RJR Nabisco's CEO Tried to Buy His Own Company. The $25 Billion Winner Lost Money.

RJR Nabisco's chief executive proposed buying the company he ran, which put him on both sides of the deal. A credible outside bidder turned his quiet insider purchase into an auction the board had to run, the price doubled, the bankers collected $1.2 billion in fees, and the firm that won the contest booked a loss.

On October 19, 1988, F. Ross Johnson, the chief executive of RJR Nabisco, took his outside directors to dinner in Atlanta and proposed something unusual: he and his top managers would buy the company themselves. RJR Nabisco, the maker of Winston cigarettes and Oreo cookies, was the nineteenth-largest industrial company in America, and its stock was trading around $56. The next day his group, backed by Shearson Lehman Hutton, announced a $17 billion buyout at $75 a share.

The problem was structural. A management buyout puts the chief executive on both sides of the table. He runs the company and owes its shareholders a duty to get them the highest price, while also being the buyer who wants to pay the least, and he knows more about the asset than anyone he is buying it from. That conflict is the seed of everything that followed. It got worse when the directors learned the side deal: Johnson and seven colleagues would put up $20 million for an 8.5% stake that could grow toward 18.5%, worth as much as $2.6 billion if they hit their targets. One director called him a "raider from the inside."

Within days the buyout firm Kohlberg Kravis Roberts bid $90 a share, fully financed and not needing management's cooperation. That move converted Johnson's quiet insider purchase into a public auction the board now had to run for every shareholder. The outside directors formed a special committee, opened the bidding to all comers, and the price climbed in rounds: $75, then $90, then $92, then $100 against KKR's $94, then a wild $118 tax-structured gambit from a First Boston group that briefly led before its financing collapsed.

The final round, over November 29 and 30, came down to two. Johnson's group bid $112 a share. KKR bid $109. On December 1 the board took the lower number. Its advisers called the two offers "substantially equivalent," but KKR's was more certain to deliver its value, its financing was committed, and it promised to keep the food businesses and protect employees where Johnson planned to sell them off. Mostly, the board would not hand the company to the insider who had tried to buy it cheap. As one person close to the bidding put it, the board "could not appear to favor management" in a buyout.

The deal closed in February 1989 at about $25 billion, roughly 87% of it borrowed. RJR Nabisco's debt went from $5 billion to $20.1 billion, and interest alone ran about $9 million a day, financed with junk bonds sold by Drexel Burnham Lambert and Merrill Lynch. The people who had lent to the old, investment-grade RJR Nabisco watched about $1 billion of bond value evaporate as their bonds were buried under new, higher-priority debt. Metropolitan Life sued, arguing management had abused its position, and lost: the court refused to read a no-more-debt promise into bonds that never contained one.

So who won? The selling shareholders did, receiving about $109 for stock that had traded in the fifties, a real premium the auction had manufactured. The bankers and lawyers collected $1.2 billion in fees. Even the loser walked away wealthy: Johnson left with about $53 million in severance. KKR, the supposed victor, did worst of all. Seven years in, Bloomberg noted it had sold its final stake for barely more than its adjusted cost, calling the deal a bust. When KKR finally exited in 2004, the New York Times reported it had booked a loss after fifteen years.

The era's critics, led by Time's "Game of Greed" cover and Robert Reich's warning that Wall Street was "giving greed a bad name," predicted the debt-fueled deal would gut American industry. The law-and-economics scholar Daniel Fischel later argued the opposite, that by throwing out Johnson and forcing discipline the buyout created more than $10 billion of value by 1991. Both were partly right. The auction delivered a genuine premium and real operational discipline. It just delivered almost none of it to the buyer.

The takeaway a modern operator should steal is this. A management buyout's structural conflict, the boss bidding for his own company, is exactly what creates the value, because it forces the board to run a real auction. The premium a contested auction extracts is genuine, and it goes to the sellers, not the buyer. The bidder who "wins" a bidding war is, by construction, the one who overpaid the most, the fee machine collects its billion either way, and the people who quietly lent money to the old, safe company are the ones who end up paying for the party. If you are ever the insider tempted to buy your own company on the cheap, assume a credible outsider is about to walk through the door and turn your bargain into a price you cannot afford.