Companies around the world are on a shopping spree. Buoyed by years of sustained economic growth and low cost of debt, global appetite for mergers and acquisitions is at a 10-year peak, despite the simmering trade war between the United States and China. Last year, announced transaction volumes surged to $4.1 trillion, the third highest ever. Yet M&As have a depressingly high failure rate of about 80%. Which ones have the best odds of success?
An obvious place to look for the answer is the C-suite. CEOs shape strategies and often make final M&A decisions. They also consult their chief financial officers, who help identify acquisition targets, conduct due diligence, arrange financing and engage in post-deal execution. Our research shows that there is an optimal CEO-CFO combination that increases the odds of M&A success: optimistic CEOs tempered by pessimistic CFOs.
In general, optimists are expected to focus on positive, goal-facilitating information and discount unwanted facts. Pessimists are more sensitive to negative, goal-inhibiting information; they are more critical and vigilant in their efforts to avoid potential disasters.
Optimism and pessimism have been shown to be aligned with the roles of CEO and CFO. CEOs are expected to be more optimistic and open to risks, but to parlay optimistic vision into healthy post-M&A return on assets also requires a dash of pessimism. And that has to come from the CFO, whose job it is to scrutinize target firms, conduct in-depth due diligence and pinpoint the potential risks of any M&A. CFOs are expected to be cautious and attuned to adverse conditions — the gatekeepers who bring the highflying CEOs down to earth.
We studied the influence of CEO-CFO pairs at 2,356 U.S. firms and the 4,529 M&As the companies undertook. Specifically, we focused on the level of optimism and pessimism the pairs of CEOs and CFOs brought to their M&A decisions. We culled transcripts of conference calls between 2002 and 2013 involving both the CEOs and CFOs and measured the executives’ optimism and pessimism by analyzing their use of positive and negative words. Positive words included “achieve,” “benefit,” “successful” and “satisfy”; negative ones included “flaw,” “false,” “prevent” and “unavoidable.”
According to our analysis, CEOs generally used more positive words and were more optimistic than CFOs. CFOs used more negative words and were more pessimistic than CEOs. We also found that the more optimistic a firm’s CEO-CFO pair was (high-optimism CEO with low-pessimism CFO), the more M&As it undertook. Unfortunately, high CEO-CFO optimism also correlated with lower ROA a year after an M&A.
At Spectrum Pharmaceuticals, for example, the relative optimism of the CEO (Rajesh Shrotriya) and CFO (Brett Scott) was in the top 5 percentile; their ROA was a disappointing -3.4% after the firm made an acquisition in 2012. In contrast, Gilead Sciences’ CEO (John Martin) and CFO (Robin Washington) ranked in the bottom 5% percentile in relative optimism, but the biotechnology company reported a ROA of 36% a year after making a major acquisition in 2009.
Our study suggests that in the presence of pessimistic CFOs, optimistic CEOs not only undertake fewer acquisitions, they are also less likely to undertake dud acquisitions. This points to an optimal pairing of an optimistic CEO who has a large risk appetite for M&As, and a pessimistic CFO who is sufficiently conservative and prudent to alert him to potential pitfalls.
Copyright 2019 Harvard Business School Publishing Corp. Distributed by The New York Times Syndicate.