Acquisitions have uncertain outcomes, and overall performance of acquisitions would increase if acquisitions that destroy value could be avoided. Manager incentives to complete acquisitions can contribute to bad deals, or acquisitions display agency problems. Advisors can help improve acquisition decisions, and research shows advisors offer benefits, including better valuation of targets and faster completion times. However, advisors also have conflicting interests in that they may be paid based on the percentage of deal value, or a deal completion. Potential positive and negative effects of advisors across acquisition phases are summarized. When recognized, the risks from using advisors can be managed, and the advantages they bring to acquiring firms outweigh the disadvantages.
1. Introduction and theoretical background
Acquisitions are a common tool for corporate restructuring and the phenomenon has received significant research attention.1 In research, there are conflicting views of acquisitions.2 On one hand, managers can use acquisitions to make the best use of available resources. On the other hand, managers may use excess cash in value-destroying acquisitions. The latter view rests on agency theory that explains that manager interests may diverge from those of a firm’s shareholders.3 Agency problems are not new, and they were observed in problems experienced by the Dutch East Indies company in the 1730s.4
While there are flaws with agency theory,5 there are clear applications to managers making acquisitions. For example, acquisitions are often used to diversify a firm’s operations into different markets. This lowers firm risk and improves its survivability, but it increases the difficulty of monitoring managers who often earn higher wages for managing larger firms. Another consideration is that investors can diversify their investment into other companies, or diversification offers them less benefit than managers.
Acquisitions are not simply an event and risk associated with them can be divided into three different stages, involving: 1) pre-merger target search, evaluation and negotiation, 2) merger of legal completion of a deal, and 3) post-merger integration to achieve planned benefits from combining firms. The risk across the acquisition stages are not the same, and earlier decisions also constrain options in later decisions. The least risk is associated with actual completion of a negotiated agreement. While the next lowest risk, pre-merger decisions significantly influence what can be achieved during post-merger integration. For example, if the price paid or costs of completing an acquisition exceeds its benefits, then merging firms will not create value, see Figure 1.
2. Role of advisors across acquisitions
While they bring some risk, advisors can help to improve decisions across acquisition phases.6 Further, in some situations advisors need to be involved or their continued benefit evaluated, see Figure 2.
In the pre-merger phase, manager decisions relate to target search, evaluation, and negotiation. Advisors play an active role in this stage of the process. For example, they may initiate managers considering an acquisition by making them aware of a potential target firm. However, the need to maintain confidentiality around acquisition considerations also leads firms to use advisors to help evaluate a target firm. For example, a visit by consultants that are serving as advisors can be less obvious than a visit by an acquiring firm’s leadership. Advisors also offer the potential for greater objectivity, knowledge of market valuation from other acquisitions, and greater experience in specific tasks associated with a review.7 Additionally, in cross-border acquisitions, advisors can offer advantages from greater familiarity with a target country’s context.8 Still, conflicts of interest may exist and need to be managed.
In the merger completion phase, investment bankers and lawyers can help implement transfer of funds and legal filings. When combined with their use in the pre-merger phase, advisors can also help complete deals faster if the number involved is managed.9 Using well-known advisors can also provide a positive signal to investors.10 However, again, potential conflicts of interest may exist and need to be managed. For example, an investment banker may have been hired to sell a target firm, and their compensation based on getting the highest price for a target firm. Additionally, advisors may be paid upon deal completion, but managers need help avoiding escalation of commitment and completing bad deals.11
In the post-merger phase, advisors can offer multiple benefits. For example, until a merger is completed, there can be legal limitations to sharing information between firms that plan to combine. This can be side-stepped with consultants acting as a firewall between the companies and this can facilitate planning for integration. This can be significant as a one-month delay in realizing USD 500 million in planned cost savings could reduce the net present value of completing an acquisition by over USD 100 million.12 Additionally, there will be a need to increase capacity for handling employee concerns following acquisition announcement and completion, and hiring human resource (HR) consultants can mitigate employee concerns turning into resistance or departure of employees. The primary disadvantage of advisors in the post-merger phases is that their cost can lead to diminishing returns in retaining them.13
Firms need advisors to implement acquisitions.14 Acquisitions can provide access to needed resources and growth opportunities for firms, but the complexity of acquisitions often exceeds the capacity and experience of managers in a firm. Advisors can provide needed experience and expertise to facilitate acquisitions. However, managers need to avoid consistently using the same advisors, as it can limit the benefits they provide.15 Overall, this drives an increased need for advisors providing different services (e.g. valuation, HR) to support acquisitions, as well as the need for competition between advisors to allow firms different advisors on different deals.
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