Worthy suitor? How ESG can ease takeover deals

When seeking a partner for life, people normally look for the best qualities. They are not guided by finances alone; they consider a wide range of other factors.

They might look for someone with integrity and compassion who shares their own outlook.

The same is true in business, especially cross-border mergers and acquisitions (M&A). Target companies often prefer a ‘worthy’ suitor, not simply any buyer who meets their price.

Businesses which aim to complete M&A deals in other countries would do well to bear this in mind.

There are a range of challenges associated with cross-border M&A, which can extend negotiating time and increase costs.

These transactions also run a high risk of not being completed. Even those which are completed often fail to meet the buyer’s expectations.

Many deals fail because they have too many cultural and institutional differences.

In fact, academics report that more than 50 per cent of cross-border M&As are unsuccessful.

Why CSR affects mergers and acquisitions

Failure of a cross-border M&A deal can be very costly for both the acquirer and the target, which highlights the importance of choosing the right suitor.

And, as with human relationships, some suitors are felt to be more worthy than others, helping them to maintain a better record when it comes to M&A.  

A key indication of worth in this context is Corporate Social Responsibility (CSR) scores.

Those companies that score more highly prove to have better cross-border deal completion and duration histories.

And this holds true unless there is a wide gulf between cultural and regulatory practices.

Can ESG practices speed up M&A deals?

In our recent study, Do ‘Good’ Firms Acquire ‘Better’? CSR and Cross Border M&A Success, we looked at Environmental, Social and Governance (ESG) scores as a proxy for CSR.

We compared these scores with the likelihood of an M&A deal being completed and how long that took. We found a clear correlation; buyers with high ESG scores were more successful at acquiring other firms and deals took less time to complete.

There appears to be a variety of reasons for this. Often an obstacle to deal progression is the willingness of the target company to be taken over.

They may have concerns over issues such as the fate of the workforce. If suitors have high ESG scores, there is more of an assumption that they are well governed and will treat employees in the target company well.

This can mean less need for tough negotiations before completion, creating a smoother transaction and integration process.

Are firms that value ESG more forward thinking?

ESG can also reduce information asymmetry by improving a company’s ethical standards and information transparency, increasing the target company’s trust in their potential suitor.

There is also a perception that a company that places more emphasis on ESG has a broader world view and is more forward thinking, reassuring target companies that the deal will leave them better placed to meet evolving environmental or geopolitical challenges.

We find that an acquirer’s reputation among stakeholders (excluding investors) plays a significant role in the expected outcome of an M&A transaction.

CSR strengthens local stakeholder trust, reduces uncertainty, and helps acquirers to mitigate the liability of their foreign status, which is a key challenge in international transactions.

Do all countries value ESG equally?

While we found that a high ESG score improved a target’s view of their suitor, this only holds among similar cultures and regulatory structures.

In cultures less favourable to ESG, it is increasingly argued that the approach distracts from commercial priorities, watering down a company’s focus on profits.

As a result, the greater the institutional and cultural divide between the home countries of the buyer and the target companies, the weaker the positive impact of ESG on M&A deals.

However, multi-nationals operate across numerous countries and cultures. Therefore, they must remain sensitive to ESG issues even if they dip out of favour in some countries from time to time, as they have in the US currently.

How should firms respond to Trump's ESG stance?

Some US companies may have retreated from their commitments on sustainability and inclusion in the face of a backlash from President Trump and his support base.

However, they would be well advised to maintain high ESG scores if they want to be accepted as a worthy suitor by target firms in other parts of the world, especially Europe.

On the other hand, if a multi-national is targeting a Trump-supporting firm in the US, they may find it is less inclined to consider high ESG worthy.

When cultural differences occur, it may be other factors that make the difference, including profitability. But ESG scores can also be an indicator of high quality in other areas such as a firm’s approach to risk management, transparency, and its capability for innovation.

