01 Jun 1997
Mergers and Acquisitions Make a Comebackby Garry Emmons and Nancy O. PerryTopics:
A wave of mergers is sweeping the country, activity that recalls the 1980s, the 1960s, and even, some say, the empire-building of a century ago. In the following article, nine HBS professors comment on the current M&As; phenomenon and how M&As; in general affect managers and organizations.
Mergers and acquisitions are back - with a vengeance - in the 1990s. Across the global business landscape, some $1 trillion in M&A; deals were completed last year. That figure includes one hundred transactions of $1 billion or more in the United States, a new record for deals of that magnitude in a single year. Those megamergers, combined with thousands of smaller transactions around the country, reached $650 billion, "nearly twice the dollar volume and the number of deals of the peak year of the 1980s," according to the Wall Street Journal.
What's going on? Why are so many companies in a variety of industries - aerospace, banking, communications, entertainment, manufacturing, railroads, retailing, and health care - opting to join forces with their former competitors? Is this a repeat of the Eighties or something altogether different? And what makes some mergers successes while others are disappointments? To learn more about some of the ramifications, pitfalls, and managerial issues associated with the M&A; process, the Bulletin asked a number of HBS faculty members to comment on the M&A; phenomenon from their several vantage points and areas of expertise.
We began by asking Professor Michael Jensen, a finance expert, how what is happening today compares to what transpired in the 1980s. A decade ago, Jensen explains, M&As; were often associated with downsizing and what he describes as "the freeing of equity trapped in old-line, inefficiently managed firms with outmoded control systems and nonfunctional governance systems."
"In the 1980s," says Jensen, "there were many more takeovers, mergers, leveraged buyouts, and restructurings intended to create efficiency and value. While some of this is happening now, little of today's hostile corporate-control activity is undertaken by those who were usually called 'raiders' in the eighties - entrepreneurs who were putting their own money and reputations on the line."
Jensen believes that most current mergers undertaken to reduce excess capacity and combine related services (such as the recent Chemical/Chase merger in the banking industry) will ultimately be successful. Those associated with growth and so-called synergies - such as the Time Warner acquisition of Turner - will ultimately be viewed as unwise.
Today's activity, he notes, is more like the "disastrous" merger wave of the 1960s, which saw "large firms run by managers who, with little of their own money at risk, were spending corporate resources on ill-conceived diversification and empire-building campaigns." "Unfortunately," Jensen concludes, "too much of the current M&A; activity falls into the latter category."
Professor Samuel Hayes, an authority on investment banking, also invokes the 1960s as a point of reference, specifically with regard to that era's conglomerate-building mania. "We saw huge companies of ill-fitting parts all held together by financial glue and the belief that the bigger and more diversified, the greater the value," says Hayes. "For several years, the cover of one conglomerate's annual report actually bore the legend '2+2=5' in large type under the company's name. They wanted you to believe that the firm's value was greater than the sum of its parts, that a premium accrued to its sheer diversity, regardless of mismatches and inherent contradictions among its various units. Similarly, consider the Wilson Company's involvement in meatpacking, sporting goods, and pharmaceuticals. That mélange earned the company the nickname 'Meatball, Golf Ball, and Goof Ball.' "
The 1980s, by contrast, Hayes says, recognized that while these curious combinations may have seemed financially attractive at their inception, they were now so functionally ill-conceived that the individual parts were worth more than the agglomerated whole. The M&A; restructuring of those 1960s dinosaurs spread to other nonconglomerate companies where inept or complacent management drew the attention of raiders.
"I give credit to that 1980s movement as a whole for having created the profit machine that we see in the 1990s," Hayes says. "We now have an M&A; movement driven by strategic considerations, especially in computers and telecommunications, and in a few cases by economies of scale. The Chemical/Chase merger is an example of the latter; there was so much overlap in back office costs and overhead that the new entity will save hundreds of millions in those outlays alone."
The Big Picture
While public and media attention tend to focus on the corporate gamesmanship and dizzying sums associated with M&A; activity, for the business scholar, such deals are often more interesting as windows inside organizations, revealing how they adapt and perform in times of dramatic change. M&As; have a way of heightening the visibility of a number of theoretical and practical challenges related to an organization's philosophy and operations.
According to Associate Professor Karen Wruck, an expert on finance and firms in crisis, acquisitions often fail to create the value anticipated by the buyer due to postacquisition organizational problems. Wruck cites one case she followed in which the initial match looked great. The target and bidder had operations in the same industry, creating a potential for synergies. But integration of the target into the acquiring firm and its subsequent oversight by corporate headquarters were unsatisfactory.
"The anticipated benefits and efficiencies never materialized," explains Wruck. "Once deals are completed, disappointing outcomes can occur because perceived premerger synergies, such as product-line complementarities, are often elusive." Furthermore, she says, the bidder in this case imposed an inappropriate centralized and bureaucratic organizational design on the target firm. Management was unable to make critical decisions without multiple approvals. "As a result, the organization lost its vitality, performance began to deteriorate, and value was lost," Wruck observes.
Professor Lynn Paine, an expert on corporate responsibility issues, notes that mergers and acquisitions involve a wide array of ethical questions, some of which relate to the degree of "fit" between the value systems of the merging firms. "A mismatch can sometimes lead to serious problems, such as when one firm invests heavily in employees and the other focuses mainly on shareholders or customers," Paine says.
