Companies around the world are on a shopping spree. Buoyed by years of sustained economic growth and low cost of debt, global appetite for mergers and acquisitions (M&As) is at a 10-year peak despite the simmering trade war between the United States and China. Last year, announced transaction volumes surged to $4.1 trillion, the third highest ever. Yet M&As also have a depressingly high failure rate of about 80%. Combine the buying frenzy with the post-deal outlook and you would have cause to ask: which M&As have the best odds of success?
An obvious place to look for the answer is the C-suite. CEOs shape strategies and often make final M&A decisions. They also consult their CFOs, who help identify acquisition targets, conduct due diligence, arrange financing, and engage in post-deal execution. CFOs are the Robin to the CEO’s Batman, the Watson to Sherlock.
Every upbeat hero needs a downbeat sidekick
Why optimism and pessimism? Because they are cognitive characteristics that affect how you think and how you act. Optimists tend to focus on positive, goal-facilitating information, and discount unwanted facts. Pessimists are more sensitive to negative, goal-inhibiting information; they are more critical and vigilant in their efforts to avoid potential disasters.
The two traits have been shown to be aligned with the roles of CEO and CFO. CEOs are expected to be more optimistic and open to risks. The upbeat, visionary, public-facing CEO is by now a standard specification across industries. Satya Nadella, Jack Ma, and Mary Barra are just a few of the flag-bearers. Companies can’t engineer or sustain an upward trajectory with a leader who shies away from risks or who can’t see beyond the medium term.
But to parlay optimistic vision into healthy post-M&A return on assets (ROA) also requires a dash of pessimism. And that has to come from the CFO, whose job it is to scrutinize target firms, conduct in-depth due diligence, and pinpoint potential risks of any M&A. They are expected to be cautious and attuned to adverse conditions – basically, a gatekeeper who brings the high-flying CEO down to earth. Former Facebook CFO David Ebersman said in a 2015 interview, “As CFO at a larger company, one of the things I felt responsible for doing was to be a bit of a pessimist: to think about what could go wrong with the investments we were making, and to make sure someone was challenging every dollar we were spending in the business.”
We studied the influence of CEO-CFO pairs at 2,356 US firms, the 4,529 M&As they undertook, and in turn, their impact on firm performance. Specifically, we focused on the level of optimism and pessimism they brought to M&A decisions. We culled transcripts of conference calls between 2002 and 2013 involving both the CEOs and CFOs. We measured the executives’ optimism and pessimism by analyzing their use of positive and negative words. Positive words included “achieve,” “assure,” “benefit,” “successful,” “reward,” and “satisfy”; negative ones included “flaw,” “false,” “overlook,” “penalize,” “prevent,” and “unavoidable.” CEO optimism was calculated as the difference between CEOs’ use of positive words and negative words, and CFO pessimism was calculated as the difference between CFOs’ use of negative words and positive words.
Our data showed that CEOs generally used more positive words and were more optimistic than CFOs. CFOs used more negative words and were more pessimistic than CEOs. We then used the ratio of CEO optimism to CFO pessimism to derive what we call the CEO-CFO relative optimism. This value is then matched with the firm’s number of M&As, their transaction value, and firms’ operating performance a year later.
We found that the more optimistic a firm’s CEO-CFO pair was (high-optimism CEO with low-pessimism CFO), the more M&As it undertook. Our models showed that one standard deviation increase in CEO-CFO relative optimism would lead to an 8.2% increase in the number of M&As.
Unfortunately, high CEO-CFO optimism also correlated with lower ROA a year after M&As. Our models showed that when CEO-CFO relative optimism was high, as when a high-optimism CEO worked with a low-pessimism CFO, ROA decreased by 1.4% when the number of M&As increased; when CEO-CFO relative optimism was low (that is, when a low-optimism CEO was paired with a high-pessimism CFO), ROA increased by 4.7% when the number of M&As experienced the same level of increase.
At Spectrum Pharmaceuticals, for example, where relative optimism of the CEO (Rajesh Shrotriya) and CFO (Brett Scott) was in the top 5 percentile, ROA was a disappointing -3.4% after the firm made an acquisition in 2012. At the other end of our data set were Gilead Sciences’ CEO (John Martin) and CFO (Robin Washington), whose relative optimism ranked in the bottom 5% percentile. The biotechnology company reported ROA of 36% a year after making a major acquisition in 2009.
We conclude that in the presence of pessimistic CFOs, optimistic CEOs not only undertake fewer acquisitions, they are also less likely to undertake dud acquisitions. This points to an optimal pairing of an optimistic CEO who has a large risk appetite for M&As, and a pessimistic CFO who is sufficiently conservative and prudent to alert him or her to potential pitfalls. Other observed CEO-CFO permutations were generally associated with lesser outcomes.
The firm’s operating environment makes a difference, too, in how the CEO-CFO pair influences M&A.
We found that companies with high CEO-CFO relative optimism carried out more M&As in a dynamic environment, defined in our study by volatile total industry sales in the five preceding years. This suggests that CEOs are more likely to consult CFOs on M&As in times of uncertainty, and when it’s a highly sanguine CEO working with a low-pessimism CFO, the result is likely to be more M&As. In other words, a dynamic environment enhances the positive relationship between CEO-CFO optimism and the number of M&As.
The current context of the US-China trade war and Brexit is dynamic to say the least, and has engendered sales slumps, earning warnings and downbeat growth forecasts across industries. How optimistic the CEO is, and how pessimistic the CFO is in parallel, under the circumstances will weigh on firms’ M&A decisions and their future performance.
Our insights go beyond the world of public companies and mergers and acquisitions; they underscore the importance of role congruence in senior management everywhere. Not all executives need to be visionary and optimistic. To assemble an A-team, you should hire people whose personality fits the role of the job to be filled. In the case of the CFO, it’s pessimism or prudence. COOs tend to be detail-oriented, and so on. One size doesn’t fit all.
We would also argue that role congruence is a necessary condition for the C-suite to benefit from diversity, which has been shown to underpin everything from higher profits to better morale. While it is definitely good to have different personalities and skill sets in the top management team, those personalities and skills should ideally be compatible with the roles they inhabit.
Whether you’re a company head honcho, investor or head-hunter, a good grasp of the personality of the CEO and the CFO and other top executives would help you make that calculated bet or hire with that much higher likelihood of success. It might help, too, to be aware of your own optimism/pessimism orientation.