A Blog by Jonathan Low


Dec 16, 2013

CEOs Appear to Have Little Faith in Their Companies' Acquisitions

'Do as I say, not as I do' has been a watchword of managerial legerdemain since the divine right of kings. But new research suggests that CEOs are doubling down on this ancient wisdom by putting their money anyplace but where their mouths are.

The capital markets have long sniffed at the potential benefits of mergers and acquisitions. The mass of research suggests that as many as 65 percent of mergers and acquisitions fail to achieve their financial or operational goals. The markets understand the difficulties of melding cultures, ambitious executives, worried employees and legacy operating systems, even as senior managers sunnily profess that they've got this and all will be well.

The new research, however, provides further support for those who question the wisdom and value of major acquisitions. Not only are CEOs 23.5 percent more likely to sell stock in the quarter following an acquisition, but are 28 percent more likely to exercise stock options in the immediate aftermath, presumably before the markets are able to assess how well or badly the post merger integration is going.

Despite this, surveys of CEOs report that 35 percent of them are ready to pursue M&A deals, up 10 percent over last year. What gives?

It appears, as the following article explains, that while the CEOs understand full well the difficulties in making any set of enterprises seamlessly combine, they also recognize that their compensation formulas tend to reward size and 'growth' at the expense of efficiency and effectiveness.

That boards of directors continue to tolerate and even encourage this approach would be curious were it not apparent that they, themselves, benefit, as well. For those inclined to take umbrage at anyone who would dare to suggest that they would risk their good governance reputations for the sake of mere financial gain, well, follow the money. The reality is that corporate boards are rarely chastised let alone actually penalized for failures of governance.

As discouraging as this may be, critics of these matters have become more vocal and more numerous. That M&A trends have been so low over the past five years is evidence of the growing awareness of these truths. that ntil executive compensation is re-engineered to reflect a broader set of interests, this behavior will continue. JL

The Academy of Management Journal Reports:

 To a well-known fact about corporate acquisitions, that most fail to generate long-term value for shareholders of buyer firms, a new study adds a startling new finding: most of the CEOs who carry out these purchases do not even expect them to do so

The long drought in corporate acquisitions, defying the current bull market, is about to come to an end, suggests an international survey of executives released in late October by the global consultancy firm Ernst & Young. Although the value of U.S. corporate deals through September was one third less than it was in 2007, when the stock market was last in a record-busting mode, the Ernst-Young survey finds 35% of executives ready to pursue acquisitions, up from 25% a year ago.
But the end of this particular drought would not be a welcome development for investors, some new research suggests.

"Scholars have long sought to understand why  CEOs might be confident that their impending acquisitions will deviate from the typical pattern of poor acquirer performance," begins the paper in the current issue of the  Academy of Management Journal.  "However, virtually no research has attempted to determine whether those CEOs actually act as though they are confident in [the deals'] long-term value-enhancing potential."
And, indeed, evidence uncovered by the study suggests that they are not -- most crucially the finding that chiefs are 28% more likely to exercise stock options and 23.5% more likely to sell company stock in quarters following acquisition announcements than after quarters without such an announcement.
In the words of the paper, which analyzed data involving more than 2,000 publicly traded firms over a 12-year period, "Although CEOs often confidently 'talk the talk' by pronouncing expected synergies and enhanced long-term value when justifying acquisitions, our results suggest they may not always 'walk the talk,' as they are more likely to exercise stock options and sell stock soon after announcing these acquisitions." 
"As a general matter, it wouldn't make much sense for chiefs to sell stock and exercise options so soon after these announcements if they truly felt that the company's stock was going to appreciate," comments Cynthia Devers of Michigan State University, who carried out the study with her Michigan State colleague Gerry McNamara and with Jerayr Haleblian of the University of Georgia and Michele E. Yoder of the University of Michigan-Dearborn.
A lack of CEO conviction about long-term company prospects, Prof. Devers adds, is suggested as well by the effect of the stock market's response to acquisitions and by the response of company directors. "What we found is that a sharply positive market response over the six-day period surrounding announcements increases the likelihood of CEO option exercises by 17.4% and of CEO stock sales by 15%. Yet, the effect should be just the opposite if CEOs are genuinely confident that their acquisitions will create long-term firm value, in which case positive immediate market reactions should further reinforce that confidence."
As for the post-announcement actions of company directors, they also bespeak lack of conviction in acquisitions' long-term value. As stated in the study, "If acquiring firm directors perceive their CEOs are confident that impending acquisitions have the potential to increase long-term firm value, then directors should feel little need to grant their CEOs additional stock options after acquisition announcements." What happens instead, the professors find, is that directors are 16.7% more likely to issue CEO stock options following acquisitions than they are otherwise, suggesting boards sense a need to bolster CEO incentives to create long-term firm value.
What accounts for this evident lack of logic among CEOs and corporate directors? Given their paucity of confidence in the true, as distinct from the purported, value of acquisitions to their companies, why do these presumably capable individuals persistently undertake them?
"The conventional wisdom," Prof. Devers explains, "has been to attribute CEOs' persistent folly in pursuing acquisitions to overconfidence in their ability to create company value from them, a view that flies in the face of the findings of our study. But a second view has gained traction as well in the management literature, to the effect that, whether or not corporate buys are good for the acquiring companies, they are good for their CEOs. For example, firm size is a key driver of executive pay, and, since acquisitions generally produce rapid firm growth, they represent a much faster way of increasing CEO compensation than through such other means as capital expenditures or organic growth. In addition, acquisitions make companies more complex, which complicates monitoring and evaluation of top management by outsiders. Further, CEOs may see acquisitions as reducing their personal financial risk by increasing firm diversification.
"In sum," Prof. Devers continues, "of the two competing views that have emerged to account for corporate acquisitions, our findings raise strong doubts about value-enhancement motives, while certainly being consistent with private-interest motives. As for whether CEOs are overconfident or not confident enough when it comes to acquisitions, the question is, really, confident about what? Perhaps not about long-term benefits for the company, but probably very much about their own personal gains. After all, even if an acquisition isn't particularly successful, it will be a year or more before that becomes clear, at which point the reasons probably won't be all that obvious. Reward CEOs based on the size of the firm rather than on how well they manage them and you'll get big firms, not necessarily well-managed ones.''


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