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Chapter 20 Acquisitions and restructuring 565

3 Review the resource base of the acquired company via a ‘resource audit’.

4 Clarify and revise corporate objectives and develop strategic plans.

5 Revise the organisational structure.

Each of these is now briefly examined.

Reporting relationships

Clear reporting relationships have to be established in order to avoid uncertainty. An

important issue is whether to impose reporting lines at the outset or whether to await

the new organisational structure. In resolving this issue, it is desirable to avoid man-

agers establishing their own informal relationships, and to stress that some changes

may be temporary.

Control of key factors

Control requires access to plentiful and accurate information. To control key factors,

acquirers should rapidly gain control of the information channels that export control

messages and import key data about resource deployment. It may sometimes be

desirable not to introduce controls identical to those of the parent, first, because

group controls may not be appropriate for the acquired company, and second,

because those group controls may no longer be appropriate for the revised organisa-

tion. If the acquired company’s existing control systems are thought to be adequate,

it may be worth retaining them. Two important financial controls are the setting of

clear borrowing limits and an early review of capital expenditure limits and apprais-

al procedures.

Jones notes that poor financial controls are often found within newly-acquired

companies, and indeed, have often contributed to their acquisition. Examples are

over-reliance on financial rather than management accounting systems (MAS), a

MAS that provides inappropriate information in an inappropriate format, poor use

of the MAS, and distortions in the overhead allocation mechanism, making it diffi-

cult to pinpoint unprofitable products and customers. The net result is often poor

budgetary control, inadequate costing systems and inability to monitor and control

cash movements.

Resource audit

The resource audit should examine both physical and human assets to obtain a clear

picture of the quality of management at all levels. The extent of the audit required will

depend on how much information is made available prior to the acquisition, but audi-

tors should not be surprised if ‘skeletons’ are found in cupboards, requiring a reap-

praisal of the value of the acquired firm and possibly a different way of integrating it

into the parent’s future strategy and plans. For example, a business that was meant to

be absorbed into the parent’s operations may be divested if its capital equipment is

unexpectedly dilapidated.

Corporate objectives and plans

These should be harmonised with those of the parent, but should also reflect any dif-

ferences due to industrial sector, such as different ‘normal’ rates of return or profit mar-

gins in different industrial sectors. Managers of acquired firms should have some

freedom to formulate their plans to meet the stated aims, but the degree of freedom

should depend on the complexity of the merger. For example, in a conglomerate acqui-

sition, where the primary aim is to secure financial control, it may be appropriate to

allow executives to develop a system of management control suitable to their own

operating patterns, so long as these are consistent with the aims of the takeover. In cases

where cash generation is the main spur, all that may be needed is centralised cash man-

agement plus control over capital allocations.

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566 Part V Strategic financial decisions

Revising the organisational structure

A discussion of organisational design is beyond our scope, but obviously a demoralised

labour force is unlikely to offer optimal performance.

Two important factors enhancing the success of a takeover are the thoroughness of

the resource audit and the degree of senior management contact in the very early

stages of the takeover. Employees of acquired companies seek a rapid resolution of

uncertainty, especially regarding how they and their company fit into the future struc-

ture and strategy of the acquirer, and how soon the new management team will

assume control. Particularly important for morale are the lifting of any previous

embargo on capital expenditure and the provision of improved performance incen-

tives, pension schemes and career prospects.

Some of these aspects are illustrated in the following short cases.

■ Case 1: Post-acquisition integration at GE Capital

According to Ashkenas, DeMonaco and Francis (1998) the process of melding one com-

pany into another is frequently badly done because few firms go through the process

often enough to develop a pattern. They suggest that many firms see it as a one-off

event rather than a replicable process – ‘something to get finished, so everyone can get

back to business’. Because ‘the acquisition event is painful and anxiety-generating,

involving change, disruption and job loss, most managers think how to get it over with,

not how to do it better next time around’.

