Do advisors generate merger value?

By Killian J McCarthy 

 

Most of these were concluded with the assistance of an advisor; that is, with the aid of a professional, third party, which is usually a specialist in merger transactions. Francis et al. (2006), for example, shows that more than 80% of US deals in the period 1984 to 2006 used financial advisors. And this is hardly surprising. 

Theoretically speaking, external advisors offer the participant firms — the target or the advisors — a number of important benefits. First, the superior deal hypothesis suggests that, as industry specialists, external advisors may be able to identify better M&A partners (Ismail, 2010). Second, the best practice hypothesis suggests that, as industry specialists, professional advisors can act as ‘impartial conduits of organisational practices’, improving the performance of the firm (DiMaggio and Powell, 1983). Third, the bargaining power hypothesis suggests that,  as industry specialists, professional advisors have superior administrative skills and experiences in negotiations, and can use these to get clients a better deal (Bowers and Miller, 1990). And finally, the reputation hypothesis suggests that professional advisory companies have a strong incentive to complete only the best deals, so that reputation is enhanced or upheld (Ismail, 2010). Together, effectively, advisors are contracted to minimise the risks of a deal. 

And advisors are well compensated for their efforts. Hunter and Jagtiani (2003) suggest that, on average, the bidder’s advisors receive about $2.4 million per deal, and the target’s advisors earn about $4.4 million per deal. Over the fifteen year period 1985 to 2000, about $36 billion was paid to financial advisors alone. Clearly, mergers are big business, and advisory companies does quite well from it! 

The problem, however, is that there is very little empirical evidence to support the conclusion that advisors add any positive value to the performance of the deal. 

To fill this gap in the academic literature, to quantify the effects of the advisor, and indeed to test the aforementioned theories, we built a sample of 27,998 North American deals, completed in the period 1990-2012. We calculated the stock-price performance for 19,782 of these, controlling for industry effects etc, and identified the ‘number’, ‘type’, and ‘role’ of the advisor in in 10,535 of these deals.  In doing so, we made number of interesting, and often surprising, discoveries. 

Firstly, we observed that the average number of advisors per deal has increased dramatically over the period of our analysis. In  1990, the average deal had 2.3 advisors, and in 1990 only 9.5% of deals used 5 or more advisors. By 2009, however, the average deal had 4 advisors, and 38% of all deals had 5 or more advisors. See 

Secondly, and relating advisors to performance, we discovered a negative and (statistically) significant relationship between external advisors and performance. Advisors, it seems, have a negative effect on merger performance. Looking at the advisor type, we observe that financial advisors have a negative and significant effect on deal performance, while legal advisors have an insignificant effect. Neither group — whether we consider them individual or as a group — has a positive effect. What is more, the more advisors the firm contracts, the more negative the performance. 

Third, and turning back to the reputation hypothesis we investigated if top-tier advisors have a more positive effect. We identified the top 1, 5, and 10 advisors, by year, and by transaction value, and re-ran our analysis. We found no evidence to suggest that top tier advisors had a better effect on the performance of the deal than ‘other’ advisors, but noted that  number of deals contracting top tier advisors had increased dramatically,  

 

 

Finally, we investigated if advisors have a more positive effect in more ‘complex’ situations. Defining complexity in terms of the type of targets (international versus domestic, related versus unrelated etc), and the type of deal (hostile versus friendly, contested versus uncontested), we again found no evidence to suggest that advisors have a positive effect in the case of a complex merger or a complex acquisition. 

So why hire an external advisor? At present, the reasoning remain unclear: advisors do not, it seems, make a statistically identifiable contribution to deal performance.

Killian McCarthy is assistant professor bij de University of Groningen en verzorgt voor MenA.nl een maandelijkse blog. Hij behaalde zijn PhD in economics of corporate strategy in 2011 voor zijn onderzoek over overnameprestaties. in dit onderzoek evalueerde Killian de prestatie van 35,000+ deals in Europe, Noord-Amerika en Azië in de periode 1990-2010.