did a “failed” negotiation really fail?
TRANSCRIPT
In Practice
Did A ''Failed'' Negotiation Really Fail? Reflections on the Arthur Andersen-Price Waterhouse
Merger Talks
Idalene F. Kesner and Debra L. Shapiro
Negotiation-whether in good faith or not-failed to avert war this past year in the Persian Gulf, and the explanations why this was the case will be debated for years to come by political analysts, negotiation scholars, and others. Likewise, despite the best of intentions, negotiated talks failed to avoid devastating, well-publicized strikes last year at the New lbrk Daily News and at Greyhound, the bus company.
Negotiation "failures" can prove to be just as instructive as negotiation success stories. And, at least in recent years, it seems like the greatest number of such "failed" negotiations have taken place in the corporate sectors, where the mergers and acquisitions boom of the 1980s continues to send shockwaves through the marketplace.
Daily news broadcasts throughout the past decade highlighted stories about hostile raiders trying to take over unwitting and unwilling ftrms. An obvious consequence of this dramatic rise in merger activity was the heightened attention given to pre-merger talks. Merger negotiations between targets and bidders became front page news items. Furthermore, because so many attempts were hostile in nature, the number of negotiation failures seemed to reach record proportions. Frequently, we read about talks that eventually dissolved or tender offers that were withdrawn because of a failure to negotiate acceptable merger terms.
In virtually all of these cases, newspapers, magazines, and even negotiations researchers characterize such talks as ''failed negotiations.'' Moreover, the reverse is also true. Th.lks between companies that ultimately led to takeovers were deemed "successful negotiations" regardless of the process (i.e., hostile vs. friendly) or the long-term consequences that resulted from the merger. However, such blanket use of the terms "success" and "failure" may have undesirable consequences. Do we really mean to characterize negotiations in
Idalene F. Kesner is Associate Professor of Business Administration at the Kenan-Flagler School of Business, University of North Carolina, Chapel Hill, N.C. 27599-3490. Debra L. Shapiro is Assistant Professor of Business Administration at the Kenan-Flagler School of Business, University of North Carolina.
0748-452619111000·0369S6.50/0 © 1991 Plenum Publishing Corporation Negotiation journal October 1991 369
such black-and-white terms? In merger negotiations, is a completed deal always a success? Conversely, if talks terminate without a merger or acquisition agreement, is this always a failure? And, can the dissolution or discontinuation of talks ever spell the successful completion of negotiations?
While similar questions about a multilateral negotiation were raised by Koh (1990) in a recent article in this journal, his examination was limited to the Paris Conference on Cambodia. We believe, however, that this question of negotiation success versus failure has important implications for all negotiations, and particularly for merger and acquisition negotiations, which we focus on in this article. We begin by providing an example of a recent merger/acquisition negotiation that was regarded as a failure. Next, we highlight theoretical and empirical reasons why the criterion of agreement versus nonagreement is traditionally used to judge such negotiations as successes or failures. Finally, we conclude by providing prescriptions for how negotiators can improve the merger negotiation process.
The Case of Arthur Andersen and Price Waterhouse In July 1989, two large accounting giants, Price Waterhouse and Arthur Andersen, announced they were beginning merger talks. This announcement followed on the heels of a number of other mergers in the industry-Peat Marwick and KMG Main Hurdman in 1987; Ernst & Whinney and Arthur Young in 1989; and Deloitte, Haskins & Sells and Touche Ross, also in 1989.1 The justification for the Andersen-Price Waterhouse merger sounded much the same as for others in the industry-synergy, economies of scale, and an increased ability to compete globally. These market and economic issues were all seen as primary benefits from the merger. In theory, merging Price Waterhouse's international contacts and its premier auditing division with Arthur Andersen's growing consulting division would create an accounting powerhouse unbeatable elsewhere in the industry. Arthur Andersen executives had still one more reason for entering merger talks. They saw a chance to regain the company's number one position as the largest accounting firm. As Andersen sat on the sidelines watching key competitors merge, it was clear that the company's executives feared the worst. They saw their market position and prestige eroding. Joining forces with Price Waterhouse was a clear way to re-emerge on top.
