Caveat Emptor: The Accountabilities and Required Actions of Directors in Securing Value When Merging or Acquiring Companies. Paper 4 of 4: Conclusions on Research into What is Right Governance Practice Over M&A Transactions, as Overseen by Directors of the Acquiring Company

33 Pages Posted: 8 May 2017

Date Written: May 8, 2017

Abstract

The paper that follows is the last of a four-part series deciphering what should constitute ‘right governance’ over mergers and acquisitions, by boards of the acquiring company.

By ‘right governance’, we don’t mean necessarily leading practice, best practice or even common practice – but rather the right blend for the unique circumstances of each transaction, company and board.

Mergers and acquisitions (M&A) are critical mechanisms for corporate growth and potentially for increased shareholder returns. The reality, however, often does not live up to the promise, as is borne out by empirical data on the high incidence rates of M&A under-performance.

At present in Australia, directors and executive management, particularly of the acquiring company, have considerable latitude to put at-risk shareholder value via M&A without any meaningful pre-event restraints or post-event sanctions (and with the benefit of the Business Judgment Rule defence).

The old adage caveat emptor (‘let the buyer beware’) still holds true for buyers, but when it comes to ensuring that their shareholders’ interests and capital are properly protected, there are few formally imposed ‘checks and balances’. Additionally, in terms of voluntary controls, there is little clarity on what are the acceptable, key activities and behaviours of the directors of the acquiring company, that represent responsible standards of conduct.

The initial question to be considered is whether there is a discernible set of ‘right practices’ that provide a reference set of benchmarks for non-executive directors to know whether they are exercising the necessary care, diligence and skill in selecting and overseeing transactions. Looking from the ‘outside in’, the corollary is ‘How do shareholders in the acquiring company have some visibility and assurance that their executive management team and board are exercising (or have exercised) sufficient due diligence (in the broadest sense of the word) over transactions?’

The challenge thus arises as to how to describe the ‘right practice’ stewardship that should be exercised by ‘reasonable directors’ of the acquiring entity to manage the risks and performance of transactions – before, during and after acquisition.

This paper is the fourth in a series of four that focus on identifying and describing ‘right governance’ i.e. the required level and mix of actions and responsibilities of directors of the acquiring company, necessary for protecting the interests of their shareholders.

To carry out this research, the opinions and experiences have been elicited from a cross-section of non-executive directors and Chairmen, via targeted interviews (‘grounded research’) to capture their views on good board oversight of M&A practice. (This has been described in shorthand form as the d-ought for ‘directors’ ought’).

What has emerged as the board-level themes from seasoned directors have been compared to the extant literature (the t-ought, shorthand for the ‘theoretical ought’ of right practice), to examine how these align and whether there are any key gaps or contradictions.

In most cases, there is alignment, although the interviewed directors’ views have crystallised what in the literature could best be described as ‘un-consolidated ideas’ based on ‘an extrapolation of managerial practices’, as the body of documented knowledge is generally not targeted at board members.

From these comparisons, has arisen an emergent theory regarding ‘right practice’, outlined in Paper 3B.

The emergent theory points to six key themes that those directors interviewed believe make a difference to deal performance: (1) the Board’s degree of strategic thinking (‘Clear strategy upfront’); (2) planning and preparation (‘Early preparation and planning’); (3) the extent of board members’ cultural due-diligence (‘Proper understanding of culture’); (4) robust business-case scrutiny and investment assessment (‘Rigorous testing of the investment business case and funding strategy’); (5) their focus on tracking the delivery of the targeted benefits (‘Effective monitoring post transaction’); and (6) the quality of their mutual challenge and critical debate (‘Well-chaired board with constructive challenge’).

This process of comparison of ‘t-ought’ versus ‘d-ought’ has indicated that these initial findings have merit and should be regarded as an emergent theory.

The key conclusions drawn below are that these themes can be grouped under three key messages: be prepared, be disciplined and be challenging, which encapsulate the behavioural implications of the six themes emerging from the research.

• In terms of the board assuring that management are prepared, well before and during the event, there is a range of practical activities and interventions that the board can adopt – such as planning and having experienced staff at executive and board levels, etc. These activities flow from practices already documented in literature and from gathered-up experienced directors’ wisdom.

• The be disciplined messaging, relates to actions during and after the acquisition event, whether that means following due process, enforcing stage-gates assurance and review checkpoints, or tracking synergies achieved.

• The be challenging dimension in particular goes to the heart of what chairmen and board members ought to do to ensure debate and vigilance. Research sources indicate a broader malaise at board level around debate and challenge. Whilst internal and external assistance – such as by enlisting the involvement of Internal Audit and Compliance functions and external deal advisers – can help a board to be better prepared and more disciplined, only the board itself can attend to the be challenging dimension.

Whilst the views of those directors interviewed are not yet a conclusively proven ‘recipe’ for board success – given the sample size and the Grounded Theory research approach selected – they do provide a solid foundation for further testing and exploration.

The emergent theory nonetheless offers important guidance for those boards who want to adopt what may be sensible, prudent actions, even if the efficacy of these steps has not (as yet) been empirically proven.

Keywords: M&A, board of directors, mergers and acquistions, governance

Suggested Citation

Blomson, Dean M., Caveat Emptor: The Accountabilities and Required Actions of Directors in Securing Value When Merging or Acquiring Companies. Paper 4 of 4: Conclusions on Research into What is Right Governance Practice Over M&A Transactions, as Overseen by Directors of the Acquiring Company (May 8, 2017). Available at SSRN: https://ssrn.com/abstract=2964761 or http://dx.doi.org/10.2139/ssrn.2964761

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