Anup Agrawal, Tommy Cooper, Qin Lian and Qiming Wang
Common Advisers in Mergers and Acquisitions: Determinants and Consequences
Journal of Law and Economics | Volume 56, Issue 3 (Aug 2013): 691-740

We find that common M&A advisers are generally chosen in ways that make economic sense. After controlling for other variables and accounting for the endogenous choice to use common advisers, deals with common advisers take longer to complete and provide lower bid premiums. We also find some evidence of lower target valuations, lower bid premiums and higher bidder returns in such deals. The magnitudes of some of these effects are quite substantial. For example, in common adviser deals, deal valuation (measured by Deal value/EBITDA) is lower by about 6 compared to the sample mean of 34.12, and bid premiums are lower by about 21 percentage points.

While we find no significant difference between the two types of deals in measures of deal quality (combined announcement returns and post-acquisition performance), our evidence that common adviser arrangements turn out to be somewhat better for acquirers than for targets favors the conflict of interest hypothesis over the deal improvement hypothesis about the role of common advisers in mergers and acquisitions. Why then do targets agree to share advisers? Comparing the observed probability of common adviser deals to their predicted probability based on random pairing of advisers and clients, we find no evidence that merging firms avoided sharing advisers during the 1980s, but strong and growing evidence of such avoidance during the ensuing two decades.

When the New York Stock Exchange (NYSE) merged with Archipelago Holdings, Inc. in 2005, Goldman Sachs served as the lead mergers and acquisitions (M&A) adviser to both parties. While such a dual advisory role is fraught with potential conflict, it can also improve deal quality. What is the nature of the conflict faced by a common M&A adviser? A common adviser receives advisory fees, which are usually contingent on deal completion, from both sides. That gives it a strong incentive to complete deals, even if they are ill-conceived, and to complete them faster compared to separate advisers. And a common adviser has an incentive to favor an acquirer over the target because the acquirer is the larger, surviving firm that can give the adviser investment banking (IB) business in the future. So the conflict of interest effect implies that relative to deals with separate advisers, common adviser deals should have: (1) lower time to deal resolution, (2) lower deal quality, (3) lower target valuations, (4) lower acquisition premiums, and (5) lower (higher) wealth gains to target (acquirer) shareholders.

Two forces can keep a common adviser from responding to its incentives, potentially reducing the effects of the conflict. First, given the repeat nature of its business, the adviser may be deterred from exploiting its clients by the fear of damage to its reputation and potential litigation costs. Second, unlike buyers and sellers who sometimes share a realtor in the residential real estate market, merging companies are sophisticated entities run by managers, overseen by boards and advised by legal counsels, which likely consider the adviser's conflict before deciding to share an adviser with the counter-party and acting on its advice.

But a common M&A adviser can also use its dual role to improve deal outcomes. An M&A adviser, usually an IB, contractually agrees to 'aid and assist' a client through the M&A process. During this process, an unshared adviser working for the seller (buyer) receives information provided by the buyer (seller), but it is likely to be less than the information that the buyer (seller) makes available to its own adviser. Presumably, a common adviser has greater access to information compared to the information available to an unshared adviser. A common adviser also has greater control over the timing of information exchanges between a target and an acquirer. As information conduits, common advisers can improve deal outcomes by reducing information asymmetry between acquirers and targets. This deal improvement effect does not have a clear implication for the time to deal completion, nor does it imply that the adviser favors one party at the expense of the other. So this effect implies that, relative to deals with separate advisers, common adviser deals should have: (1) higher deal quality, (2) similar or higher target valuations, (3) similar or higher premiums to targets over their pre-bid share prices, and (4) higher gains from the merger to both target and acquirer shareholders.

The two effects of a common adviser, conflict of interest and deal improvement, are not mutually exclusive. Which effect dominates is an interesting empirical question that we address in this paper. We start by examining the determinants of the choice to use a common or separate M&A adviser. We then examine the consequences of this choice on several deal outcomes such as the speed of deal completion, deal quality, target valuation multiples, bid premiums, and the announcement returns to targets and acquirers. We analyze a sample of 6,272 acquisitions of U.S. targets by public acquirers during the period 1981-2005. Of these, 98 deals have common advisers and the remaining have separate advisers. Though rare, deals with common advisers are economically important, with an average deal size of $982 million and total deal value of $96 billion in inflation-adjusted 2005 dollars. And many of these deals involve prominent companies.

We account for the endogenous nature of the choice to use common or separate advisers by using four econometric approaches: Heckman's (1979) treatment effect model, two-stage least squares (2SLS), propensity score matching (PSM) and Abadie-Imbens (2006) matching (AIM). In addition to analyzing the full sample, we employ all of these methodologies on a choice-based sample designed to address the estimation issues that arise from common adviser deals being rare events.

Determinants of the choice of a common adviser

If the choice to use a common adviser is a random occurrence, we should not expect it to be related to firm, deal and adviser characteristics. Regression results show that this choice is generally made in economic sensible ways. Specifically, a common adviser is more likely to be picked in deals that are larger relative to the acquirer and smaller in absolute size; deals that involve private targets or stock payment; deals where each party has a prior relationship with the counter-party's, but not its own, adviser; deals where both parties are advised by a top adviser and multiple advisers; and deals where more IBs specialize in industries of both target and acquirer.

