Mind the information gap: Putting new selection criteria and deal structures to work in M&A

Mergers and acquisitions represent one of the main ways that companies get bigger, and the importance of this vehicle of corporate growth for the global economy has only seemed to increase. During 2006 the volume of global M&A activity reached an all-time high volume of $3.8 trillion, with the U.S. and Europe sharing equally large chunks of the pie-roughly $1.6 trillion each, according to Dealogic. Despite (or perhaps because of) such growth, acquisitions present some well-known challenges that have led to notably high failure rates, with half or more of all deals producing disappointing results and, in many cases, future divestiture candidates. A number of explanations for such widespread failure have been offered by academics and practitioners, including misalignment of incentives amongst the various parties to the deal, the inability of acquirers to implement successful integration practices after a deal takes place, and the departure of key personnel in the target firm following integration. Another major challenge, however, is the information problem associated with due diligence in the early stages of M&A deal-making. In this article, we focus on the risks inherent in the valuation of target companies and offer some suggestions to buyers on how to minimize their exposure and increase their chances of a successful transaction. During the due diligence stages of a deal, buyers often have insufficient information, which can leave them facing the risk of either withdrawing from a potentially attractive deal or overpaying and so failing to realize the expected gains from their M&A efforts. Indeed, despite advances in M&A practices over the past decade or more, this problem continues to confront buyers and contribute to the mixed track record of corporate growth through acquisition. However, a number of relatively new approaches and tools for tackling the challenges surrounding M&A valuation have been explored in financial economics, and our aim in these pages is to provide a detailed explanation of these practices and some evidence of their value in choosing M&A targets and structuring transactions.