Baruch Lev is the Philip Pardes Professor Emeritus of Accounting and Finance, Kauffman Center for Management, Leonard N. Stern School of Business at New York University. Feng Guo is Chair and Professor of Accounting and Law at the College of Management at the State University of New York at Buffalo. They recently posted together The Mergers and Acquisitions Failure Trap: Why so many mergers and acquisitions fail, and how so few succeed (Wiley). They discuss their findings, and the lessons they have drawn from acquirers Global Finance.
Global Finance: Why did you write this book now? What brought you into the current M&A environment?
fiber: Three years ago, Feng and I, as keen observers of mergers and acquisitions, witnessed several troubling matters. There has been a significant and sustained increase in write-offs of goodwill in investment acquisitions. Write-downs are essentially an admission by management of the partial or total failure of an acquisition, which is a very bad sign, especially if they have been increasing over time. We have also seen, to our surprise, a huge rise in the past 10 to 15 years in conglomerate mergers: mergers of unrelated entities where there are no synergies. Essentially, all or most of them will fail, but there will still be a significant increase in conglomerate mergers. We also saw a significant increase in stock prices, which is usually followed by large merger waves.
gf: What methodology did you follow to study mergers, and what were the significant results you reached?
fiber: We took a sample of at least 40,000 acquisitions, a really representative sample over the last 40 years, and applied very advanced statistics to them. We found some amazing things. The first is that the failure rate of acquisitions is 70% to 75%, as these acquisitions do not increase sales, reduce costs, or create value for shareholders. You would expect the managers who would be doing these very complex and expensive deals to learn from what they’re doing, and what we’ve found is that there’s not really a learning curve, more like an unlearning curve.
I’d like to focus for a minute on some general features. Most CEOs are confident; This is how you get there. But overconfidence means that they believe their acquisition and investment capabilities are much higher than their true capabilities, and studies have shown that approximately 30% or 40% of CEOs are overconfident. One of the key characteristics of an overconfident CEO is multiple acquisitions. They are convinced that even if they take losers, they will turn them into great winners.
We also focus on something I’ve never seen before in the literature, which is the misplaced incentives of managers. Most companies pay executives a buyout bonus. These bonuses are very large, $5 million, $15 million, $20 million, and they are paid for making an acquisition, not for making successful acquisitions. And we found something else that we had never seen before. If you look at buyers in general, their operating position, profits and sales weaken over time.
Of course, the reason for the purchase is to somehow revive the business model. But a weak buyer is an invitation to failure. Their stock prices are usually too low to be used for acquisitions, so they have to raise debt, which is very stressful. Target talent does not like to move to work for buyers with underdeveloped processes.
Go: The human element is a frequently overlooked aspect of mergers and acquisitions, and we have put a lot of effort into uncovering some important, previously unknown patterns regarding employee behavior at the time of the acquisition. For example, once a merger or acquisition announcement is made, employees of the target company begin to leave. A lot of them realize, well, as we know from past experience, once two companies merge, many employees will lose their jobs. So, the most talented employees in particular don’t want to wait for this to happen to them. Post-acquisition, essentially the same trend continues, but this time, most of it is likely driven by the combined company’s decision to increase efficiency by laying off employees in order to create synergies such as cost savings. After several years of this pressure, employee productivity continued to decline. In fact, you generally don’t see employee productivity recover to its pre-acquisition level.
gf: Regarding talent loss, can better and timely communication help prevent this?
fiber: Managers typically provide very broad information when announcing an acquisition, and studies have shown that most of this information is overly optimistic. They talk about the huge synergies coming and the great things to be gained from acquisitions. I would say, if you cut out 50% of the nonsense – excuse me – and presented a plan, especially one that explains how the target employees will be integrated into the new company, what new positions await them, and what things they should do such as moving from… Country to country, reducing uncertainty and focusing on the new opportunities they will have, and perhaps with some financial incentives, more of them might stay.
gf: Is there anything systematic that potential acquirers can do to anticipate success or failure?
fiber: We introduce a new idea to the M&A literature, the acquisition scorecard. We used our statistical model to identify the top 10 factors that positively or negatively influence the consequences of acquisitions, and weighted them accordingly. Some factors are more important than others, especially for executives considering an acquisition. We offer a very easy to use tool where you just enter the numbers from the target and from the buyer, and you get a score that indicates the probability of success.
gf: When is a company in a good position to make an acquisition?
fiber: The ideal buyer will look like a company that is performing reasonably well, not necessarily incredibly well; A company can use some of its stock for payment, not just cash; A company that will be attractive to the target’s employees. So don’t wait until the crisis reaches its peak and incur losses, lose market share, and lose customers. This is a bad time to buy. Look ahead! Find out when your patents will expire. Look forward to your business model, when it reaches a plateau. Look at the competitors that are creeping up on you, and then, relatively early on, make a decision and buy. Don’t wait until it’s too late.
gf: When it comes to due diligence, what should managers do to avoid a rude surprise?
fiber: An important element of successful due diligence is looking at accounting. I know it’s boring – certainly for the CEO and maybe even the CFO – but good goal book analysis is essential. In the case of Hewlett-Packard’s purchase of Autonomy, one chartered accountant showed that they could have easily seen that their books had been tampered with 10 years back. Each quarter, it met or exceeded analyst revenue expectations. I think this is impossible even for Amazon. So do even the mundane things seriously: audit accounts, contracts, and then, of course, all the human elements. You want to make sure that what you buy is worth the price. Go: Another area of failure to do due diligence relates to technology. Nowadays, an increasing number of non-technology companies are buying technology startups, in an attempt to modernize their business model. The main asset they are trying to acquire is not a physical asset, not a stock, not even cash. It is the so-called technology that the target uses to penetrate a new type of market. If the buyer doesn’t do a very good job of doing their due diligence to really verify the technology they are trying to acquire, it may turn out to be worthless to the buyer. Later, we’ll see a huge Goodwill write-down showing a completely failed acquisition: something very embarrassing for the CEO of the purchasing company.
gf: What are the most important things a potential acquirer can do to improve their chances of success?
fiber: First, they should change incentives; Acquisition incentives should only be offered for successful acquisitions.
