As we begin a newyear, we have theopportunity to

look back on somevery large recentmergers and acquisi-tions (M&As) that canbe considered failuresand try to identify the causes ofthose failures. The fifth mergerwave in the second half of the1990s provides a fertile groundfor such critical examination. Inthat period, we saw not onlysome of the largest mergers andacquisitions of all time, but alsosome of the greatest failures.While not all these mega-fail-ures can be attributed to thesame cause, failed corporategovernance clearly played animportant role in many of them.In order to examine the role ofcorporate governance, we willbriefly discuss how companiesare governed and managed. Indoing so, we will seek to estab-lish what the proper corporategovernance process is and howit can fail when it comes todeal making. Lastly, we willdiscuss some of the leadingfailures of the recent mergerperiod and see to what extentfailed governance played a rolein their difficulties.

CORPORATE GOVERNANCE

The ultimate owners of cor-porations are shareholders.Shareholders elect directors torepresent their interests. Direc-tors, in turn, select managers torun the company on a day-to-day basis. The typical boardhas, on average, ten directors,and of this group, approximate-ly three are insiders, while theremainder are outside directors.Outside directors are those whoare unaffiliated with the compa-ny, while insiders are membersof management. Some directorsare what are called “grey direc-tors,” as they have some affilia-tion with the company, such asa consulting contract, but arenot employees. In many cases,the CEO sits on the board andmay even be the board’s chair-man. It is usually believed thatboards work better when insid-ers have less influence andwhen the board is not dominat-ed by the CEO. The market

tends to prefer suchindependent boards.This has been con-firmed by researchstudies that show, forexample, positivestock price reactionsto appointments of

outside directors. Such researchalso implies that smaller boardsmay be more effective at disci-plining management than largerboards. Other studies haveshown that for companies thathave been performing poorlyand have become the target oftender offers, board sizes tendto shrink after failed tenderoffers. This implies that whenpoorly performing companies“dodge a bullet,” they some-times try to “get their acttogether,” and this oftenincludes getting the board downto a size that is more effectiveat governance. The fact thatsmaller boards do corporategovernance better than largeones is an intuitive result, as itmay be easier for a CEO todominate a larger board, whereeach board member may haveless overall influence and clear-ly has lower voting controlwhen there are more boardvotes. Smaller boards, on the

The last wave of mergers also produced some ofthe greatest merger failures of all time. Howmany were due to failed corporate governance?

© 2005 Wiley Periodicals, Inc.

Patrick A. Gaughan

Failed Merger: Failed CorporateGovernance?

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3© 2005 Wiley Periodicals, Inc.Published online in Wiley InterScience (www.interscience.wiley.com). DOI 10.1002/jcaf.20081

other hand, allow each boardmember to potentially havegreater influence.

Increasingly, large U.S. com-panies are owned by institutionalshareholders, which includemutual funds, pension funds, andinsurance companies. It is typi-cal that the majority of share-holders in any given large, pub-licly held company areinstitutions. These institutionshave become somewhat moreactivist over the last 10–15years. The California PublicEmployees’ Retirement System(CALPERS), for example, is amajor institutional investor thathas become more activist andoccasionally has takenstrong positions opposingmanagement proposalswhen they see they are notin the best interest ofshareholders. However,while such actions tend todraw attention in themedia, they do so partly dueto the fact that they are not thatcommon an occurrence. Moretypically, institutional investorsare not very active in monitoringany one firm, as each companyin their portfolio may be a rela-tively small percentage of theirtotal holdings and may not war-rant close attention. When insti-tutional investors are dissatisfiedby the performance of a compa-ny in their portfolio, it usually iseasier to sell the holding than totry to influence management.Only when they have a largeholding and/or are reluctant tosell for a loss will they considerother options.

