The idea of shareholder value won its first victory of the new millennium Monday, when Procter & Gamble announced that it was breaking off talks for a possible three-way merger between it, Warner-Lambert, and American Home Products. Prior to the announcement, P&G’s shares were down almost five points on the day, which meant that the company’s stock had dropped 17 percent since rumors of the merger talks leaked last week. After the announcement, the company’s shares rebounded sharply, and on a day when stocks were down pretty much across the board, P&G was actually in positive territory at the close.
Durk Jager, P&G’s president, CEO, and chairman (did he also invent Tide?), said in a statement that he’d ended the negotiations because the leaks and news stories had “created an environment in which we cannot continue meaningful discussions.” In practical terms, what that really means is that since P&G would have been the acquirer in any deal, the stock market’s reaction to the rumors made any acquisition much more expensive than it would have been previously (since P&G’s shares became less valuable), more expensive, apparently, than Jager thought the deal was worth. In addition, since P&G’s shares were still plummeting this morning as the market anticipated a deal, Jager couldn’t count on there being any upside if P&G actually did buy one or both of the pharmaceutical companies.
In calling off negotiations, then, Jager was effectively deferring to the wishes of the stock market, whose verdict on the possible deal was unequivocal. In this, he was singularly unlike any number of CEOs who have happily pushed through deals in the face of unremitting opposition from investors (including, most recently, the heads of SmithKline Beecham and Glaxo Wellcome). Jager has not, to be sure, fully accepted that the stock market was right about the prospective deal, since in his statement he said putting the three companies together would have been “a blockbuster combination of technology, marketing, and scale capabilities” and that it would have “created substantial shareholder value.” But we’ll take what we can get.
The interesting question is whether Jager’s reaction would have been the same if he had been able to close the deal in secret and had the sell-off in P&G’s stock occur only after the deal was announced (as was the case in AOL’s acquisition of Time Warner and in the SmithKline-Glaxo deal). There’s no definite answer to this question, but the historical track record of CEOs in a similar position suggests that in fact Jager would have just gone ahead with the deal (unless P&G’s stock dropped to a prohibitively low price). In other words, the leak about the negotiations may very well have saved P&G investors billions of dollars in shareholder value.
This doesn’t, of course, make economic sense. The shareholders of the company are the ones who own it. They’re also, perhaps more importantly (in a practical sense), the ones who decide what it’s worth and what potential acquisitions will or won’t do to the value of the company. Whether they make that decision before or after a deal is officially announced should be irrelevant to whether a company goes through with a deal or not. The default position has to be that the shareholders’ decision is the right one, and CEOs should defer to it regardless of when it’s reached. But in practice, announced deals are treated by company management as if they’re faits accomplis. Since managers are ultimately just shareholder representatives, this is a little bit like your lawyer closing a deal on your behalf and then, when you protest, saying, “I’m sorry. The deal’s done. Nothing I can do about it.” (There are some quirks that make it not exactly like this, which I’ll get to in a piece tomorrow.)
One reason announced deals are treated like faits accomplis is because so often they come accompanied by huge breakup fees. In the AOL-Time Warner deal, for instance, AOL will have to pay Time Warner X billion if the deal falls through. The justification for breakup fees is that they prevent companies from announcing deals to test the waters or to freeze other potential acquirers or from using the deal-making process to acquire information to which it would otherwise never had access. But that’s not justification enough. The breakup fee loads the deck in favor of making the deal go through. It distorts any economic analysis of the impact of the deal on the acquiring company. And it protects the party who always reaps the real benefit from acquisitions anyway, namely the acquired company. Had P&G actually been able to buy Warner-Lambert and AHP, there would undoubtedly have been a breakup fee in the deal.
All of this suggests that the only thing really separating Durk Jager from his CEO peers is that he was the victim of a news leak (which is truly ironic, given how closemouthed P&G has traditionally been about its business). But still, let’s give the man credit. The market spoke, and he at least listened.