By Christopher Farrell
Spring is in the air, and amorous CEOs are seeking marriage partners. Among some of the more notable nuptial proposals in recent weeks are Comcast's (CMCSA ) $50 billion offer for Disney (DIS ) and the $41 billion deal struck between Cingular and AT&T Wireless Services (AWE ). The courtship frenzy is global in scope. For instance, drugmaker Sanofi-Synthélabo (SNY ) is bidding $57 billion in its hostile attempt to win rival Aventis (AVE ), and France Télécom is putting up about $4.8 billion to absorb the shares it doesn't own in Internet provider Wanadoo.
Mergers and acquisitions are exhilarating. The courtship. The negotiations. The high-stakes gamble. The clash of egos. The prenuptial agreement. The newspaper and magazine cover stories lauding the winner. The trip to the altar. Problem is, the owners of the acquiring firm usually lose money. (In sharp contrast, the shareholders in the company being bought usually receive a premium for their stock.)
Most studies of mergers and acquisitions by consultants and academics come to the same conclusion: Mergers tend to destroy value, not create it. Work by McKinsey & Co. shows that 65% to 70% of deals fail to enhance shareholder value. Consultant Booz Allen Hamilton estimated that 47% of deals didn't meet the objectives laid out by management in the merger announcement. A recent study by economists Sara B. Moeller of Southern Methodist University, Frederick P. Schlingemann of the University of Pittsburgh, and Rene M. Stulz of Ohio State University calculates that acquiring outfit's shareholders lost $216 billion from 1991 to 2001.
Now, in an important sense these results aren't surprising or even upsetting. The stock market is reasonably efficient, with millions of investors managing trillions of dollars as they try to get an edge on the competition. The fact that only about a third of mergers are successful is about as good a result as anyone could expect. There are also business pressures driving companies to contemplate mergers, including some of the most powerful economic forces of our era, such as heightened international competition, rapid technological change, and fierce price competition.
Still, why do so many CEOs persist in dealmaking if the long-term track record for takeovers is so poor for owners? Two arguments stand out in the literature, and neither puts CEOs in a kindly light. Richard Roll, a finance professor at UCLA, advanced in 1986 the "Hubris Hypothesis of Corporate Takeovers." In other words, all CEOs think they were born and raised in humorist and broadcaster Garrison Keillor's fictional Lake Woebegon, where all the children are above average.
CEOs believe they can beat the odds. Sure, two-thirds of mergers don't do well by owners, but they all see themselves in the one-third camp that beats the takeover odds. In addition, it's a lot more fun to get into a high-stakes takeover battle surrounded by legions of investment bankers, lawyers, consultants, and the media than it is to focus on improving the flow of product through a manufacturing plant or overhauling an inventory management system. We've also learned in recent years just how much CEO compensation packages reward management for overseeing a bigger company -- even though the owners are left holding the proverbial financial bag.
NO MONEY FOR JOBS.
Management and owners are also in a deep-rooted power struggle for cash flow. CEOs don't want to give up control of corporate money. They have dreams to fund, empires to build, and stock options to cash in. The corporate sector has rarely been in such good financial shape as it is today. CEOs could substantially hike dividend payments to their owners. Owner-capitalists could then decide if the best use for the money was in the stock market or at the shopping mall. But handing cash flow over to the owners is anathema to senior managements. Instead, they prefer to invest the money in bold takeover deals.
One other downside of current merger mania is readily apparent. Management is all too willing to open its checkbooks to buy other companies, but not to hire workers. Indeed, since many employees of a newly merged company are restructured out of their jobs, the recent spate of deals is a factor in the job-poor recovery. For instance, JP Morgan Chase (JPMCP ), which agreed to buy Bank One (ONE ) in January, has said it expects to trim some 10,000 jobs. Gateway (GTW ) expects to cut some 2,000 jobs once its $235 million merger with eMachines is done.
Shareholders have started to rebel against imperial CEOs, most notably Michael Eisner of Disney (see BW, 03/15/04, "A Wake-Up Call From Investors"). Investors should start demanding that management share more of the corporate cash through dividend payments before too many bad marriages are struck. Divorce is always expensive, and it's not just CEOS who suffer.
Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over Minnesota Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BusinessWeek Online
Edited by Beth Belton