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January 13, 2008
David Warsh, Proprietor


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Dancing With Tycoons?

One of the things that news reporters learn early in their careers, if they are fortunate, is not to take anyone’s claim to authority too seriously. For example, I remember meeting Louis Kelso in the early 1980s.

Kelso was the San Francisco attorney and amateur economist who, starting in 1958, had gained a measure of fame as the author of a plea for employee ownership that he called The Capitalist Manifesto. As a Colorado teenager, he had driven mining companies’ dynamite trucks for short money with which to finance his legal education. As a young lawyer, he had pondered the mysteries and inequities of the Great Depression. And as a Navy intelligence officer assigned to the Panama Canal during World War II, he had written a 600-page tome on how to get the economy moving again after the war through the tax-advantaged distribution of companies’ shares to their workers.

But it wasn’t until Mortimer Adler, the entrepreneurial educator, University of Chicago hanger-on, and founder of a Great Books of the Western World business, took an interest in his scheme and agreed to share a byline on The Capitalist Manifesto that Kelso’s “two-factor economics of reality” began to attract a following, mainly among lawyers, small investors and businessfolk. A steady stream of books poured forth; eventually he married the writer he hired to help him, Patricia Hetter. He was in the process of taking his critique of neoclassical economics to Mike Wallace and 60 Minutes when we met.

Private-equity artists William Simon, Michael Milken, and Ronald Perelman were in their ascendancy at the time; the buyout firm of Kohlberg Kravis Roberts & Co. was gathering steam: famous journal articles, by Franco Modigliani & Merton Miller and Michael Jensen & William Meckling, were revolutionizing the practice of corporate finance: though wealthy, Kelso was an easy guy to ignore. He died, at 77, in 1991.

On the other hand, Kelso had been politically acute. In the early 1970s, he and his associates made a concerted effort to sell their ideas on Capitol Hill. They culminated in a famous dinner at the Madison Hotel in 1973 with Louisiana Sen. Russell Long. Son of famous Louisiana demagogue Huey Long and chairman of the Finance Committee, Sen. Long became a convert over the course of the four-hour meal. He was no populist Robin Hood, he asserted (implying that his father had been), but he liked the idea that every worker should become an owner of capital – he even paid for dinner. (Norman Kurland has written a thorough history of the episode.)

The upshot was that the influential Long wrote a series of little-noted tax breaks for Employee Stock Ownership Plans (ESOPs) into an enormous piece of legislation that eventually would become the Employee Retirement Income Security Act of 1974 (ERISA). The measure thus created a set of opportunities for a new generation of missionary organizers of worker ownership for firms for whom the Chrysler bailout of 1979 was a signal event. When I moved to Davis Square, in Somerville, Massachusetts, in 1979, I was not surprised to discover that the dusty old stop on the vaudeville circuit had become a hub of worker ownership activity, home to the Industrial Cooperative Association, founded by Christopher Mackin, David Ellerman and Steve Dawson. Cambridge was a hotbed, too. Paula Rayman and Joseph Blasi touted kibbutzim; John Case, of Inc. magazine, promoted “open book” management. (Corey Rosen started the National Center for employee Ownership in Arlington, Virginia in the 1970s and moved it to Oakland in the ’80s.)

In 1987, the same year that Avis employees bought their car-rental company with the assistance of Wesray Capital, William Simon’s firm, Mackin of the ICA founded Ownership Associates to advise workers and managers in the growing ESOP world. Soon the collapse of central planning in Eastern Europe and Russia would open a new set of opportunities, even if they were seldom taken up. Thanks to the ESOP legal framework, worker ownership had a seat at the table, though the seat was small and the table enormous. In 1998, Harvard professor Richard Freeman started a research project in Shared Capitalism at the National Bureau of Economic Research.

Eastern Europe was one thing. Little did I imagine, even then, that the path of employee ownership would lead some day to the mighty Chicago Tribune. I am a Chicagoan, bred if not born, and even though I have not lived there for forty years, I still remember the fortress-like solidity of the arch-conservative Chicago Tribune, to whom President Roosevelt’s Lend-Lease Act of 1941 was “the Dictator bill.” What a circus that newspaper was! (At least in its upper echelons; none of the reporters I knew led such antic lives.) Such a fount were its earnings that, in the 1940s and ’50s, while Col. Robert McCormick broadcast patriotic pep-talks on Saturday nights from his fabulous tower on North Michigan Avenue (the “Chicago Theater of the Air”), his cousin Alfred Cowles, he of the eponymous Cowles Commission, quietly bankrolled a substantial portion of the early phases of economics’ modern movement and the Keynesian Revolution, then unfolding at the University of Chicago, with his dividend checks alone.

Tribune Co. had suffered greatly in recent years, having drafted as its top managers accountants and investment bankers with little feel for the newspaper business, but in 2000 the company still threw off enough free cash that when the Chandler family was looking for a buyer for its Los Angeles Times, Chicago had but to write the check. With that, it became the nation’s second-largest newspaper publisher, after Gannett. (Among its other papers are New York’s Newsday, the Baltimore Sun, the Hartford Courant, and the Orlando Sentinel. Its other assets include television stations and even the Chicago Cubs, though it has pledged to sell the baseball team. )

Never mind that the lip of the waterfall lay just ahead.

The collapse the Dot.com boom wasn’t enough to camouflage the fact that that traditional sources of newspaper earnings, both circulation and advertising revenues, were in serious trouble. The ebullience of the 1990s turned to despair. First Knight Ridder put all newspapers up for sale. Then Rupert Murdoch made an offer to the Bancroft family for The Wall Street Journal and the rest of Dow Jones that ultimately proved irresistible, Finally Tribune Co. put itself up for auction, a moved which produced only a couple of leveraged buy-out offers, which it spurned, before zeroing in on a management-led “self-help” deal, which would have led to large borrowing and the draconian cuts necessary to make it work.

