0:01
We're talking about growth through acquisition.
And remember, mergers and acquisitions have a pretty dismal success rate.
And we've talked at some length about why that is,
what the sources of most acquisition failures are.
So now I want to focus on the second question.
Given the fact that on average most acquisitions fail or
destroy value, why is it such a common strategy?
Why do businesses and managers persist in pursuing bad mergers or
overpaying for those acquisitions?
So let me talk in some detail about the potential reasons
that firms tend to pursue these bad deals and overpay for them.
The first reason has to do with what's known as moral hazard.
And this involves the idea of the transaction
intermediaries that often play a role in any big merger or acquisition.
And the idea here, remember, most acquisitions, on average, don't pay off,
especially for the acquiring firm, destroys value in that acquiring firm.
But what does every acquisition create value for?
We can count on the fact that it usually creates value for the investment banks and
the other financial and
legal intermediaries that are facilitating that acquisition.
So the idea behind moral hazard is simply that some of those parties might be
driving some of the tendency to pursue acquisition strategies because of course,
they always win.
They gain a lot of fees from facilitating those transactions, irrespective
of how good those transactions might turn out to be for the acquiring firm.
So that's one source of why firms might tend to pursue these things.
What's another source?
Another might be simply what's known as the agency problem,
which is it may be that the managers, the leaders in that acquiring firm
might be pursuing growth sort of for growth's sake.
They might be pursuing an acquisition simply
because it's in their own self-interest.
Maybe it will increase their compensation.
It might increase other things that are important to those individuals,
those leaders.
Perhaps it's the advantage of leading a larger institution.
Or maybe there's more legitimacy or
more recognition that comes from leading a larger enterprise.
But any rate, the point here is that for agency problem reasons,
that there's a reason to believe that one of the drivers behind acquisitions and
the frenzy of them and the frequency of them might simply be that the individual
managers and decision-makers involved have something personally to gain.
From putting those mergers and acquisitions together,
even if they end up being not that great for the firms involved, right?
Okay, finally, another reason that businesses and
managers might pursue bad mergers, or overpay for
those mergers, is something that's known as the winner's curse.
So what do we mean by the winner's curse?
Well, it's often useful to think about the winner's curse in an auction setting.
And actually, that's not far from what happens oftentimes in a potential
acquisition.
Sometimes there are, in fact, multiple bidders, and
there might be kind of a bidding war for that target firm.
Well, the idea behind the winner's curse is there may be a number of bids, and
they might come in at different prices.
So again, think of this as sort of an auction.
And what we find is that the law of large numbers, statistics sort of tells us that
if we have enough bids and if there’s enough activity and
if the markets are free flowing enough, that the actual value is gonna be pretty
close to the average price that's proposed for that potential acquisition, right?
But, of course, what happens?
What happens is the winner of the auction
is the person who offers the highest price, right?
So sort of by definition the winner's curse suggests that
oftentimes if it's a competitive bidding situation,
the winner ends up potentially worse off than all the losers of the auction,
because they're much more likely to overpay for that acquisition.
3:58
So let me talk about one other example.
We've talked about moral hazard and agency problem and the winner's curse.
The final reason that I'll touch on that might drive some of this pursuit
of bad mergers or the overpayment, is what's known as escalation of commitment.
And this is simply the idea that once the merger idea is out there and
once it's in motion, the individuals involved, the managers, the leaders,
have a tendency to wanna stick to that course of action beyond a level that
would be rational or that would even be beneficial for the firms involved, right?
And that means that there's selective attention.
We sort of look for data that's gonna confirm the idea that this merge is a good
idea and that's what we anchor on to and focus on.
There's sort of pre-existing bias.
We might just think that well, we thought this was a good idea.
We're committed to the idea of continuing down this path,
because we thought it was a good idea before.
We might rationalize past behavior, and
when we're in some sort of a competitive situation, giving up,
sort of, we feel like that means we lost, or we're giving up in defeat, right?
So what all this boils down to oftentimes is that the ego involved
in the executives involved that are driving these mergers is oftentimes one of
the biggest drivers of these acquisitions and this merger activity.
And there's a lot of research that demonstrates that that's in fact the case.
So there's lots of reasons why firms might overpay,
why they pursue mergers that aren't in their best interest, and it's important to
understand what all those reasons are so that you can avoid those pitfalls.
Michael LenoxSenior Associate Dean and Chief Strategy Officer
Jared HarrisSamuel L. Slover Research Chair in Business Administration
