INTERNATIONAL Airlines Group (IAG), formed in January 2011 through a merger between British Airways and Iberia, is in difficulty. Operating losses at IAG in the first nine months of 2012 were €169M (£135m).
Shareholders have a right to feel disgruntled. They might question IAG’s revenue forecasting methods, and how realistic their projections have been. Or they may ask how much “revenue synergy” has actually been achieved. I could go on.
These problems are specific to IAG. But similar issues can be found in many publicly-listed companies that have merged or acquired other businesses.
A study by three business school academics, 20 years ago, transformed the economic approach to analysing mergers. A lot of work had already been done into the impact of a merger announcement on share prices, and on the value to the shareholders of the target company. But Julian Franks, Robert Harris and Sheridan Titman looked at the long-term impact on the share price of the company in the driving seat.
What they found was not good news. Their results gave rise to a whole new area of academic thinking – the so-called “post-merger performance puzzle.” Most of the time, the shareholders of the acquiring company lose out. Each individual case has its own specific explanation, but initiating a merger or acquisition is usually bad news for your shareholders.
For believers in economic rationality and efficient markets, this is an intriguing puzzle. People are allowed to make mistakes, but not consistently. For every merger that underperforms, there should be one that delivers unexpectedly large benefits to the shareholders. And there’s been such a large number of mergers and acquisitions that executives ought to be able to learn from the mistakes. Yet there is persistent downside for shareholders of the acquiring company. Occasionally they gain, but usually they lose.
IAG is just one example of this phenomenon. To understand why experienced managers still pursue mergers and acquisitions, despite the track record of such activity, we need to turn less to economics and more to psychology.
In a speech in June, investor George Soros borrowed a phrase from University College London psychoanalyst David Tuckett. Soros described Europe’s boom before the most recent crisis as a “fantastic object”, unreal but immensely attractive. Executives may create similarly fantastic objects when they think of mergers and acquisitions.
BA remains vital to the British economy. So we should all hope that chief executive Willie Walsh brings his merged airline giant back to Earth and sorts out the mess.
Paul Ormerod is an economist at Volterra Partners, a director of the think-tank Synthesis and author of Positive Linking: How Networks Can Revolutionise the World.