levin and AOL co-founder Stephen Case. The deal is cited as one of the worst bargains in history and has resulted in the destruction of up to $220 billion in value for Time Warner shareholders. Moreover, in the deal-making arena, the market constantly proclaims winners and losers based on the outcome of takeover and other contests, rather than on pure economics. Whether it is the clash of wills in Yahoo! and Microsoft-will Steve Ballmer prove his mettle as the newly anointed CEO of Microsoft-or another Stephen, Stephen Schwarzman of Blackstone, out to crown himself the king of private equity, the need for perceived success and the psychology of the actors drive deals. <p> <i>(Continues...)</i> <p> <!-- copyright notice --> <br></pre> <blockquote><hr noshade size='1'><font size='-2'> Excerpted from <b>Gods at War</b> by <b>Steven M. Davidoff</b> Copyright © 2009 by John Wiley & Sons, Ltd. Excerpted by permission.<br> All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.<br>Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.