Why Some CFOs Make Better M&A Deals

Despite the tremendous uncertainty and disruption caused by the persistent COVID-19 pandemic, global M&A volume exceeded $5 trillion for the first time in 2021, with many experts predicting that this current wave is only the beginning of a merger frenzy that could last for several years.1 The abundance of capital and the ever-increasing pressures to grow more quickly, become larger, and digitalize are driving companies to close deals with over-the-top premiums.

Overpriced acquisitions are hardly a new phenomenon: In the past two decades, U.S. public companies have paid, on average, a 36% premium in excess of the prevailing market value of the target company prior to the news of the takeover. But in the current hot market for acquisitions, the risk of overpayment is significantly heightened — and, according to our research, that’s a risk organizations might be able to mitigate by examining and changing power dynamics in the C-suite.

Numerous empirical studies have identified behavioral biases and misalignment between managerial and organizational interests as the main reasons companies overpay for acquisitions.2 In particular, CEOs, who are typically the primary decision makers in acquisitions, are often overconfident about their deal-making prowess.3 They tend to overestimate a target company’s intrinsic value and realized synergies, and underestimate the execution and integration risks. In addition, corporate chiefs might have a personal interest in gaining power, prestige, and additional compensation through acquisitions rather than through other major capital expenditures. In many cases, their decisions are not monitored closely because they have outsize influence on the acquisition process and their companies’ boards.

We hypothesized that the player ideally positioned to mitigate the risks of overpayment is a company’s CFO. Besides their fiduciary duties and core responsibility to monitor important financial decisions, they are also likely to have access to the same information as the CEO, unlike external directors, who might not be fully informed. But are companies with more powerful CFOs indeed less vulnerable to overpaying for acquisition targets?

To investigate this question, we analyzed 1,983 public company acquisitions made by 926 U.S. public companies between 1992 and 2019. Our findings support our main thesis that companies with more powerful CFOs pay smaller acquisition premiums. These findings complement the results of a recent study conducted in the U.K.4 However, given that CEOs have outsize formal power and discretion in the U.S. corporate governance system, we thought it was important to look beyond the traditional sources of formal power (such as an executive’s position in the C-suite hierarchy and/or having a seat on their company’s board) to understand what makes CFOs influential in acquisition decisions.

We found that the CFOs of companies that pay lower premiums for acquisitions have one or more of the following characteristics: They possess generalist skills, they demonstrate independence from the CEO, and they enjoy high status in the organization. These characteristics appear to confer three informal sources of power that we refer to as skill-based, relationship-based, and status-based power. Our analysis found the following.

Generalist Skills

Companies employing CFOs with general management skills paid 9% lower premiums for acquisitions than did those with specialist CFOs. Unfortunately, many acquiring corporations in the U.S. lack a generalist CFO. Around 40% of CFOs in large acquiring companies could be characterized as specialists — that is, they have deep expertise in traditional finance functions, such as accounting, controlling, budgeting, audit, tax, and treasury.

Our analysis indicates that in response to the governance and compliance demands of the Sarbanes-Oxley Act of 2002, and a tighter focus on financial risk management in the wake of the 2008 financial crisis, acquiring U.S. companies started appointing specialist CFOs, usually from their internal ranks, at a higher rate than they appointed generalist CFOs.

In addition to having an in-depth understanding of finance typically gained via higher education and early work experience, a generalist CFO has extensive experience in nonfinance roles and/or contexts, such as in different organizations, industries, or countries.5 Charles Holley, retired CFO of Walmart, and Tracy Travis, CFO of Estée Lauder, are two vivid examples of generalist CFOs.

Holley, who started his career as an accountant, gained significant business experience at Tandy, a retail and consumer electronics conglomerate. There, he served as a director of finance for its international operations, with responsibilities in managing greenfield startups, negotiating overseas joint ventures, and doing business abroad. His next position as the managing director in Europe provided him with operational experience running a company. According to Holley, his skills in finance, operations, and international business and his portfolio of experience prepared him well for his leadership roles in finance at Walmart.6

Travis has taken a similar approach to her career and has highlighted the importance of having a wide range of experiences to broaden her skill sets, particularly early in her career. She has also noted that all of her positions at five different companies in different industries gave her the opportunity to contribute to strategy.7

Both executives have explicitly attributed their effective relationships with the boards and CEOs of their respective companies to their in-depth understanding of their company’s strategy and operations, which they gained through their generalist skills.

Independence

The premiums companies paid for acquisitions were 18% lower when they had an independent CFO (that is, when the CFO was not appointed by the incumbent CEO). Nonetheless, 61% of CFOs were appointed by the incumbent CEO.

The CEO-CFO relationship is certainly complex and requires close collaboration between the two executives. It’s understandable that new CEOs usually insist on choosing their own executive team. We have witnessed this recently at Boeing, Ford, and Intel. The downside of this type of CEO-CFO relationship is that the CFO’s independence is often compromised.

