Baruch Lev, Feng Gu
A Canadian Natural Resources acquires shale assets from Chevron for US$6.5 billion. THE Adnocfrom the United Arab Emirates, buys the Convestro for US$16.4 billion. THE PepsiCo absorbs the Siete Family Foods for US$ 1.2 billion, and the Marsh McLennan snatches away McGriff Insurance for US$7.8 billion. THE Rio Tinto buy the Arcadium Lithium for US$6.7 billion. This is just a small sample of the mergers and acquisitions (M&A) October 2024.
The number of annual acquisitions in the United States ranges from 1,200 to 1,500 and reaches 5,000 worldwide, totaling a transaction value of about $2 trillion. Corporate acquisitions affect shareholders, employees, customers, suppliers and the economy as a whole, influencing market competition and productivity.
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What will surprise investors is that 70-75% of acquisitions—presumably carried out for your benefit—failaccording to our rigorous statistical analysis of no fewer than 40,000 acquisitions worldwide over the last 40 years. Over this period, most acquisitions failed to achieve their stated objectives of increasing post-acquisition sales growth, cost savings, or maintaining the acquirer’s stock price.
We are not alone in making this observation. NYU assessment guru, Aswath Damodaranonce aptly described corporate acquisitions as “the most value-destructive action a company can take.” A study of contested acquisitions (with multiple competitors) found that the shares of those who failed to buy outperformed the acquirers by 20-25% in the three years after the acquisition.
Furthermore, our data shows a “reverse learning curve”—an increase over time in the M&A failure rate.
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Here are the main factors that our statistical model indicates hinder the success of acquisitions. Overcoming these failure triggers will substantially improve M&A results.
The urgency to merge
Corporate acquisitions, where an external business is transplanted to the buyer, resemble human organ transplants in its challenges and risks. Doctors will try any available alternative before resorting to transplants. But that’s not what most CEOs do. Faced with a slowdown in sales, loss of market share, or deterioration in the company’s competitive situation, they bow to pressure from concerned investors and follow the advice of commission-hungry investment bankers and consultants, seeking a big, transformative acquisition to save the day. .
Some of the attractive alternatives to acquisitions are the development of internal capabilities (patents, brands), partnerships and joint ventures. The ROI of these formats is often higher than that of acquisitions. But in their urgency to merge, executives often buy a strategically unsuitable target, pay too much for it, and fail to integrate it properly. Acquisitions should be the last resort, not the first option.
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Value destructive targets
Our statistical model relied on 43 distinct variables to identify several key target attributes that negatively affect acquisition success. Examples:
Large targets: The integration of a large target into the buyer is particularly difficult and prone to failure, as many employees (from the buyer and the target) must be reallocated, lines of control changed, and complicated operating procedures of the partners unified. Large acquisitions often require the buyer to substantially increase debt, which must be managed regardless of the merger’s consequences, causing many acquisitions to fall through.
Conglomerate acquisitions: Non-business acquisitions now constitute nearly 40% of all acquisitions. They don’t make economic sense: they don’t offer synergies because the merger partners operate in different industries, and if an investor wants to diversify their securities portfolio, they can simply buy different stocks. They don’t need company executives to do it for them and pay a big premium to the target’s shareholders. In fact, most conglomerate acquisitions fail.
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Operationally Weak Targets: Successful CEOs are under the illusion that they can repeat their past success by resurrecting failing targets. This rarely happens.
Misaligned executive incentives
Many companies pay their CEOs a substantial acquisition bonus just for completing the deal. Annual executive compensation also typically increases after acquisitions, since company size is an important determinant of executive pay. And if that’s not enough, we show empirically that serial acquirers serve, on average, as CEOs for four to five years longer than leaders who acquire a few companies. Acquisitions appear, in many cases, to be a term insurance for CEOs.
Notice what is fundamentally wrong with these arrangements: the emphasis on completing a deal rather than its success. And with an acquisition failure rate of 70-75%, the difference between completion and success is huge. We also show that the penalty for failed acquisitions often results in a simple warning to the CEO in many cases. Shifting CEO acquisition incentives from acquisition completion to success is critical to improving M&A outcomes.
The consequences of corporate acquisitions affect people’s lives, the state of the economy and the wealth of investors. The current state of 70-75% procurement failures is intolerable. Executives must be more steadfast in their due diligence and research before signing a deal to begin reversing the widespread M&A failure across virtually every sector and industry vertical.
This story was originally published on Fortune.com.
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