Companies mulling a merger would do well to have an investment banker on their board of directors.
A new study from the University of Iowa found that firms with an investment banker on their boards of directors pursue mergers and acquisitions more often. Moreover, those firms perform better after the acquisition has been completed than firms that don’t have investment bankers on their boards.
Corporate governance has become an increasingly common subject of financial analysis since Congress passed new laws to better monitor boards of directors after the collapse of Enron and other corporate titans in the early 2000s. But Lie says that governance is “made up of so many parts” that trying to analyze its impact in broad studies is difficult.
“We suggest that directors with investment banking experience help firms make better acquisitions, both by identifying better targets and reducing the cost of the deals,” says Erik Lie, professor of finance in the Tippie College of Business.
Instead, Lie says a more useful method is to break up those parts and look at how each of them impacts corporate performance, such as the impact of having an investment banker on a board. Lie says investment banks that facilitate mergers and acquisitions for clients are paid by the transaction, and prior studies have shown those banks frequently engage in transactions that generate revenue for the bank, but may not deliver the best value for the client. Lie says the new study was intended to determine if investment bankers bring that acquisition philosophy with them when they become corporate board members.
Lie and his co-authors—former Tippie doctoral students Qianqian Huang, Feng Jiang, and Ke Yang—looked at more than 2,465 acquisitions between 1999 and 2008 and found those that involved an acquirer with an investment banker on the board—808—had increased short-term stock returns. Those acquirers with an investment banker had a stock price return that was .7 percent better within three days of the merger announcement than those in which the acquirer did not have an investment banker.
In addition, they looked at more than 41,000 firms that had an investment banker on its board between 1998 and 2008. They found firms that had an investment banker were 13.6 percent more likely to make an acquisition within a year of the appointment.
Lie says the study also looked at potential conflicts of interest, noting that if the investment banker board member steered the firm to his or her own bank. He says they found little such conflict, though, as the number of such instances was so small as to be statistically insignificant.
Lie says the experience of investment bankers pays off for firms because they help the board improve the screening of takeover targets, assist in identifying good target firms, and steer them away from potential value-destroying acquisitions. Their experience likely also helps the firm negotiate better terms, reducing fees and other costs involved with a merger or acquisition. The study found deals involving investment banker board members paid at least 12 percent lower fees than firms that don’t have investment bankers.
Lie cautions, however, that the study looks only at how effective investment bankers are when it comes to M&A (mergers and acquisitions) activity. It doesn’t measure their effectiveness in other areas of corporate governance.
The study, “The role of investment banker directors in M&A,” will be published in a forthcoming issue of the Journal of Financial Economics. Co-author Huang is now on the faculty of City University of Hong Kong, Jiang at the State University of New York Buffalo, and Yang at Lehigh University.
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