A secondary category of ethical issues, she notes, involves questions arising from the actual M&A; transaction. "Some really vexing issues surface in the course of these deals," Paine observes. "Management must decide, for example, when to disclose plans for the merger, what restrictions to place on insider use of information, what counts as fair and proper accounting and taxation, and how to treat employees who may lose their jobs.
"In M&As; that cross borders," Paine notes, "these issues can be particularly difficult because of cultural and legal differences. For example, the legal definition of 'redundant employees' varies widely as do requirements for severance arrangements. In the face of such differences, managers of the merging companies have to wrestle with what is fair to the different sets of employees and what will help build a cohesive organization with a single set of ethical standards going forward."
In management ranks, Professor Michael Beer, an expert in organizational effectiveness and change, has too often seen questions about who will run a postdeal company not fully answered in advance. "Executives from each side may have different assumptions about which strategy and management practices will be best for the new company," Beer says. "These issues are often hidden and not discussed during initial negotiations. After the merger, executives from one company may end up feeling that executives from the other company have taken over. All of these human forces can destroy the potential economic value of the merger."
Beer suggests that cross-company task forces be established to design the structures, systems, and processes needed to support the vision for the new entity. "Only a well-conceived process for integration and a spirit of partnership can prevent a clash of cultures," he warns.
A clash of cultures can be bad enough, but an even more tangible nightmare arises if the new entity's computers can't talk to each other. How do merging companies manage the transition of their information systems?
"If a company is addressing the transition of information systems after a merger, it is probably too late to avert the loss of key information technology (IT) professionals, costly delays, and crisis," says Professor Richard Nolan, an authority on information-systems management. "The right time is during due diligence. At this point, the IT assets should not only influence the 'go/no-go' decision to merge but also the price of the merger or acquisition. After the merger, the disposition of IT assets, including information systems, should be included in the postmerger integration plan based on the respective firm's quality of IT assets and management."
Two Heads Aren't Better Than One
All these potential problems become moot if there's resistance at the very top. The worst-case scenario, says Professor Jay Lorsch, an expert on corporate governance, is when neither CEO wishes to step aside. "The deal will likely be dead in the water," he observes. "If these individuals cannot satisfy their own career and financial interests, our research shows that, in general, the CEO most likely to lose his job scuttles the deal. Similarly, a CEO has considerable power to forestall any merger that doesn't appeal to him."
Sometimes, however, Lorsch adds, reluctant CEOs do come under such intense pressure from boards that they are forced to accept offers, or directors recognize that a deal is such a favorable one for the company and its shareholders that they override the CEO.
"But the real zero-sum game is which one of them will win the CEO's position," says Lorsch. "It is relatively simple for two leaders to agree on a lucrative financial package for themselves - after all, they are working with multiple millions of shareholder dollars."
Michael Beer says misunderstandings at the senior level about who will run the new entity and how they will run it can cause postmerger disruptions. What can be done to avoid this situation? Again, the groundwork for an effective merger should begin well before the deal is consummated, with the two CEOs agreeing early on about who will run the merged company. Members of the new top management team, he notes, should also ideally come from both sides if a spirit of partnership is to develop.
"Immediately after the merger," Beer says, "the new senior management team should come up with its business strategy jointly. And it must agree as a group on an organizational vision for the new firm, as well as on which managers will occupy key positions and what should be expected of them."
In contemplating mergers, corporate leaders must also take into account certain ethical issues. Professor Joseph Badaracco, an authority on business ethics, cites two central concerns in this area: the first is whether the merger will create economic value for shareholders; the second involves a company's implicit contracts with its stakeholders.
"On paper, mergers and acquisitions often look terrific," Badaracco observes. "But in practice, they are generally costly and frequently disappointing. They often disrupt organizations, sometimes for years, and divert the time and energy of senior management." Because Badaracco believes that managers' principal ethical obligation is to serve the interests of their shareholders, he says the first question senior executives should ask is this: Is there a detailed, realistic, implementable plan for making a merger or acquisition succeed?
"Every company has implicit contracts with its shareholders that are the result of its past actions, statements, and commitments," Badaracco notes. "When an M&A; modifies or breaks these contracts, as they sometimes must, compensation may be due to people and groups that reasonably depended on the company to make good on its commitments. Thus, the second question senior executives must ask themselves is: What does a company owe the people and groups, particularly the weakest and most vulnerable, that may be left behind as the company moves forward?"
Down the Road
That movement forward, inevitable and inexorable, becomes ever more pressing and demanding in the modern age. Many experts agree that one key factor driving the M&A; boom of the 1990s is companies' need - in response to today's highly competitive global economy - for both speed and brawn. Firms must be imposing enough in terms of size and resources to hold their own in the international arena, yet nimble enough to make rapid strategic moves to stay competitive. Such strategic adjustments are often best achieved by a quick purchase or merger.
As business's global links expand, mergers and acquisitions will likely become an increasingly international and cross-border phenomenon. Professor Krishna Palepu, an expert on emerging markets, reports that in that sector, "the M&A; market is not well-developed, although demand is growing. The transactions that do occur are conducted for strategic rather than corporate control reasons.
"Emerging markets," Palepu continues, "are undergoing radical changes both in terms of increased competition in product markets and increased investment in financial markets by international investors. India, for one, has recently taken steps to facilitate the orderly development of an M&A; market there. With this sort of regulation in place," he predicts, "M&A; transactions should rise."
In the coming decades, then, the feverish M&A; activity of the Go-Go Eighties and the Roaring Nineties may, in retrospect, appear modest and localized compared to what will happen when the vast potential of the emerging markets is more fully developed and incorporated into the global economy.