There’s a global mania for mergers

This year, global merger activity (annualising at $4.5 trillion) will surpass the previous highs made in 2007. A combination of factors have contributed to this surge in M&A activity: weak organic topline growth for corporations; a stock market sitting at record high levels; companies able to access debt markets at record low interest rates; and corporations hoarding an extraordinary $2.6 trillion cash earning zero rate of interest. As a result, many firms around the world have gone on a spending spree looking for new markets, new products, and hoping to discover avenues to lower their companies’ cost of doing business.

Despite the large number of deals completed during the last few years, the track record of management teams to deliver increased shareholder value through mergers is seriously questionable. Looking at historical M&A data, we find that three out of four deals fail to add shareholder value for the acquirer even 12-36 months after the deals are completed. Outside of the premium paid to the target firms (the benefits of which accrue to the target firm shareholders), an acquiring firm’s stock price usually languishes long after the transaction is consummated.

Over a hundred large acquisitions made by companies around the world over the last 6 years (2008-2014) failed, on the average, to outperform the local stock market indices where the combined firms were listed as much as 12-18 months after the relevant acquisition was completed.

Several reasons account for this. Most significant is the failure by acquisitive executives to distinguish between purchases which are transformative from those which are expansionary. The transformative ones change the way a company does business going into the future thereby significantly altering its growth prospects. The more common expansionary type of mergers are simply aimed at protecting their current business model and/or their market share. In expansionary mergers, a common problem is a tendency to overpay. These companies often encounter other bidders within the industry resulting in overpayment for the asset; the stock market then penalises the acquiring firm.

Managements’ expectations from a merger are often unrealistic, especially in quantifying savings from potential synergies — integrating merged companies is seldom easy and resistance from mid-level managers can slow down progress substantially.

Senior executives at acquisitive firms tend to be overconfident. Often, the reasons to embark on acquisitions can be questioned. Pressure to beat Wall Street analysts’ earnings estimates puts immense burden on management to find ‘quick’ growth solutions. An acquisition is perceived as a way of buying time and slowly resetting analyst expectations down. The recently announced acquisition of Humana by Aetna is a case in point.

Often, it is the advisors and consultants who exacerbate this problem. When a company’s growth strategy flounders, managers are quick to engage the help of M&A bankers and consultants to sell the idea of an acquisition to their boards.

It is interesting to note that companies seldom switch their M&A advisors, for whom deal fees on acquisitions are usually very lucrative. The incentive is to complete transactions regardless of economic sense. It is also strange that there seems to be little correlation between the size of the fees paid to the advisors and the subsequent performance of the acquisitions themselves.

Applying the usual principles of corporate governance, such as acting in good faith and ensuring no gross negligence in M&A decisions, clearly does not seem to do the trick. Lawyers and bankers are happy to provide the so-called “fairness opinions” behind which boards and managements can hide, seemingly exonerating them from responsibility for subsequent poor performance of these deals. Case law on holding management teams accountable for bad acquisition decisions from around the world has so far been spotty .

Since shareholders of the acquiring firms are the ones that are directly affected, it is they who need a greater voice. Many companies don’t even put the question to a shareholder vote at all. Much as there are audit and compensation committees, acquisition committees should also be formed. Upon their recommendation, a vote on approving a merger can occur. Together with making the appointment of an independent lead director (outside of the CEO) to oversee these acquisitions mandatory, these are ways to temper merger optimism and minimise the ‘deal fever’ syndrome.

But ultimately, the only long-term way to solve this propensity for waste and the destruction of value for shareholders is to hold executives and their boards accountable for the actual success or failure of their decisions. Compensation for managers (and their boards where applicable) should have claw-back mechanisms allowing shareholders to penalise executives in the event mergers fail to add value.

The writer is the chief executive officer of the Meru Capital group