How Investment Bankers Affect Acquisition Outcomes

Friday, November 14, 2003

Prof. Mathew Hayward, Abstracted from Strategic Management Journal, http://

from: Professional Influence: The Effects Of Investment Banks On Clients' Acquisition Financing And Performance
By: Prof. Mathew Hayward University of Colorado

Strategic Management Journal - Vol. 24, No. 9, Pgs. 783-801

Cash versus stock acquisitions.
CFOs who hire investment banks and other advisors for acquisition-related activities might wonder whether the considerable fees they spend will yield a better outcome than if they use their own internal resources. Mathew Hayward studied 120 large companies that made acquisitions between 1985 and 1995 to determine whether the decision to use an investment bank influences the method selected to finance an acquisition. The answer is significant, since stock-financed acquisitions often underperform those involving cash. One study of 947 acquisitions conducted between 1970 and 1989, for example, showed that companies using cash to finance the deal showed a 62% return over the five years after the acquisition, while companies using stock saw a loss in valuation of 25%.

Post-acquisition performance and investment banks.
Companies that employed investment bankers in past deals turn to stock financing for acquisitions more frequently than those that have not been exposed to a banks influence. Furthermore, they are more likely to hire a bank to advise on a stock-financed acquisition in the future. Experience with previous stock acquisitions, even with negative outcomes, does not seem to result in the company deciding to avoid the bankers. Clients that hire investment banks for stock-financed acquisition have lower acquisition performance, the author finds. Yet the explanation may not lie with the choice of financing, since those acquirors that do stock-based acquisitions on their own see an improvement in performance over time. Even the bankers seem to have suffered; although M&A surged during the 1990s, banks' fees from acquirors have stagnated.

Caught on the horns of a dilemma.
Despite the track record, bankers continue to recommend and companies continue to make stock-financed acquisitions, raising the obvious question of why the professionals are encouraging clients toward a value-damaging choice. Investment bankers often tout equity-financed deals as affordable and promote their own expertise as a way to achieve superior performance from those acquisitions. They have ample motivation to recommend stock over cash, the author proposes, because stock-financed acquisitions take much more time to complete, entail greater expertise, and involve a higher level of complexity. The author speculates that bankers might simply be responding to a dilemma: if they offer too simple a recommendation, their client might decide that it can do the deal without professional assistance; if they recommend a more complex avenue, their client faces the higher risk of poor performance. Perhaps acquirors that undertake value-damaging equity-financed deals are overly aggressive, insufficiently monitored by shareholders, or simply overestimating the bankersability to beat the odds.

Abstracted from Strategic Management Journal, published by John Wiley & Sons, The Atrium, Southern Gate, Chichester, West Sussex PO19 8SQ, England.

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