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Ideas Made to Matter
3 hidden forces driving the M&A market
A global pandemic may seem like a strange time to strike a deal, but the market for mergers and acquisitions is booming: low interest rates and a surging stock market are helping fuel a 158% rise in global M&A.
Now, new research from MIT Sloan uncovers less obvious dynamics that shape the deal-making.
“It's not just that the M&A market is hot because there is an opportunity for consolidation and the industry has capital — it's more complex than that,” saida professor of accounting at MIT Sloan. “During the M&A negotiation process, the information that is disclosed and the incentives that shape transactions are much more subtle.”
Verdi collaborated with co-author Ben Yost, an assistant professor at Boston College, on research that explored the factors involved in price formation and what makes deals more or less likely to happen. Here’s what they found.
1. The tax implications for the acquired company’s CEO affect a deal’s value and structure
In mergers and acquisitions, “the acquired company’s CEO is a key decision-maker, and we thought this could be an interesting setting to look at,” Yost said. “We wanted to know what sort of frictions their personal incentives introduce in the M&A market.”
Verdi, Yost, and MIT Sloan professorexamined federal and state-level tax burdens, as well as other factors that mitigate the influence of CEOs’ tax incentives, and found that CEOs often take their own taxes into account when structuring deals (as opposed to paying attention to shareholder-level taxes).
The authors’ research showed that the personal tax incentives of the acquired company’s CEO can affect how corporate acquisitions are structured.
Yost recalled when the Murdoch family sold Fox Entertainment to Disney in 2018 and announced plans to make the sale an all-stock merger. Doing so meant that the purchase would have avoided “billions of dollars in tax” that Rupert Murdoch and the Murdoch family would have owed if they paid cash.
So when Fox later received a competing, all-cash offer from Comcast that was taxable and “a higher dollar value, it actually would have been better for some other shareholders,” Yost said. When the Murdoch family turned it down, “an activist investor got involved and said, ‘Hey, you can't just make these decisions based on your own personal interests.’”
The Murdochs still ended up selling Fox to Disney, but the competing bid raised awareness of how much a CEO’s personal tax position can factor into the negotiations process, Yost said.
More details are available in the research, “CEO Tax Effects on Acquisition Structure and Value.”
2. Buyers strategically disclose news to depress the purchase price of an acquisition
News strategically released during M&A negotiations reduced the average cost of a takeover by approximately $23 – $58 million.
When negotiating the price of an acquisition, “if the acquirer can drive down the value of the target, they benefit directly,” Yost said. “One way to do that is by disclosing news that influences the target’s stock price — a phenomenon known as information spillover, where one firm's disclosures can affect the value of other related peer firms.”
In their research, the authors showed that acquirers have an incentive to strategically disclose negative news when doing so could reduce the acquisition price. In fact, the authors found that strategically released news reduced the average cost of a takeover by approximately $23 – $58 million.
One example the authors referenced: Before Avery Dennison was in talks to buy Paxar, the company delivered an optimistic outlook when announcing first-quarter earnings. Then eight months later, after negotiations began, Avery Dennison released more negatively biased news articles, including a report that detailed a pessimistic view of industry demand, even when the fundamentals didn’t merit a negative spin.
Following that, Paxar’s stock price dropped by 32 basis points, which the authors say illustrates how acquirers can selectively direct attention toward negative industrywide news.
More information can be found in “Do Firms Strategically Internalize Disclosure Spillovers? Evidence from Cash-Financed M&As,” co-authored by Verdi, Yost, and Jinhwan Kim, a professor at the Stanford Graduate School of Business.
3. Companies issue fairness opinions to protect themselves from litigation — not just to negotiate a transaction price
When companies are considering making a deal, they rely on fairness opinions, documents that are usually put together by an outside advisor to ensure that a transaction meets a threshold level of fairness from a financial perspective.
In their research, the authors found that targets are strategic in what companies they choose as “peer comparables” in M&A valuations. Specifically, these companies choose lower-valued peers when the risk of litigation is higher. The authors say this suggests that fairness opinion reports are being issued to protect from litigation and not exclusively to negotiate the stock price, as was originally thought. (Litigation can arise in mergers when the shareholders of target companies believe the transaction price was too low.)
“What we show is that when companies issue these reports, they’re not just issuing them to justify that the price is good, to close the deal and move on,” Verdi said. “Companies are also issuing them to cover their exposure in terms of potential liability.”
The authors concluded that targets were less likely to be sued when selecting a lower-valued peer, but doing so was also associated with receiving a lower takeover premium.
"The strategic choice of peers in M&A valuations” was co-authored by Verdi, Yost, Claudia Imperatore, a professor at Bocconi University, and Gabriel Pundrich, a professor at the Warrington College of Business.