Corporate Governance

Acquirer-Target Social Ties and Merger Outcomes

By Harvard Law School Program on Corporate Governance

In our recent working paper Acquirer-Target Social Ties and Merger Outcomes, we estimate the relationship between merger announcement returns and the extent of social ties between the top managers and directors of the two merging firms. We focus on educational institutions as well as employment history as the basis of the social networks that we use in our analyses.

Using a sample of 539 mergers between publicly-traded U.S. firms between 1999 and 2007, we find that acquirers? announcement returns associated with a merger tend to be lower in the presence of many social connections. Upon examining the relationship between target announcement returns and social ties, we find no significant relationship that would indicate that targets are overpaid based on social networks. We then consider the acquirer and target weighted average announcement return for the combined entity and confirm that the overall effect of social ties is significantly negative, both statistically and economically. This supports the view that the negative impact of social networks outweighs whatever positive information-based effects might be present.

We conduct a number of additional tests. First tests, we use the Governance Index (G-index) of Gompers, Ishii, and Metrick (2003) to test the effect of governance structure, but we find no significant effect. We also examine the impact of acquirer CEO stock ownership, and we find that this does appear to matter. The effect of social ties remains negative, but acquirer CEO ownership reduces the effect significantly. CEO stock ownership thus appears to help align incentives with shareholders in this context. Next, we find that the degree of social connection between the acquirer and the target significantly increases the likelihood that the target firm?s CEO and a larger fraction of the target firm?s pre-acquisition board of directors remain on the board of the combined firm after the merger. We also find that acquisitions are more likely to occur between two firms that are well-connected to each other through social ties. Moreover, these acquisitions are subsequently more likely to be divested, particularly for performance-related reasons, indicating that these transactions are recognized ex post as bad decisions.

Overall, our results suggest that social connections between the acquirer and the target have a negative impact on merger outcomes. Acquirer-target social ties can lead to poorer decision-making and lower value creation for shareholders as a whole. The negative effects of social connection between decision-makers at the acquiring and the target firms may be one important potential source of value destruction in many merger transactions.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on January 14, 2010 (boomark / email).