When Social Ties Hamper Merger Performance

Regardless of how you cut it, middle market M&A is a relationship business. Whether it is securing the perfect buyer for one of your clients or being the first call in a targeted auction process, developing the right relationships can lay the foundation for a successful firm.

The importance of these relationships recently caught the attention of Joy Ishii of Stanford Business School and Yuahi Xuan of Harvard Business School, two academics who sought to “investigate the impact of social ties between the senior executives and directors of the acquiring and the target firms on merger outcomes, focusing on ties across the two merging firms.”

Their study explained, “The interactive nature of the negotiation and decision-making processes makes mergers corporate events in which cross-firm social ties are likely to be especially relevant. Understanding whether and how such connections between the acquirer and the target impact decision-making and ultimately affect merger outcomes and shareholder value is, therefore, of particular importance.”

After analyzing more than 500 mergers from 1999-2007, Ishii and Xuan identified two interesting trends: 1) greater social connectedness increased the likelihood of the transaction closing and 2) greater social connectedness had a negative impact on short-term merger performance.

The study defined “a negative impact on short-run merger performance” by the fact that the “acquirer announcement returns are significantly lower in the presence of social ties” and “these acquisitions are subsequently more likely to be divested for performance-related reasons.”

Ishii and Xuan believe the greater social connectedness of the two companies results in “flawed decision-making based on weaker critical analysis, a lowering of standards, or missed opportunities.” The homophily that results from the relationships can be “conducive to groupthink and poor decision-making.”

The report continued, “In the merger setting, these flaws in decision-making by socially connected acquiring and target firms could again translate to failure to consider other potential merger candidates, and overestimation of the synergistic gains as well as lowering of due diligence standards for the favored deal.”

Although social connectedness can have certain benefits — namely information symmetry and a heightened sense of trust — “the negative effects of social networks on decision-making in mergers outweighs any positive information-based effects that might be present.”

While it may be impossible to eliminate any social ties from current and future mergers, it is helpful to be aware of these risks, of other cognitive biases, and to be always expanding your network to include new and burgeoning relationships.