They reported on acquisition integration at GE Capital, a subsidiary of General

Electric Corporation, founded in 1933 to provide consumers with credit to purchase

GEC appliances. GE Capital has grown by acquisition, including over 100 in the five

years prior to their report. From interviews with managers and key staff involved in

acquisitions, both as former targets and subsequently as acquirors at GE Capital, they

devised a framework for acquisition management based on four ‘Lessons’:

Lesson 1

Acquisition management is not a discrete phase of a deal and does not begin when the docu-

ments are signed. Rather, it is a process that begins with due diligence and runs through the

ongoing management of the new enterprise.

Lesson 2

Integration management is a full-time job and needs to be recognised as a distinct business

function, just like operations, marketing, or finance.

Lesson 3

Decisions about management structure, key roles, reporting relationships, lay-offs, restructur-

ing, and other career-affecting aspects of the integration should be made, announced and

implemented as soon as possible after the deal is signed – within days, if possible. Creeping

changes, uncertainty, and anxiety that last for months are debilitating and immediately start to

drain value from an acquisition.

Lesson 4

A successful integration melds not only the various technical aspects of the businesses but also

the different cultures. The best way to do it is to get people working together quickly to solve

business problems and accomplish results that could not have been achieved before.

Source:

Ashkenas, et al. (1998).

■ Case 2: UK bank mergers bear fruit

In early 2002, two British banking groups reported strongly improved performance

resulting from the respective mergers that had created them. The source of the benefits

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Chapter 20 Acquisitions and restructuring 567

was broadly similar – large cost savings combined with buoyant demand for retail

financial services.

Royal Bank of Scotland, the UK’s second largest by market value after its acquisi-

tion of NatWest Bank, was able to shrug off increased bad debt provisions and expo-

sure to Enron, the insolvent US energy trader, after exploiting more synergies than

originally forecast from the acquisition. Royal Bank shares had out-performed the UK

banking sector by 18 per cent as news of rapidly increased revenue growth from

NatWest synergies leaked on to the market.

HBOS plc, number five in the banking league table, was formed by Halifax’s takeover

of Bank of Scotland. It also achieved strong gains from the merger in the area of sav-

ings and mortgage loans. It had achieved a 25 per cent market share in the mortgage

market via a policy of interest rate cutting, after years of decline following the de-

mutualisation of Halifax Building Society in 1997. It was also threatening the market

dominance of the ‘Big Four’ banks in the small business sector by offering higher inter-

est rates on credit balances (4 per cent against 0.1 per cent!). HBOS had outperformed

the banking sector by 27 per cent over the previous year.

20.10 ASSESSING THE IMPACT OF MERGERS

The impact of mergers can be assessed at various levels. At the macroeconomic level, if

takeover activity is performing its function of weeding out inefficient managements,

we might expect to find takeovers resulting in superior economic performance.

However, over the long haul the two economies where takeover activity is most

prevalent – the USA and the UK – have underperformed economies where growth by

takeover is less common (e.g. until the mouldbreaking takeover of Mannesmann by

Britain’s Vodafone-Airtouch in 2000, there had been only four completed hostile

takeovers in Germany since 1945 and not one completed by a foreign bidder). Measures

of economic performance such as growth in gross domestic product (GDP) per head

and capital formation as a percentage of GDP were, certainly until the 1990s, consider-

ably lower in the UK than in Japan and Germany, as were figures for ‘growth drivers’

like R&D expenditure as a percentage of GDP.

Although such associations do not prove causation, the presumed link is via the

impact of horizontal mergers reducing competition and through the pressures for

short-term performance. It is often argued that managers in the ‘Anglo-Saxon’

economies are forced to pay out higher dividends to bolster share price in order to

deter prospective raiders. Ever higher payouts represent cash that could have been

used to finance investment and growth. However, it seems implausible to argue that

the institutions would withhold funds from companies that showed a willingness to

perform according to short-termist rules. Nevertheless, after reviewing the evidence,

Peacock and Bannock (1991) concluded that mergers and takeovers did not create

wealth, but merely transferred ownership of assets. The full explanation of why merg-

er-active economies underperform is probably less simple, as Porter (1992) explains,

involving a complex interplay of economic, social and political factors.

Another level of analysis is that of the performance of individual companies. If

takeovers are beneficial, we should expect to see merger-active firms improving their

performance post-merger.

Self-assessment activity 20.5

What are the key elements of an acquisition strategy?