A which point Chicago real estate developer Sam Zell, who had plenty of experience buying and selling undervalued real estate, but none with newspapers, slipped in with a surprise offer to lead an ESOP with $315 million of his own money. California magnates Eli Broad and Ron Burkle, who had made one of the two LBO offers, sought to counter, but they were too late, and Zell got the nod.

When first proposed last spring, the deal was the object of a scoop by the ever-perspicacious Allan Sloan, then of Newsweek, now of Fortune magazine: Tribune Deal Makes Zell Ace of Tax Dodgers was the headline. Zell was taking advantage of a provision slipped into law in 1997 under which converting Tribune from a C Corporation (many shareholders) to an S Corporation (fewer than 100 shareholders) would permit the employees trust (60 percent ownership) and Zell (40 percent) to qualify as an ESOP, thus avoiding all Federal taxes for ten years, Sloan reported, creating savings sufficient to permit the company to borrow enough to pay the highest price to existing shareholders who would tender their shares. The deal “exploits a loophole so gaping that we taxpayers can only pray somebody closes it quickly.” (Zell’s interest may have been spurred by two other recent successful applications of the ESOP provision, Amsted Industries and Unites Airlines – both Chicago firms.) A profile of Zell, by Connie Bruck, in The New Yorker, is as good a piece of business writing as any I have read in years.

Since then, Zell has been on a tear, meeting with Tribune staffers in Chicago, hanging banners around the newsroom of the LA Times proclaiming “You Own This Place Now,” naming a board of directors conspicuous for its lack of experience in the newspaper industry, etc. He explained his new role to a reporter this way: “You call it CEO and I’ll call it owner.” (The transition has been covered with old-time newspaper verve and tenacity by Tribune reporter Michael O’Neal and columnist Phil Rosenthal.) “This was an 160-year-old company that was a monopoly business,” Zell told O’Neal. “The monopoly went away, and the way in which the company functioned and distributed authority never changed.” At the moment, Zell continued, “You’ve got a CFO of [the Chicago] Tribune, you’ve got a CFO of publishing, and you’ve got a CFO of the Tribune Co. Why do you have three people doing this? I don’t know. That doesn’t mean I’m right, but it’s an example of the kinds of questions we need to ask. … I don’t think, frankly, the newspaper business has ever been subjected to that kind of clear thinking.”

Well, maybe. Or maybe not. Perhaps Zell was just lucky to be at the right place at the right time. It is certainly true that, if it works, the deal offers a significant upside to employees. It prevented major cuts, at least to begin with. And the way it is structured, he won’t see a payday until the employees receive $750 million in value, a figure that would average tens of thousands of dollars, perhaps hundred of thousands, per employee. (For Zell, that payday could be a whopper: he holds a warrant entitling him to eventually buy 40 percent of the company for $500 million. The company was worth $8.2 billion when it changed hands.)

There are flaws in the ESOP, naturally, from the employees’ point of view. Union representatives point to the lack of any consultation by employees in selecting the ESOP trustee that will play the lead role in governing the corporation. They may be employee-owners, but they don’t have much of a voice. Retirement accounts will remain partially diversified, but will be overly concentrated in Tribune stock. Still, at the end of the day the Zell transaction means that a company that is in need of significant change will succeed or fail through the workings of a partnership between a tycoon and his partners, the employees.

Is that a good thing? The chorus of complaints about the tax expenditures that make the Tribune ESOP work (and others like it) is growing, among those who, like columnist Sloan, take the Treasury Department seriously. Already Congressman Charles Rangel (D-NY) has inserted a provision that would shrink them in the omnibus tax bill he is preparing for when the next Congress convenes a year from now. But are such experiments in collaboration between the super-rich and the deeply-threatened necessarily such a bad thing? David Henderson of the Hoover Institution has derided them as “a step towards feudalism.”

Suppose the Sulzberger family were able to use an S Corp ESOP to consolidate their control of The New York Times? Or the Graham family used the device to assure the continuing independence of The Washington Post? Suppose Warren Buffet were willing to take Michael Bloomberg out of the company he founded, by financing its sale to employees? As Mackin of Ownership Associates says, “In an economy as radically unequal as ours, it is difficult to defend tax breaks for the wealthy. But when the wealthy are ready to use those breaks to share real economic gains with workers they just might deserve a break. It all depends upon the alternatives. Sometimes a tycoon is the best friend a worker is going to get.”

Looking back, then, I am inclined to revise upward my opinion of Louis Kelso and Sen. Long, downward my estimate of the importance of those famous journal articles by Modigliani & Miller (which asserted that debt was essentially no different than equity) and Jensen & Meckling (which argued that owners ordinarily made better decisions than the professional managers who were their agents). Kelso’s ideas seemed a little wooly to me at the time; the journal articles had the virtues of clarity, depth and precision. Certainly Wall Street thought so. At one point, Jensen boasted, “By solving the central weakness of the public corporation – the conflict between owners and managers over the control and use of corporate resources – these new organizations [private equity firms] are making remarkable gains in operating efficiency, employee productivity, and shareholder value.”

What I have concluded since then is that reformers often know things that economists don’t begin to grasp. Sam Zell may think he’s the Tribune’s owner; he is also the steward of a 160-year-old newspaper. I’m rooting for the employees of Tribune Co.’s newspapers – past, present and future.

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