Sunday, June 5, 2005

Mergers and Incentives

Check out this great NYT article on mergers and acquisitions and the disconnect between manager incentives and shareholder benefits. Agent-principle failures at work!

Some choice quotes from the article below:

"Unfortunately, shareholders find out how much of a merger's costs will wind up in the pockets of one or both company's executives only after the deals are announced. And because uncovering the payouts requires digging through complex corporate filings, some shareholders never learn about them at all."

''I speak with senior executives in the course of my research,'' Robert Bruner, the Darden business school professor, told me. ''They all tell stories about how they are charged with maintaining earnings growth. They can only get 5 to 6 percent growth organically, yet the C.E.O. has set a target that is much more ambitious, and they must make up the difference by acquisitions.'' Bruner is critical of this process, which he calls financial cosmetics. ''It invites the creation of growth for appearance rather than growth that creates wealth for investors and society,'' he says.

''It is not too strong an expression to say that investors have become addicted to these transactions.'' [- James A. Fanto (professor at Brooklyn Law School)]

''The only thing people get paid for these days is growth, not running a company well,'' Jack Ciesielski, editor of The Analyst's Accounting Observer in Baltimore, says. ''The cult of growth will always encourage companies to buy other companies to paper over the valleys in their earnings patterns.''

"An academic study from 2000 examined the relationship between chief-executive compensation and mergers in the banking world. Richard T. Bliss, a professor at Babson College in Massachusetts, and Richard J. Rosen, then a professor at the Kelley School of Business at Indiana University, studied bank mergers that occurred from 1986 to 1995. They found that these deals had a positive effect on the size of executive compensation and that even when an acquiring bank's stock declined following a merger, the compensation paid to the chiefs running the institutions grew significantly enough to offset any losses to their stockholdings.

''The net result is that even mergers which reduce shareholder value can be in a manager's private interest,'' Bliss and Rosen concluded.

"In addition, Bebchuk [professor of law, economics and finance at Harvard Law School] claims, after a firm is acquired, its directors often step down. As a result, they have less reason to be worried about confronting angry shareholders. "

"One apparent drawback to these enormous payments is the enormous tax bill they generate for executives. Happily for them, however, their contracts almost always require the companies to pay those bills. Enter the so-called excise tax gross-up provisions, which can be so colossal that, according to one pay expert, a major merger was scuttled not long ago because the cost of covering executives' tax bills generated by the deal exceeded $100 million."

''It is not uncommon to see opportunistic transactions take place following a large drop in the target company's stock price or periods of chronic underperformance. It would seem illogical in situations like this that target executives would be 'rewarded' with a severance payout that can often approach three times their annual salary and bonus.'' [Tim Ranzetta, president of a compensation analysis firm]

"What may be most troubling about the lavish benefits and perquisites paid to executives is that they are doled out even as lower-level employees at the merging companies lose their jobs."