(Answer in Appendix A at the back of the book)

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568 Part V Strategic financial decisions

Investigating the effects of merger activity is one of the busiest areas of contempo-

rary applied finance research. There are two main ways of attempting to assess the

impact of mergers.

The first, ‘the financial characteristics approach’, is based on examining the key

financial characteristics of both acquiring and acquired firms before the takeover, to

study whether they are more or less profitable (taking profitability as an indicator of

efficiency) than firms not involved in acquisitions, and whether their profitability

improves after the acquisition. The second, ‘the capital markets approach’, is based on

examining the impact of the takeover on the share prices of both acquired and acquir-

ing firms, to assess the extent to which expected benefits from merger are impounded

in share prices and how these are shared between the two sets of shareholders.

The first method, the financial characteristics approach, suffers from severe limitations:

1 Different accounting conventions used by different firms (e.g. treatment of R&D)

often make comparisons misleading.

2 Measures of profitability may have been distorted due to the application of acquisi-

tion accounting procedures. Prior to the issue of FRS 10 in 1997, firms in the UK were

allowed to write off goodwill (the excess of purchase price over ‘fair value’) against

reserves. This lowered their equity bases and raised their recorded return on invest-

ment. Goodwill now has to be shown on the Balance Sheet as an asset and amortised

over its useful life up to 20 years. This abrupt change in the rules of accounting for

goodwill means that pre- and post-takeover measurement of performance of firms

active in takeovers before and after 1997 is likely to be seriously distorted.

3 To assess properly the impact of the takeover requires an extended analysis ranging

over, say, five to ten years. Many acquisitions are undertaken for ‘strategic’ purpos-

es, the benefits of which may emerge only after several accounting periods, perhaps

following lengthy and costly reorganisation. Very frequently, when ‘efficient’ com-

panies take over ‘inefficient’ companies, the group’s return on net assets and fixed

asset turnover ratios automatically fall.

4 Accounting studies are not capable of assessing what the performance of the

expanded group would have been in the absence of the merger, and are thus unable

to assess what improvement in performance (if any) was due to factors beyond the

merger. This problem increases with the time period used for the post-merger

investigation.

5 Any improvement in profitability may simply be due to a restriction of competition,

rather than more efficient use of resources.

6 The approach does not allow for risk. If the aim of many mergers is to lower total

risk (possibly for managerial reasons), or to shift the company into a lower Beta

activity, a lower return post-merger is not especially surprising, since according to

the EMH/CAPM, relatively low-risk investments offer relatively low returns.

The second method, the capital markets approach, caters for many of these diffi-

culties, and is thus the most frequently used mode of analysis. By adopting a CAPM

framework, it enables the returns on shares of acquiring firms to be examined prior to

and following the merger. As noted in Chapter 10, the market model indicates that the

expected return on any security, j, in any time period t, is a linear function of the

expected return on the market portfolio:

However, the actual return in any time period, results from a compound of

market-related and company-specific factors:

is an error term with zero expected value, indicating that random company-specific

factors are expected to cancel out over several time periods.

 a

 b

 u

 a

 b

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Chapter 20 Acquisitions and restructuring 569

If, over a suitable period and allowing for overall movements in the market, we

examine the differences between the expected returns and the actual returns, the

‘residuals’ or ‘abnormal returns’ should sum to zero, i.e. the expected value of the

cumulated differences between and is zero.

A takeover bid is a company-specific event likely to raise the share price, and hence

the return on holding the shares. When a bid occurs, the increase in returns can be

attributed to the market’s assessment of the impact of the bid, i.e. the evaluation of its

likelihood of success, and if successful, its appraisal of the benefits likely to ensue.

Therefore, both in the period leading up to the bid, as the potential bidder builds a

stake, and also on the day of announcement of the bid, we might expect the residuals

to be non-negative. For example, if the market thinks the takeover is a mistake, we

may find negative residuals for the bidder but positive residuals for the target, if, as

usually happens, the share price of the target rises sharply. Hence, the cumulated

residual returns may be taken as the stock market’s assessment of the value of the

takeover to the shareholders of the acquirer and acquired companies, respectively.

