Ruder Urges Caution in Stemming LBOs : Changing Tax Laws Could Create Problems in Markets, He Says

The chairman of the Securities and Exchange Commission urged Congress Wednesday to move cautiously in trying to use tax law changes to stem the current wave of leveraged buyouts.

“You should be aware that your committee’s activities may influence a stock market that is skittish and nervous,” SEC Chairman David S. Ruder told the Senate Finance Committee.

Ruder said SEC studies after the October, 1987, stock market crash showed that one factor contributing to its severity was legislation then being considered by the House Ways and Means Committee to curtail some of the deductions on interest paid by companies to holders of high-yield junk bonds.

Ruder admitted that the double taxation of dividends--first as part of the 34% income tax on corporations and again when they are distributed to shareholders as personal income--is helping drive the leveraged buyout or LBO phenomenon.

But he said he opposed taxing the interest that leveraged companies pay on junk bonds as a way of equalizing the tax treatment between the two primary means for raising capital: issuing debt or stock.

Ruder, like Treasury Secretary Nicholas F. Brady, who testified before him on Tuesday, said the better alternative would be to allow companies to treat as a deductible expense the dividends they pay or to give shareholders a tax credit for the corporate income taxes paid by a company.

But like Brady, he added, “I do not believe we can do that, given our enormous deficit problem.”

In an LBO, an investment group borrows heavily in order to buy out stockholders and take over the company. Often LBOs are proposed by managers seeking to thwart a hostile takeover.

The company’s new owners either cut costs or sell off pieces of the company to pay back loans. Critics of the practice fear that the high debt levels, in a recession, would endanger both the bought-out company and the banks and brokerage firms financing the buyout.

Both the tax-writing Finance and Ways and Means committees are re-examining leveraged buyouts in the wake of the pending $25-billion purchase of RJR Nabisco by LBO specialist Kohlberg Kravis Roberts & Co. and the $13-billion buyout of Kraft by Philip Morris last year.

Those were the two biggest of more than 300 leveraged buyouts totaling nearly $100 billion in 1988.

Sen. Lloyd Bentsen (D-Tex.), the Finance Committee’s chairman, said the primary concern is the possibility that the recent surge of leveraged buyouts “has created a mountain of corporate debt that will make our next recession deeper and longer than it needs to be.”

While Bentsen said the goal is to balance the attractiveness of equity and debt financing that is clearly tilted to the debt side under current tax laws, he acknowledged that it is going to be difficult to find the right combination of “carrots and sticks.”