What the Kraft and Heinz Merger Teaches Us About Protecting American Jobs
Guest Columnist Christina Alam of the University of Pittsburgh School of Law discusses the negative effect corporate mergers have on preserving American jobs…
While some public figures paint horror stories of how immigrants steal American jobs, subtler, but yet powerful forces leave thousands of American employees jobless. These forces are corporate restructuring and downsizing. And the 2015 merger of two iconic brands — Kraft and Heinz — is a good example of this phenomenon.
The two companies announced their merger in March 2015 backed by two affluent groups of investors: for Heinz, Warren Buffett’s Berkshire Hathaway, and for Kraft, Brazilian venture capital fund 3G Capital. With an estimated $10 billion from these investors, the merger was supposed to generate significant synergies in what would become the fifth largest food and beverage company in the world.
But in reality, “synergy” was just a euphemism for “severe cost cutting.” As was the case with other past acquisitions, 3G Capital’s modus operandi was to introduce aggressive cost reduction policies as a way to improve profitability. The core of these policies was “zero-based budgeting,” where the management had to justify its expenses every single year as if no money had existed the previous year. Other policies were more far-reaching — such as massive reductions in the work force and complete closure of unprofitable manufacturing lines — while other policies were almost beyond belief — such as requiring permission to make color photocopies and counting how much paper and soap employees used. Generally, the gist of 3G Capital’s strategies fits well within the words of Gary Stibel, the founder of the New England Consulting Group, whose clients have included both Kraft and Heinz: “When [3G Capital] see[s] something that isn’t working, [it] eliminate[s] it.” The empirical evidence of this hypothesis followed — in November 2015, the management announced the plan to close seven of its facilities that would eliminate 2,600 jobs in the U.S. and Canada.
The question arises whether there are legal ways to stop this process. Unfortunately, under the well-established business judgment rule, courts will not second-guess the policies and tactics of corporate management, unless there is “self-dealing, conflict of interest, or illegality.” Most states, however, modified this rule by enacting constituency statutes [PDF]. These are the laws aimed to allow the board of publicly traded corporations to consider an expanded group of “interests” when making decisions on behalf of the corporation or, more precisely, decisions concerning the course of the corporation’s business.” Specifically, these statutes authorize corporations to consider interests of different corporate constituencies [PDF] besides merely shareholders, and thus shield corporate management from liability if the management sacrificed shareholders’ interests to interests of other constituencies.
Baron v. Strawbridge & Clothier well demonstrates the benefit of the constituency statutes. In that case, Ronald Baron, a Strawbridge & Clothier’s shareholder, attempted to cause several bidders to target the company in order to inflate the company stock price, so that Baron could later sell his shares at a premium. After Strawbridge & Clothier adopted a series of anti-takeover measures, Baron challenged the board’s actions. The court, however, found that the management adopted the measures to keep the family business nature of the corporation intact and to protect its employees from potential downsizing, and therefore dismissed the action. The court also noted that the management acted in good faith and with due care, and that it was proper for the management to turn down the hostile bidder’s offer, instead considering the interests of the company’s “employees, customers and community.” Although the decision does not expressly mention the constituency statute, it impliedly endorses the extension of the business judgment rule to consider the interests of non-shareholder constituencies.
Unfortunately, the situation described in Baron v. Strawbridge & Clothier is only one side of the coin. While the constituency statutes help keeping local jobs when the corporate board itself desires to protect the jobs, the statutes are toothless in making the board consider such interests, when the board is unwilling to do so.
The reason behind it is that most constituency statutes are only permissive [PDF], i.e., the board has a right, but not an obligation, to consider the interests of different groups. Although the state of Connecticut initially passed a constituency statute that required the board to consider the interests of all corporate constituencies, the law was later amended to reflect permissive standard.
More importantly, non-shareholder constituencies do not even have standing to sue the board for failure to consider their interests or for the breach of fiduciary duties. For example, in Dugan v. Towers, Perrin, Forster & Crosby, Inc. [PDF], the U.S. District Court for the Eastern District of Pennsylvania held that the duty of the board to act in the best interests of the corporation “may not be enforced directly by a shareholder or by any other person or group.” Therefore, due to the lack of any enforcing mechanisms [PDF], corporate constituencies can only rely on the pure and not self-serving intentions of the corporate board.
Back to the Kraft Heinz merger… Did the merger affect employees? Most certainly: 5 percent of Kraft employees have already lost their jobs and more are yet to come. Kraft executives also felt the hit — 10 out of 12 Kraft top executives are not joining the new Kraft Heinz. Consequently, the merger negatively affected Kraft employees on all levels.
Answering the question if the employees have any remedies, we have to admit that they do not. Kraft employees are unable to change the course of events simply because they do not have an opportunity to challenge Kraft CEO Cahill’s decision to merge with Heinz. Likewise, Heinz employees were unable to challenge 3G Capital acquisition of Heinz in 2013. However, in both the 3G Capital acquisition of Heinz and the Heinz acquisition of Kraft, these constituencies paid the most in the course of merger. While it might be too late for Pennsylvania and Illinois employees, there are other corporations that can be new targets of aggressive merger and acquisition strategies as employed by 3G Capital. Therefore, states should consider whether it is time to revisit constituency statutes to make them actually workable by providing different corporate constituencies with standing to challenge major corporate changes.