Merger Fever Can Be a Menace for Shareholders; Deals often stroke the ego of chief executives. But they can also destroy much value

Merger Fever Can Be a Menace for Shareholders

JUNE 21, 2014

By JEFF SOMMER

Shareholders beware: M.&A. mania is back.

The numbers suggest that chief executives have a bad case of the seven-year itch: After eyeing other companies hungrily for so long, they have begun trying to buy them.

Mergers and acquisitions are surging to levels last reached before the financial crisis. There are likely to be more than $1 trillion in M.&A. announcements in this year’s second quarter alone, according to a Bloomberg tally that includes proposed deals that may never be consummated. With overflowing corporate coffers, extraordinarily low interest rates and modest prospects for revenue growth in their own businesses, corporate executives are on a buying spree. A new survey, “M&A Trends Report 2014,” by Deloitte, the consulting firm, found that more than 80 percent of executives expect this M.&A. revival to continue or even accelerate — even though nine out of 10 executives said they were dissatisfied with the financial returns on their previous acquisitions.

No matter. Prospective deals in the single-digit billions are already a dime a dozen. And colossal ones — like Comcast’s planned $45 billion merger with Time Warner and AT&T’s $48.5 billion bid for DirecTV — are practically commonplace. Even when deals fail, they can mean big fees for lawyers, bankers and consultants. Yet is deal-making fever good for shareholders?

In any individual case, of course, the answer depends on the details of the deal and on the position of the shareholder. If a prospective acquirer swoops in and bids up the price of a company in your portfolio, you can take a quick profit, and that may be all you care about.

But despite all the hoopla in the stock market and in the media about mergers and acquisitions, decades of academic research provide a surprisingly gloomy picture about the deals’ financial results.

In general, said René M. Stulz, a finance professor at Ohio State University, “M.&A. deals cause wealth destruction for shareholders of public companies.”

Mr. Stulz bases that answer on the empirical record. He is a co-author of a classic paper on the subject, called “Wealth Destruction on a Massive Scale?” It found that during the M.&A. mania of the Internet bubble years, from 1998 through 2001, shareholders of public companies over all lost huge sums of money because of mergers and acquisitions.

That study was based on changes in share prices after an acquisition announcement. The prices of companies doing the acquiring — generally the larger of the two — typically fell after the announcement, an indication that the market viewed the deal as overpriced. In fact, the losses averaged 12 cents on every dollar spent on acquisitions, for a total of $240 billion.

On the other hand, shares of companies being acquired generally rose. (For a new deal to make any sense at all, an acquirer must offer an amount higher than the current market price.) But because the companies being acquired are typically smaller than those doing the buying, the net effect for shareholders as a whole was negative: a total of $134 billion. That, Mr. Stulz says, is wealth destruction, a pattern that has held up in data he’s examined over many years.

“The astonishing thing is that decade after decade, there are these periods of great excitement, with lots of big mergers and acquisitions, yet we see the same basic pattern of losses,” he said.

When publicly traded companies acquire one another, they tend to be afflicted by “the winner’s curse” — a tendency to overpay in auctions and later regret it. Interestingly, he said, there is evidence that acquirers of privately held companies typically get better deals. One reason is that in a public auction, the winning bid must be higher than the prevailing market price, which may already be based on considerable, widely available information.

Seeking to explain the phenomenon of loss-making deals by otherwise impressive chief executives, Richard Roll, a professor of finance at the University of California, Los Angeles, came up with “the hubris hypothesis of corporate takeovers.” Hubris is excessive self-confidence, and in an interview, he said that “executives tend to think that this deal is different, that they’ll be able to find synergies in a merger that will unlock value in a way that nobody else can.” Usually, though, that assumption is misguided. “It’s just hubris,” he said. “They can’t really pull it off.”

Lately, Professor Roll has been studying the role of narcissism — a personality disorder characterized by excessive self-love — in corporate takeovers. When executives are excessively self-involved, he said, they may ascribe unrealistic attributes to themselves, like great strategic vision or deal-making ability, leading them to extend their domains by seeking acquisitions and wheeling and dealing rapidly.

On the other hand, he says, when the target company’s C.E.O. is narcissistic, he tends to demand — and receive — a higher price from a prospective acquirer, which may be good for shareholders. “We’re just beginning to study the behavioral nuances of mergers and acquisitions,” he said.

The Deloitte survey provided some clues about executive motivations. It showed that only 41.6 percent of executives said that obtaining “bargain-priced assets” was a primary M.&A. goal. Every other reason listed in the survey got a higher rating, including items like finding synergies, expanding a customer base, entering new markets, diversifying products and acquiring talent or technology.

Tom McGee, deputy C.E.O. of Deloitte and head of its M.&A. practice, said in an interview that mergers’ results could be improved “if companies perform due diligence the right way at the beginning and if they have a good, coherent plan for corporate integration and actually implement it properly after a merger takes place.”

No doubt that’s true. But I suspect that the problems may be deeper than that. Buying low and selling high is the most reliable, honest way of making a profit, but if executives of big corporations aren’t even looking for bargain-priced acquisitions, they are unlikely to get them. Combining companies is an easy way to grow in size, but is it usually in the interest of a company, its shareholders or anybody else?

These are open questions. It may be that in this season of merger mania, executives, shareholders and just about everybody else would be advised to remember that while a specific merger may make sense, mergers and acquisitions over all have led to immense wealth destruction. An M.&A. surge is a customary part of a hot market. But unless you stand to profit directly from the deal, it may be more cause for grief than celebration.