The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems

This article, which is based on the author's Presidential address to the American Finance Association in 1993, argues that squeezing out excess capital and capacity is one of the most formidable ongoing challenges facing not only the U.S. economy, but the economies of all industrialized nations. In making this argument, the article draws striking parallels between the 19th- century industrial revolution and worldwide economic developments in the last three decades. In both periods, technological advances led to not only sharp increases in productivity and dramatic reductions in prices, but also massive obsolescence and overcapacity. And much as the great M&A wave of the 1890s reduced capacity by consolidating some 1,800 companies into roughly 150, the leveraged takeovers, LBOs, and other leveraged recapitalizations of the 1980s provided "healthy adjustments" to overcapacity that was building in many sectors of the U.S. economy. To help public companies make the necessary adjustments to overcapacity, the author urges them to consider adopting some of the features of private equity, including significant equity stakes for managers, high leverage or payouts, and the recruiting of active investors as "partners in the business."