Category: Leadership

Beating the M&A Odds: Three Big Risks and Key Questions for Directors

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Director Essentials: Strengthening Oversight of M&A

Director Essentials: Strengthening M&A Oversight is available exclusively to NACD members. To become a member, please contact Brandan Nass at Join@NACDonline.org. To learn more about NACD, visit NACDonline.org

Every corporate director knows the importance of M&A in the grand scheme of enterprise. With some 40,000 significant transactions announced annually, M&A is hard to ignore. Yet there are persistent risks that directors need to understand and mitigate through insightful questions and the dialogue that ensues.

  1. Risk: Not all bets will pay off—at least not right away. Buying a company means placing a bet on the future. Given the level of unpredictability involved, there is some chance that the merger will fail to achieve its goals and/or fail to return incremental value to shareholders. It is commonly cited that “80 percent of all mergers fail” to add value; however, this percentage is an exaggeration. Event studies that compare transactions over time present a more realistic picture by showing that incremental financial value is not assured. For example, a study conducted by Kingston Duffie, publisher of the digital magazine Braid, indicates that companies actually lost 4.8 percent of their value when they spent at least five percent of their market capitalization on M&A during the 18-month period between October 2014 and March 2016. The interactive graphic included in the study shows differentiated performance during the period—high for Stamps.com Inc., medium for Starwood Hotels & Resorts Worldwide Inc., and low for EV Energy Partners. Your company could experience returns like any one of these.

Question for Directors: If this merger ends up having a slightly negative result for our shareholders, what are the compelling strategic reasons to do this deal? When do we believe that deal synergies will materialize?

  1. Risk: As a director, you could be named in a lawsuit—especially if you are voting on the sale of a company. In 2015, lawsuits were brought in 87.7 percent of completed takeovers. Although most cases settle, some do go to trial. In a trial setting there are four main standards for judging director conduct in the sale of the company, ranging from lenient to stringent:
  • The business judgment rule (trusting the decision as long as directors have no conflicts of interest and are reasonably well informed).
  • The Unocal standard (protecting anti-takeover moves only if a threat is real).
  • The Revlon standard (requiring an auction process once a company is in play).
  • Entire fairness (requiring both a fair price and a fair process).

In addition, when a company has promised its shareholders the right to have the company appraised, the court itself can impose its own valuation. In the original Dell go-private transaction, the court retroactively forced the company to pay aggrieved stockholders what the court deemed to be a missing increment to their premium.

Question for Directors: How can we find assurance that sale is in the best interest of the company and its owners, and that we have chosen an optimal price? How can we ensure that there is a litigation-ready record of our deliberations in this regard?

  1. Risk: You could lose your board seat. According to a study by Kevin W. McLaughlin and Chinmoy Ghosh of the University of Con­necticut, there is a higher rate of retention for directors from the acquiring firm (83 percent) following a merger, with the most likely survivors being individuals who serve on more than one outside board. Only about one-third of directors from the target board (34 percent of the inside directors and 29 percent of the outside directors) continue to serve after the merger.

This October, when Dell Inc. and EMC Corp. officially merge (assuming full regulatory clearance following their recent shareholder approval), many who serve on the EMC board may not be on the post-merger Dell board, including retiring EMC Chair-CEO Joe Tucci. When the merger was first announced last October, a spokesman for Elliott Management Corp. stated in a press release, “Elliott strongly supports this deal. As large stockholders, we have enjoyed a productive and collaborative dialogue with Joe Tucci and EMC’s Board and management. We are confident that this Board has worked tirelessly to evaluate all paths for the company and that today’s transaction represents the best outcome for stockholders.”

Saying goodbye to some or all of these incumbents this fall will seem to be an ironic outcome for creating value. And yet that is how it must be. Fiduciaries are not self-serving, but rather they serve on behalf of shareholders to promote the best interests of the company. As such, they need to be ready to move on when that is the best outcome for the corporation. Still, it is disruptive (and not always creatively so) to be a trusted voice of wisdom for the future one day, and mere history the next.  

Question for Directors: If we sell this company and our board must merge or disband, who among us will be most useful in steering the combined company in the next chapter?

These are not easy questions. But by asking them, directors can help their companies beat the tough M&A odds.

For more insights, see Director Essentials: Strengthening M&A Oversight, and Governance Challenges 2016: M&A Oversight—two new publications available without charge to all NACD members. See also “Does the Deal Fit the Strategy?” in Metropolitan Corporate Counsel, and “Project M&A” in Financier Worldwide.

The Brexit Vote: Scenarios for Business Leaders and Boards

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This Thursday, the United Kingdom (UK) will vote in a referendum on whether to leave the European Union (EU)—referred to as the “Brexit.” Opinion polls have shifted sharply over the past two weeks to indicate that the likelihood of Brexit has increased substantially, but Frontier Strategy Group continues to believe that the UK will vote to remain in the EU, albeit by a very small margin. Opinion polls have been extremely inaccurate in the past two UK elections and we believe some hesitant voters will choose to remain in the EU in a conservative bias that we saw in both the parliamentary elections last year and in the Scottish referendum. Markets are also interpreting the murder of pro-EU Labour MP Jo Cox as likely to damage the Leave campaign.

A narrow win for the Remain campaign—our baseline scenario—is unlikely to alleviate the grievances of those supporting Brexit and would cause deeper tensions within the UK’s Conservative Party, raising the likelihood of early elections and another referendum in the next couple of years. While the economic impact of these trends would be relatively modest, lingering uncertainty would cause investments to underperform.

