Study Looks at Why CEOs Get Merger Bonuses When Selling Cheaply

Dr. Eliezer Fich, associate finance professor at Drexel's LeBow College of Business

In about one in every four deals, the CEO of an acquired firm is awarded a merger bonus according to a recent study that examined more than 949 merger and acquisition offers that occurred in the U. S. between 1999 and 2009. The study also found that target shareholders received inferior premiums when their firms were sold while their CEOs received a merger bonus.

According to the study’s authors– Eliezer Fich from Drexel University's LeBow College of Business, Edward Rice from the University of Washington and Anh Tran from the City University London—for the average deal the presence of a bonus is associated with a decline in the acquisition premium of 3.87 percent. Such a decline implies a drop of about $186 million in terms of deal value for target shareholders. Target CEOs in these transactions are paid merger bonuses that average $1.6 million but can be as high as $12 million.

Because of this evidence, the authors examined whether bonuses identify a conflict of interest between CEOs and shareholders when their firms become acquisition targets but found that this doesn’t necessarily indicate shareholder expropriation or nefarious managerial behavior on the part of the target CEOs that get a merger bonus.

“At first glance, one would be tempted to conclude that target CEOs that get a merger bonus sell out their shareholders for their own personal gain,” according to the authors. However, their study also shows that merger bonuses are often tied to legal agreements that prevent the target CEO from competing against the merged firm. The return to the acquiring firms is not higher when target CEOs receive a merger bonus. Based on these additional findings, the authors argue that in transactions in which target CEOs get a merger bonus, acquirers pay less for the targets, but they also buy less in the form of low synergy targets.

The authors conclude that bonuses arise endogenously when takeovers generate small synergy gains, and either encourage target CEOs to act in the interest of their shareholders or don’t effect CEO actions. The study emphasizes that for low synergy targets, merger bonuses seem to mitigate rather than exacerbate agency problems. The reported analyses show that firm- and transaction-specific circumstances could justify additional managerial benefits in somewhat counterintuitive situations (such as deals in which targets get low takeover offers).

The study is available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2139732