Th.lks between the two firms began optimistically with a 60-day deadline to reach agreement. With so many benefits to be gained from the merger, negotiators felt that few, if any, obstacles existed that would delay progress. Yet, shortly after the start of negotiations, barriers began to emerge. Questions arose as to which firm would hold the most power and the role of auditing versus consulting. Clients that simultaneously used Price Waterhouse for auditing services and Arthur Andersen for consulting services represented a conflict of interest and a violation of Securities and Exchange Commission (SEC) regulations. 2
It was clear, therefore, that the merger would not mean a simple addition of one firm's client list to the other. Each side could potentially lose clients, and this realization gave rise to issues of territoriality. Both companies began positioning themselves to emerge the dominant firm, as illustrated in a statement by Shawn O'Malley, chairman of Price Waterhouse: "We are the premier auditing firm in the world, and we are not going to sacrifice an audit client for some short-term commercial advantage."
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As talks between Arthur Andersen and Price Waterhouse progressed, differences in the firms' market and economic goals and objectives became clear. Moreover, negotiation sessions also began to uncover managerial differences. Discussion revealed wide gaps in a number of areas, including cultures, compensation methods, and retirement plans.
It was over this combination of management and economic issues that merger negotiations between Price Waterhouse and Arthur Andersen eventually broke off in October 1989. Public accounts of the talks tended to view the negotiation as a failure.
Why We Judge Agreement as Success and Nonagreement as Failure An examination of the empirical literature underlying negotiation theories demonstrates why we typically judge agreement as success and nonagreement as failure. In most cases, researchers provide negotiations participants incentives for reaching agreement and disincentives for failing to do so (see reviews by Pruitt, 1981; Neale and Northcraft, 1991; Thompson, 1990). Specillcally, participants typically receive more experimental payment for reaching, rather than not reaching, agreements (e.g., Carnevale, Pruitt, and Seilheimer, 1981; BenYoav and Pruitt, 1984; Carnevale and Conlon, 1988; Conlon and Fasolo, 1990). Analyses examining relationships between negotiators' tactics and outcomes typically focus on the quality of subjects' agreements, in terms of the extent to which they are "integrative" or mutually beneficial. Thus, outcomes of nonagreement are often excluded from analysis. In essence, they are deemed unimportant.
In practical settings, the same reward structure exists. Mediators, for example, are more likely to receive future employment if they have a reputation for bringing disputing parties to agreement (Shapiro, Drieghe, and Brett, 1985). Agents, or representatives, in general, typically receive more rewards (e.g., approval or payment) from their clients or constituency when they can strike deals, or agreements, with the opposing side.
This reward structure also exists in merger and acquisition situations. For most negotiators, the rewards for agreement are substantially higher than for nonagreement. Investment brokers, who are responsible for negotiating deals between targets and bidders, typically receive a percentage of the final dollar value of the deal. Thus, incentive exists not only to complete the deal, but to do so at the highest acceptable price. When talks are discontinued without a fmal agreement, the target and/or bidder may pay a transaction fee, but this amount is often substantially below the fees paid for a completed deal.
According to the January 28, 1991 Fortune, fees for financial intermediaries in 1990's largest merger and acquisition deals reached as high as 1.25 percent (Fierman, 1991). In the $656.4 million acquisition of Foxboro by Siebe, for example, this percentage amounted to more than $4.2 million for Lazard Freres, which handled the Siebe side of the deal. For Foxboro's representative, Salomon Brothers, the fee amounted to $8.2 million. Even in cases where the percentage is less, dollar fees can still reach astronomically high levels. In the McCaw Cellular Communications acquisition of Lin Broadcasting, representatives of Lazard Freres and Morgan Stanley each received .48 percent, or $18.3 million. Even the small .05 percent received by Lin Broadcasting's representa-
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tive, Wasserstein Perella, amounted to $2 million. As these examples illustrate, the reward structures in practice, and the reward structures established for purposes of research, encourage us to judge negotiated agreements as successes and nonagreements as failures.
