Mergers and Acquisitions: The Great Shareholder Ripoff?

It’s no secret that most acquisitions fail (see Why M&A Deals Go Bad). Academic research has long demonstrated that acquisitions generally fail to create value. But if most acquisitions fail, the question then becomes: Who wins and who loses?

Kudos to David Weidner of the Wall Street Journal for asking the question (ht David). In his insightful piece, Wall Street’s Biggest Con, David sheds some light on the acquisition game:

M&A is a mostly empty exercise built on promises of profits and efficiencies that rarely come to fruition. Companies almost always overpay for their targets, hurting their shareholders and enriching few except the CEOs who do deals and the investment bankers who goad them into the next must-have merger.

Multiple studies have shown no evidence that shareholders of acquisitive companies do better than their stingier counterparts. Some companies are able to wring costs from acquisitions, but usually don’t.

With so many deals failing to meet expectations, it would seem that corporate boards and CEOs would be skeptical of the practice. They aren’t though, not when presented with smooth-talking investment bankers whispering in their ears and financial incentives awaiting them.

Investment banks love the M&A business. Except for underwriting initial public offerings, advising on mergers is the most profitable business on Wall Street…Wall Street bankers are constantly scheming up potential deals for their clients. They schmooze. They cold call. They spread rumors in the media that a company is for sale, or on the prowl, or cheap, or needs to do a deal. Strategies change like fashion: one year diversification is important. The next, a company should focus on its core business and sell non-essential divisions.

Executives of acquired companies are [even] famous for getting big payouts.

These financial incentives and the pressure from advisers make it hard for even the most confident and skilled CEO to ignore the M&A race…The sad backdrop to all of this is that companies and CEOs feel compelled to merge in lieu of anything exciting happening in their own company.

Not all deals are bad, but making a deal for the sake of the deal says something about the executive suite. Seduced with the temptation to get bigger, richer and a lot of attention, why would Joe CEO ever want to get smarter?

So let’s take stock.

Winners:

1. Top-level executives on both the buy-side (who can justify higher salaries as a result of presiding over larger empires) and sell-side (who take out a one-time windfall in options and golden parachutes)
2. Interested parties (e.g., bankers and lawyers) whose collect fees associated with deal consummation
3. Target firm shareholders
4. Merger arbitrage funds

Losers:

1. Shareholders of the acquiring firm whose wealth gets transferred to the various winners mentioned above

But these are not new problems.

We’ve known about the perverse financial incentives underpinning the M&A market for decades. The truly sad part is that armed with this information, shareholders of acquiring companies and their boards have done little to keep managerial behavior of the acquisitive kind in check.

Disclosure: No positions