When Mergers Happen, Ask a Friend for Advice
Consultancy services for mergers and acquisitions generate a considerable volume of proceeds for investment banks. The top three advisor banks (Goldman Sachs, J.P. Morgan e Citi) have in fact managed transactions of over €1,000 billion, collecting commissions of circa €3 billion in 2008. A research study by CAREFIN Bocconi (Centre for Applied Research in Finance) suggests that their services also produce value for client companies. In addition, if a company chooses an advisor with which it has a strong relationship, the value of its shares will appreciate.
In the paper, Gianfranco Forte, Giuliano Iannotta and Marco Navone analyze the factors that influence the choice of financial advisor in merger operations and the effects that that choice has on the value of client companies. Utilizing data from 473 operations carried out in Europe during the period of 1994-2003, the CAREFIN researchers documented that the choice of a company to turn to a particular bank is greatly influenced by the intensity of the bank-company relationship. This intensity is measured based on the volume of financial transactions (other merger or acquisition operations, loans, bond issues, etc.) that the company had already carried out with a given bank in the five years before the merger.
Investment banks are specialized in the production of information; when they act as consultants in merger operations they utilize this ability to determine the value of the synergy, the risks of the transaction, etc. fixing the correct price in the end. Therefore, if a prolonged relationship is established with the company, a bank can obtain more information on its activity, which can be useful in evaluating the quality of a merger. As a matter of fact, if the role of a financial advisor in a merger is to provide information, the choice of referring to the bank with which the company has had the strongest relationship (the "relationship bank") seems like a very logical. That relationship allows the bank to be more informed and provide a better service.
However, it could be that companies are "trapped" in a relationship with their bank: in other words, thanks to this relationship, the bank can influence the company, increasing the probability of obtaining a commission, without necessarily providing a better service. "When we need some advice we ask a friend because we know they know us better," says Iannotta. "This, however, doesn't mean that it will be the best possible advice."
In this case the advice is crucial, because a merger is a bit like a marriage.
To understand if a strong relationship truly produces benefits, CARAFIN researchers examined stock market prices of companies involved in mergers. If the relationship between the bank and the company improves the quality of service offered by the advisor, then the stronger the relationship, the more the value of the company client should increase. The study indeed demonstrates that when a merger operation is announced a strong relationship with the advisor bank corresponds with a significant increase in the share movements of the company client.
As a matter of fact, when a company involved in a merger or acquisition announces they have taken on an advisor, the yield of its shares is around 0.4% higher (i.e. 1.4% instead of 1.0%) if the advisor has a strong relationship with that company. Though 0.4% may seem small, this percentage more or less corresponds to the commission on investment bank consultancy services: it's a little like saying that the company obtains free consultancy because the commission paid to the bank is compensated by an increase in share value. "It seems that the advice of a friend is actually the best, at least in merger operations," concludes Iannotta.