To illustrate this use of the market model, consider the data in Table 20.6. This

relates to the successful takeover bid for the Kenning Motor Group by the conglomer-

ate Tozer Kemsley Milbourn (TKM) in 1986. There was a degree of industrial logic in

this bid, as both TKM and Kennings retailed motor cars and Kennings operated a sub-

stantial car hire business. Kennings had attempted in previous years to diversify, but

owing to the haphazard selection of targets and poorly executed integration, its core

business was suffering, reflected in declining profitability and weakening cash flow.

The data show the residual returns for both companies in the three months prior to,

and also following, the bid; month 0 is the day of the bid, eventually completed at a

price of

The data clearly show positive residuals for Kennings, before the bid, on the day of

the bid itself, and also in the following periods as TKM raised its bid. In this case, both

sets of shareholders enjoyed substantial returns. After allowing for the movement in

the market as a whole, the returns on the shares of both companies were substantially

positive, indicating market expectations that this merger would be wealth-creating.

£3.10.

Table 20.6

Pre- and post-bid

returns

Kenning Motor Group

Time period Share Actual Expected Cumulated

(months) price (p) return (%) return (%) Residual residuals

140

160 14.29 1.67 12.61 9.45

158 1.25 1.56

0 212 34.18 7.63 26.54 28.10

1 268 26.42 26.60 54.70

2 310 15.67 18.71 73.41

3 310 0 3.08 70.33

Tozer Kemsley Milbourn

81 22.73 1.87 20.86 18.24

108 33.33 7.42 25.91 44.15

0 136 25.93 8.53 17.39 61.54

1 177 30.15 30.36 91.90

2 172 0.58 92.48

3 180 4.65 3.44 1.21 93.69

Source:

Data collected by Krista Bromley.

3.402.82

0.21

1

2

2.622.620.322.943

3.08

3.04

0.19

7.896.641

2

3.163.160.293.453

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570 Part V Strategic financial decisions

This proved to be the case, following very swift and effective reorganisation of

Kennings by TKM.

Until quite recently, the bulk of the empirical evidence (e.g. see surveys by Jensen

and Ruback (1983); Department of Trade and Industry (1988); Mathur (1989)) suggest-

ed that positive gains from takeovers accrue almost entirely to the shareholders of tar-

get firms. While the average abnormal returns (the cumulated residuals for all firms

divided by the number of firms examined in the study) recorded in these studies are

invariably positive and statistically significant, returns to the shareholders of bidding

firms are negative for mergers and not significantly different from zero for takeovers.

In other words, on average, takeovers and mergers are not wealth-creating, but the

acquisition process transfers wealth from the shareholders of acquirers to those of the

acquired. These are very important results as they seem to question the judgement or

the motives, or both, of the instigators of takeover bids.

However, a very significant study by Franks and Harris (1989), based on both UK

and US data, contradicted much earlier work in an important respect. The study is

especially important for two reasons. First, the authors took mergers and takeovers

over a much longer period (1955–85) than most other studies; and second, they exam-

ined a considerably larger sample than any previous study. For the UK, 1,900 acquisi-

tions involving 1,058 bidders were studied and the US sample was 1,555 acquisitions

involving 850 bidders. The targets were all publicly traded, facilitating a capital mar-

kets approach. Table 20.7 shows their results in terms of excess stock market returns as

compared to the market portfolio, and allowing for systematic risk.

As with earlier studies, these data record a substantial increase in wealth for the

shareholders of target firms, but unlike earlier ones, they reveal a relatively smaller,

but statistically significant, increase in wealth for the shareholders of acquirers over

the whole period leading up to and just after the bid.

A subsequent study by Limmack (1991), using only UK data for the period 1977–86,

suggested that ‘the gains made by target company shareholders are at the expense

of shareholders of bidder companies’. He also suggested that the average wealth

decreases suffered by the shareholders of bidding companies are mainly confined to

the period 1977–80, and that bids made in the years 1981–86 produced no significant

wealth decrease for shareholders of bidding firms.

Limmack’s study seemed to imply that bidding firms and the capital market in gen-

eral might have learned from earlier mistakes, and that some of the gains from merg-

er might be retained by the bidder.

