Method of Payment
Firms can pay for an acquisition using either cash, a combination of cash and stock, or with stock alone. Research suggests that managers finance acquisitions in the manner perceived to be the most profitable. Managers who believe their stock is undervalued will thus pay for an acquisition using cash, and pay with stock when they think their firm's stock is overvalued.43 However, the choice of payment may also consider the type of acquisition. Related acquisitions are often paid for with stock because this shares the risk inherent in the acquisition with the target firm.44 Additionally, paying with stock can help align a target firm's interests with improving performance in a combined firm. For example, stock payment may provide a means for coping with information asymmetries between an acquirer and its target.45 The use of stock to align target firm interests with a successful outcome is similar to how stock options are used to align executives' interests with those of shareholders. Another way to align target executive interests is with an earn out, or an arrangement where the final price paid depends on meeting performance targets.46
The use of stock as a form of payment should also help an acquirer to avoid the negative effects associated with taking on too much debt when paying for an acquisition with cash. Debt can lower an acquiring firm's financial performance. The stock price of a firm with higher debt will be discounted in comparison to that of a firm with less debt (assuming everything else is equal) to reflect the higher risk of investing in the firm. This discount results from equity investors having a lower priority than bondholders when making claims against the assets of bankrupt firms. Accounting measures of financial performance will also be poorer when levels of debt increase as a greater share of a firm's earnings are allocated to servicing debt payments. As a result, high debt levels raise the bar for the performance needed to improve performance and can lead to strict controls that negatively impact the adaptation needed to improve performance following an acquisition.47 In summary, there is reason to believe that successful acquirers take steps to align target interests by paying for their acquisitions with stock or using an earnout.
The time between an M&A announcement and its completion is typically called due diligence, and represents the start of integration planning. There is a growing chorus of voices from institutional and other investors calling for more rigorous due diligence. Greater justification is needed from managers for their rationale in pursuing an acquisition to overcome resistance attributable to there being managerial incentives from M&A yet low average M&A performance. Though the purpose of due diligence is not to identify reasons to abandon an acquisition, it is the last chance for avoiding an acquisition that does not make sense. Conditions where deals should be terminated include distrust between acquirer and target management, a combination that threatens important customer relationships, or expectations that key employees will leave a combined firm.48 Necessity often dictates involving only a few key people in acquisition planning. However, it is better to err on the side of including more people to ensure that as many potential problems are identified and potential solutions considered.
Most firms do not efficiently use the time between announcement and completion as optimism from successful negotiations delays planning for implementation. Indeed, a sense of accomplishment from bringing negotiations to a close when a deal is announced tends to shorten due diligence. However, taking more time for due diligence can improve success and avoid problems that hinder improved performance.4 9 One positive result of taking additional time for planning is that unexpected information uncovered during due diligence will usually be negative, which in turn requires more time to evaluate its implications.5 0 Focusing on the right things can also help firms make better use of the time available. This can be facilitated by establishing and communicating clear goals that can be used in making decisions, something that can make a difference in developing an executable plan. Integration planning typically focuses on the depth and speed of integration, but developing an integration plan begins with considering M&A goals.
The goals for an M&A should have already been established; thus integration planning relates to the experiential learning stage of applying theories or models in relation to what has been observed. Stakeholder analysis represents an existing tool that applies to M&A integration, and the interests of stakeholders in achieving M&A goals can first be addressed during integration planning.5 1 A stakeholder is any group that can affect or is affected by a firm's objectives.52 Managers can be caught by surprise and have initiatives derailed by an unanticipated negative reaction from a stakeholder group. With effective stakeholder analysis, urgent concerns can be identified and addressed. A stakeholder group that should have already been considered when making a public bid is important target shareholders such as institutions or family holdings. By performing an analysis of additional stakeholder interests, an integration plan can balance the interests of different groups in pursuing M&A goals. Obvious additional stakeholders in an acquisition involve government regulators, customers, employees, and competitors. However, additional stakeholders, such as vendors or other business partners exist and need to be considered. Once identified, it helps to prioritize stakeholders to better manage how to approach them. One method is to build a matrix for prioritizing stakeholders along dimensions of stakeholder power and interest.53 Resulting stakeholder groups are shown in Table 3.1 and each is discussed in the following sections.