University of Washington finance professor Jarrad Harford, who helped me outline Microsoft’s options after Yahoo’s board of directors rejected its $44.6 billion buyout offer Monday, has conducted interesting research relevant to two aspects of mergers and acquisitions, and this deal in particular.
In one paper, he looked at how cash-rich companies fare when they go shopping (not all that well). In another, he researched how directors at a company targeted for acquisition balance shareholder interests with their own.
Microsoft, with more than $21 billion in cash and short-term investments on its balance sheet on Dec. 31, is certainly cash rich, though less so than it was just a few years ago, thanks to stock repurchases and dividends.
Here’s how Harford described his research, which looked at a broad set of companies and was published in the Journal of Finance, December 1999: “When managers have a lot of cash available to them, they don’t have to go out and raise the capital and so they’re not getting vetted at that point. They’re not really being monitored by the capital market.
“You could very broadly paraphrase this as [cash] sort of burning a hole in their pocket,” he said.
Companies in that situation, he found, are less careful about their acquisition targets and “their own natural optimism doesn’t get put in check.” As a result, “cash-rich firms are more active as acquirers and the acquisitions they make tend to be worse than average.” He also found, quoting now from the abstract of his paper, that the targets of cash-rich acquirers tend not to attract other bidders and “mergers in which the bidder is cash-rich are followed by abnormal declines in operating performance.”
Microsoft’s proposal to buy Yahoo includes a combination of stock and cash from the balance sheet, as well as outside financing — a departure from the company’s norm. I asked Harford if that, plus the added scrutiny because the deal is particularly large and high-profile, means that it wouldn’t fit the pattern described in his research.
“It certainly mitigates it in these extremely high-profile [cases]. This particular case actually does fit the pattern in the sense that they were cash rich and the market reacted pretty negatively to the offer” — Microsoft shares are down about 13 percent since the proposal was made public Feb. 1 — “But that doesn’t mean that’s what’s going on. There’s so much that goes into the market’s initial reaction to a bid that you really need a large sample to kind of say what the trends are.”
Directors at acquisition targets
Harford points out, in a paper published in the Journal of Financial Economics, July 2003, that company directors, like most people, have a natural drive for self preservation. Voting to accept an acquisition proposal could mean no more sitting in the big leather chairs.
“When a target director votes to accept a bid, he or she is basically voting him or herself out of a job,” Harford said. The acquiring company usually brings only one or two key people from the target on to its board. “… A lot these [directors] are retired executives and they maybe have plenty of money, but they value the prestige of being involved in something like that.”
They’re supposed to be acting with the shareholders’ best interests in mind, but they do face some conflict of interest in considering an acquisition, he said.
Harford’s research found that if directors do the right thing — or the thing that is perceived to be in the best interest of shareholders — they will be rewarded in the long run. “If your company has been doing badly and you accept a takeover bid, than you will be asked on to other boards,” he said.
This typically holds true for directors at firms that have been doing poorly under the current management and board, he said. The converse is also true, his research showed.
So if Yahoo’s board ultimately rejects Microsoft’s offer?
“Basically, they would be less likely to be invited onto other boards in the future,” he said.