Research consistently shows that when target CEOs receive extra benefits during mergers, takeover premiums are lower. Drexel LeBow professor Eliezer Fich says this is often interpreted as a conflict of interest: target CEOs sacrifice premiums for personal gain, facilitating a wealth transfer from target to acquirer shareholders.
However, Fich argues this research does not tell the whole story. He recently co-authored a paper that examines merger bonuses, in which he finds evidence inconsistent with wealth transfer. His results indicate that when target CEOs get bonuses, acquirers pay less, but also get less in the form of low synergies – the gains that are created when two companies merge that might not be created if the companies remained standalone units.
Fich says this evidence suggests that bonuses are used to revise compensation contracts when takeovers generate small synergy gains, helping firms circumvent conflicts of interests between target CEOs and their shareholders.
“We looked at acquisitions where a target CEO got a merger bonus, and asked, is this bonus an indication of agency problems? Or is it an indication of CEOs doing right by their shareholders? More often the bonuses are present in situations where the target firm was a hard-to-sell company that was not very appealing to potential acquirers.”
An important consideration, Fich says, is the merger often eliminates the target CEO’s job. In this case, target CEOs may resist acquisitions unless they get some special payment. This situation is likely to occur whenever the target CEOs’ incentives are not aligned with the incentives of their shareholders. In these circumstances, an extra payment is sometimes necessary to get the target CEOs to consent to an acquisition. Fich notes that, on average, the evidence related to merger bonuses is not consistent with payments being used to “bribe” target CEOs.
“Oftentimes, the bonus is a reward for achieving something that was hard to do,” says Fich. “Many people have a cynical view of executive compensation, believing CEOs are trying to consume and get paid as much as they can at the expense of firm value and shareholder wealth. I believe our findings show some of that sentiment is undeserved.”
Fich’s paper, titled “Contractual Revisions in Compensation: Evidence From Merger Bonuses to Target CEOs,” was originally published in the Journal of Accounting and Economics.