Agency conflicts between investment banks and corporate clients in merger and acquisition transactions: Causes and remedies

Academy of Management Executive

Volumn 11, Issue 1, 1997, Pages 7-20

  Kosnik, Rita D ^a,b   Shapiro, Debra L ^b,c  

^a TRINITY UNIVERSITY   (United States)

^b NORTHWESTERN UNIVERSITY   (United States)

^c IL   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 0002532784     PISSN: 10795545     EISSN: None     Source Type: Journal    
DOI: 10.5465/ame.1997.9707100656     Document Type: Article

References (71)

1. H. Servaes, and M. Zenner, Forthcoming. "The Role of Investment Banks in Acquisitions," The Review of Financial Studies.
2. Business Week, "Can You Trust Your Broker?" February 20, 1995, 72.
3. P.J. Foye and S.A. Scruggs, "Investment Bank Liability in Mergers and Acquisitions," in R.H. Rupert (ed.), The New Ear of Investment Banking (Chicago, Illinois: Probus Publishing Company, 1993);
4. Delaware Journal of Corporate Law, "Investment Banks Liability: A Panel Discussion," Spring, 1991, 557.
5. Wall Street Journal, "Brokerage Firms Pay Big Damages in 'Dramshop' Case," May 17, 1995, C1.
6. Chicago Tribune, "Dealmaking Gone Awry," October 27, 1991, C1.
7. Foye and Scruggs, Chicago Tribune op. cit.
8. S. Labaton, "$200 Million in Wall Street Fees Seen From Federated Deal," The New York Times, April 5, 1988, D1.
9. D.A. Lax and J.K. Sebenius, The Manager as Negotiator: Bargaining for Cooperative and Competitive Gain. (New York: The Free Press, 1986, p. 310).
10. Ibid.
11. Michael Jensen and William Meckling define the agency problem as follows: "... a contract under which one or more persons [the principals] engage another person [the agent] to perform some service on their behalf which involves delegating some decision making authority to the agent. If both parties to the relationship are utility maximizers, there is good reason to believe that the agent will not always act in the best interests of the principal. The principal can limit divergences from this interest by establishing appropriate incentives for the agent and by incurring monitoring costs designed to limit the aberrant activities of the agent." M.C. Jensen and W.H. Meckling, "Theory of the Firm: Managerial Behavior and Ownership Structure," Journal of Financial Economics, 3, 1976, 308.
12. M.H. Bazerman, M.A. Neale, K.L. Valley, E.J. Zajac, and Y.M. Kim, "The Effects of Agents and Mediators on Negotiation Outcomes," Organizational Behavior and Human Decision Processes, 53, 1992, 55-73.
13. Servaes & Zenner, Organizational Behavior and Human Decision Processes, op. cit.
14. Fortune, "The Deal Decade: Verdict on the '80s," August 26, 1991, 59-60.
15. Servaes & Zenner, The Deal Decade: Verdict on the '80s, op. cit.
16. Foye & Scruggs, The Deal Decade: Verdict on the '80s, op. cit.
17. Institutional Investor, "The 1995 M&A Sweepstakes," March 1995, 103-105. Other firms such as Drexel Burnham Lambert Inc., Shearson/American Express Inc., Lehman Brothers, and Dean Witter Inc., are typically considered second-tier firms, while the smallest firms (also know as "boutiques") such as Oppenheimer & Company and Advent Inc., constitute the third tier.
18. Security analysts examine the performance and strategies of publicly traded corporations in order to predict stock price movements. Risk arbitrage refers to speculative stock transactions that intend to exploit short-term rises in stock price, such as during merger negotiations or takeover contests. J.P. Williamson, "Mergers and Acquisitions," in J.P. Williamson (ed.), The Investment Banking Handbook (New York: John Wiley & Sons, 1988), Chapter 13.
19. Fortune, 1986, The Investment Banking Handbook op. cit.;
20. R.M. McLaughlin, "Investment-banking Contracts in Tender Offers," Journal of Financial Economics, 28, 1990, 209-232.
21. Mergers and Acquisitions, "Payday for m&a Advisors," January/February, 1990, 11-12.
22. S. Labaton, Mergers and Acquisitions, op. cit.
23. Institutional Investor, op. cit.,
24. Mergers and Acquisitions, Premium Paydays for Quality Service, January/February, 1995, 6-7.
