Fierce arguments are raging across the U.S. business community over the value or harm arising out of a fairly recent phenomenon - the "leveraged buy-out," or LBO, for short. The majority opinion seems to be that LBOs have the potential for more harm than good.
In its simplest terms, an LBO involves corporate raiders, or sometimes even insiders, buying up control of a company by offering higher prices for the stock, using borrowed funds, mostly from banks, instead of their own money.The resulting debt in a successful LBO may be enormous and have a high interest rate, one of the things that makes it attractive to banks to lend the money. Buyers may break up and sell off part of a company to cover a portion of the debt.
Critics say all this maneuvering is simply designed to make a lot of money for buyers and lenders while perhaps resulting in the eventual demise of the company at the center of it all. Any kind of a recession could make it difficult to pay the loans. Then the banks could face trouble, too.
Backers of the LBO concept agree that the debt load becomes extremely heavy, but argue that this is a spur to better management practices that can result in a more productive company.
But being faced with a critical need to produce more profit can have its drawbacks as well. One criticism of American business is that it already focuses too much on the immediate bottom line, to the detriment of research and long-range planning.
A study released this week emphasized the problem. It showed that major companies involved in LBOs suffered a 12.8 percent drop in spending for research and development in 1986 and 1987, while the other businesses had a 5.4 increase in R&D.
In any case, sentiment in Congress appears to be running against LBOs because they have a negative impact on the U.S. Treasury. All the interest on the huge debt incurred in an LBO is tax deductible.
While no figures are yet available as to what the tax loss might be, Treasury Secretary Nicholas Brady told the House Ways and Means Committee this week that the "driving force" behind LBOs is that companies can avoid a 34 percent corporate income tax rate by being buried in debt.
Reducing or eliminating the tax deduction for debt interest in an LBO certainly would make it less attractive way to take over a company. In fact, it probably would mean the end of LBOs. But that's not necessarily a bad thing.
After all, the aim of business is to produce goods and services, not be a cash cow to be milked by a few wheeler-dealers.