Board Changes and the Director Labor Market: The Case of Mergers

Boards of directors perform the critical tasks of monitoring and advising management and it is logical to suspect that the necessary skills vary with the nature of a particular firm.  That is, a board should be chosen with consideration of the needs associated with advising and monitoring a particular business.  So what happens to boards after a merger?  After all, mergers change the nature of a firm, sometimes in dramatic ways.  Do boards change as well?  

In a recently revised working paper, David Becher, Jared Wilson and I examine this question. However, to ascertain whether board changes around mergers are significantly different from the status quo, we needed a benchmark of normal board changes.  To our surprise, there was little information available in the literature.  Consequently, our work provides evidence on changes around mergers but also provides a benchmark for normal non-merger changes.  

The abstract is below:

Board Changes and the Director Labor Market: The Case of Mergers

David Becher, Ralph Walkling and Jared Wilson

Abstract:      

We examine the stability and composition of acquirer boards around mergers, contrasting changes with the same firms in non-merger years and a sample of non-merging firms. Contrary to perceived wisdom, the post-merger board changes substantially and variation is significantly different from both non-merger years and non-merging firms. Adjustments reflect firms upgrading skills associated with executive and deal experience and bargaining between targets and acquirers rather than agency motives. Conversely, director selection in non-merger years is driven by general skills and diversity. Our analyses provide insight into the dynamic nature of board structure and characteristics valued in the director labor market.

The complete paper may be downloaded here.

All the best,

Ralph

“Board Walk or Parked Place? Acquiring Firms and the Director Labor Market”

A lot of attention has been given to the composition of a firm's board of directors.  Much less attention has been directed to changes in the board of directors, particularly around major events.  An important literature does address changes around mergers, but concentrates on target firms.  What about acquiring firms?  After all, mergers can represent dramatic shifts in the evolution of a firm.  It makes sense that monitoring and advising needs of boards should evolve as well.  The only evidence we do have on acquiring board changes around mergers suggests relative stability with few changes.  This evidence comes from the examination of target firms which finds that target directors are not often retained by the acquiring firm.  If these are the only changes, general stability of the acquiring board is implied.

In recent research with my colleagues David Becher and Jared Wilson, we find that stability is far from common with acquiring firm boards.  There are significant and substantial changes of boards over time and the changes are significantly different around mergers.  As just one indication the post-merger board typically consists of 7% target directors, but 11% of new directors unaffiliated with either target or bidder before the deal.  In addition, board size often changes either increasing or decreasing

“Board Walk or Parked Place?

Acquiring Firms and theDirector Labor Market”

Abstract

"This paper examines the stability and composition of acquirer boards around mergers.  Contrary to perceived wisdom, composition of the post-merger board changes substantially and these variations are significantly different from both non-merger years and non-merging firms.  These adjustments reflect firms upgrading skills associated with executive and deal experience.  Board changes also reflect bargaining between targets and acquirers rather than CEOs seeking a more friendly board.  Conversely, director selection in non-merger years is driven by general skills and diversity.  Overall, our analyses provide insight into the dynamic nature of board structure around mergers and characteristics valued in the director labor market."

All the best,

Ralph

Here We Go Again?

The best of deals are made in the worst of times while the worst deals are made in the best of times. We may be seeing a replay of this mantra in the current M&A market. Coming off a deep post crash low, M&A activity has sharply rebounded. This reflects a recovering economy, booming capital markets and rising managerial and investor optimism. The activity is driven by strategic buyers instead of private equity. The number of large deals over $5B has also increased. Larger deals are froth with danger given the potential to over pay and heightened integration problems associated with larger deals. The buyer’s shareholders usually react negatively to the announcement of such deals-and for good reason. Their track record underlies this reaction; namely, 50% of targets are disposed of within 10 years of the closing.

Yet, such deals are now receiving a largely positive response from the buyer’s shareholders. Some possible explanations for this development include:

1)     Buyers are getting better at making acquisitions (AKA this time is different).I have seen no evidence to support this possibility.

2)     We are early in economic and M&A cycles. Thus as the cycle continues we will see mean reversion.

3)     Shareholders are confusing size and growth with value creation.

My concern is a toxic brew may be developing. This brew includes investor bias towards growth combined with managerial overconfidence. Board selection of CEOs favors over confident CEOs who are viewed as decisive optimists. The process favors the lucky risk taker with a “successful” track record -think of past Hewlett Packard CEOs Carly Fiorina and Leo Apotheker who both engineered disastrous acquisitions.

So what can boards do to prevent future over priced ill conceived acquisition disasters? It is unlikely subordinates will question CEO’s who want to do the deal. What is needed is a strong experienced lead independent director who can challenge-not second guess- large scale transactions by considering the following:

1)     Does due diligence support the deal’s thesis?

2)     Is there a detailed integration plan based on the strategic rationale of the deal?

3)     Have competitor responses been considered?

