The M&A Failure Trap: Why Most Mergers and Acquisitions Fail and How a Few Succeed. 2024. Baruch Lev and Feng Gu. Wiley.
At a presentation by a number one investment bank to a bunch of business school graduates within the early Eighties, the bank’s CEO was confronted through the question-and-answer session in regards to the high failure rate of corporate mergers and acquisitions (M&A), which has plagued Wall Street generates a significant slice of its income. The CEO responded by mentioning that corporations’ internal projects – their investments aimed toward constructing corporations from the bottom up somewhat than buying them – also often fail. He didn’t mention the perverse incentive by which divestitures after failed takeovers generate additional fees for bankers. He also didn’t cite data on comparative success rates of internal and external business growth initiatives.
Thanks to Baruch LevProfessor Emeritus of Accounting and Finance at New York University Stern School of Business, and Feng GuChairman and Professor of Accounting and Law on the University at Buffalo School of Management, we now have a reliable measure of the M&A failure rate. Lev and Gu define failure when it comes to post-acquisition sales and gross margin trends, stock performance, and goodwill amortization. Based on a sample of 40,000 transactions over a 40-year period, they find that 70 to 75% of M&A deals fail. That’s double the 36% error rate for internal projects reported from project management application service provider Wrike, Inc.
As if these numbers weren’t troubling enough, Lev and Gu report that the failure rate is increasing. Acquisition premiums have increased and average amortization of goodwill has increased. In addition, conglomerate takeovers – purchases of corporations that don’t have anything to do with the acquirer’s core business – are making a robust comeback.
This comeback occurred though a lot of the broadly diversified corporate giants of the Sixties disbanded – after their stocks traded at discounts to the stocks of focused corporations and management failed to attain the synergies they claimed would arise from their hectic business operations. Lev and Gu also find that the frequency of using “synergies” in corporate merger announcements tripled between the 2000s and 2010s.
For investors, this book is a useful resource. Not only do shareholders must vote on large proposed M&A transactions, but additionally they sometimes suffer horrendous losses from ill-conceived and poorly executed acquisitions. Based on a radical statistical evaluation of their huge sample of deals, the authors discover 43 various factors that increase or decrease the likelihood of success.
For example, the larger the deal size, the upper the share of the acquisition payment made within the acquirer’s stock, and the upper the S&P 500 return within the yr prior to the deal, the greater the likelihood of failure. Lev and Gu summarize their evaluation in a 10-factor model that is beneficial for investors to evaluate the merits of a proposed merger.
The authors support their wealth of quantitative detail with colourful prose. They complement their quantitative findings with case studies of successful and unsuccessful M&As. Prominent deals resembling Hewlett Packard/Autonomy, AOL/Time Warner and Google/YouTube are being examined for clues that may predict the fate of future transactions.
Lev and Gu don’t shrink back from identifying the culprits as they examine the underlying causes of the high M&A failure rate. These include (of their formulation) “commission-hungry investment bankers.” They also point to overconfident CEOs and boards of directors who imagine, despite strong evidence on the contrary, that a transformative acquisition can lift an organization’s profitability and stock performance out of the doldrums. CEOs receive additional compensation for completing such transactions, but are usually not penalized if the transactions fail.
Poor CEO incentives also help explain the resurgence of conglomerate takeovers noted above. Dividing an organization’s operations across a big selection of independent corporations provides no real profit to shareholders, who can diversify on their very own by owning shares in corporations from many alternative industries.
In contrast, the manager of a single-business company has no insurance against an industry downturn that might negatively impact CEO compensation. Spreading the danger by converting the corporate right into a conglomerate makes strategic sense for the CEO because he has a more direct say within the matter than shareholders.
In addition to describing all these agency costs and providing comprehensive evidence that corporations should strongly consider internal investments as an alternative choice to acquisitions, particularly given the usually significant integration challenges of the buy-versus-build route, the authors also address relevant accounting issues a B. the subjectivity of the fair value estimates required to calculate goodwill.
This discussion draws on Lev and Gu’s expertise in financial reporting as expressed of their seminal book (2016). reviewed here in June 2017. You also write in regards to the disturbing phenomenon of acquisitions with the intention of ending the business of a successful competitor.
It by no means detracts from the general quality of , that it comprises a number of misattributions. Publishers should instruct their editors to make use of these Quote investigator®. Had the editors of this book checked this indispensable website, they’d have learned that there isn’t any reliable evidence that PT Barnum ever said, “An idiot is born every minute.”
This is an example of an anonymous saying put into the mouth of a big name, as is the case with many aphorisms. Also within the case of “It is difficult to make predictions, especially about the future,” which Lev and Gu (together with many other authors) attribute to the physicist Niels Bohr, Quote Investigator concludes that the creator of the “funny saying “This one is unknown. Bohr died in 1962 and no published association of his name with the joke before 1971 has been found.
Despite these very minor editorial flaws, it should be considered a convincing success. Large M&A deals make headlines, but rarely generate income for shareholders. “We fervently hope, let us fervently pray” (yes, Abraham Lincoln actually used those words in his Second Inaugural Address) that the company executives, directors, and investors to whom the book is addressed will absorb its vital message and adapt it to their future behavior consistent with its principles. Reducing the wealth destruction that would result from such a change could be an infinite social gain.