However, Sudarsanam et al. (1996), in a study of returns around bid announcement

dates over the period 1980–90, found significant negative CARs of around 4 per cent

for the announcement period minus 20 days to plus 40 days. In a subsequent study of

398 takeovers during 1984–92 involving bid values of over million, Gregory (1997),

found ‘the post-takeover performance of UK companies undertaking large domestic

acquisitions is unambiguously negative on average, in the longer term’. The results

were clearly ‘not compatible with shareholder wealth maximisation on the part of

acquiring firms’ management’, Gregory found that acquiring firms underperformed

the stock market by 18 per cent on average for two years following a bid. The method

£10

Table 20.7

The gains from mergers

UK (months) US (months)

0 4 to  104 to 1

Targets

Bidders

Source: Franks and Harris (1989).

4%1%8%1%

24%16%31%24%

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Chapter 20 Acquisitions and restructuring 571

of financing the takeover was also discovered to be significant, with share exchanges

being especially poor for shareholders. Agreed bids were less successful for acquiring

companies than hostile takeovers, and companies making their first takeovers were

likely to be poorer performers than more experienced bidders. Finally, companies bid-

ding to diversify their interests were less likely to succeed than takeovers in related

business areas (which echoes many previous analyses).

US studies, by both academics and firms of consultants, have found parallel results.

Research in 1995 by the Mercer consultancy and Business Week of 150 deals valued at

$500 million or above during 1990–95 showed that about half destroyed shareholder

wealth and only 17 per cent created results that were more than ‘marginal’. These and

similar studies appear to confirm the view that bidders overpay for their targets

(Gregory found an average bid premium of around 30 per cent) and that managers

underestimate the work required to make a takeover succeed. Moreover, many man-

agers seem determined to ignore the warning signs.

Some researchers in both the USA and the UK have studied the post-merger

behaviour of corporate cash flows. This has the merit of avoiding the problems of

accounting measurement and policy when profitability data are used, and also

avoids relying on the efficiency of the capital market if share price data is used. For

example, Manson et al. (1994) studied 38 UK mergers over 1985–87, and found that,

on average, takeovers produced significant improvements in operating perform-

ance, reflected in higher cash flow. This supports the view that the market for cor-

porate control provides a discipline for managers, and is consistent with US studies

using similar methods.

Franks and Mayer (1996 a, b) undertook an explicit test of the disciplinary role of

hostile takeovers. They hypothesised that hostile takeovers would have a discipli-

nary impact, shown by association with, first, a high rate of managerial turnover,

second, with substantial internal restructuring (asset sales exceeding 10 per cent of

the value of post-acquisition fixed assets) and third, with weak firm performance

post-acquisition.

Their study of hostile UK takeovers completed in 1985–6 found:

■ 50 per cent of directors resign soon after a friendly bid as compared to 90 per cent

after a hostile bid.

■ Asset sales exceeded 10 per cent of the total fixed asset value in 26 per cent of

friendly bids compared to 53 per cent of hostile bids.

■ Bid premia averaged 30 per cent of firm value for hostile bids compared to 18 per

cent for friendly bids.

■ Bid premia on hostile bids were not correlated with rate of management turnover.

■ Using four measures of performance (abnormal share price performance, dividend

payments, pre-bid cash flow rates of return and Tobin’s Q (the ratio of market value

to replacement cost of assets), they found little significant evidence that recipients

of hostile bids were poor performers prior to the bid.

Overall, the evidence was not consistent with hostile takeovers exerting a form of

natural selection in which underperforming managements are supplanted by alterna-

tive teams offering improved results.

Finally, what about international mergers? In 2000, the accounting firm KPMG

reported a study of 700 of the largest cross-border takeovers occurring between 1996

and 1998 in which it attempted to assess the value created. KPMG measured compa-

nies’ share price performance before and after the deal, and compared the post-deal

performance with trends in each of the firm’s industries.

The results were:

■ 17 per cent of takeovers added value to the combined company.

■ 30 per cent produced no significant difference.

■ 53 per cent actually destroyed value.

