The Perils of Personal Connections in Mergers and Acquisitions

In what many consider to be the worst business transaction in all of history, the AOL-Time Warner merger highlights the risks that come with allowing personal connections to influence a business decision of this caliber. Driven by the close relationship between CEOs Gerald Levin and Steve Case, both men disregarded strong warnings from their advisors against proceeding with the merger. The resulting failure not only led to massive financial losses but also severely damaged the reputations of both companies and their leaders.

Personal relationships can be a double-edged sword in the world of business. While friendships can foster trust, collaboration, and a shared vision, they can also lead to clouded judgement such as in the AOL-Time Warner case. Whether this is due to biased decision making or overlooked risks, both can lead to costly mistakes for everyone involved. This dynamic is particularly evident in the high-stakes game of mergers and acquisitions (M&A), where decision-making and strategy are often no place for personal connections.

The recent article, “Personal connections, financial advisors and M&A outcomes” examines how personal ties between a bidding firm’s top leadership – such as the CEO, CFO, COO, President, or Chair of the Board—and their financial advisors affect M&A performances. In this article, authors Dobrina Jandik and Tomas Jandik from the department of finance at the University of Arkansas, as well as Walton alum Weineng Xu (University of Wisconsin-Whitewater), caution shareholders to beware of these connections as they could be detrimental to the company.

Start with the Positive... Well, Maybe?

We have all heard the advice “Never mix friendship with business.” Yet, time and time again, businesses are formed through friendship, with owners often facing the same pitfalls we have been warned of. What persuades people to do this? What are the advantages of these personal connections in business?

Social connections can provide many benefits in business such as improved information transfer, as trust between individuals can streamline communication and decision-making. These relationships can also influence the structure and success of financial deals, as the added level of familiarity may foster a collaborative atmosphere. Such relationships can lead to enhanced overall corporate performance, driven by shared goals and a mutual understanding of the company’s vision.

Beyond improved communication and trust, personal relationships in business can foster a greater sense of loyalty and commitment. Executives and financial advisors might be more likely to go the extra mile to ensure mutual success when there is a shared bond. This loyalty can enhance teamwork and collaboration, creating a cohesive environment where individuals feel more invested in the company’s goals.

The study by Jandik, Jandik, and Xu finds that personal connections between the management of acquiring companies and their financial advisors significantly increase the likelihood of M&A deals being completed. While these connections can help facilitate smoother negotiations and align interests, they also bring the risk of introducing biases and conflicts of interest. As a result, the benefits of these relationships come with considerable risk. The authors’ research shows that such connections can be just as harmful as they are beneficial. Take your time!

While the percentage of M&A deal completion might be higher for those who have a social connection, so is the amount of time it takes to finalize these deals on average. This research finds that increased closing times may be evidence of ineffective execution of their deals. Instead of utilizing better information transfer due to existing personal connections, advisors might simply collect their fees and serve as “passive executors” of the bidder managers’ desire to acquire the company regardless of the effects on the bidding company.

These extended timelines are not usually just a scheduling issue, but instead suggest that the advisors might not be spending their time wisely. Instead, advisors could simply be going through the motions without adding much value in terms of improving the deal’s terms or its execution. Additionally, if the advisor has a close personal relationship with, say, the CEO, they may be more inclined to support the CEO’s desire to pursue a merger, even if it isn’t in the best interest of the company. This relationship can lead the advisor to prioritize fulfilling the CEO’s wishes over making an objective assessment of the deal’s potential impact on the company’s future.

In this case, these challenges or delays in completing this deal increase the time it took to close the deal. To make sure that this is not the case, company leadership should pay attention to the personal benefits that leadership and advisors are receiving in relation to these transactions.

How Does This Benefit Me? 

With higher completion rates as well as longer closing times, it raises an important question: Are these deals actually beneficial to the company as a whole? Or are they only beneficial to a select few?

In M&A deals, bonuses and payments to advisors and CEOs can be substantial. These payouts reflects the high stakes and complexity that comes with these types of transactions and is intended to reward those who worked so hard to successfully complete this deal. However, when it comes to personal connections, these rewards might also be an incentive to make a deal happen, regardless of harmful results.

In their research, Jandik and Jandik find that advisors with personal connections to the bidder are paid 57.6% higher than those without connections. This increase is quite substantial considering the median payment for advisors in this article was $9.5 million. Additionally, top executives who have personal connections to their M&A financial advisors get an additional 46.7% in cash bonuses upon completion of the deal. Again, this increase is particularly substantial given that the average bonus for CEOs is $1.84 million dollars.

These incentives bring to light a potential conflict of interest that may undermine the overall value of the deal to the company. When advisors and CEOs stand to gain such significant financial rewards, particularly when personal connections are involved, the focus may shift from what is truly best for the company and its shareholders to simply ensuring that the deal goes through.

This raises concerns about whether the deal’s benefits are being distributed equitably across the company, or if they primarily serve the interests of a select few at the top, potentially at the expense of the company’s long-term success. This research suggests that it might be the latter.

Winners and (Mostly) Losers

While deals involving connected advisors provide higher fees paid to advisors and higher cash bonuses for the CEOs, they also earn significantly lower returns to acquirer shareholders. In deals where bidder top managers share past personal connections with their advisors, there is an average of 1.7% lower bidder announcement returns compared to deals where there is no such connection. So, shareholders will likely experience reduced gains, and, in most cases,  losses, as a result of the deal, which could lead to dissatisfaction among investors and a potential drop in the company’s stock price.  This suggests that the market tends to react more favorably to deals where there is not concern about conflicts of interest, which can increase investor confidence in the company’s leadership and the success of the merger.

Personal Ties Not Welcome Here

While personal connections can be of value in many aspects of business, the authors suggest that mergers and acquisitions might be one place that these connections are not a welcome addition. While these relationships might seem advantageous at first glance, they also introduce significant risks such as biased decision-making, longer and less efficient deal execution, and ultimately, reduced financial returns for shareholders. 

The study by Jandik, Jandik, and Xu serves as a cautionary tale for those shareholders as well as corporate leadership. By prioritizing objective, impartial advice over the comfort of familiar relationships, bidders can avoid the complications that these relationships create. Understanding the impact of these relationships can help in assessing the true value of a deal and its potential impact on their investment.

In the end, the success of a merger is not only about completing the deal, but also maximizing the value for the company as a whole. If not managed properly, personal connections can compromise that goal, leading to costly mistakes and missed opportunities. This research serves as a vital reminder to maintain a clear-eyed focus on what’s best for the company and avoid letting personal relationships cloud judgement in important decisions.