It’s no secret chief executives love a good M&A deal. Worldwide mergers and acquisitions soared 53 per cent to US$2.5 trillion in the first half of this year, and a new study shows why CEOs may be so hot to cut those massive cheques: regardless of a deal’s success, even when shareholders lose, execs make a killing. “Equity-based compensation gives CEOs a perverse incentive to undertake empire-building acquisitions, at the expense of shareholder value,” says Kai Li, a finance professor at University of British Columbia’s Sauder School of Business.
Li, along with Jarrad Harford from the University of Washington, looked at 370 big acquisitions involving U.S. companies between 1993 and 2000 in their study, published in the Journal of Finance. Like today, that period was marked by high-profile megamergers—such as the AOL/Time Warner deal and Dennis Kozlowski’s manic acquisition spree at Tyco—many of which ended badly. Researchers found that even in mergers where shareholders lost money, in threequarters of cases the CEOs of the acquiring companies wound up a whole lot richer than before the deal.
The researchers found that when CEOs do big deals, they tend to renegotiate their pay to compensate for the added workload of running a larger company and receive huge grants of restricted shares and stock options. Even when an acquiring company’s shares plummet after a deal, the big pay packages put the CEO further ahead. “That acts as insurance,” says Li. “The performance of the acquisition is not linked to pay so they’re encouraged to undertake value-destroying acquisitions.” In fact, those executives who grew their companies by investing in plants or through small acquisitions, saw their compensation lag their counterparts.
It’s not that executives necessarily seek out bad deals, says Li. It’s just that there’s an incentive for CEOs to rapidly expand, despite the abundance of evidence showing most merger deals fail to live up to the hype. Chances are, many of today’s mega-deals will leave CEOs rolling in it, while shareholders get left with a nasty hangover. M
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