25. Institutional Investor, 1995, op. cit.
26. P.C. Hapeslagh and D.B. Jemison, "Managing Acquisitions. Creating Value Through Corporate Renewal," (New York: Free Press, 1991);
27. H. Servaes, "Tobin's Q and the Gains from Takeovers," Journal of Finance, 46, 409-419.
28. S. Labaton, Journal of Finance, op. cit.
29. B. Ely, "Alternatives to the Lehman Formula for Broker Fees," Mergers and Acquisitions, Summer, 1982, 45-46.
30. Fortune, 1986, Mergers and Acquisitions, op. cit.;
31. Fortune, 1991, Mergers and Acquisitions, op. cit.
32. I.F. Kesner, D.L. Shapiro, and A. Sharma, "Brokering Mergers: An Agency Theory Perspective on the Role of Representatives," Academy of Management Journal, 37(3), 1994, 703-721.
33. S.K. Cooper, and D.R. Fraser, S.K., and The Financial Market Place. Reading, MA: Addison-Wesley Publishing Company. 1993.
34. As underwriters, investment banks buy new securities from issuing corporations, with the intention of finding buyers and reselling the securities at a higher price. In return, investment banks receive an underwriting commission plus the margin between the sales price and the purchase price. The underwriting business has always been highly profitable for investment banks. The shelf-registration rule was introduced by the SEC on a temporary basis in 1982 and made permanent in 1984. The new ruling allows corporations who plan to issue new stock or bonds to choose the timing of their new issues and to ask bids (pricing services) from more than one investment bank. Even though no formal or explicit bidding process occurs among underwriters, shelf registration creates a competitively set pricing service. For more extensive discussion of the impact of Rule 415, see E. Bloch, Inside Investment Banking (Dow Jones-Irwin, Homewood, IL, 1986);
35. S. Bhagat, "The Evidence on Shelf Registration," Midland Corporate Finance Journal, 1984, 2, no. 1 (spring), 6-12.
36. Fortune, 1986, Midland Corporate Finance Journal, op. cit.
37. Bhagat, Midland Corporate Finance Journal, op. cit.
38. Wall Street Journal, "Baxter Travenol Bids for American Hospital Supply," June 24, 1985, 2.
39. C.D. Ellis, "Attracting Corporate Clients," in J.P. Williamson (ed.), The Investment Banking Handbook (New York: John Wiley & Sons, 1988), Chapter 3.
40. Fortune, 1986, The Investment Banking Handbook op. cit.
41. M.H. Bazerman, M.A. Neale, K.L. Valley, E.J. Zajac, and Y.M. Kim, "The Effects of Agents and Mediators on Negotiation Outcomes," Organizational Behavior and Human Decision Processes, 53 1992, 55-73;
42. K.L. Valley, S.B. White, M.A. Neale, and M.H. Bazerman, "Agents as Information Brokers: The Effects of Information Disclosure on Negotiated Outcomes," Organizational Behavior and Human Decision Processes, 51, 1992, 220-236.
43. W.C. Hunter and M.B. Walker, "An Empirical Examination of Investment Banking Merger Fee Contracts," Southern Economic Journal, 56(4), 1990, 1117-1130;
44. G. Benston, and C.W. Smith, "A Transaction Cost Approach to the Theory of Financial Intermediation," Journal of Finance, 31:215-231;
45. Ellis, Journal of Finance, op. cit.
46. See S.B. Bacharach and E.J. Lawler, Bargaining: Power, Tactics, and Outcomes (San Francisco: Jossey-Bass Publishers), 1981,
47. R.L. Pinkley, M.A. Neale, and R.J. Bennett, "The Impact of Alternatives to Settlement in Dyadic Negotiation," Organizational Behavior and Human Decision Processes, 57, 1994, 97-116.
48. Most of these negotiation studies used a prisoner dilemma framework. In prisoner dilemma studies, participants (A) are separated from their "partner (B)," the latter often being a confederate or a programmed computer, unbeknownst to A. Participants are told that the amount of their reward-allocation (e.g., pay) depends on choices they and their partner make regarding cooperation and competition. Typically, a cooperative choice by both A and B results in mutual gains; and a competitive choice by both A and B results in mutual losses; and the biggest gain to A results when A chooses to be competitive but B chooses to be cooperative. Thus, the dilemma is whether to be cooperative or competitive, since both choices have the potential to bring about more, or sometimes less, gain - depending on the partner's willingness to cooperate. For a review, see A. Colman, Game Theory and Experimental Games: The Study of Strategic Interaction, (New York: Pergamon Press, Vol. 4. 1982).