Are deals with common advisers resolved more quickly?

We estimate regressions of the natural logarithm of the number of days to deal completion, where the main explanatory variable is an indicator variable for a common adviser deal. The regressions control for other things. After accounting for selectivity, we find that the use of common advisers increases the time it takes to complete a deal. The magnitude of this increase ranges from 1.6 days in the treatment effect regression to 38.7 days under the PSM approach. Compared to the sample mean of 121.8 days to deal resolution, the marginal effect of having a common adviser represents an increase of 1.3% to 31.8%. This result does not support the conflict of interest effect that common advisers use their influence and information advantage to hurry up the M&A process.

Deal quality

Following prior research, we measure deal quality by the value a deal creates over the short-term and long-term for the shareholders of acquirers and targets. For acquisitions of public targets, we compute the combined cumulative abnormal return (CCAR) around acquisition announcement dates to measure the short-term value created by an acquisition. We measure the long-term value created by an acquisition as the post-acquisition stock performance of acquirers. Our regressions find no evidence that having a common adviser affects the short- and long-term value that a deal creates for the shareholders of the combined company.

Valuations, premiums and announcement returns

We measure target valuation using two multiples, computed as deal value divided by the target firm's sales or EBITDA, and acquisition premium as  100  times [( text{Deal Value} /  text{target's equity market cap at event day –40}) - 1] . Our regression results suggest that the use of common advisers leads, on average, to deals with lower valuations and lower acquisition premiums for targets. The magnitude of this effect is about 6 (or 18% of the mean valuation) for Deal value/EBITDA, and about 21 percentage points in lower acquisition premium. This evidence suggests a net conflict of interest effect: common advisers appear to favor acquirers at the expense of targets. Our regression results provide some evidence that deals with common advisers lead to higher acquirer CARs (by about 6 percentage points), while target CARs are unaffected.

Why do targets agree to share advisers?

We find that, on average, deals with common advisers work out better for acquirers (who experience higher abnormal returns upon deal announcement) than for targets (who receive lower deal valuations and bid premiums). These findings favor the conflict of interest hypothesis over the deal improvement hypothesis about the role of common M&A advisers. Why then do targets agree to share advisers with acquirers? Well, a priori, it is unclear whether common advisers will respond to their incentive to favor acquirers over targets in the face of advisers' reputational and litigation concerns, and the benefit from potential deal improvement may outweigh any cost to targets from adverse incentives of common advisers. To shed some light on this issue, we test whether merging firms avoid sharing advisers. We do this by comparing the actual probability of common adviser deals to the predicted probability of such deals assuming purely random choice of advisers by acquirers and targets. A finding that firms avoid (seek out) [neither avoid nor seek out] common advisers would suggest that the conflict of interest (deal improvement) [neither] hypothesis dominates.

Except for three years during our sample period, the predicted probability of common adviser deals consistently exceeds the observed probability. During 1981-89, the difference between the predicted and actual probabilities is statistically insignificant. But the predicted probability exceeds the actual probability by 2.4 percentage points during the 1990s and by 3.2 percentage points during 2000-05. Both differences are statistically significant. The results suggest that while merging firms did not avoid sharing advisers during the 1980s, they did so actively during the 1990s and 2000s.

Why? We can think of at least three possible explanations of this growing avoidance of common adviser deals. First, as targets realized that they usually end up getting the short end of the stick in common adviser deals, they start avoiding common advisers. Second, there is increasing sensitivity to (and scrutiny of) conflicts in the corporate sector and on Wall Street in the wake of numerous corporate scandals such as Enron, the adoption of Sarbanes-Oxley Act in 2002, and the global analyst settlement in 2004. Finally, the growing avoidance of common adviser deals may also be due to an increase in litigation costs over time. We find that deals with common advisers attract securities class action lawsuits with somewhat greater frequency than deals with separate advisers. We leave a complete resolution of this issue to future research.

Conclusion

We find that common M&A advisers are generally chosen in ways that make economic sense. After controlling for other variables and accounting for the endogenous choice to use common advisers, deals with common advisers take longer to complete and provide lower bid premiums. We also find some evidence of lower target valuations, lower bid premiums and higher bidder returns in such deals. The magnitudes of some of these effects are quite substantial. For example, in common adviser deals, deal valuation (measured by Deal value/EBITDA) is lower by about 6 compared to the sample mean of 34.12, and bid premiums are lower by about 21 percentage points.

While we find no significant difference between the two types of deals in measures of deal quality (combined announcement returns and post-acquisition performance), our evidence that common adviser arrangements turn out to be somewhat better for acquirers than for targets favors the conflict of interest hypothesis over the deal improvement hypothesis about the role of common advisers in mergers and acquisitions. Why then do targets agree to share advisers? Comparing the observed probability of common adviser deals to their predicted probability based on random pairing of advisers and clients, we find no evidence that merging firms avoided sharing advisers during the 1980s, but strong and growing evidence of such avoidance during the ensuing two decades.