While corporate governancehas gotten more attention inrecent years, the role that suchgovernance plays in merger andacquisition strategy has notattracted such attention. Much ofthe recent public attention oncorporate governance has been

focused on corporate accountingscandals and their prevention.Legal remedies such as Sar-banes-Oxley and better industryself-policing have gotten themost attention. Corporate gover-nance and merger strategy, how-ever, has not been the focus. Oneof the reasons why this is thecase is that it is difficult topolice poor merger strategy.CEOs have been pursuing manybad mergers and acquisitions,which have cost shareholdersmany billions of dollars, yetthere has been little call forchanges to remedy the problem.When a CEO or CFO engages inaccounting fraud and other

manipulations, it is easy to seethat this is wrong and requireremedies and punishment. It ismuch less clear when a mergerturns sour and shareholders losevalue in their investment that weneed to alter the corporate gov-ernance process so that sucherrors are prevented in thefuture. In the section that fol-lows, we will discuss some lead-ing merger blunders that havecost shareholders billions of dol-lars and for which the corporategovernance movement has putforward no solutions.

CLASSIC FAILED MERGERS

One classic case of a mergerstrategy gone wrong was World-Com. This was a company builtby growth-oriented CEO BernieEbbers, who took it from a smallMississippi-based telecommuni-cations reseller to one of the

leading telecommunicationscompanies in the world. It wasbuilt through a series of mergersand acquisitions that culminatedwith the 1998 $40 billion mergerwith MCI. Not content to standstill, Ebbers then tried to mergewith Sprint, but his merger planran into resistance from the Jus-tice Department, which opposedit on antitrust grounds. Ebberswas great at building a companythrough mergers and acquisi-tions. However, his strength wasin doing deals, not managingcompanies. Reports of hismicromanagement tendencies,which ranged from counting cof-fee bags and filters to monitor-

ing smoker breaks of work-ers, have provided someamusement for the businessmedia. WorldCom’s boardlet him stay in place evenas the days for growththrough mergers shouldhave come to an end.WorldCom had reached an

efficient size, if not grownbeyond that, and it was time forthe board to ask him to stepaside and bring in a better man-ager. Unfortunately, this was notdone until the company washeaded to bankruptcy.

The case of DaimlerChrysler is different yet, in someways, is similar. Both WorldComand Daimler were run by strongCEOs who seemed to dominatethe board. Daimler had a lesssuccessful M&A track record, asthe company had done manydeals that it was forced to undo.For example, it had pursed adiversification program that itwas forced to unwind. Many ofits investments, such as a largeholding in Japanese automakerMitsubishi, proved to be ill-con-ceived drains on the company.However, Daimler CEO JurgenSchrempp’s biggest mistake washis merger with Chrysler. The

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Much of the recent public attentionon corporate governance has beenfocused on corporate accountingscandals and their prevention.

deal was called a merger ofequals, but many consider it sim-ply an acquisition of the thirdlargest American company bythe German luxury automaker.Schrempp dreamed of buildingan international auto companythat was to be unparalleled. Hewas not content to run the lead-ing luxury car manufacturer inthe world. Schrempp’s hubris-filled merger strategy generatedlarge losses for shareholders and,as of the end of 2004, showedfew signs of turning around.Once again, where was the boardwhen Schrempp proposed hisgrandiose takeover scheme?Why did they not question it inlight of Daimler’s priorM&A mishaps?

The second largest dealof all time, and perhaps thebiggest merger flop ofthem all, was the January2002 AOL and Time Warn-er merger. This deal, whichwas valued at $166 billion,was supposed to be a synergy-filled marriage of content (TimeWarner) and distribution (AOL).Instead of realizing synergies,however, the merger causedTime Warner shareholders toincur great losses with theirmerger with AOL, which used itsovervalued shares to gain atTime Warner shareholders’expense. One of the most funda-mental flaws of this deal wasthat its strategy and goals werepoorly defined. Years after thetransaction has been completed,it is difficult to see any syner-gies. It never was clear howTime Warner would gain fromits association with AOL. Admit-tedly, Time Warner tried to pur-sue Internet-based activities andlost hundreds of millions of dol-lars. Gerald Levin, Time Warn-er’s CEO, thought the Internetwas key to Time Warner’s futureand forced his shareholders to

