Mergers and Acquisitions: CEO Leadership and Board Dynamics

In this lecture we discuss the "reasons" given most frequently for the failure of acquisitions. I will contend that these do not explain the why of the failure but only summarise what happened. Nontheless, these are an important starting point for our discussion

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

The key point is that most "reasons for failure" do not explain why the failure has occurred. There is something much more systemic going on which we need to explore if we are to understand why acquisitions fail.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

We need to understand what we mean by failure and also who this failure affects. It can be argued that even in a disastrous deal there are winners and loses over the short and the long term. Its appreciating this that helps us to develop our insight into why these deals happen at all.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

I asserted in the previous lecture that the CEO was often a winner even when the deal was disastrous for shareholders. Now I need to explain what I meant by that statement. After all, at the end of the day the CEO calls the shots and (should but does not always) carry the can!

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

This phenomenon is not taught in business school but has been "outed" by Warren Buffet as the cause of much stupidity and bad decision making in business. I explain what it is and some of its consequences in this lecture. Its not the whole answer but we are beginning to peel back the layers of the onion.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

When looking to Boards of Directors for independent thought and action, you may have a very long wait. As I explain in this lecture Board Directors have real self interest at heart in being acquiescent and supportive rather than questioning and critical. This makes the acquisition process easy to orchestrate and control for the CEO and his advisers.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

This is a key question to ask of any CEO - or just judge him or her by their actions. I want to challenge the assumption that CEOs are automatically going to act in the best interest of shareholders as they are exposed to considerable conflict of interest challenges - to varying degrees. I also share with you a business model where this question can be answered without any ambiguity.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

We examine the two critical roles of a CEO - spoiler alert - one is Capital Allocation. This has to be done in a way that creates shareholder value - but we shall have to consider how to measure this in a later lecture. Acquisitions fail when deals are done which lose sight of this essential pre-requisite and use other yard sticks for measurement. Don't worry all will become clear!

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

Here we examine how CEOs feel about doing deals, about making acquisitions. If you can imagine piranhas in a fish tank at feeding time you are on the right track. If running a business was more fun than deal making, there would be many less deals. Acquisitions become an addiction which is very hard to shake and like most forms of dependency, very often destructive.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

This simple question does not have a straightforward answer. The answer is very much dependent on the incentive structure with which the CEO is motivated because much as he will want to do the best for the company, in the back of his mind will always be his bonus and share option plan.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

I want to stress with an example how important incentives are. Even more so when we are talking about the incentives for decision makers. Once we have emphasised this point we are going to take a closer look at the critical issue of Incentive Bias in the next lecture.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

This is one of the critical lectures in this course. The golden rule in management is "Get the incentives right!" Here Charlie Munger from Berkshire Hathaway explains why this is so critical and I show how this can have an equally critical impact on the behaviour of CEOs when making acquisition decisions. I also have a little swipe at Investment Bankers which you will enjoy

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

Now we will make the connection between CEO incentives - through share options - and the desire to maximise share price growth ahead of all other factors of corporate performance. Once we understand this and its link to Earnings Per Share and Price Earnings Ratios, we will be able to discuss whether this is the right measure of corporate performance for the option plan and the consequences if it is wrong.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lectur

As our CEO is being incentivised by his options, we need to question whether the share price which is driven by Earnings per Share is the best yardstick by which to measure the success of the company and the performance of the CEO. This lecture discusses the key issues and comes to a conclusion - no spoilers, watch the video!

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

One of the consequences (possibly unintended) is that CEOs become fixated on managing their share price in the market but unfortunately, as I explain in this lecture, that is something that they do not have the power to do directly. Furthermore, as Benjamin Graham explains in The Intelligent Investor, Mr Market, a highly emotional partner, effects major up and down swings in share prices based on emotion rather than reason. Even knowing this does not change the behaviour of the highly incentivised CEO

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

We continue exploring the consequences of the CEO's options incentivising him to focus on the wrong actions and decisions. We explore how when EPS becomes a target it is possible to adjust earnings to meet Wall Street's expectations and how short termism can lead the CEO further and further away from the true path as he strives to meet Wall Street's expectations. When this becomes an embedded culture, the long term consequences are seldom good. Add the opium of Acquisitions to this already heady mix and it is clear why poor decisions can be made.

As we will see in the next section however, human nature also plays a significant part.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

In this section we are going to study human behaviour and our tendency to make bad judgements without realising we are doing so. I am indebted to that great student of human nature, Charlie Munger, Vice Chairman of Berkshire Hathaway for the insights in this section.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

This is what happens when we are unsure what to do

In these situations we make quick, ill informed decisions to avoid all doubt

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

Here we have a tendency to maintain previous habits and conclusions

Quickly arrived at conclusions, triggered by Doubt Avoidance, which combine with a tendency to resist any change in that conclusion

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

People hate to hear bad news or anything inconsistent with their existing deep seated opinions

When new facts emerge which go against these beliefs, the brain goes into a state of denial

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

Excessive self-regard man mostly misappraises himself on the high side

This also make a person prefer people like himself

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

Loss hurts more than gain

If you almost get what you really want and lose it, it will hurt more than if you always had it

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

Behaviour is much simplified when he automatically thinks and does what he observes to be though and done around him

"Followership"

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

We tend to overemphasise information that is widely available

Your brain works with what’s available to you

We have a limited capacity to remember, recall, and think, so we jump to what’s easily available

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

People tend to follow instructions from authority, even blindly

What happens when leaders are wrong or their ideas are misinterpreted?