A CFO appointed by an incumbent CEO is more likely to share the CEO’s preferences and have incentives to go along with rather than challenge or monitor the CEO’s major decisions.8 Such CFOs’ fiduciary duties and responsibilities for monitoring financial decisions might conflict with their loyalty to the CEO who hired them. Having been appointed by the incumbent CEO is therefore considered a significant indicator of a lack of sufficient independence.9

In acquisition decisions, CFOs who can maintain a sufficient degree of independence from the CEO are more empowered. They will likely be willing to voice different opinions based on realistic data, and to urge the CEO and the board to carefully evaluate the synergistic value and post-merger implementation costs in order to make more objective decisions. Holley worked with two different CEOs at Walmart who, respectively, took the helm after Holley’s appointment as the executive vice president of finance and as CFO. According to Holley, his most important role in M&A decisions as the company’s CFO was to be “the healthy skeptic in the room to balance the optimism that can lead some M&A leaders to push for deals that may not align to overall strategy or to build business cases not necessarily based on realistic numbers.”10

Our findings clearly show that CFOs can exercise more effective monitoring and control, and can substantially limit the sizes of the premiums paid for acquisitions, when they are not appointed to their position by the incumbent CEO. However, less than 40% of the acquiring companies’ finance chiefs can be characterized as independent CFOs.

High Status

The premiums companies paid for acquisitions were 7% lower when they had a high-status CFO (determined by a smaller discrepancy between CEO and CFO compensation). However, at most companies, there was a significant gap between CFO and CEO compensation.

The formal power of executives stems from their positions and job titles, but their actual status is related to their social standing and how they are valued within the organization based on their individual characteristics.11 Since such status indicators are not always directly observable, prior research has often used executive compensation as an objective indicator of an individual’s status, and we’ve done the same.12

High-status actors gain high levels of social esteem and influence; accordingly, high-status CFOs can garner support for their points of view from the board of directors and other likely stakeholders. According to Holley, this type of social influence is particularly vital for the CFO’s role in acquisitions. As he put it: “When it comes to M&A, CFOs also need to exercise influence and persuasion along with authority.”13

However, the compensation of a CFO is, on average, less than 40% of the compensation of a CEO. Indeed, over the past decade, the gap between the total compensation for CEOs and CFOs has increased to the benefit of CEOs. This suggests that the status of CFOs has been decreasing relative to the status of CEOs.

In summary, our findings show that when CFOs have established informal power in a company by virtue of their skills, their independence, or their status, the collective leadership will make better decisions about the very consequential matter of acquisitions. How, then, can boards and CEOs be more effective at hiring or developing CFOs with the right characteristics?

Where to Find the Generalist CFO

Large investment banks, diversified industrial groups (such as GE, PepsiCo, and P&G), and tech companies (such as Alphabet and Amazon) are among the best outside sources for companies seeking to hire generalist CFOs. In these companies, the finance function tends to have broader responsibilities, and finance professionals typically gain experience outside of the finance function and in different industries and regions. For instance, Ruth Porat, CFO of Google’s parent company, Alphabet, was previously the CFO of Morgan Stanley, the global head of its Financial Institutions group, and co-head of technology investment banking. Though she has spent most of her career in the finance industry, she has had numerous large and varied tech industry assignments involving M&A deals, IPOs, and crisis management. She has also held advisory positions in government and academia.

Similarly, Brian Newman was hired as CFO of UPS at a time when the company was planning to ramp up its capital spending to seize a larger market share from e-commerce and increase its same-day delivery services. Newman started his career as an investment banker and then joined PepsiCo, where he held a variety of finance, operations, and strategy leadership roles in Europe, Asia, North America, and South America. When he was recruited by UPS, he was serving as PepsiCo’s chief strategy officer and had recently launched its global e-commerce business.

There are strategic and cultural benefits to bringing fresh perspectives from outside the company into the higher ranks of finance leadership and ensuring that internal candidates for executive positions face outside competition. However, large companies should continue to invest in succession planning with a clear aim of developing a deep bench of generalist talent inside the company who are qualified to ascend to leadership positions in finance.

There are clearly many pathways to helping talented finance professionals develop into generalist CFOs. In general, finance professionals should be exposed early in their careers to different business functions, or to finance assignments that enable them to leverage their deep knowledge of finance across different product lines and geographical regions. These professionals should then be given job assignments with general management responsibilities that can broaden their perspectives and skills and provide them with a holistic view of the company’s markets, strategy, and operations.

Hugh Johnston, CFO of PepsiCo, is a good example of this kind of insider generalist. Except for three years in general management at Merck, Johnston has spent his entire career at PepsiCo. After studying finance and earning an MBA, he held a variety of positions in finance, M&A, and strategy at PepsiCo’s headquarters and at its North American snack and beverage businesses. He also served as the senior vice president of transformation and the executive vice president of global operations. Indra Nooyi, the former CEO of PepsiCo who recognized Johnston’s high potential early in his career, has discussed how she took him “out of his comfort zone in field finance” and involved him in corporate strategy.14

Cultivating CFO Independence

Catherine Lesjak had been working at HP for more than 30 years and served as the CFO for four years when Leo Apotheker took the helm. The two had starkly different opinions about whether HP should acquire the British software company Autonomy for $11 billion, a price that represented a 60% premium and 11 times the company’s revenue at a time when comparable companies were valued at around three times their revenues.

