Just as cogent as it is to assume that prior experience in M&A has a positive effect on future performance, it is easy to think that the counterbalance is some form of indulgent acquisition excess. While academics might disagree on the impact of factors, they would all agree that apart from the specter of value destruction, the pitfalls of serial acquisition do not have a single theme. Reading through their papers, acquisition overreach has many possible explanations.
- The Indigestion Hypothesis proposes that the short time period between acquisitions adversely affects acquirers that quickly execute multiple acquisitions. Each subsequent acquisition results in worse performance than the previous acquisition, because the acquirer becomes less able to integrate successfully.
- The Hubris Hypothesis is something I touched on in week 38 with the notion of a mythical ‘managerial kiss’. Managers in the acquiring firm assume that they can manage the target firms’ resources better than current management. Overconfidence drawn from previous success leads them to overpay for their targets, be less careful in their choice of targets, and/or take on too much debt to pay for targets.
- The Mean Reversion Hypothesis argues that acquirers that initially do well at acquisition are unable in subsequent acquisitions to maintain the above average takeover performance. Since acquiring firms generally outperform the market prior to the merger, the underperformance subsequent to the merger may merely be a result of the mean-reversion in long horizon returns on individual stocks
- The Diminishing Returns Hypothesis applies the diminishing efficiency of investment schedule to the firm’s acquisition programme. It argues that the best opportunities are taken first and so the decreasing attractiveness of the investment opportunity set means that value derived from subsequent deals are bound to decline over time.
- The Bid Learning Hypothesis is another explanation for such a positive relation between the time between deals and acquisition performance. It argues that improved bidding capabilities by the executive leads to a higher number of successful bids, which in turn rationally increases their willingness to pay, which ultimately leads to a decreasing return pattern.
- The Merger Programme Announcement Hypothesis proposes that that part of the overall performance effect of an M&A programme is already incorporated into a bidder’s share price. Should the market respond favourably to a first transaction announcement, when a second acquisition is announced, then there is some announcement gain since it is now a known event, but part of the value was already discounted in the share price.
So an interesting question would be under which conditions managers can navigate through these possible tendencies and learn how to acquire successfully again and again.