pay a heavy price for his failedgamble. Time Warner boardmembers will have a difficulttime providing reasons why theyapproved this deal. One of thelessons of this disaster is that ifyou have trouble seeing how thesynergies will manifest them-selves, it is likely that they neverwill. Synergies are hard enoughto realize when their path hasbeen clearly defined. When it isdifficult to see how they willoccur, odds are pretty good thatthey never will. This seems to bemore of a case of a board rub-ber-stamping a deal proposed bythe CEO without raising enoughquestions. When the CEO

becomes too strong, he or shetends to overpower the board.Strong CEOs need to be opposedby strong boards. In fact, thestronger the CEO, the strongerthe board has to be. One com-mon theme that we see in manyfailed deals is that we have adeal-making, strong-willed CEOand a compliant board that rub-ber-stamps the CEO’s grandioseempire-building schemes.

KING OF THE MEGA-MERGERFLOPS

Perhaps the company withthe worst merger and acquisitiontrack record is AT&T. This com-pany has a knack for doingmega-merger flops, and few cancompete with it. One of the hall-marks of AT&T’s merger historyis that the company is undauntedby prior billion-dollar mergerfailures. New CEOs come and

go and do not seem to learnfrom the mega-failures of theirpredecessors. After giving up the“boring” regional phone compa-nies for the right to enter thehighly competitive computerindustry, AT&T found that itcould not succeed in that busi-ness. Rather than cut its losses,the company engaged in a hos-tile takeover of NCR, which ithoped would solve its computerindustry woes. AT&T paid ahigh price for NCR, which resis-ted the telecom giant’s overtures.The deal was a money-losingflop, and the market put suchpressure on AT&T’s stock that ithad to restructure the entire

company and separate theequipment and computerbusinesses while survivingas a smaller, but morefocused, long-distancetelecommunications com-pany. However, AT&T wascontinually losing marketshare to more aggressive

rivals. Rather than focus onbeing better at the core business,AT&T CEO Michael Armstrongdecided to enter the cable andwireless telephone business.AT&T paid $52 billion toacquire TCI in 1998 and then$43 billion to acquire MediaOne less than a year later. Itspoorly conceived strategy ofacquiring cable companies so asto allow it to offer telephone ser-vice over cable lines directly tocustomers was flawed. It wasalso a pretty humorous strategy,as AT&T was already well estab-lished in that market when itowned the regional telephonecompanies—but AT&T did notsee the value in these businessesand pursued more exciting pas-tures in the risky computer field.This adventure brought themnothing but red ink. Now it waspursuing another even biggergamble, and this one would be

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© 2005 Wiley Periodicals, Inc.

One of the hallmarks of AT&T’smerger history is that the companyis undaunted by prior billion-dollarmerger failures.

equally as bad. The cable lines itacquired could not handle thetelecom needs of AT&T andneeded major investments toupgrade them. Rivals continuedto attack the company in everymarket it was in. The stock mar-ket greatly questioned the com-pany’s strategy, and pressuremounted for the company torestructure once again.

AT&T is a company that hasmade merger blunders on such ascale that it should be barredfrom ever doing a deal again.Where was AT&T’s board whenits CEO proposed his $100 bil-lion acquisition program? Whydid they allow him to move soquickly to complete hisdeals without requiringhim to do his homework?Why was the market slowto register its concernsabout the company’s acqui-sition strategy? Clearly,AT&T’s board did not doits job, and shareholderslost as a result.

Still another case of failedcorporate governance as itrelates to a merger and acquisi-tion strategy was Vivendi Uni-versal’s acquisition strategy. Thecompany’s board allowed itsflamboyant CEO, Jean-MarieMessier, to transform it from aFrench water utility into an inter-national entertainment company.For Messier, movies and musicwere obviously much moreexciting than a boring water util-ity business. Apparently theboard did not have a problemwith acquisitions across theglobe that were in fields farremoved from the company’score focus. They allowed him topile up debt while doing deals hefound exciting. They did notquestion his strategy seriouslyuntil the company faced severedebt-service pressures and hadbecome a company with a very

confused assemblage of compa-nies in highly diverse fields andwith little in common with eachother. As with so many of theother merger failures we haveconsidered, the board was slowto act and passively stood bywhile the CEO wasted share-holders’ capital.

