Does the Deal Fit the Strategy? Directors should bring a healthy skepticism to proposed transactions

Wednesday, September 9, 2015 - 09:25
Two thought leaders from NACD cover the roles and responsibilities of corporate boards and directors when it comes to mergers and acquisitions. They discuss new concerns that have cropped up – like risk management – that boards must consider – and the need for good legal counsel. They also encourage directors to challenge the assumptions behind M&A strategies.


MCC: Let’s start with a general question. Please give us a top-level view of the roles and responsibilities of corporate directors in mergers, acquisitions, joint ventures and other transactions in which their companies might engage.

Lajoux: I tend to be cautious when it comes to making statements about director responsibilities. Obviously, directors have a duty of due care, which constantly is being redefined and recalibrated by judicial decision, and they have a duty of loyalty. M&A is an area that, to some extent, boards can delegate to management in a responsible way. They can help management develop the strategic plan for the company, and they can and should make sure that, from the get-go, they understand the broad outlines of how a proposed transaction fits the company’s strategy and how it will affect all stakeholders. They can also help make sure the implementation of any strategy and related deal is correctly done. But they can leave to management the job of identifying specific opportunities to buy a company, sell a division and so forth.

An excellent board questions management's assumptions, guides managers' thinking, and ensures they do not have a conflict of interest. That’s what NACD recommends. It also ensures that there's a proper third-party advisor and that the proposed transactions – buying or selling – fit the strategy. In that sense, the board serves at a very high level in the M&A process to make sure the strategy is working. In the broadest strokes, the transaction should ideally connect with the company’s strategy. That’s why it’s a good idea for the board to be engaged in that strategy from the earliest stages.

Van der Oord: Boards are conservative, generally for the right reasons. But sometimes they may be a little too conservative out of fear of crossing the line between governing and managing the company. That’s especially the case when it comes to M&A.

Boards are in a strong position to take a long-term view of the value of a deal. The tenure of CEOs and other executives is often shorter than that of directors, who may sit on a board for many years – at least until the value of a transaction comes to fruition. They're also in a strong position, given their wealth of experience and knowledge as former business leaders, to challenge the prevailing short-term biases about a deal's value. Bringing that level of expertise and skepticism to bear is really important in what can be a feverish environment where everybody wants to get in on the dealmaking action. There are deals getting closed these days that may deliver short-term performance boosts but are unlikely to transform a company or create long-term value. Boards can offer informed views on deals that can deliver transformative value and truly disrupt business models to prepare an organization for long-term value creation.

MCC: In exercising their responsibilities, should boards be concerned about liability?

Lajoux: Just because directors don't follow recommended practices does not constitute grounds for liability. The authority for that is the 2005 Delaware Chancery Court Disney decision. Of course, there is the famous “Revlon Doctrine.” The principle is that once a company is "in play" the directors have an affirmative duty to get the best possible price. But that's still a matter of constant definition. NACD filed a friend of the court in the Rural Metro case arguing that Rural Metro directors did not violate Revlon when they agreed to sell the company. Gibson Dunn wrote the brief and the arguments were extremely detailed. It gets very technical pretty quickly when it comes to the actual affirmative responsibility of directors in M&A.

MCC: Companies, including their directors, rely on outside advisors. How does a director exercise independent judgment with high-powered experts whispering in his or her ear? It seems especially difficult when it comes to pricing, where everyone talks about synergies, but there’s often plenty of room for disagreement about just how real those synergies will be.

Lajoux: They need to be aware of the valuation impact of any potential transaction, be it buying or selling. Synergy should never be a surprise. Any board should be striving constantly to understand the value of the company. Is the stock appropriately valued? If it’s undervalued, why doesn’t the market appreciate its full value? What’s the quality of the financial reporting? Board members need to be aware of company value not just in the present, but in the foreseeable future. They should never be surprised when somebody comes along and offers a 50 percent premium on the stock. They need to be able to say, “That’s not good enough. Our stock is selling at 20, and you're offering us 30, but our stock is severely undervalued. We have long-term potential. We’re responsible to all our holders, including the very long-term holders, and they will actually get better value than this deal. We predict a doubling of share value within five years." Of course counsel will need to approve the statement and ensure proper disclaimers to take advantage of safe harbors.

Although valuation's not a science, it's not just a fluffy art. There's a lot of discipline to valuation. While audit committees have a key role to play, we’ve said that every single director should be financially literate, not just the members of the audit committee.

Van der Oord: The other data point you often see is the abysmal failure rate of M&A deals. It's in the interest of the corporation's shareholders for a board to retain independent advisors to understand what root causes drive both failure and success of similar acquisitions. They can get benchmarking information and analysis from external parties and offer healthy skepticism before management applies its own “irrational exuberance,” so to speak, to dealmaking.

Alex alluded to another important question: If this transaction is supposed to help us grow and realize our strategic imperatives, why couldn't we do that organically? Is the acquisition going to help us execute on our strategy faster and in a more economical fashion? If there are any doubts, the board should re-engage management to look at less costly internal alternatives with a higher success rate.

Lajoux: Friso makes a good point about independent external advisors. I may have overemphasized the burden on the board to be alert and aware of value. They can't do it all. Virtually every transaction has to have a fairness opinion from an independent advisor.

