Animal spirits stir in the boardroom
By Simon London in San Francisco
Published: February 12 2004 17:00 | Last Updated: February 12 2004 17:00
news.ft.com
Animal spirits are stirring in boardrooms across the US. How else but by this new sense of optimism can you explain the revival this year of M&A activity, culminating in Comcast's $66bn hostile bid for Walt Disney?
In fact, there are a number of explanations that owe more to rational self-interest than to voodoo. Academic research shows that M&A tends to occur at times when the stock market is valued highly, and among companies where chief executives are powerful relative to their boards.
If the current wave of bids and deals has investment bankers jumping for joy, then, shareholders should keep their feet planted firmly on the ground.
Brian Roberts at Comcast, Bill Harrison at JP Morgan Chase (which has lined up a $59bn merger with Bank One), Ken Lewis at Bank of America (paying $47bn for FleetBoston) and Larry Ellison at Oracle (mounting a $9bn hostile bid for PeopleSoft) would doubtless disagree.
They might concede, however, that the deluge of deals signals an end to the "siege mentality" that engulfed managers in 2002 and 2003.
Following the collapse of Enron in late 2001, concerns about accounting transparency, corporate governance and executive compensation meant that bold strategic moves were mostly off the agenda.
"Business has been under siege. Maybe that era is coming to an end," says John Roberts, professor of strategy and international business at Stanford University's Graduate School of Business.
[no the seige has just started imho ...pb]
The media, one barometer of the climate of opinion, is certainly less interested in tales of corporate malfeasance.
An analysis by the FT of major English language newspapers shows that articles including the phrase "corporate scandals" were being published at a rate of more than 1,000 a month during the summer of 2002.
Since the middle of last year, the monthly count has run consistently below 200.
The strength of world stock markets is another factor behind the willingness of companies to dust off their acquisition plans.
"Mergers - especially those financed with stock - tend to cluster in times when aggregate valuations are high, especialy when market-to-book values are high for acquiring firms," observes one recent study of historic patterns of M&A activity.*
As the authors point out, this does not imply that markets in general, and bidding companies in particular, are overvalued. An alternative explanation is that high stock valuations reflect well-founded expectations of future growth.
Thus M&A is the mechanism by which efficient markets enable talented managers to gather more assets under their control.
The snag with this rosy picture is that the financial returns on M&A - for the acquiring company - are often poor. Countless studies show that the value created by M&A flows almost invariably to the shareholders of the acquired company.
A recent review of more than 100 academic studies by Robert Bruner, professor of business administration at the University of Virginia's Darden business school, concludes: "The mass of research suggests that target shareholders earn sizeable positive market-returns, that bidders (with interesting exceptions) earn zero adjusted returns...Executives should approach this activity with caution."
With so much evidence stacked against M&A as a profitable growth strategy, why do CEOs continue to indulge in big deals?
One answer is that executives and corporate boards always believe their deals will be among the "interesting exceptions".
But power is also at work. In a paper published last summer, Yaniv Grinstein and Paul Hribar of Cornell University found that CEOs who have more power to influence board decisions - those who are also chairmen and sit on nomination committees, for example - receive significantly larger bonuses for completing acquisitions.
They also found that CEOs with more power tend to engage in larger deals relative to the size of their own companies.
More work needs to be done before these relationships are fully understood. But it is clear that M&A activity on a grand scale is less of a sign of "animal spirits" and more of a signal that "imperial" CEOs are at work.
*'Valuation Waves and Merger Activity: The Empirical Evidence' by Matthew Rhodes-Kropf, David Robinson and S Viswanathan, August 2003. Available for download at www.ssrn.com |
