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The slickest merger of all: CEOs, cash
By Al Lewis, Columnist
Denver Post
Tuesday, June 26, 2007

Cash Eating Organisms -- or, as most people call them, CEOs -- are handsomely paid no matter how destructive a job they do.

This is particularly true in the case of mergers.

This is why CEOs start muttering odd words like "synergies" and "accretive" when they are suddenly overcome with fits of self-interest and pangs of greed.

Shareholders should remember that these cash-eating organisms can't help themselves. They will get paid, no matter how ridiculous the merger they propose.

That's what happens when you separate ownership from control, which is what our corporate system has done so effectively. It's also why academic studies consistently find that most mergers fail to deliver the returns that chief executives initially promised.

New research published in The Journal of Finance demonstrates why little of what a CEO says about a pending merger can be trusted. CEOs are too conflicted by the potential economic rewards.

"If you find out your company has a plan for growth through acquisition, you need to look really hard at that," said one of the study's authors, Jarrad Harford, an associate professor of finance at the University of Washington in Seattle.

"These synergy projections rarely work out," Harford said. "Rosy scenarios where mergers will be accretive to earnings or they're going to have all these cost savings in the first year -- that almost never happens."

Harford should know. He and Kai Li of the University of British Columbia's business school analyzed merger data from the largest 1,500 U.S. publicly traded companies between 1993 and 2000.

They began with 1993 because that was the year improved disclosure rules forced companies to list more data regarding CEO compensation. They ended with 2000 to allow enough time to elapse to analyze post-merger performance.

They looked at companies by an index number, rather than by name, to keep the study purely quantitative and empirical. Here's what they found:

Most mergers created companies that underperformed the market. On average, a company's stock value fell 1 percent upon announcing a merger. After three years, it fell an average of 5 percent, netting out returns attributable to the rising stock market of the 1990s. This finding is in line with earlier studies.

The CEOs who did these deals started out with a median stock-and-options portfolio worth $23 million. Three years later, this median portfolio had grown to $51 million.

CEOs who proposed mergers that outperformed the market saw their portfolios grow by $47 million or better over three years. CEOs who led underperforming mergers saw their portfolios grow by $14 million or better.

"You are clearly better off if you do a good merger," said Harford, "but you are not worse off if you do a bad merger. So, on the margin, why not do it?"

How do CEOs manage to do better, even when their companies and shareholders do worse?

It begins with a bonus for a job well done.

"They get a big cash bonus for the extra work they had to put in to make the merger complete," Harford said. "But we didn't even look at that. That's gravy."

Typically, their existing portfolio of stock and options have taken a hit as their company's stock price has fallen. But not to worry. Boards of directors are quick to lavish more stock and options on CEOs at the new, lower stock price created in the merger.

"Even the ones who are doing bad mergers are getting this huge slug of new options and stock," Harford said. "All the decision makers ... are getting extra stuff that the shareholders aren't."

Additionally, CEOs typically get a fat raise following a merger. They are now running a larger organization, which justifies the larger paycheck.

Mergers are infinitely complex undertakings. There are diverse cultures, redundant positions, disparate operations, idiosyncratic customers and myriad other unpredictable factors to consider.

Any CEO who claims to have this all figured out is probably just looking for his next big meal.

Al Lewis' column appears Sundays, Tuesdays and Fridays. Respond to Lewis at denverpostbloghouse.com /lewis, 303-954-1967 or alewis@denverpost.com

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