4)     How will changing economic and industry conditions impact deal economics?

5)     Are CEO incentives tied to the success of the acquisition?

The real key is to run alternative stress case projection scenarios reflecting what could go wrong not just what is expected. A useful approach is to consider what could cause your deal to fail financially in the next few years. If you cannot think of any - then think again - they are out there.

J

GM, Product Risk and Corporate Governance

We've written many times of the importance of corporate governance.  It becomes readily apparent when something like the GM ignition switch crisis occurs.  The product problem relates to a faulty switch which would turn the engine off with a slight nudge of the knee or when heavy objects (other keys?)  dangled from the keychain.  The company problem is much more complex.  The company links 13 deaths to the problem.  Plaintiffs attorneys suggest a figure considerably higher.  Even one known injury is too many.

The obvious questions to be asked are ones without any suitable answers: Who knew what when?  Top management?  The board?  If they did know, what actions were taken?  If they didn't know why not?  The board states that they were not aware of the problem, yet numerous customer complaints began pouring into the firm as early as 2005.  Press reports assert that some engineers knew of the problem in 2001.  Why wasn't management aware of these problems?  Why wasn't the board informed?  At the time of this writing, GM has recalled over 2.6 million cars costing more than $1.7 billion dollars. This doesn't begin to measure the cost of liabilities facing the firm, nor can it ever measure the human loss.  Why did it take so long to begin the recall?

It apparently would have cost about fifty seven cents to improve the switch.  Instead of doing so, the company tried makeshift solutions, shipping modified key inserts and writing to customers to be aware of hanging heavy objects from their keys.  When the part was finally improved, the company kept the same part number, providing further confusion.

The other solution the company took when at least some managers were made aware of the problem is to form two committees - not committees of the board - but committees of employees - and the board was never made aware of the situation.

To be fair, the current board is largely new, but it is not enough to say 'We weren't there.'  The board needs to understand if this is a systemic governance problem within the company.  They must assure themselves, as well as investors and customers that something like this could not happen again.  Those steps must begin with a thorough analysis of the process of risk management and the process by which the board is informed of problems.  

A dramatic audit of the firms governance structures is needed.  What governance structures led to this situation?  How must they be improved?  What was/is the process by which the board monitors product risk?   What whistleblower functions are in place and more importantly, what is the corporate culture with regards to reporting and addressing problems - even if they appear costly.

Moreover, it is not sufficient to make changes that could have prevented known problems.  The board needs to have a process for anticipating and eliminating future problems.  Again, this begins with having the right processes in place, and monitoring the corporate culture.  It begins with management developing the right tone for the firm and with the board continually probing and asking leading and open ended questions.  Board experience in working with other problems of risk management at other firms is essential, especially in pointing to weaknesses in current processes and in anticipating the unexpected.  

We'll know more about what happened soon as the firm has hired Anton Valukas to provide a detailed report on the situation.  Valukas was also the person who provided an analysis of the Lehman Brothers bankruptcy.  It should present a good start for reform and for recognition that safety of the customer has to be the highest priority.  Lack of safety is not an option.

All the best,

Ralph

When Say on Pay Becomes Binding: Australia's Two Strike Rule

Hello from Perth, Australia.  As some of you know, I am on sabbatical, currently touring Australia.  Last night I had the honor of talking to a local CPA society on Corporate Governance.  The question of Australia's two strike rule came up during the discussion.

The two strike rule is an interesting, if controversial rule in corporate governance.  If a board receives a 25%, no-vote on its compensation policy for two consecutive years, shareholders vote to decide if the the entire board must stand for re-election.  The rule, implemented in Australia in 2011, gives teeth to the previously advisory Say on Pay.

See this interesting article in The Sydney Herald.

One can imagine the pluses and minuses of such a system.  First, if directors are not responsive to shareholders a second year in a row, the shareholders get additional power to alter that situation.  It is reminiscent of the provisions in some preferred stocks, where if a firm misses dividends for say three years, the stock acquires voting rights.)

On the other hand, 25% might be a low threshold, and less than a majority could hold a firm hostage. Or, as directors often fear during a Say on Pay vote,  a low vote may be the result of something quite different from problems with compensation.  

David Trebeck, the Chairman of Penrice Soda, which recently survived a close call on the two strike rule, commented, ‘‘I think directors generally are more than capable of identifying and responding to prevailing shareholder sentiment without needing a legislative sledgehammer to do it for them."

(Source:  http://www.smh.com.au/business/axe-twostrikes-rule-penrice-directors-say-20130125-2dbam.html#ixzz2hJu9p5li)

The two strike rule isn't the case in the US but, by the way, Australia had Say on Pay, well before the United States.  It makes sense to keep track of what is happening in other venues and use that knowledge to improve practice.  This is NOT to say, I'm endorsing this idea, but it bears watching the empirical results.  

See our related post on Swiss Say on Pay.

All the best,

Ralp;h