For example, Unilever uses ESG to manage supply chain risks, leading to cost savings and stronger brand value. Meanwhile 3M drives innovation by aligning its environmental goals with employee-driven creativity and stakeholder collaboration.

Three factors that affect M&A completion

Within ESG, the three factors – environmental, social, and governance scores – appear to work in different ways on M&A outcomes, although they all have a positive impact.

The main divide is that high social scores are associated with a reduction in the deal duration, while overall ESG performance, environmental performance, and governance performance are all positively associated with deal completion.  

Governance

The high governance score correlation suggests suitors believe the acquirer is more likely to manage it well and adopt leading edge practice that may result in higher potential future value. It may also lead to more opportunities for the target company and those working in it.

Targets may also assume the suitor has high ethical standards that it will apply once the deal is complete, such as promoting female board representation and other broader Equity, Diversity and Inclusion (EDI) policies, and less opportunity for opportunistic behaviour.

Companies targeting M&A deals can demonstrate these qualities by ensuring their own boards are diverse and independent, being transparent about executive compensation packages, and other ethical business practices.

Environmental

Similarly, high environmental scores – which get most media attention – help get deals done. This is perhaps because target companies believe they indicate a longer term, more holistic view, which could help better prepare them for a more regulated future world as global warming becomes more evident.

As time has progressed the environmental aspect has become more pronounced, especially after events such as the 2015 Paris COP Agreement.

Firms can demonstrate their environmental commitment by setting goals to reduce their emissions and disclosing them, shifting to renewable energy sources and improving energy efficiency, and using reporting frameworks such as the Task Force on Climate-related Financial Disclosures (TCFD) and the Carbon Disclosure Project (CDP).

Social

Once a target is happy with these external factors, then the negotiation tends to move to social aspects – especially what happens to employees. This can drag out the negotiations if there is a lower social score, which often reduces trust.

Target companies are frequently privately owned, so some employees may have options, as well as pensions and salaries. The quicker that these negotiations can be resolved, the faster and cheaper the deal can be done.

A track record for ensuring consumer safety and fair labour conditions, investing in workforce development, and supporting community social impact initiatives can all strengthen a company’s image as a worthy suitor that honours its social commitments.

However, social scores on their own are not as relevant in deal completion. Social performance only had a significant positive effect on deal completion until 2015, after which it was perhaps eclipsed by environmental scores.

Therefore, strong social values should be seen as a valuable addition to good governance and environmental sustainability, rather than a substitute for them.

By understanding this wide range of factors that make an acquisition more attractive to a target company, multi-nationals can increase the likelihood of being seen as a worthy suitor and enjoy the benefits when it comes to completing M&A deals efficiently.

Further reading:

Four rules to avoid failure in mergers and acquisitions

Six tips to find hidden benefits in tech M&A

Six ways businesses can maximise social impact

Beyond the balance sheet: Accounting for sustainability

Jeongsun Park is studying for a PhD in Strategy and International Business and is a Research Assistant at WBS.

Irina Surdu-Nardella is Professor of Strategy and International Business. She teaches International Business and Strategic Advantage on the WBS MBA programmes, Doing Business in Mexico on the Global Online MBA, and Global Challenges in Management and Sustainability on the MSc International Business, MSc Marketing and Strategy, MSc Business with Operations Management, and MSc Business and Finance.

Hossam Zeitoun is Reader of Strategy and Behavioural Science at Warwick Business School and Course Director for the Executive MBA based at the Warwick campus. He teaches Leading Organisations: Performance, Stakeholders, and Governance on the Executive MBA, Global Online MBA and Accelerator MBA (London). He also teaches Strategic Thinking: Strategic Evaluation and Analysis on the Executive MBA, Full-Time MBA and Accelerator MBA (London).

Learn how to add value and avoid common pitfalls in M&A with the three-day programme, Mergers and.Acquisitions: How to Maximise Success, at WBS London at The Shard.

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