Page 39 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 1. Executive Compensation Framework 25

goodwill and must be amortized, thereby diluting earnings. In accord with Accounting
Principles Board 16, “Conditions of Pooling of Interest Methods of Accounting for
Combination,” pooling rules must be used if they apply. If not, purchase accounting must be
used and the difference between purchase price and net assets amortized or written off over a
40-year period. However, that changed in 2001 when FASB eliminated pooling but gave some
relief on the treatment of resulting goodwill.
Companies planning mergers or acquisitions would look to investment bankers to struc-
ture the deal. In return, the bankers would likely receive fees ranging from 0.5 percent to 1.5
percent, depending on size, with the highest fees going for the smaller deal. An offer to buy
a company that is not welcomed is called an unfriendly takeover by a black knight. In other sit-
uations it may simply be a bear hug, with a company threatening a takeover but willing to back
away for greenmail—a legal form of blackmail. If another organization considered more
attractive by the company being pursued enters the scene, it is sometimes referred to as a
white knight (charging to rescue the fair maiden). The takeover could be by a company or by
venture capitalists who see the breakup value of the company exceeding its market price.
Following the signing of confidentiality agreements, financial and other experts are sent
in to analyze the company’s strengths and weaknesses. This is the due diligence stage. If the
results are acceptable, an agreement in principle is signed. Implementation details are worked
out, and the deal is approved by the respective boards. Throughout the entire process, it is
critical that all interested parties be kept informed.
During discussions, both sides typically sign confidentiality agreements to prevent the other
from using confidential information should the talks fail, as many do. However, even with
enforcement of these agreements, companies gain a better understanding of their own
competitive strengths and weaknesses.
M&As could occur in any stage of the market lifecycle, although the later rather than the
earlier stages are more likely. The key issue is which is better—to build or to buy? Among
the considerations are key product portfolios, research and development opportunities, time
to market improvements, cost-reduction opportunities, management depth, culture, and the
expected rate of return on capital before and after the merger or acquisition. Is the focus on
cost reduction or revenue growth? Diversification by customer, products, or geography may
also be factors.
In a merger, it may be appropriate to design new pay programs; with an acquisition, the
issue is whether to bring employees into the acquirer’s programs or permit them to continue
with their current plans. It is important that employees of the acquired or merged company
clearly understand the effect the action will have on their pay, benefits, and job security. The
reasons for such changes must also be understood. Whether an acquisition or merger, stock
options will be recast based on the stock prices of the two companies before they were com-
bined. Executives of either company may be given a transaction bonus—payment for staying
until the transaction is completed. This payment is not only to keep the individual with
the company but also to gain cooperation in making the deal. Posttransaction consulting
agreements may also be awarded to assist in postdeal issues. Executives in both probably
have employment contracts specifying severance agreements ; the contracts should therefore
be carefully examined before awarding transaction bonuses or posttransaction consulting
agreements.
At some stage in the market lifecycle, typically maturity, although it could be earlier or
later, the company looks to shed certain businesses, typically because they do not fit with core