49. W. Austin, "Friendship and Fairness: Effect of Type of Relationship and Task Performance on the Choice of Distribution Rules," Personality and Social Psychology Bulletin, 6, 1980, 402-408;
50. H. Sondak, R. Pinkley, and M. Neale (1994), discussed in Valley et al., "The Effects of Relationships and Outcome of Dyadic Negotiations" in R.J. Bies, R.J. Lewicki, and B.H. Sheppard (Eds.), Research on Negotiation in Organizations (Vol. 5) (Greenwich, CT: JAI Press, 1995).
51. J. Halpern, "Friendship's Effect on the Buyer/Seller Relationship: Understanding the Asymmetry," Paper presented at the National Academy of Management Meeting, Atlanta, GA, 1993.
52. K.L. Valley, M.A. Neale, and E.A. Mannix, National Academy of Management Meeting, op. cit.
53. Fortune, 1986, National Academy of Management Meeting, op. cit.
54. Ellis, National Academy of Management Meeting, op. cit.
55. Ibid.
56. Leveraged buy-outs (LBOs) involve the repurchase of a company's publicly-traded stock by a small group of investors who then become the private owners of the company. The buy-out is 'leveraged' because it is financed largely with debt. IPO (or initial public offering) refers to the first issuance of stock (or debt, but that is less common) by a corporation seeking to raise capital. The issuing company sells parts of the private equity that is owned by management or other private owners equity stake and/or creates new shares and offers them to the public. The main role of investment banks is to underwrite the IPO by creating a syndicate of investment banks who buy the entire issue and resell the stock to investors (individual or institutional). The underwriting firms gain a 'spread,' which is the difference between the price paid to the issuing firm and the price at which the stock sells in the market (average 6 percent to 10 percent of the gross proceedings). See J.J. Clark, J.T. Gerlach, and G. Oson, Restructuring Corporate America, (New York: Dryden Press, 1996).
57. Williamson, Restructuring Corporate America, op. cit.
58. Ibid.
59. O. Ben-Yoav and D.G. Pruitt, "Accountability to Constituents: A Two-Edged Sword," Organizational Behavior and Human Performance, 34, 1984:283-295.
60. P.J.D. Carnevale, D.G., Pruitt, and S.D. Britton, "Looking Tough: The Negotiator Under Constituent Surveillance," Personality and Social Psychology Bulletin, 5, 1979, 118-121.
61. See P.J.D. Carnevale et al., op. cit.,
62. P.J.D. Carnevale, D.G. Pruitt, and S.D. Seilheimer, "Looking and Competing: Accountability and Visual Access in Integrative Bargaining," Journal of Personality and Social Psychology, 40, 1981, 111-120.
63. A. Michel, I. Shaked, and Y. Lee, "An Evaluation of Investment Banker Acquisition Advice: The Shareholders' Perspective," Financial Management, Summer 191:40-49.
64. For a review of this and other relevant studies, see Michel, Shaked, and Lee, Financial Management, op. cit.
65. W.C. Hunter and M.B. Walker, Financial Management, op. cit. To discourage a bidding war from occurring, the valuation of the target firm's worth would need to take into consideration the price at which multiple bidders would not be encouraged to enter the transaction.
66. Ely, Financial Management, op. cit.,
67. R.J. Cappuccio and J.P. Callahan, "Linking Fees to Skills of Buy-Side Intermediaries," Mergers and Acquisitions, January/February, 1987, 58-60.
68. M. Sikora, Mergers and Acquisitions in the 1990s. In R.H. Rupert (ed.), "The New Era of Investment Banking," (Chicago, IL: Probus Publishing Co.), 1993 (Chapter 32).
69. Business Week, "Mergers Today, Trouble Tomorrow?" September, 12, 1994, 30-32;
70. Institutional Investor, 1995, op. cit.;
71. Institutional Investor, "The M&A Masters, June 1995, 165-167.