Corporate Kleptocracy at RJR Nabisco

Of the many worries facing shareholders, damage from incompetent or irresponsible management is a big one. CEOs can hurt a company simply by steering it the wrong way, diversifying too much or too little, expanding at the wrong times and so on. Occasionally, the damage is much more intentional and wanton. In this article, we'll look back at a prime example of corporate kleptocracy—the case of RJR Nabisco.

In the 1980s, tobacco giant R.J. Reynolds was despairing about its future as a one-product company. Cigarettes were known to be carcinogenic, and litigation was getting costly. CEO J. Tylee Wilson was searching for another business to merge with; a company to offer an upside to counteract the company's expected declines. The best candidate, according to Wall Street advisors, was Nabisco Brands. Nabisco Brands was already a merged company created in 1981 by joining food companies Standard Brands and Nabisco. The CEO of the original Standard Brands, F. Ross Johnson, had managed to stay on through the merger and wrest control of the new entity. (See also:  Is Your CEO Street Savvy?)

Johnson had established a clear M.O. despite only holding the CEO post at two companies. His first moves after getting charge at Standard Brands and later Nabisco Brands was to ingratiate himself with the board of directors, increase management's compensation and then pile on the perks. The CEO's compensation at Standard Brands tripled when he took over, and company jets and Jaguars soon followed. The same thing happened with Nabisco Brands, with Johnson seizing the reins within three years of the merger.

In the spring of 1985, Wilson and Johnson met to discuss a friendly merger in which Wilson would become chairman of the new company. Johnson disliked his proffered job of vice chairman and asked for the post of president and chief operating officer, as well. Wilson countered by suggesting Johnson could have the top post when Wilson retired two years later. In the end, Wilson was more desperate for the deal than Johnson. Wilson had to pay a high premium for Nabisco, and Johnson pushed through demands for various perks and the two posts in a sweetheart deal that saw R.J. Reynolds acquire Nabisco Brands for $4.9 billion. It was a record setting-merger for non-oil companies.

The price of the merger was increased when the ubiquitous Ivan Boesky bought Nabisco stock prior to the merger, signaling the takeover to the market and making a tidy sum in the process—it was one of the trades that fueled the investigation into his seeming prescience and resulted in his conviction for insider trading. As for the newly christened RJR Nabisco, the two CEOs soon found that they had very different views. Wilson was very cost conscious; Johnson spent freely. While Wilson wondered what to do with his brash, spendthrift partner, Johnson got close to the board of directors and managed to open a rift between them and Wilson. It took him less than a year to wrest the top post from Wilson. (See also: Top 4 Most Scandalous Insider Trading Debacles.)

With RJR Nabisco, Johnson had a much bigger larder to raid. The salaries and perks of the management quickly grew to outsized proportions. When Johnson ran into troubles with the new board chairman for his growing expense, Johnson managed to get the chairman switched and began filling key positions with sympathetic friends. (See also: The Basics of Corporate Structure and Governance Pays.)

Although Johnson and his buddies were having a grand time, RJR Nabisco was back in the doldrums. It took a huge hit in the 1987 crash, dipping from around $70 per share to the low $40s. Johnson believed that the bad publicity of tobacco products was holding back the profitable foods division of the company. He started putting feelers out for merger candidates and asking investment bankers for ideas. Several suggested a leveraged buyout (LBO) with shareholders taking up the tobacco business and Johnson and his management taking Nabisco private. Johnson initially didn't like this idea because owing money to a bank would bring oversight, thus forcing him to rein in his rapacious spending.

In 1988, Johnson met informally with Kohlberg Kravis & Roberts, better known as KKR. Henry Kravis of KKR talked about the benefits of LBOs, including the tightening of management and improved efficiency. Again, Johnson didn't want to lose his perks. After talking with KKR, however, some of the benefits of an LBO, namely more money, stuck in Johnson's mind.

When RJR Nabisco's price continued to languish, Johnson began buying back shares to try and force up the price—spending $1.1 billion in the process—but the price dropped back down again. Johnson feared the low stock price would attract corporate raiders, so he began building defenses. In the meantime, Kravis started to wonder about Johnson's lack of follow up on his proposal. Kravis started to run numbers on taking over RJR Nabisco. (See also: Nasty Shareholder Activist Battles and Why They Happened.)

Johnson was actually working with Shearson Lehman Hutton to bring a completed LBO to the meeting to avoid bringing the company into play, where it would be auctioned to the highest bidder. Johnson's terms for the LBO were control of the board and 20% of the stock for himself and seven managers—stock that was projected to be worth almost $3 billion in five years—without putting up any money.

Johnson's greed stunned everyone involved, including the investment banking team that was working with him. Johnson offered a buyout at $75 a share or $17.6 billion. The board refused outright—they were shocked to find a black knight on their own payroll. The board issued a press release, putting the company into play while they considered their options.

KKR swooped in and offered the board $90 a share, touching off a bidding war. KKR wanted the company but they didn't want Johnson anymore. Johnson's team upped its bid to $92. The board decided that the company would sell itself to the highest bidder. KKR raised its bid to $94, $68 in cash and $26 funded by Drexel junk bonds. Johnson's team bid $100 a share, $90 in cash and $10 in other securities. (See also: Why Owners Sell a Business.)

At the last minute, First Boston came in as a gray knight with a bid of $118, causing the board to extend its deadline for a deal, but the First Boston bid turned out to be poorly financed. Johnson upped his bid to $101 and KKR bid $109. Board members and a watching public had turned against Johnson by this time. Johnson tried $112, $84 in cash and the rest in securities, but KKR's deal was chosen at $3 less. The justification was that the superior financing of the KKR bid would involve less gutting of the company to pay off debts, but many saw it as a final snub at Johnson. The $25 billion deal set yet another record non-oil takeover and the biggest LBO ever. Johnson was ousted by KKR but still got his record-making $30 million golden parachute.

After the deal, RJR Nabisco continued to get juggled about. KKR cut jobs and divisions, spinning the international tobacco business off to Japan Tobacco. The domestic parts, both tobacco and food, were separated and recombined in a shuffle involving almost as many players as the original dance—even Carl Icahn was in there. As it turned out, RJR Nabisco represented the height of the LBO craze even as it highlighted corporate excesses. It was the last big LBO of the decade and that kind of corporate restructuring has largely fallen out of favor since. Corporate kleptocracy, in contrast, doesn't look like it will ever vanish completely. (See also: The Wacky World of M&As.)