International Airlines Group (IAG), formed in January 2011 by a merger of British Airways and Iberia, is in the news. Operating losses at Iberia in the first nine months of the financial year are believed to be in excess of £200 million.
Since the start of last year, IAG’s shares are down by nearly 40 per cent. Shareholders have a right to feel disgruntled. They might, for example, reasonably raise queries about the revenue forecasting methodology of IAG, just how far out were the projections? Or they may ask how much ‘revenue synergy’ – his task specified on the IAG website – has actually been achieved by Robert Boyle, the Director of Strategy. The list can go on.
Such details of the problems are specific to the BA/Iberia merger. But the principles are general across a whole range of merger and acquisition activity amongst publicly listed companies. Twenty years ago, three American business school academics carried out a studied which transformed the approach to analysing mergers and acquisitions. There was a lot of work about the impact on share prices of an announcement of a merger, and on the value to the shareholders of the company being acquired. Julian Franks, Robert Harris and Sheridan Titman looked instead at the long-run impact on the share price of the company in the driving seat.
What they found was not good news. Their results gave rise to a whole new area of academic activity, the so-called ‘post-merger performance puzzle’. Most of the time, the shareholders of the acquiring company lose out. Each individual case has its own particular reasons, but initiating a merger or acquisition is usually bad news for your shareholders.
For believers in economic rationality and efficient markets, this is a puzzle of the first magnitude. On this view of the world, people are allowed to make mistakes. But they are not permitted to do so consistently. For every merger which underperforms, there should be one which delivers unexpectedly large benefits to the shareholders. And there have been such a large number of mergers and acquisitions that executives ought to be able to learn from previous mistakes. Instead, we observe that there is a persistent downside for shareholders of the acquiring company. Occasionally they gain, usually they lose.
IAG is just one more example of this phenomenon. It is one more nail in the coffin of the concept of economic rationality. To understand why very experienced managers still pursue mergers and acquisitions, despite the track record of such activity, we need to turn less to economics and more to psychology.
George Soros in a speech in June this year borrowed a phrase from University College London psychoanalyst David Tuckett, when he described the boom phase in the EU as being a ‘fantastic object’, unreal but immensely attractive. Executives may create such objects when they think of mergers and acquisitions. BA remains a vital part of the British economy. Let’s hope that Willie Walsh brings IAG back to Earth and sorts out the mess.
Paul Ormerod
As published in City AM on Wednesday 14th November 2012
