Market Transparency for Whom

The FBI and U.S. Justice department have been very busy arresting and prosecuting insider trading cases.  Some of these insider trading cases are so called "expert networks" where a matchmaking process is used.  One example of a matchmaking tie up is between employees and investors at public companies.  Employees are compensated for passing along proprietary or insider company information to investors, just not to the degree that investors are.  Consider an insider tip on a potential mergers and acquisitions transaction where generally there is a premium paid to the target or acquired company, a premium that could be 20 - 30% above the current stock price before public disclosure.  That return beats the stock market everytime, which for the S&P 500 has been 11%  (CAGR) from 1950 - 2011.  Insider trading is a risk mitigation strategy. 

A more sophisticated form of "expert networks" is the matchmaking between investors and the U.S. Congress.  Lobbyists are an overt example.  Lobbyists are intelligence gatherers.  It is a misnomer to assume that lobbyists are only senders of communication.  Between 92 - 94% of communication is estimated to be non-verbal and if a lobbyist has any training in reading micro-expressions, then a U.S. Congressperson is giving a whole hell of a lot away.  Add in a travel junket or dinner meeting, paid for by lobbyists, and the reciprocity principle is triggered.  The reciprocity principle is a habit formed from a civilized upbringing where parents train children to be nicey, nicey when someone does something nice to you.  To call it quid pro quo is to give it an unnecessary edge because quid pro quo implies a choice or control, however the reciprocity principle is a habit and harder to control.

Now, switch the prey and the predator images - U.S. Congresspersons gleaning insider information from the intentions of lobbyists.  Then add in the specialized knowledge of U.S. Congresspersons on committees.  Investing is about finding the sweet spot and for U.S. Congresspersons the sweet spot is where regulation and business meet or deliberately do not meet.  That has equated to a 6% advantage for U.S. Representatives and a 10% advantage for U.S. Senators in the stock market.  The Executive Branch is restricted from trading in-person through the use of blind trusts, however it is a porous wall so a complete ban would be the only real solution to what is essentially a breach of fiduciary duty by both branches. 

Wall Street investors would like to be self regulated when it comes to enforcing rules on insider trading, yet the U.S. has decided that that is a bad idea.  And somehow the U.S. Congress has different standards.  The STOCK Act, introduced in 2006, was only recently revived by the U.S. Congress as a public relations strategy.  Since an outright ban on trading is not going to pass because of the self interested nature of the legislation, all blind trusts should be administered by a government entity with accountability and a strong firewall.  Allowing U.S. Congresspersons and the Executive Branch to have their blind trusts administered through existing relationships is akin to trying to hold water in one's hand.  Financial services companies are not a solution either as the client relationship focus ensures a firewall vulnerability.

It is unlikely that Preet Bahara, U.S. Attorney for the Southern District of New York (S.D.N.Y.), will be on the steps of Congress or in front of the White House speaking on the new arrests and prosecutions for insider trading because that is not where Wall Street is located .... or is it?  There is a reason why politicians spend millions of dollars on being elected to an office that only pays $170,000 or $400,000 a year. 

"Merger of Equals": Not Really

The latest mergers and acquisitions story is getting the "merger of equals" label.  Glencore International and Xstrata are in the mining industry and used to be one company before Xstrata went public in 2002.  The merger of equals label is simplistic and used erroneously usually based on market value.  Even twin children with the same DNA are not considered equals due to functional and personality differences.  The value in mergers and acquisitions transactions is that the combined company will be able to operate with a competitive advantage which necessitates that the mergers and acquisitions companies bring differences to the bargaining table.

Buried inside a merger of equals label is the idea that the greatest benefit of the merger or acquisition is its synergies because the companies are viewed as the same.  Not so fast.  The economies of scale become diseconomies of scale when the largess of the operations raises the combined company's cost of doing business.  Synergies are difficult and often based on a confluence of assumptions, more so than sales projections.  Downsizing the combined company's workforce seems to be the only reliable synergy unlike areas such as merging technology platforms where subsequent user adoption by the remaining workforce is vulnerable to subterfuge.  Synergies are useful in identifying areas for cost cutting, but should never be used as a reason for a merger or acquisition.

As difficult as synergies are to realize, the merging of company cultures including each company's respective leadership can be chaotic and demoralizing.  The merger of equals label is good for newspapers and magazines, however it is not a label that should be used by the companies in the merger or acquisition.  The implication is that all employees are on somewhat equal footing in the combined company and that is most often not the case.  High potentials are valued, but in a work culture where most of the employees are high potentials, the distinction is less useful to an employee's identity.  And for whatever intrinsic motivation that flows from being a high potential, this can be demoralizing.  There may also be learning curves for employees that can destroy an employee's sense of mastery.

Consider the CEO position.  Becoming a CEO is the culmination of ambition, leverage, and talent.  Rarely are companies led by two CEOs.  One only has to look to Research in Motion to understand the pitfalls of two leaders in a position meant for only one.  If two CEOs were better than one, it is likely the corporate organizational structure would have implemented co-leaders a long time ago.  The degree to which the companies are not recognized as equals is evident in the negotiations for whom will lead the combined company.  The choice of CEO sends a value message in a transaction being labeled as a merger of equals.  CEOs imprint company cultures with their own leadership style so choosing a CEO of one of the companies means some of the employees enjoy a natural advantage via experience in identifying with the CEO.  In the end, attrition will be the greatest indicator of what company was more important going forward to the combined company.

Based on historical evidence, mergers and acquisitions look and work better on paper than they do in reality.  Value creation can quickly turn into value destruction if it is not clear which company is dominant.  The first group that this should be spelled out to is the employees of each company so that expectations are set at the correct level and change management is aligned properly to the degree necessary.  There is no mergers and acquisitions transaction that is a merger of equals and failing to understand that further burdens an already difficult transaction.