Baruch Lev is the Philip Bardes Distinguished Professor of Accounting and Finance at the Kaufman Management Center at the Leonard N. Stern School of Business at New York University. Feng Gu is chair and professor of accounting and law at the School of Management at the State University of New York at Buffalo. Together they recently released The M&A Failure Trap: Why So Many Mergers and Acquisitions Fail and How a Few Succeed (Wiley). They discuss their discoveries, and the lessons they learned would be useful to buyers, with Global Finance.
Global finance: Why did you write this book now? What motivated you in today’s M&A environment?
Lev: Three years ago, Feng and I, as keen observers of mergers and acquisitions, noticed several troubling things. There has been a significant and continuing increase in goodwill write-offs related to acquisition investments. Write-offs are essentially management’s recognition of a partial or total failure of the acquisition, which is a very bad sign, especially if it gets worse over time. We have also seen, to our great surprise, a sharp increase over the last 10 to 15 years in conglomerate mergers: mergers of unrelated entities where there is no synergy. And basically all or most of them would fail, but we still see a big increase in conglomerate mergers. We have also seen a sharp rise in stock prices, usually followed by large waves of mergers.
Girlfriend : What methodology did you follow to study mergers and what were your main conclusions?
Lev: We took a sample of no less than 40,000 acquisitions, a truly representative sample of the last 40 years, and applied some fairly sophisticated statistics. We discovered some amazing things. The first is that the failure rate of acquisitions is 70-75%, when those acquisitions do not increase sales, decrease costs, or create shareholder value. You would expect that the managers who are going to do these extremely expensive and elaborate deals would learn from what they do, and what we found is that there isn’t really a learning curve. learning, but rather an unlearning curve.
I would like to focus for a minute on some general attributes. Most CEOs are confident; that’s how you get there. But overconfidence means they think their ability to acquire, to invest, is significantly greater than their actual ability, and studies have shown that about 30 to 40 percent of CEOs are overconfident. One of the main characteristics of an overconfident CEO is multiple acquisitions. They are convinced that even if they take losers, they will make them big winners.
We also focus on something I haven’t seen before in the literature, which is bad incentives for managers. Most companies pay CEOs an acquisition bonus. These bonuses are quite large, $5 million, $15 million, $20 million, and they are paid for making the acquisition, not for making successful acquisitions. And we discovered something else we’d never seen before. If you look at buyers in general, their operational situation, their profits, their sales weaken over time.
And of course, the reason to buy is to sort of restart the business model. But a weak buyer is an invitation to failure. Its stock price is generally too low to be used for acquisition purposes, and so it has to take on debt, which is very, very oppressive. And target talent doesn’t like working for buyers whose deals are behind schedule.
Gu: The human element is an often overlooked aspect of mergers and acquisitions, and we put a lot of effort into uncovering some important and previously unknown patterns in employee behavior at the time of acquisition. For example, as soon as a merger or acquisition announcement is made, employees of the target company begin to leave. Many of them realize, okay, we know this from previous experience, that once two companies merge, many employees will lose their jobs. That’s why the most talented employees, in particular, don’t want to wait for this to happen to them. And after the acquisition, the same trend continues, but this time it is probably largely due to the decision of the merged company to increase its efficiency by laying off employees in order to create synergies such as cost savings. costs. After several years of retrenchment, employee productivity continued to decline. In fact, you generally don’t see employee productivity returning to pre-acquisition levels.
Girlfriend : When it comes to talent loss, can better and more timely communication help prevent this?
Lev: Executives typically provide very detailed information when announcing an acquisition, and studies have shown that most of this information is very optimistic. They talk about huge synergies to come and great things to be gained from acquisitions. I would say that if you cut this bullshit by 50%, excuse me, and you provide a plan, including how the target’s employees will be integrated into the new company, what new positions await them, what things they should do Like moving from one country to another, reducing uncertainty and focusing on the new opportunities they will have, perhaps with some financial incentives more of them could stay.
Girlfriend : Is there anything systematic that potential buyers can do to anticipate success or failure?
Lev: We introduce a new idea to the M&A literature, that of an acquisition dashboard. We used our statistical model to identify the 10 most important factors that positively or negatively affect the consequences of acquisitions, and we weighted them accordingly. Some factors are more important than others, especially for executives considering an acquisition. We provide a very user-friendly tool where you just plug in the target and buyer numbers, and you get a score indicating the probability of success.
Girlfriend : When is a company well positioned to make an acquisition?
Lev: The ideal buyer would look like a company that is doing reasonably well, but not necessarily incredibly well; a company that can use part of its shares for payment purposes, not just cash; a company that will be attractive to the target’s employees. So don’t wait until a crisis reaches its peak and you suffer losses, lose market share, lose customers. It’s a bad time to buy. Look ahead! Anticipate the expiration of your patents. Think about your business model, when it will reach a plateau. Look at the competition in front of you, then, relatively early on, make a decision and buy. Don’t wait until it’s too late.
Girlfriend : When it comes to due diligence, what should managers do to avoid an unpleasant surprise?
Lev: An important part of successful due diligence is reviewing the accounting. I know it’s boring – certainly for the CEO and maybe even the CFO – but a good analysis of the target’s books is essential. In the case of Hewlett-Packard’s takeover of Autonomy, a forensic accountant showed that it was easy to see that their books had been manipulated 10 years earlier. Every quarter it has met or exceeded analysts’ revenue forecasts. It’s impossible, I think, even for Amazon. So do even the mundane things seriously: review accounting, contracts, and then of course all the human elements. You want to be sure that what you are buying is worth the price. Gu: Another area of due diligence failure relates to technology. Nowadays, a growing number of non-tech companies are buying tech startups, trying to modernize their business model. The primary asset they are trying to acquire is not a physical asset, it is not a stock, it is not even cash. This is the alleged technology used by the target to enter a new type of market. If the buyer does not do a very good job of due diligence to actually vet the technology they are attempting to acquire, it may turn out to be worthless to the buyer. Later, we will see a huge write-off of goodwill showing a completely failed acquisition: very, very embarrassing for the CEO of the purchasing company.
Girlfriend : What are the most important things a potential buyer can do to improve their chances of success?
Lev: First, they should change incentives; Acquisition incentives should only be given for successful acquisitions.