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

This tendency is when we get extreme consequences from confluences of psychological tendencies acting in favour of a particular outcome

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

In this section of the course I want to focus on some of the ways the market operates which adversely impacts CEOs, companies and the acquisitions they make. To add credibility to my arguments I will be calling Warren Buffett and Charlie Munger as witnesses for the prosecution

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

Asking who benefits from advice is a critical question when judging the quality of such advice particularly in the M&A scenario. It is clear that advisers largely benefit when deals close which align them with the interests of the CEO but not shareholders. Is this right?

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

Here we highlight the hyper activity and short termism which drives much activity on Wall Street and who's consequences are most frequently negative, particularly if judged by the performance of the market when compared to Berkshire Hathaway. The impact on acquisitions can likewise be judged on the poor performance which has already been highlighted in this course.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

This lecture highlights the potential issues which can be raised when information and guidance to results are provided by CEOs to Wall Street Analysts. I highlight this issue to provide a very real example of Wall Street putting pressure on and affecting the behaviour of CEOs. Supporting Warren Buffett, I also cite a former Chairman of the SEC. I am really not making this up!

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

In any examination of the system which manages acquisition activity, Investment Banker cannot be ignored due to there central role. Again we turn to Messers Buffett and Munger to shed light on this imperfect process and see what we can learn about failing acquisitions from so doing.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

The financial and operational consequences of leveraged buyouts or "private equity" deals are considered in this lecture. We suggest that these deals are more likely than not to contribute to problematic acquisitions and we explain why.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

This section is summarised by considering the losers in this game of musical M&A chairs. If some parties are winning and making money, we highlight the losers in this lecture and explain why they are having their wealth damaged even if its not immediately apparent.

We do not want to end on a negative note however, so in the next section of the course we will discuss how to make successful acquisitions and how to avoid many of the issues identified in this course.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

As an introduction to Berkshire Hathaway I have prepared a summary of how the business operates which you can download with this lecture. I take the opportunity here to focus on some of the key aspects of the BH system to help you understand why they have such a good acquisition record. The record however is not perfect and we will be looking at where and why poor investment decisions have been made, helped I might add by Warren Buffett who is always candid in this respect.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

The purpose of reviewing Warren Buffett's acquisition criteria is to show you how he positions himself in the M&A market to avoid making many of the mistakes we have seen made as we have gone through this course. If you are considering making an acquisition, there is a lot you can learn here.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

By positioning Berkshire Hathaway as the buyer of choice for many privately owned businesses, Buffett completely changes the deal dynamics to a position of mutual trust and respect making a deal much easier to achieve. This is a near unique strategy in my experience of working on M&A deals.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

You need to understand the value benchmarks used by Warren Buffett and Charlie Munger when appraising companies in order to appreciate their approach and why, for the most part, they do not over pay for deals. Interestingly in the occurrences when they have over paid it is because their appraisal of intrinsic value was wrong.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

The benefits of a "managers as owners" culture in Berkshire Hathaway is explained in this lecture with some help from Mr Buffett. This is a factor that goes a long way towards explaining why acquisitions at Berkshire do not fail after the deal, which is so often the case in other companies.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

The importance of aligning incentives to the results you want to generate has been explained earlier in the course. We have also illustrated what happens when it goes wrong. In this lecture we explain how Berkshire Hathaway avoid these pitfalls and organise their incentive compensation on a much fairer and effective way.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

You will find a PDF attached to this lecture which is a letter from Warren Buffett entitled "Some Thoughts on Selling Your Business". You can download and read it. It is about as close to a template for making a successful acquisitions as I have ever read. See what you think!

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

The final lecture in this section highlights that even Warren Buffett and Charlie Munger don't get acquisitions right every time. These examples serve to highlight why things went wrong and to allow Mr Buffett to educate us from his shareholder letters.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

We have seen how poorly devised incentives can lead to the temptation to make ill considered acquisitions to move the needle that is being measured. This lecture suggests a better measurement of success than EPS or simple share price.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

This is a better measure of performance than Earnings Per Share and I briefly explain why this is. It is also useful to highlight why Buffett so likes companies that have high returns by this measure.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

As Buffett used Book Value Per Share as a performance measurement right up to 2018 it is worth examining why this can be a useful measure of company performance and a guide towards intrinsic value. We also examine why Buffett abandoned this measure in 2018 and what he replaced it with

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

This is one of the major lessons of this course and will help you to avoid making bad decisions when it comes to making acquisitions - you must remain critical and questioning at all times.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

Before we complete this course, I wanted to leave you with a final word of caution. What you have learned in this course can be very effective if applied with tact and sensitivity. People hate to be told that they are wrong. So proceed with caution and do your best to make sure that your input makes a significant contribution to ensuring that the acquisitions you work on are successful

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

This concludes our course and I hope you very much enjoyed everything we have covered. Before we leave, let me run through what has been covered in the course

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture

A free thank-you for finishing this course.

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The download link is in the Resources section of this lecture.

About John Colley Cambridge University MA · Bayes Business School MBA with Distinction · 30+ years across investment banking, M&A and private equity since 1988. Author of The Investment Banking Practitioner's Handbook Series