Aurora Borealis
1 January 2014 CFA Institute Journal Review

How Do CEOs Matter? The Effect of Industry Expertise on Acquisition Returns (Digest Summary)

  1. Victor E. Jarosiewicz, CFA

CEO characteristics affect the performance of acquirers in diversifying takeovers. CEOs with prior experience in a target’s industry create better acquirer stock returns at the M&A announcement. This superior performance tends to be the result of lower-premium deals and of better negotiations to capture more of the “surplus” from these lower-premium deals.

What’s Inside?

A CEO’s past experience in a target’s industry seems to affect acquirer stock returns upon announcement of a diversifying M&A deal. The authors’ findings suggest that such experience leads to favorable acquirer stock returns at announcement and that the transactions those CEOs undertake capture more of a deal’s value at a lower acquisition premium, although the effect is less pronounced for public takeover targets.

How Is This Research Useful to Practitioners?

The authors separate the value added from transactions—or rather, acquirers—into categories of value creation and value capture. In particular, given that the returns of most acquirers are negative or neutral relative to the market around M&A announcements, this research could help with investment decisions regarding stocks of firms announcing or expected to announce a diversifying acquisition.

“Experienced CEOs”—that is, those with prior industry experience for a target whose industry differs from that of the buyer—produce positive M&A announcement returns for their firms when compared with M&A announcements by CEOs without such prior experience. This finding is more pronounced for private targets than for public targets. Experienced CEOs are also less likely than others to use financial advisers in their transactions—an interaction worth noting for professionals in advisory firms.

For public targets being acquired by experienced CEOs, the average announcement increase is smaller than the average announcement drop for the buyers, which the authors interpret as better bargaining by experienced CEOs. They capture more of the combined surplus than those without related experience. The returns are particularly pronounced when the target negotiates bilaterally rather than using an auction process. For private targets being acquired by experienced CEOs, the advantage is reflected in even stronger buyer stock returns.

Therefore, some of the first things to consider when a firm announces a diversifying M&A transaction are whether the CEO has target industry–related experience and whether the target is private or public. The combination of an experienced CEO and a private target leads to relatively more positive results for the acquirer’s stock. If the target is not engaging in an auction process but only negotiating with the buyer, the additional expected return is even larger.

How Did the Authors Conduct This Research?

Using constituent firms of the S&P 1500 Index from 1992 through 2008 and identifying their CEOs, the authors consider the effects on buyer stock price of M&A transactions when the buyer firm is in an industry different from that of the target. The industries are broad “Fama–French 12 industry” classifications. Cumulative abnormal returns strip out expected market-driven returns so that the authors can focus solely on event-driven results. A CEO’s prior industry experience must be in top management. The transactions are restricted to US buyers and targets only, with deals below $50 million excluded.

Because stock returns, selection and negotiation of M&A transactions, and selection of CEOs by acquirers are determined by many factors, the authors use a number of control variables to more clearly focus on their area of interest. Their final sample includes 1,193 diversifying deals, with 16.5% of those deals performed by CEOs with related experience. A minority of mergers (24.6%) are classified as diversifying deals.

Alternative explanations are tested. CEOs create no clear benefit for deals in which they have no related experience. Being a more powerful CEO or in a more concentrated industry has very little effect on the base results. Vertical integration is not a driver of the results.

The findings support the conclusions that diversifying acquisitions by experienced CEOs result in stock outperformance at the announcement relative to acquisitions by CEOs without related experience and that the reason for those returns is value capture (i.e., better bargaining). The value of experienced CEOs, therefore, is much more likely to be through value capture than through value creation.

Abstractor’s Viewpoint

The authors cannot differentiate between better bargaining per se and better ability to select weaker bargaining partners (targets with fewer outside options). On the surface, it may not matter in terms of the trading strategies, as long as the results continue to hold regardless of the source of acquirer outperformance. For longer-term investing, it might become more important to understand how well acquiring firms integrate and improve weaker bargaining partners. Otherwise, short-term trading gains may not translate as easily into buy-and-hold investment returns. Put another way, do these announcement results hold up for completed transactions?

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