Even though the United States is in the middle of a financial crisis, it is worth remembering that our capital markets are supported by a highly sophisticated legal system that has evolved over decades into an enviable source of economic resilience. When functioning smoothly, our laissez-faire system includes checks, balances and incentives that are intended to operate as an “invisible hand,” as economist Adam Smith put it, ensuring that, on a macroeconomic scale, corporate resources are used efficiently.
The market for corporate control serves as the fundamental building block of our system of checks and balances. Specifically, when management of a publicly listed corporation is not taking enough risks or, for some other reason is generating an unreasonably low return on capital, two things can happen that should rectify the situation: Shareholders can oust management, or else anyone who thinks they can obtain a better return from the assets of a publicly listed company can make a hostile takeover attempt by offering to purchase the company at a premium over the market price of the outstanding shares in the company.
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