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572 Part V Strategic financial decisions

Commenting on why 83 per cent of mergers apparently fail to generate net benefits

for shareholders, it was suggested that many firms concentrate too heavily on the busi-

ness and financial mechanics and overlook the personnel-related issues, echoing the

earlier study by Lees (1992).

KPMG identified six factors that merit close attention:

■ evaluation of synergies

■ integrated project planning

■ due diligence

■ selection of the right management team

■ dealing with culture clashes

■ communication with staff.

Not much new here, readers may think, but it is remarkable how often over-ambi-

tious managers have to be reminded of the ingredients of a successful merger.

In a further survey released in 2002, KPMG claimed that over a third of giant inter-

national takeovers completed at the peak of the bull market were being unwound, that

32 per cent of chief executives or Finance Directors responsible for planning the origi-

nal deals had moved on, and that two-thirds of firms acquired during 1996–98 still

needed to be properly integrated. The lesson appears to be that, like Chris Gent of

Vodafone, following the acquisition of Mannesmann, top managers should negotiate

their bonuses after completion of the mega-deal, but before the problems begin to

appear.

The KPMG study suggests the importance of internal cultural issues. One might be

forgiven for thinking that acquisitions by British firms of US enterprises would have a

greater chance of success given the similarity in language and corporate cultures. Yet

recent research by Gregory and McCorriston (2004), based on a study of 197 major

British takeovers in the USA (excluding banking – itself a disaster area), suggests

exactly the opposite. See the box below for more details.

Acquisitions in US ‘disastrous’ for British

companies

The US has been a graveyard

for acquisitive UK companies,

losing shareholders vast sums

of money on projects picked for

‘the wrong reasons’, says new

UK academic research.

Alan Gregory, professor of

corporate finance at Exeter

University, said: ‘The research

shows on average that UK

companies make disastrous

acquisitions in the US.’

Five-year returns from UK

companies acquiring US com-

panies between 1985 and 1994

underperformed stay-at-home

companies by 27 per cent.

British acquisitions of EU

companies, by comparison,

have yielded slightly negative

returns short-term but paid

off over longer periods.

Prof Gregory, who is also on

the panel of the UK’s Competi-

tion Commission, said: ‘The

research findings tell us that

UK companies are attracted to

buy businesses abroad for the

wrong reasons: short-term

events such as exchange rate

fluctuations, growth in share

prices and stock markets, and

policy decisions by govern-

ments, often drive a wave of

cross-border acquisitions.’

The research, covering UK

acquisitions in the US of more

than £10 m ($17.9 m), was

prompted by the growth in

cross-border acquisitions by

UK groups. Prof Gregory said

UK companies accounted for

more than a third of the devel-

oped world’s cross-border

transactions, which have risen

markedly in recent years. Most

research on the success of

acquisitions has focused on

short-term effects, for example,

share price movements imme-

diately following takeovers.

The exceptions to Exeter

University’s findings were

acquisitions in industries rich

in research and development,

for example technology or

pharmaceuticals, which have

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Chapter 20 Acquisitions and restructuring 573

20.11 VALUE GAPS

Self-assessment activity 20.6

What are the main causes of ‘failure’ of takeovers?

(Answer in Appendix A at the back of the book)

Evidence from some studies indicates that there may be net gains from merger, while

most surveys indicate that the shareholders of target companies experience a beneficial

wealth effect. The near certainty that shareholders of targets will benefit suggests that

market values typically fall short of the value that potential or actual bidders would

place on them. These disparities in value are called value gaps, and there are four main

explanations of how they arise.

■ Poor corporate parenting

Value gaps may arise because some business segments do not make their maximum

possible cash or profit contributions to the parent. Ultimately, this is a reflection of poor

central management, which is thus failing to add value to the group or actually reduc-

ing value. The following are some examples of management deficiencies:

1 Some assets, such as land and premises, may not be fully exploited by either the

parent or its subsidiaries.

2 The parent pursues too many ventures of dubious value, perhaps intending to gain

entry into other areas of business, but in which it does not possess appropriate

expertise.

3 HQ may fail to take sufficiently decisive action to prevent or correct poor prof-

itability in business segments.

4 HQ may indulge in costly central activities or services that are a net burden rather

than of benefit to business units.

