The Merger Mystery
by Geoff and J. Gay Meeks
‘Anyone who has researched merger success rates knows that roughly 70% fail’, reported McKinsey, the consultants [i]. Yet, across the globe, ever-increasing sums are spent on mergers and acquisitions - $5trillion in 2021. How can it be that the mainly talented, highly-skilled, law-abiding, income-maximising people who participate in the M&A market do so with such eagerness and energy even though mergers so often fail to realise operating gains? This is the conundrum that ‘The Merger Mystery’ tackles.
It finds answers in a complex, interacting set of features of the M&A market. The multifaceted solution then offered – drawing on aspects of taxation, accounting, and company law and governance – also points to some possible remedies.
A key contributor to the conundrum is that this is a market characterized by asymmetric information, sometimes the result of accounting manipulation. Another is that merger participants have enjoyed a number of subsidies and privileges at other people’s expense, which have made some deals attractive in spite of bringing no operating gains – while taxpayers, creditors, pensioners, customers and suppliers have lost out. ‘The Merger Mystery’ explores both the information and subsidy problems, as well as ways in which they might be addressed, but begins by investigating a third element in explanation of the mystery: how incentive structures for the main players and their advisers induce perverse, inefficient results. In this blog we focus on incentives affecting the chief executive and other top managers of the acquiring business – incentives liable to spur them into pursuing mergers that do not achieve the rosy outcomes economic theory might predict.
A major statistical analysis for the US by Harford and Li concluded that ‘even in mergers where bidding shareholders are worse off, bidding CEOs are better off three-quarters of the time.’ [ii] One factor in this is the strong correlation between CEO salary and firm size [iii]. Acquisition of another company is one of the easiest ways of achieving a rapid increase in firm size. For example, the $27billion acquisition of Refinitiv by London Stock Exchange (LSE) in 2021 tripled the acquirer’s revenue in a month [iv]. The CEO was ‘rewarded with a 25 per cent increase in base salary…to reflect the LSE’s increased size following the Refinitiv purchase’ [v]. Yet in the same month, LSE shares fell 25% on concerns about ‘LSE’s ability to extract synergies from its acquisition of Refinitiv’.
In an attempt to align the interests of executives with shareholders, the last three decades have seen increasing use of performance-related bonuses in addition to salary. However, the bonuses are not always well-targeted. In one notorious case, the ‘performance’ outcome which triggered a bonus for the CEO was simply closing the deal – Vodafone’s $181billion acquisition of Mannesmann. This triggered a $10million bonus for the acquirer’s CEO, yet has been described as ‘one of the most value-destroying takeovers in the corporate world’ [vi]; tens of billions of the investment were subsequently written off [vii]. More commonly, bonuses are linked to measures of performance such as earnings per share, with potential benefit to shareholders. But the ‘Merger Mystery’ explains the rich opportunities afforded by mergers to ‘game’ performance-related pay via creative accounting, tax avoidance and ‘morally hazardous’ increases in riskiness, leading to more pay (and more perks) for no genuine improvement in the underlying performance that matters most for the wider economy.
Rewards to the CEO for increasing firm size are sometimes defended on the general grounds that a bigger organization is harder to manage. But growing by the particular means of acquiring rivals can often make the CEO’s life easier. Wu (2018) describes Facebook swallowing up Instagram and WhatsApp when their innovative products challenged Facebook [viii]. As Nobel Laureate economist Sir John Hicks wrote, ’the best of all monopoly profits is a quiet life’ [ix]. Moreover, the more the CEO expands her firm through merger, the smaller the probability, the statistics show, of her being the subject of a hostile takeover herself – again a quieter life [x].
Then there is the glamour of life on the acquisition trail. Collins of the Financial Times captured this:
‘Think of the impact of a “transformational” deal, the thrill of the chase, the media spotlight, the boasting rights, and –of course –the massive pay rises. You will be number one! By the time it all ends in tears, the executives who have laid waste to the shareholders are long departed with their winnings…’ [xi]
[i] McKInsey & Company (2010) Perspectives on Merger Integration, June 2010, https://www.mckinsey.com/client_service/organization/latest_thinking/~/media/1002A11EEA4045899124B917EAC7404C.ashx.
[ii] Harford, J. and Li, K. (2007) Decoupling CEO wealth and firm performance: The case of acquiring CEOs, Journal of Finance, 62(2), 917–49, https://doi.org/10.1111/j.1540-6261.2007.01227.x.
[iii] Blanes, F., de Fuentes, C. and Porcuna, R. (2019) Executive remuneration determinants: New evidence from meta-analysis, Economic Research-Ekonomska Istraživanja, 33(1), 2844–66, https://doi.org/10.1080/1331677X.2019.1678503.
[iv] Elder, B. (2021b) Shareholder doubts escalate over LSE takeover of Refinitiv, Financial Times, 22 March 2021, https://www.ft.com/content/57b1b431-f897-47f8-a4c8-f4efdebefcfe.
[v] Stafford, P. (2021) LSE’s Schwimmer given 176% pay rise’, Financial Times, 23 March 2021, https://www.ft.com/content/bbbf8294-a49e-4bd9-a4f1-d736f7080be3.
[vi] Hargreaves, D. (2019) Are Chief Executives Overpaid? Cambridge: Polity Press.
[vii] Amel-Zadeh, A., Meeks, G. and Meeks, J.G. (2016) Historical perspectives on accounting for M&A, Accounting and Business Research, 46(5), 501–24, https://doi.org/10.1080/0014788.2016.1182703.
[viii] Wu, T. (2018) The Curse of Bigness, New York: Columbia Global Reports.
[ix] Hicks, J. (1935) Annual Survey of Economic Theory: The theory of monopoly, Econometrica, 3, 1–20.
[x] Meeks, G. and Whittington, G. (2021) Death on the Stock Exchange: The fate of the 1948 population of large UK quoted companies, 1948–2018, Business History, https://doi.org/10.1080/00076791.2021.1893696.
[xi] Collins, N. (2014) Common sense disappears when mining groups merge, Financial Times, 24 August 2014, https://www.ft.com/content/a6be7ca6-292c-11e4-8b81-00144feabdc0.
About the book
The Merger Mystery: Why Spend Ever More on Mergers When So Many Fail? by Geoff Meeks and J. Gay Meeksis an Open Access title available to read and download for free below.