The cases of a board standingup to a CEO’s empire-buildingplans are few and far between.However, one prominent exampleoccurred in November 2001when Coca-Cola’s board rejecteda $15.75 billion takeover proposalfor Quaker Oats. In this case, theCEO was new and lacked theleverage of some of the other

CEOs whose deals we have dis-cussed. In some ways, the syner-gies of the deal Coke’s boardrejected were clearer than insome of the other deals we havequestioned. Quaker Oats had var-ious products, such as the popularGatorade line, that matched wellwith Coke’s other soft drink prod-ucts. Gatorade commanded over80 percent of the sports drinkmarket, whereas Coke’s ownPowerade brand accounted forjust over 10 percent of the mar-ket. However, the board tookissue with the dilutive effects thedeal would have on its sharehold-ers and it put their interest aheadof the CEO’s feelings and ambi-tious plans. The board wanted tokeep Coca-Cola focused on itsmain soft drinks business, andworried about straying too farinto areas in which it did notbelieve the company had strongcomparative advantages. In this

instance, the board wanted to seethe CEO follow its strategy,rather than change to fit a newCEO’s ambitious plans.

TAKEOVERS AND CORPORATEGOVERNANCE

When the board is not suffi-ciently diligent and does notkeep an acquisitive-minded CEOin check, the market sometimessteps in to correct the errors inthe corporate governanceprocess. The way this sometimesoccurs is that the market regis-ters its concern about a failedmerger strategy by lowering thestock price. This can make a

company vulnerable to ahostile takeover, as thecompanies that may havebeen acquired in error maybe easily resold and theirvalue may not fully beincorporated into theacquired company’s marketvalue. The more such

acquisitions a company does, themore vulnerable to a takeover itbecomes. When these badacquirers are taken over, theprior failed acquisitions can besold off and the company canpursue a more focused strategy.Companies that eventually real-ize the vulnerable position theymay be in may head off thetakeover process by selling offthe prior acquisitions them-selves. When they do this, themarket tends to quickly registerits approval, and shareholderstypically gain as a result. This isan after-the-fact solution to aproblem, however, that can easi-ly be prevented by better corpo-rate governance.

FAILED MERGER, FAILEDGOVERNANCE

When we consider severalof the major merger failures of

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The cases of a board standing up toa CEO’s empire-building plans are fewand far between.

recent years, we see that a com-mon theme they share is poorcorporate governance. In eachinstance, the board failed tostand up to its CEO when heproposed a deal that was not inthe shareholders’ interest. Theyrubber-stamped the CEO’sgrand plans, and shareholdersended up paying for their pas-siveness. As we focus on bettercorporate governance as it

applies to accounting fraud andfinancial reporting, we need tobe mindful that corporate gov-ernance needs to also be vigi-lant in monitoring managementstrategy and merger and acqui-sition plans. Boards need toindependently evaluate CEO-proposed deals and not merelyrubber-stamp them. Boards thatare largely independent andgenerally smaller are often bet-

ter positioned to accomplishthis. If boards can focus on thistask, they may be able to pre-vent future merger failures.Now that we have gone a longway to achieving greater accu-racy in financial reporting, per-haps the next area where wecan sharpen the corporate gov-ernance focus is on strategy,especially merger and acquisi-tion strategy.

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© 2005 Wiley Periodicals, Inc.

Patrick A. Gaughan, PhD, is president of Economatrix Research Associates, Inc., which is an economicand financial consulting firm specializing in analysis of economic damages in litigation and valuation ofbusinesses, with offices in Newark, New Jersey, and New York City. He is also a tenured full professor atthe graduate level in the College of Business at Fairleigh Dickinson University. Dr. Gaughan has authoredtwo of the three textbooks in the field of mergers and acquisitions, including the award-winning Mergers,Acquisitions, & Corporate Restructuring (Wiley, 1999, 2nd ed.). He has also authored numerous other booksand journal articles.