Acquisitions: A Great Shareholder Rip-off??
September 21st, 2009It’s no secret that most acquisitions fail (see Why M&A Deals Go Bad). Academic research has long demonstrated that acquisitions generally fail to create value. But if most acquisitions fail, the question then becomes: Who wins and who loses?
Kudos to David Weidner of the Wall Street Journal for asking the question (ht David). In his insightful piece, Wall Street’s Biggest Con, David sheds some light on the acquisition game:
M&A is a mostly empty exercise built on promises of profits and efficiencies that rarely come to fruition. Companies almost always overpay for their targets, hurting their shareholders and enriching few except the CEOs who do deals and the investment bankers who goad them into the next must-have merger.
Multiple studies have shown no evidence that shareholders of acquisitive companies do better than their stingier counterparts. Some companies are able to wring costs from acquisitions, but usually don’t.
With so many deals failing to meet expectations, it would seem that corporate boards and CEOs would be skeptical of the practice. They aren’t though, not when presented with smooth-talking investment bankers whispering in their ears and financial incentives awaiting them.
Investment banks love the M&A business. Except for underwriting initial public offerings, advising on mergers is the most profitable business on Wall Street…Wall Street bankers are constantly scheming up potential deals for their clients. They schmooze. They cold call. They spread rumors in the media that a company is for sale, or on the prowl, or cheap, or needs to do a deal. Strategies change like fashion: one year diversification is important. The next, a company should focus on its core business and sell non-essential divisions.
Executives of acquired companies are [even] famous for getting big payouts.
These financial incentives and the pressure from advisers make it hard for even the most confident and skilled CEO to ignore the M&A race…The sad backdrop to all of this is that companies and CEOs feel compelled to merge in lieu of anything exciting happening in their own company.
Not all deals are bad, but making a deal for the sake of the deal says something about the executive suite. Seduced with the temptation to get bigger, richer and a lot of attention, why would Joe CEO ever want to get smarter?
So let’s take stock.
Winners:
- Top-level executives on both the buy-side (who can justify higher salaries as a result of presiding over larger empires) and sell-side (who take out a one-time windfall in options and golden parachutes)
- Interested parties (e.g., bankers and lawyers) whose collect fees associated with deal consummation
- Target firm shareholders
- Merger arbitrage funds
Losers:
- Shareholders of the acquiring firm whose wealth gets transferred to the various winners mentioned above
But these are not new problems.
We’ve known about the perverse financial incentives underpinning the M&A market for decades. The truly sad part is that armed with this information, shareholders of acquiring companies and their boards have done little to keep managerial behavior of the acquisitive kind in check.
Sphere: Related Content
September 22nd, 2009 at 2:07 pm
I’m going to push back on this a little bit.
The empirical basis for saying that acquisitions “fail” is that the stock market reaction to the announcement of acquisitions is, on average, indistinguishable from zero. Sometimes the market likes the deal and the stock price goes up, sometimes it doesn’t and the stock price goes down — which averages out to zero. Imagine the counterfactual in which 100% of acquisition annoucements were greeted with a positive market bump. Everyone would see that acquisitions are surefire winners and would rush to do more of them. They would do the best deals first and then engage in increasingly marginal transactions until the average mkt annoucement effect was… what? Zero? There are many different ways one could model this but I think there are many plausible models that result in an average zero expected value for acquirers without having to impugn anyone’s motives.
That said, we ought to be able to do better than a zero average. Saying that the _marginal_ deal should have a zero expected value is different from saying the _average_ deal should have a zero expected value. The only way for rational, share-holder value-maximizing managers to get an _average_ zero return on their acquisitions is for the managers to be really bad at distinguishing good and bad deals. If the distribution of possible deals has a zero mean and they choose from targets from that distribution at random like numbers from a bingo cage and can’t throw out bad draws with negative expected values, then you wind up where we are now.
Perhaps I should point out though that others in the marketplace aren’t doing any better. The average mutual fund underperforms indexes. The average motion picture barely breaks even. etc. I’m sure you would find that the average new product launch fails as well. That’s life in a highly competitive environment.
But even if you believe managers are doing deals at random, they still aren’t doing harm when they do these deals. If the expected value to aquirer shareholders is zero, but target shareholders get a big premium, then a diversified shareholder is actually better off because of the M&A deal.
Finally, it’s important to note that the typical deal is not one you read about in the WSJ. Only unusual deals are newsworthy. According to data from Thomson Financial’s SDC, the typical deal is under $200M and is done without outside advisers on either side.
September 22nd, 2009 at 2:59 pm
All valid points, and definitely some food for thought.
I am not sure that my reading of the literature is quite the same. My understanding of the empirical literature is that, if anything, the event-study results suggest a “slightly” negative effect of acquisitions on returns (in some cases insignificant in others statistically significant but weak in statistical magnitude). But then there are the studies of firm performance that demonstrate reduced ex post profitability and increased likelihood of ex post divestiture.
I actually even remember a study in SMJ (can’t recall the authors right now) that demonstrates that deals in which advisers were not involved performed significantly better than those in which advisers were involved. Consistent with your latter points about the “typical” deal.
September 22nd, 2009 at 3:25 pm
Just received an email from a friend who has been (and currently is) a CEO at various large corporations. He writes:
…dead right about this. At XXX Firm, the Financial Restructuring Group was part of the M&A Group for a number of years because I had done some work for the M&A guys very early on and they liked me. In consequence, for those years I had a front row seat to a lot of M&A activity. It amazed me how the M&A guys would toss together a proforma combination analysis of two companies (without having ANY in depth comprehension of either company’s business), convince the CEO(s) to do the deal, then arrogantly extend their hand and demand 10s of millions of dollars in fees. For what? What value did they add? How has society improved? How has commerce been made more efficient? How is anyone better off?