Van der Oord: It’s also worth mentioning that independence in board oversight extends to post-merger integration. We often see deals that are successful on paper fail mightily in the integration process due to cultural differences, lax internal controls, ineffective project leadership, incompatible technology platforms and systems and the like. Boards should not disengage from the integration process, which can last one, two, even three years for megadeals. Boards should stay engaged and pose hard questions to management during the integration phase.

MCC: Are there other special obligations a board would have during the integration process?

Lajoux: I haven’t seen a lot of litigation with that as the theme. The clock seems to stop at closing. When people are second-guessing, it's usually about issues prior to closing such as what should have been disclosed that wasn't disclosed? What should have been anticipated that wasn't anticipated?

Van der Oord: It's an interesting paradox. Consultants and management, of course, pay a lot of attention to the execution of the post-M&A integration process. What is often overlooked, however, is the effective integration of the board itself. The directors of the two companies involved may be distracted as a new board is composed. It's a difficult and emotional period for many directors who may lose their board seat or need to adjust to a new board structure and composition. At that point, they may fail to deliver effective oversight of that really critical phase in the M&A process.

MCC: Activist investors have been top of mind the last few years thanks to some very high-profile situations. Sometimes a board’s interests may align with the activists, and sometimes not. What’s the impact on the way boards should look at their M&A responsibilities?

Lajoux: We have a new Blue Ribbon Commission Report coming out on the board and its role in long-term value creation. The report makes it clear that the board should have its own playbook and not wait for activist investors to come along and say, "This is what you should be doing to restructure the company.” The board should be thinking about capital allocation all the time and needs to be more strategically minded itself. Shareholder activists have raised the consciousness of directors in this regard. The unfortunate thing, though, is that sometimes directors want to circle the wagons and perhaps discredit the activists when, in fact, they can learn from the activists; they may need to be more critical about their own strategic strengths.

MCC: Let’s talk about the M&A outlook. Given the devaluation of the yuan and the fallout around the globe, what’s ahead for M&A?

Van der Oord: The strategy-driven deals will continue. Companies are looking at fundamentals. They're recognizing disruption in the marketplace from startups. In talent acquisition deals, as they call them, there's going to be a lot more activity. What smaller companies with unique competencies, specific talent, or new-to-world technologies, including data analytics, for example, can we snap up and embed? That trend will continue as brick-and-mortar businesses play catch up in an environment where their business models may get disrupted. We may also see more counter-cyclical international acquisitions – Western firms going into places like Brazil, China and South Africa to buy up local champions or forge JVs with them. I expect that the fast and smooth dealmaking in the first half of the year may slow down a bit as global markets continue to cool. Another trend likely to continue is deconglomeration, with large, diversified conglomerates, such as GE and HP, working to become more coherent businesses and selling off non-core parts to other companies.

Lajoux: And let’s not forget that most of the deals we hear about involve a public acquirer and/or target and are of a certain size. The Deal won’t count a transaction worth under $100 million. Meanwhile, you have lots of private or smaller deals that go completely unreported – the base of deals beneath the tip of the iceberg. Mergers are constantly going on; they are always there as an alternative. They’re not a one-time event like an IPO.

MCC: Delaware is the 800-pound corporate gorilla as far as deals and directors are concerned. But there's a lot of local law and international law that dealmakers and their advisors need to be aware of. Are there hot spots to be concerned about?

Lajoux: Delaware is the leader, but if I'm a director I need to look first of all at the law for my company’s state of incorporation, which may not be Delaware. Also, what about all the major corporations that are doing business all over the country? They need to know all the relevant state laws. There's also the issue of federal law itself. There are antitrust considerations, for example, from the DOJ and the FTC, and a laundry list of other laws and regulatory authorities. Good legal counsel is indispensable in M&A and must be factored in as a major and unavoidable cost.

MCC: Given the concern over cybersecurity, are there special considerations for the board in the M&A context?

Van der Oord: In the euphoria around M&A, most organizations tend to overlook the strength of enterprise risk management and compliance defenses. They're an afterthought. Yes, it's exciting to acquire a startup. They may bring unique technology capabilities, but they may have really ineffective compliance controls or a really poor security culture. You're buying a great opportunity, but you may actually buy a greater risk. How do you figure that into your valuation? If you're going to have to spend another $20 million getting that smaller company up to speed to meet your standards, that's a cost you have to consider.

MCC: One final question. If there's a single bit of advice you’d give to directors who are involved in potential deals, what would that be?

Van der Oord: Challenge the assumptions behind the M&A strategy, including forcing executives to consider the viability of organic growth alternatives. Your role in challenging the strategic assumptions and biases will deliver the biggest impact as a director through the M&A process.

Lajoux: Know thyself, meaning know thy corporation, know thine own value. If a board understands the true value of the company, it makes M&A, when it happens, a lot more valid.

Friso van der Oord is director of research at NACD. He has 15 years of management consulting and research experience in governance, risk, compliance and integrity. Formerly with CEB (the Corporate Executive Board), Friso recently joined the NACD. He is based in Washington D.C. and can be reached at

Alexandra Reed Lajoux is chief knowledge officer at the National Association of Corporate Directors. She has more than 30 years of experience as a senior writer and editor of newsletters, articles and books on various business topics. Alexandra is based in Washington, D.C., and can be reached at