When firms combine via a merger or acquisition, the oft-hoped-for outcome is that the union will produce synergies—that is, new value for the merged firm that exceeds the total value of the two separate firms. Cost and revenue synergies can spark, for example, when one of the companies has access to technology, factories, patents, or supply chain relationships that benefit both.
Less well understood is the value potentially created by changes at the level of rank-and-file employees. After a merger, some employees will leave a firm, by choice or not. Prof. Heather Tookes, whose previous research has looked at the impact of mergers on firm valuation, wondered how these departures help make the combined company more valuable—and in particular, whether one synergy might be a reduction of employee misconduct.
“When I teach about how mergers can create value, one of the things I talk about is the potential cost reduction that comes from redundancies in the labor force. But when firms merge and let go of employees, are they letting go of the right ones?”
“When I teach about how M&A can create value, one of the things I talk about is the potential cost reduction that comes from redundancies in the labor force—that’s something we’re very clear on,” Tookes says. “But when firms merge and let go of employees, are they letting go of the right ones?”
In a new paper, Tookes and her coauthor, Emmanuel Yimfor, an assistant professor of finance at the University of Michigan’s Ross School of Business, zeroed in on M&A activity in the investment advisory industry. They sought to determine whether M&A in the space yielded a beneficial byproduct they call “misconduct synergies”—meaning post-merger reductions in disclosures of employee misconduct.
Tookes notes that this question is especially difficult to dig into because data on individual employee behavior is typically not available. “There are just a lot of questions that we have a hard time answering due to data constraints,” Tookes says. But in conversation with Yimfor, who has spent time thinking about the investment advisory industry, they saw that the highly regulated sector had publicly available data that allowed them to answer questions around employee synergies from M&A events.
The researchers analyzed misconduct histories (drawn from SEC and FINRA records) of over a million investment advisers between 2001 and 2020 and found that following a merger, the firms in their sample did indeed see a significant decline in disclosures of employee misconduct: new regulatory disclosures dropped by between 25 and 34% following an M&A event. What’s more, their research indicated that having fewer employee disclosures is associated with higher firm value in more ways than one—it’s linked to lower firm closure rates, more assets under management, and being a more attractive target for a future acquisition.
In designing their study, Tookes and Yimfor opted to focus on investment advisory firms because of the particularly strict disclosure requirements in that industry—both on the firm and individual levels. The researchers pulled adviser-level disclosure data from the SEC’s Investment Adviser Public Disclosure website and FINRA’s BrokerCheck, collecting the misconduct histories of 1.2 million investment advisers between 2001 and 2020. They coded the disclosures according to FINRA’s 23 categories, which include customer complaints, allegations of fraud and negligence, excessive fees and commissions, and regulatory actions. The researchers tracked a subgroup of six FINRA categories that have been determined by other research to be the most strongly indicative of adviser misconduct, so that they could separately report results tied to all 23 types of disclosures and those linked to those six types considered to be most serious.
Tookes and Yimfor’s database of 13,455 investment advisory firms, draws from ADV forms filed with the SEC between 2001 and 2020. From these forms they extracted pertinent firm information, including number of employees and total assets under management. To fill out their database’s information on merger activity, they combined data from four sources: PitchBook, Securities Data Company (SDC), InvestmentNews, and Form ADV-W, a document filed by advisory firms when they withdraw their registrations with the SEC. The researchers’ final merger sample included 419 events occurring between January 2004 and June 2020.
Tookes says that, as a first step, she and Yimfor needed to determine whether there is a relationship between misconduct disclosures and firm value.
“We thought that these disclosures would be value-relevant, but no one’s really looked at it in the M&A context before,” she says. “So we started with that first level just to establish, is this something that is of economic relevance at all?”
Their findings suggest that it is. Advisory firms in their sample with fewer incidences of past misconduct per employee had significantly more assets under management (AUM); a one standard deviation increase in disclosures was associated with between 5.4 and 6.8% lower AUM the following year.
Firms with higher disclosure rates were also more likely to permanently shut their doors. A one standard deviation increase in misconduct predicts an increase in the likelihood of closure of between 8.3 and 9.8%.
With the connection between misconduct and firm value established, the researchers sought to explore how employee records affected M&A activity—both in terms of which firms were attractive targets of acquisition, and which firms were likely to pair up.
“There’s a traditional view that a good firm buys a bad firm, makes changes, and creates value,” says Tookes. “But there’s also the possibility that two firms with similar characteristics are just better matches.”
“If you’re the kind of firm that is tolerant of, or even encourages, a lot of misconduct disclosures, when it’s time to shut your doors, the likelihood of selling the firm is much lower.”
The researchers’ findings suggested that the latter pattern is actually the more likely one, with acquirers and targets demonstrating similar disclosure levels to one another—and acquirers actually having the slightly worse records than their targets.
Importantly, the researchers also found that high levels of disclosures seem to preclude firms from entering the M&A market at all.
“I think this is an underappreciated implication of having a culture where there are a lot of these types of disclosures,” Tookes says.
Finally, when the researchers looked for the presence of “misconduct synergies” post-merger, they found them to be not only present, but significant in magnitude—with disclosures of new disciplinary events decreasing in the combined firm by between 25 and 34%.
“The decline in new disclosure that we see post-merger could be consistent with careful selection of the employees that are leaving—or it could be a change in behavior following the acquisition,” Tookes says.
To find out which of these mechanisms was driving the results, the researchers analyzed the differences in separation rates between employees with no disclosures versus those with some.
Perhaps surprisingly, they saw that in firms that were the targets of M&A events, employees with misconduct records were, pre-merger, no more likely to separate from their firms than their counterparts without such records. After mergers, however, employees with recent disclosures were between 7 and 11% more likely to separate from combined firms than their colleagues without marks on their records. Employees with records in one of the six most serious categories of disclosures were also more likely to leave the new firms.
“We took a close look to make sure that it was really the mergers driving this, and for the subset of data where we have the exact merger date, we saw that all of this was happening within a month of the merger,” Tookes says. “So it seems that the firms are looking at their employees and thinking about who should stay and who should go.”
Interestingly, at acquiring firms, employees with disclosure histories were more likely to leave their firms than their colleagues with clean records both pre- and post-merger—but were less likely than their counterparts at target firms to separate from firms after a merger.
In other words, employees with records at firms that had been acquired were more likely to be on the chopping block than those with similar histories at the acquiring firms. Tookes points out that this is consistent with conventional wisdom, which would assume, for example, that an acquiring CEO would be more likely to retain the role than a target-firm CEO. Crucially, this research highlights who from the target-firm rank-and-file is most likely to move on post-merger. “It’s this one particular group—those with these disclosures,” she says.
Tookes sees important implications in the findings for both employees and firm owners. For their part, employees might find it useful to know that if they have a record of misconduct, the likelihood of sticking with their current job post-merger goes down. And owners, too, ought to understand the underdiscussed consequences of cultivating a firm culture in which misconduct disclosures are rampant, she says.
“We can now provide some data showing that if you’re the kind of firm that is tolerant of, or even encourages, a lot of these types of disclosures, when it’s time to shut your doors, the likelihood of selling the firm is much lower,” Tookes says. “That’s potentially an incentive to change the environment within the firm.”