Why the incentive structure for M&A deals is broken and how to fix it

The stats are true. 70% of mergers fail to create sustainable profits from that deal. Jarrad Harford Kai Li’s examination of bidder CEO incentives from 2007 found that, “even in mergers where bidding shareholders are worse off, bidding CEOs are better off three-quarters of the time. Imagine how absurd this is. The significant correlation between CEO pay and firm size is one contribution cause to this. One of the simplest methods to expand is through the acquisition of another business. So, can you fulfill such a goal without ensuring long-term benefits? Of course. Let us look at one example. 

For instance, the London Stock Exchange Group’s $27 billion acquisition of Refinitiv in 2021 resulted in a threefold increase in the acquirer’s revenue. David Schwimmer, the head of the London Stock Exchange, was rewarded with a 25% rise in his salary to reflect the London Stock Exchange Group’s enlarged scale following the Refinitiv takeover. Investors that observed the case commented that London Stock Exchange Group had bitten off more than it could chew. Still: The increase in profit for the company executives came at a significant cost to shareholders. The incentive structure for many Executives in mergers is questionable. 

What about the financial advisors, attorneys, accountants, and consultants the acquirer hired to executes the deal? When the executives who hire them express no such doubts and are fully supporting the agreement, it is not realistic to expect expert advisers to issue a warning against it. Let us remember: The executives may want to hire those financial advisor, attorney and consultants again. The advisers' fees are tied to closing the deal, not to generate post-merger operating gains. In the case of AB InBev's merger with SABMiller, which was followed by poor financial performance, fees of about $1.5 billion were related to closing the deal, not to post-merger operating gains. Financial advisers, attorneys and consultants will most likely work to close a deal. They usually do not work to stop or deal, neither to generate long-term synergies from the deal. 

Many Executives and M&A teams fall into a trap. They adapt processes and systems that have been in place long time before. Many deals rely on manual systems and processes that do not allow for digital deal-making and good documentation. Manual communication, semi-automated reporting, using spreadsheets that are not made to support M&A deals, the list goes on. Falling into this trap means, relying on legacy systems and processes that put hard limits onto your team. Leading teams make sure that they embed the most important value drivers of the deals into their systems and processes. This allows them to review if those objectives have been met and, e.g. if operating synergies have been created or not. 

We have looked at different examples that show that the incentive structure for M&A deals is broken. Neither the incentive structure of company Executives nor the incentive structure of financial advisors, attorney and consultants does support the objective to generate operating synergies and profits. This grievance causes that 70% of mergers fail. 

In order to create a system that is truly beneficial for all parties, we need to overhaul the current incentive model. Instead of focusing on the short-term success of a particular deal, we should prioritize long-term growth and shareholder value creation. For example, we could provide consultants and advisors with bonuses based on the long-term performance of the acquired company. Additionally, these bonuses could be based on the percentage of improvement seen in the bottom line of the acquired company. This would provide a more tangible incentive for advisors and consultants to create value in deals. 

Let’s fix incentive structures to create more value from M&A deals. Let’s create more transparency. Let’s prepare decisions by providing good data and tracking successes. Let’s discuss how to involve all stakeholders, internally and externally to measure success differently. Shall we?

What do you think? Drop us your thoughts at hello@smartmerger.com.