The Consequences of Judging Nonagreement as Failure It is clear that researchers and practitioners base their evaluations of negotiations on the outcome of the talks rather than on the process. Furthermore, reward systems reinforce this "ends" versus "means" orientation. Yet, it is important to recognize that adopting this focus leads to several undesirable outcomes. First, it places undue pressure on negotiators to secure a fmal agreement. In the case of merger negotiations, for example, such an orientation may encourage investment brokers to accept less than desirable merger terms simply for the sake of reaching an agreement and ''closing the deal.'' Moreover, this orientation may discourage in-depth review of critical issues (e.g., managerial, cultural, economic, strategic) that could potentially reveal stumbling blocks to a merger.
Recent studies hint that this may be a significant problem. A study by Ravenscraft and Scherer (1987), for example, found that the expected positive benefits from mergers did not materialize. The authors examined approximately 6,000 mergers that took place between 1950 and 1977 and found that, on average, profitability declined after the acquisition. In another study, of the top 1,000 U.S. firms for the period 1950-1972, Mueller (1985) found that acquisitive companies experienced a sharp drop in market share vis-a-vis comparable companies that did not engage in such activity. The poor track record of acquisitions is also highlighted by Porter (1987), who examined the business portfolios of 33 large U.S. companies between 1950 and 1986. In this study, the average rate of divestiture in the postmerger period was almost 60 percent.
Still other reviews of deals in the 1980s recount postmerger problems (Oneal et al., 1990; Mergers & Acquisitions, 1990). The 1984 Beatrice and Esmark merger, for instance, resulted in severe culture clashes as the two companies combined operations. Ultimately, the problems were so severe that Beatrice was forced to restructure in order to cope with the mounting problems of integration. It is possible that had cultural differences been addressed during the course of the negotiation, the two parties might have agreed not to merge. Limited coverage of issues in the negotiations between Westinghouse and Unimation might also have been the cause of problems in their 1983 merger. It is clear that Westinghouse set unrealistic technological goals for the postmerger period. By 1989, Westinghouse was forced to sell Unimation to get out from under mounting costs. Similarly, in 1984, IBM underestimated the challenge of integrating its computer technology with ROLM's telecommunications technology. A failure to achieve objectives led to IBM's divestiture of ROLM in 1989. Each of these examples illustrates problems and barriers to integration that should have been anticipated and addressed during the negotiations phase of the merger. In some cases, recognition of these differences may have prevented a merger agreement. Yet, even if the parties agreed to proceed, advance notice of potential problems would have allowed negotiators to address and possibly resolve integration issues as part of their final agreement.
372 Kesner and Sbaptro Dtd a "Fatted" Negotiation Really Fat/?
The above studies and examples reflect a disappointing contribution to overall corporate performance by acquired businesses. It is possible that during the negotiation stage, negotiators may not be asking the right questions or enough questions to uncover potential problems that could affect future integration of the two firms.
In addition to discouraging in-depth review of critical issues, pressure to reach an agreement may also reinforce a tendency known as "escalation of commitment.'' Here, individuals rationalize previous actions or psychologically defend themselves against perceived errors in judgment (Staw, 1980). In some cases, individuals may even go beyond mere distortion and actually enlarge their commitment of resources to a particular course of action as a means of justifying the ultimate rationality of an original course of action (Staw, 1976).
In the context of negotiations and, in particular, merger negotiations, this tendency toward escalation of commitment is very real. The time, energy, and resources put into negotiation preparation and actual sessions represent a substantial investment on the part of both firms (i.e., the target and the bidder). It is likely, therefore, that over the course of discussions, the commitment of both firms increases. It may even increase to the point where possible negative consequences and irreconcilable differences are ignored. In the end, the two parties may agree to a merger simply to justify or rationalize their original decision to enter into negotiations.