5 Poor group structure may leave business units at a disadvantage compared with

competitors. For example, a business unit may be too small to compete effectively

in its main markets, or it may be denied sufficient capital resources to develop its

activities. As a result, it may have a greater value under alternative, more percep-

tive, management.

specific advantages such as

unique products or patents.

One example, said Prof

Gregory, was SmithKline

Beecham’s purchase of Sterling

Winthrop in 1993 which added

‘substantial value’.

This compared, he said, with

less successful deals, including

Hanson’s

£2.1

bn acquisition of

Quantum Chemical, English

China Clay’s deal to buy Calgon,

and Rolls Royce’s £335 m acqui-

sition of Allison Engine. ‘This

underperformance is despite

cultural similarities between

the US and UK, which might

make the job easier,’ he said.

The Exeter team plans fur-

ther research to explain why

UK companies have done so

badly in the US but Prof

Gregory attributed some of it

to companies overpaying for

US opportunities and inade-

quate local knowledge.

Source: Kate Burgess, Financial Times,

11 October 2004.

This section relies on ideas presented in Young and Sutcliffe (1990).

In the next section, we return to a recurrent theme in this book: the meaning and reli-

ability of the values placed on companies by the stock market.

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574 Part V Strategic financial decisions

■ Poor financial management

The HQ corporate finance department might have followed a gearing policy that fails

to exploit its ability fully to borrow and gear up returns to equity; or alternatively, it

may be severely over-borrowed. Similarly, its past dividend policy may have been

over- or under-generous.

■ Over-enthusiastic bidding

It has been said that takeover bidders’ greatest victims are themselves. Many bids are

undoubtedly successful, such as the merger between the Danish security firm Group 4

Marrying in haste

Merger and acquisitions continue apace in spite of an alarming failure rate and evidence that

they often fail to benefit shareholders. Last week’s collapse of the planned Deutsche-Dresdner

Bank merger tarnished the reputation of both parties. Deutsche Bank’s management was

exposed as divided and confused. Dresdner Bank lost its chairman, who resigned. Senior mem-

bers of Dresdner Kleinwort Benson, its investment banking unit, walked out.

Deutsche-Dresdner was a fiasco that damaged both parties. But even if the takeover had

gone ahead, it would probably still have claimed its victims. A long list of studies have all

reached the same conclusion: the majority of takeovers damage the interests of the share-

holders of the acquiring company. They do, however, often reward the shareholders of the

acquired company, who receive more for their shares than they were worth before the

takeover was announced. Mark Sirower, visiting professor at New York University, claims that

65 per cent of mergers fail to benefit acquiring companies, whose shares subsequently under-

perform their sector. Yet the evidence of failure has done nothing to dim senior managers’

enthusiasm for takeovers.

Why do so many mergers and acquisitions fail to benefit shareholders? Colin Price, a partner

at McKinsey, the management consultants, who specialises in mergers and acquisitions, says the

majority of failed mergers suffer from poor implementation. And in about half of those, senior

management failed to take account of the different cultures of the companies involved.

Melding corporate cultures takes time, which senior management does not have after a

merger. ‘Most mergers are based on the idea of “let’s increase revenues”, but you have to

have a functioning management team to manage that process. The nature of the problem is

not so much that there’s open warfare between the two sides. It’s that the cultures don’t

meld quickly enough to take advantage of the opportunities. In the meantime, the market-

place has moved on.’

Many consultants refer to how little time companies spend before a merger thinking about

whether their organisations are compatible. The benefits of mergers are usually couched in

financial or commercial terms: cost-savings can be made or the two sides have complementa-

ry businesses that will allow them to increase revenues.

Mergers are about compatibility, which means agreeing whose values will prevail and who

will be the dominant partner. So it is no accident that managers as well as journalists reach for

marriage metaphors in describing them. Merging companies are said to ‘tie the knot’. When

mergers are called off, as with Deutsche Bank and Dresdner Bank, the two companies fail to

‘make it up the aisle’ or their relationship remains ‘unconsummated’. Yet the metaphors fail to

convey the scale of risk companies run when they launch acquisitions or mergers. Even in

countries with high divorce rates, marriages have a better success rate than mergers. And in an

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