Finance: Warning: that acquisition may not mean the pay rise you're expecting

Why do executives pursue mergers, even when financial reasons don't make a convincing case? They might be after a salary increase, writes Roger Trapp
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The Independent Culture
The calling off of merger talks between first the accountancy firms KPMG and Ernst & Young and then the pharmaceuticals giants Glaxo Wellcome and SmithKline Beecham is likely to do little to hold back the wave of mergers hitting just about every sector you care to name. Indeed, last week, while commentators were still digesting the collapse of the Glaxo-SmithKline deal, insurers Commercial Union and General Accident announced a pounds 14bn tie-up.

Consolidation, we are constantly told, is inevitable in almost every business. The justification is economies of scale: only by becoming much larger and global in reach can companies offer the service and prices that customers want. Even allowing for the fact that clients of accountancy firms - to judge from the fuss they have been cooking up - would prefer choice of supplier over global reach, this argument appears to fall down. On the simple basis of financials. Study after study shows that the majority of mergers and acquisitions fail to achieve their targets.

So, if enhancement of that modern-day talisman "shareholder value" is not the spur for all these deals, what is? Cynics might lay the blame at the feet of the bankers in the City and on Wall Street who supposedly encourage these transactions in the interests of earning fees. But while they no doubt do their share of "scouting around" for opportunities, it would appear that they are not necessarily kicking against closed doors when they come up with proposals.

According to a US study, there is evidence to support the view that executives go in for acquisitions because they inflate not just their egos but also their pay. And, looking at all those surveys that show executive remuneration to a large extent governed by company turnover, this certainly makes sense.

However, the authors, Ajay Khorana of the Georgia Institute of Technology's Dupree School of Management and Marc Zenner of the Kenan-Flagler Business School at the University of North Carolina at Chapel Hill, are careful to be circumspect. They say: "The compensation of executives of acquiring firms is strongly related to sales growth prior to an acquisition, whereas it is not for executives of non-acquirors - suggesting that a significant pre-acquisition size-compensation sensitivity motivates executives to make large acquisitions."

The research prepared last summer for publication in the Journal of Corporate Finance looked at 46 top executives in 27 organisations undertaking large acquisitions over the period 1982 to 1986 and compared their compensation with that of 53 executives in 27 companies of like size and industry that did not go in for sizeable acquisitions at the time.

It found that in the sample group for the two years following large acquisitions "a significant and positive direct acquisition effect on cash and total compensation of 10.5 per cent and 4.9 per cent respectively." The authors add that it is possible that this direct effect compensates the acquiror's executive "for the complexity and risk of managing a large acquisition".

But they also point out that acquisitions can have an indirect effect on executive compensation in that "they affect the acquirors' sales and stock returns which, in turn, impact executive compensation" - though in the sample the indirect effect was negative and thus reduced the positive acquisition effect.

Since, as has been pointed out, the majority of mergers and acquisitions fail by most financial criteria, it appears that managers are motivated by a positive approach that might be termed a triumph of wishful thinking over experience.

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