In unfriendly takeover situations, this tendency toward escalation of commitment is likely to be somewhat lopsided toward the bidder. 3 Yet, it is likely to be reinforced by a second tendency. The hostility of the situation is likely to create a ''win/lose'' atmosphere. One party is likely to see victory at the other party's expense. As time goes on, not only is the bidder likely to become increasingly committed to the merger, but he is likely to view the negotiations as a contest. His goal may change from various strategic and economic outcomes to winning the contest. And, as Neale and Northcraft (1991:179) note, ''Once egos are involved, the substance of the negotiation is fundamentally altered.'' Perhaps the best illustration of this change in goals is reflected in the 1988 merger negotiations between Campeau and Federated Department Stores. Before receiving a bid, Federated's stock was selling at a price of $28 per share. In January 1988, Campeau launched its unfriendly bid at $47 per share. Federated rejected this offer and three subsequent offers before Campeau's rival, R. H. Macy, stepped into the picture with a bid just under $74 a share. Macy's challenge seemed only to intensify Campeau's determination to win Federated in a merger agreement. Campeau responded to Macy's bid with a matching offer, despite analysts' warnings that the price of Federated had exceeded its "break-up value."4 Moreover, in an effort to force R. H. Macy out of the picture, Campeau agreed in April 1988 to sell two of Federated's prime divisions to its rival. This move reduced still further the strategic value of the merger for Campeau.
The end result of this three-way battle was an eventual ''victory'' for Campeau; or was it a victory? The price of Federated jumped from a prenegotiation level of $28 per share to a final level of $73.50-more than a 150 percent increase. Moreovet; the final assets acquired by Campeau excluded some of Federated's prime holdings that had to be sold off to help finance the deal. Worse still, Campeau quickly found itself overextended. Unable to pay its loan corn-
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mitments, the company was forced to declare Chapter 11 bankruptcy in January 1990, and it has been operating under this protection ever since. Can we still call the Campeau/Federated negotiations a success? Is a short-term victory ever truly a success if it brings with it long-term failure?
The Campeau/Federated merger is just one example of a merger negotiation that escalated beyond a reasonable level. Many others can be cited (Oneal et al., 1990; Mergers & Acquisitions, 1990). Throughout the 1980s, bidders "caught up in the heat of the battle" frequently made bids well beyond levels that were financially and strategically sound. Deals completed at all costs produced companies overburdened with debt. Handling these debts often meant layoffs, divestitures, and even bankruptcy.
The Campeau/Federated merger also illustrates the often costly tradeoff between short-term costs and long-term costs. Negotiators who focus exclusively on the short-term costs of the negotiations process (e.g., negotiators' time, materials) may continue talks even when outcomes from the merger are questionable. They may look at the money already spent and argue that calling a halt to merger talks would be the equivalent of "throwing money down the drain.'' Further investment (i.e., continuing the merger discussions and eventually reaching an agreement) is seen as a way of increasing long-run returns. Yet, this view of negotiation expenses is misleading. It treats costs as investments rather than as sunk costs.5 In so doing, it encourages escalation of commitment to potentially undesirable courses of action.
The Arthur Andersen and Price Waterhouse "Success" Returning to our original case of Arthur Andersen and Price Waterhouse, the "success" of this negotiation becomes clear. Pressure was put on both sides to reach an agreement, and the potential rewards for the intermediaries were high. The fact that negotiators were able to identify critical cultural, managerial, and strategic differences and recognize these differences as irreconcilable before an agreement was reached represents a significant accomplishment. In this instance, rather than using the talks to put the finishing touches on a ''done deal;' the talks were used to answer critical questions: Can we make this merger work? How do we handle the merger? What critical implementation challenges are we likely to face in the postmerger period?
To some, our labeling of this case as a ''success'' may seem more like an exercise in semantics than a substantive change, but we disagree. We are encouraging practitioners and researchers to evaluate the outcome of negotiations based on the process. Evaluating merger negotiations, for example, would mean asking: (1) Did the talks uncover critical differences between the two parties? (2) Did the talks address implementation issues important in the integration of the two firms? (3) Did the talks include discussions of more than just financial considerations? and (4) Were managerial, cultural, and strategic issues addressed? If the answer to these questions is yes, and the result is an agreement not to merge due to irreconcilable differences, we feel the parties have achieved a success.
Failing to uncover impediments-or worse, uncovering them yet ignoring or minimizing them in order to close a deal-is a failure regardless of the final agreement reached. It is a failure of process, not outcome. Yet, it is potentially the most costly failure negotiators can make. We, of course, do not mean to
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suggest that poor negotiation processes that end in mergers are guaranteed to fail in the long term. In many cases, ftrms work through their differences and are able to achieve their initial objectives. In other cases, parent ftrms adopt a holding company structure, and their acquisitions are treated as separate entities. Naturally, this makes eventual integration less troublesome. Instead, we mean only to suggest that a failure in process makes whatever level of integration is necessary just that much more difficult.