Should Brexit happen, however, multinational businesses would be affected in several key ways. Besides the initial financial volatility and somewhat weaker growth in Europe, most of the broader effects of Brexit outside the UK would be slow-moving, although their long-term implications could be significant enough to reshape the European Union. Companies need to be prepared for short-term volatility—particularly of currencies—but should Brexit occur companies can expect to be gradually adapting to its effects for at least the next two to three years.

Financial-market volatility and currency depreciation

The possibility of Brexit has already rattled currency, bond, and equity markets and this volatility will increase in the immediate aftermath of the event should Brexit occur. The British pound could depreciate by as much as another 10–20% against the United States’ dollar (USD) in the aftermath of Brexit, and the euro would also likely lose value, possibly as much as 5–10% against the USD. The scale of the losses would likely be temporary, but neither currency would be likely to recover to pre-Brexit levels. Brexit would also dampen investment confidence, softening commodity prices and causing overall financial market uncertainty. Added to a backdrop of weak global growth and deep concerns about China’s slowdown, Brexit would prompt another bout of volatility that would cloud corporate expectations and complicate 2017 planning for emerging markets generally.

Growth in Europe

Brexit would cause a slowdown in UK investment and business activity. A similar, though smaller, effect would be likely in the EU as a whole. Markets strongly linked to demand from the EU—such as North Africa, Eastern Europe, and parts of Asia—would see a softening of demand for the next 12 months that would affect industrial performance but would not disrupt growth trajectories. The demand effect for other parts of the world would likely be negligible. As corporate leaders gear up for 2017 planning, they would have to dedicate more analytical energy to identifying sources of growth in Asia, the Middle East, Africa, and the Americas to compensate for weaker performance in Europe.

Policy predictability

Brexit would raise a host of trade issues from the future of the Schengen Area to the outlook for the Transatlantic Trade and Investment Partnership, all of which would increase uncertainty over the cost and structure of supply chains that involve the EU. Any tangible effect on supply chains, however, would likely materialize over a period of several years, giving companies ample time to respond. It would, however, raise fundamental organizational issues such as where companies’ European headquarters will be located, tax rates, distribution-chain structure, and other concerns that should be factored into 2017 and longer-range planning as well as profitability targets. Making changes earlier could yield valuable competitive differentiation for cost and talent.

Political risks

Brexit’s most dangerous effect could be to galvanize anti-EU sentiment and populist parties across the EU, setting into effect a series of policy disruptions in the region that could weaken the EU, slow down EU integration, or even lead to other EU members exiting the union. All of this would undermine the EU’s economic outlook, and force multinational corporations to manage political risk in this usually stable region much more closely. While that would be unlikely to have ripple effects globally, it could contribute to greater instability in the Middle East and Eastern Europe if it coincided with increasingly isolationist foreign policy from the United States.

Overall, Brexit would put greater pressure on regions outside of Europe to deliver strong results that can compensate for years of underperformance by the UK and the EU in corporate portfolios. This may be a big challenge in the current global growth environment, requiring an even greater focus on agile strategies that emphasize strong competitive positioning, careful risk management, and a reshaping of how companies plan to win in emerging markets.

In case the UK votes next week to leave the EU, boards and executive teams should ask themselves several urgent questions to effectively prepare their response:

  1. What is our company’s exposure to short-term currency volatility of both the British pound and the euro? How would significant depreciation against the dollar affect our overall revenue and profit targets for this year?
  1. Have we developed alternative international growth strategies that rely less on demand in Europe?
  1. What production and distribution disruptions are we likely to face in our European operations?
  1. How should we adjust our long-term outlook for doing business in Europe? What economic and political risks are now more likely and more significant to our company?

Joel Whitaker is Senior Vice President of Global Research at Frontier Strategy Group (FSG), an information and advisory services firm supporting senior executives in emerging markets.

NACD Names Dr. Karen Horn as Board Chair

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Karen Horn

Dr. Karen Horn

NACD elected Dr. Karen Horn as its board chair last week during its board of directors’ meeting. She succeeds Dr. Reatha Clark King, who had held the position of board chair since 2013 and will now serve as chair emerita.

“I am delighted to welcome Dr. Horn as our next NACD board chair,” King said. “She brings to the position several distinguished leadership experiences in business, board governance, and associations. Her demonstrated commitment to board excellence will enable her to work with NACD’s board, management, members, and many partners to further advance board leadership and excellence.”

As NACD’s incoming chair, Horn has high ambitions for NACD’s future. “As shareholders, regulators, and stakeholders hold directors to an increasingly higher standard, NACD will continue to play an important role in shaping and upholding exemplary board-governance standards,” said Horn. “I am honored to be NACD’s chair and I look forward to supporting NACD’s mission to help our members lead with confidence in the boardroom.”

Horn, who was a commissioner of the NACD Blue Ribbon Commission (BRC) on the Effective Lead Director and co-chair of the BRC on the Board and Long-Term Value Creation, joined NACD’s board in 2011 and has most recently served as NACD’s vice chair. She also serves as the chair of the nominating and governance committee of the Simon Property Group Inc., as vice chair of the National Bureau of Economic Research, and as vice chair of the U.S. Russia Foundation for Economic Development and the Rule of Law.

Previously Horn was a director of Eli Lilly and Co., where she was lead director and chaired the compensation committee; of Norfolk Southern Corp., where she chaired the audit committee; and of T. Rowe Price Mutual Funds.

She is a senior managing director of Brock Capital Group. Horn also has been the global head of Marsh Private Client Services, the head of international banking at Bankers Trust, and the sixth president of the Federal Reserve Bank of Cleveland—the first female president in the Federal Reserve System’s history.

For more information about NACD’s board of directors, visit www.NACDonline.org/NACDBoard.