The pressure to reach agreement at all costs, including the cost of neglecting initial goals, would be greatly eased if negotiators were charged with the mission of reaching an outcome based on a successful process. The reward structure surrounding negotiations would need to support this mission rather than a goal of simply reaching an agreement. Moreover, rewards would need to be established for uncovering critical information-information that guides decision making on the basis of economic rationality and takes into consideration both short-term and long-term costs. These changes in reward structures should minimize negotiators' tendencies to escalate commitment since "winning the contest" would no longer be the basis for all rewards.
Improving the Merger Negotiations Process Although a change in reward structures and a focus on process should improve all negotiations, we also have some speciftc advice for negotiators involved in merger negotiations. First, we encourage negotiators to go into the talks with a strong sense of their constituent's strategic purpose. In other words, negotiators must have a clear understanding of their ftrm's goals. At the same time, negotiators should be careful not to deftne this too narrowly. While fmancial goals are important, strategic goals and other goals should also be considered.
Second, we suggest that negotiators have a good understanding of the businesses they represent and that they investigate their clients' ftrms thoroughly. While most investment brokers are likely to be knowledgeable about the fmancial aspects of the transaction, they may know little about the companies or industries they represent. This, in turn, may limit their ability to ask the critical probing questions necessary to uncover stumbling blocks to future integration. Thus, while familiarity with the company and its industry may not guarantee a successful process, it is likely to improve the odds.
In addition to thoroughly investigating the company they represent, we also recommend negotiators investigate the firm represented by their counterpart. While information about both parties will certainly be revealed during the course of the talks, this information may be biased or favorably slanted toward agreement. Possible synergies may be overstated, for example, and cultural differences may be understated. A separate, more objective fact-ftnding expedition on the part of the opposing negotiator is an important means of supplementing critical information and building realistic assumptions about the value created by the merger.
A fourth suggestion for merger negotiators may seem obvious, but it is, nevertheless, important. Negotiators must set a maximum price prior to negotiating and then stick to it throughout the process. According to experts, this price should be the pre-merger target value plus the value created from the merger minus the integration cost, all adjusted for risk and time. The point of establishing such a limit is to minimize the problems of escalation of commitment.
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Prices get out of hand when the goal switches from achieving certain strategic and economic objectives to winning the contest. By establishing an upper limit before beginning the negotiation, the "heat of battle" is unlikely to produce long-term, costly errors.
Also, negotiators will want to address critical implementation issues. Both parties must discuss their views on the postmerger integration process. Who will give up what? How long will it take? Who will be in charge? How will it happen? Inevitably, these issues must be resolved before integration can take place. Why not address them before the deal is closed? If they cannot be resolved, this is a clear sign that irreconcilable problems are likely to emerge later.
Lastly, we would like to encourage negotiators, when reporting back to their constituents, to highlight the strengths of their outcome for their organizations regardless of the direction taken (i.e., agreement or nonagreement). As we found in the Arthur Andersen and Price Waterhouse case, a decision not to merge can sometimes be more cost effective than the reverse.
In sum, we recognize that separating the ''goodness of process'' from the "goodness of outcomes" is not likely to be easy. Nevertheless, we feel it is critical if negotiators are to think objectively, and maintain objectivity, during negotiations where outcomes can spell long-term success or failure for their organizations.
NOI'ES
1. Although mergers for the last two examples were not complete until the end of 1989, rumors about the mergers and negotiations between the firms began as much as a year in advance.
2. SEC regulations prohibit a single firm from performing consulting work with an auditing client.
3. The terms "unfriendly" or "hostile" refer to cases where the target receives an unsolicited and unwanted merger bid.
4. "Break-up value" refers to the value of the individual divisions/pieces of a company if they were disaggregated and sold separately in the market.
5. A sunk cost is a cost that has already been incurred and cannot be reversed or avoided.
376 Kesner and Sbaptro Did a "Failed" Negotiation Really Fail?
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