After telling Apotheker in private that she was opposed to the deal on the grounds that it was too expensive, Lesjak made an impassioned case against the acquisition before the board by explicitly stating, “I can’t support it. … I don’t think it’s a good idea. I don’t think we’re ready. I think it’s too expensive. I’m putting a line down. This is not in the best interests of the company.”15 Although she did not lose her job, Lesjak later said that after the board meeting, Apotheker told her she would be fired.16

While the CEO’s decision to proceed with the acquisition ultimately carried the day, the deal cost him his job when the company had to write off $8.8 billion of Autonomy’s value. His successor, Meg Whitman, assigned Lesjak to oversee acquisitions.

The HP case vividly illustrates how vital it is for CFOs to be able to act independently, particularly during the early stages of an M&A process — and how starkly their fiduciary duties and responsibilities for monitoring financial decisions may draw them into conflict with the CEO. We recommend that boards assume a leadership role in CFO selection in order to foster greater CFO independence. When a new CFO needs to be selected, the board should drive the process, including specifying the qualifications sought based on the company’s strategic needs — identifying candidates from both inside and outside the company, interviewing the finalists, and making the final hiring decision. Of course, the CEO’s input is important, given that every working partnership requires a healthy degree of personal compatibility, but we recommend that they not direct the process. Since the CFO is directly accountable to the board and shareholders, a board-driven CFO succession will also give the right signals to all parties that the board, not the CEO, is the primary decision maker about the CFO’s tenure and career prospects at the company.

The CFO must wear the hat of an independent facilitator and monitor of the company’s M&A decision-making processes and strategy for growth and value creation. At the same time, they must closely partner with the CEO in the subsequent stages of the execution of a deal and the integration of the target company. Moving between these roles can be complicated. However, CFOs who are appointed, guided, and evaluated within a board-driven framework should be more willing and able to make these role transitions.

Therefore, we recommend that the boards of companies that are heavily engaged in M&A activity provide clear guidance to the CFO about performance expectations for the different stages of the M&A processes. We strongly advise boards to diverge from prevailing practices, which do not sufficiently differentiate the performance indicators of the CFO from those of the CEO in M&A processes and typically give outsize authority to the CEO in evaluating and rewarding the CFO’s performance.

Does the CFO Need a Status Upgrade?

Nooyi, who retired from her CEO role at PepsiCo in 2019, described her relationship with Johnston, the CFO since 2010, as one of virtual equals in a 2016 interview: “We argue and fight about lots of issues. We shut the door and we debate. … When we come out to the executive committee, we have to show a level of unity. … It’s very important that the CEO and CFO see eye to eye — and we discuss things ahead of time. … Hugh and I can finish each other’s statements. That is why we are able to have the constructive fights and the constructive dialogues leading to a better outcome.”17

Nooyi implied that despite her celebrity CEO status in the business world and considerable power in the company, her power in the C-suite was moderated by a high-status CFO. Johnston gained social influence both from his long experience and reputation at PepsiCo, and his positions as a board member at several organizations and his chairmanship of the audit committee at Microsoft. He also frequently appears on prominent business media channels and has regularly been ranked among top CFOs. Johnston’s high status has clearly helped to create more egalitarian power dynamics between the CEO and the CFO, which enables open communication and healthy debate between the executives on important issues. It also improves the chances that the CFO’s strategic advice will be taken seriously and valued by the company’s leaders and directors.

However, based on recent empirical research on CEO-CFO relationships in U.S. companies and our study’s findings, it appears that the CEO-CFO relationship at PepsiCo is more the exception than the norm.18 We therefore recommend that boards elevate and leverage the status of the CFO to create more balanced power dynamics between the two top executives, which can eventually lead to a more objective M&A decision-making process.

A large gap in compensation between the CEO and other senior executives is probably the most visible sign of differences in their status and organizational influence — and one that boards of acquiring companies might be mindful to minimize in the case of the CFO in particular.19 We can infer from our research and anecdotal evidence that highly valued CFOs demonstrate more than deep knowledge and strong leadership in the finance function. They also have substantial management experience and a successful track record beyond the finance function, a strong relationship with the company’s board, broad external networks, and external visibility. The appointment of a CFO with a combination of some of these characteristics can help ensure that the CFO is able to gain the social influence they need to balance the CEO’s power in the C-suite, which may, in turn, improve the quality of the company’s M&A decision-making.

External directors must foster a strong relationship with the CFO in order to leverage and enhance that executive’s status. In practice, this may be difficult for many corporations to achieve, since the CEO formally governs the relationship of the CFO with the board and largely determines the schedule and the agenda of the board-CFO interactions. Therefore, we recommend that the company’s external directors take control of their relationship with the CFO. They can, for example, invite the CFO to attend board meetings when important strategic matters, such as growth and M&A strategies, are being discussed. They can also more actively involve the CFO in board activities, such as board retreats or director lunches, before annual shareholder meetings. Furthermore, since serving on outside boards as a director typically elevates the status of the CFO, external directors can support CFOs in cultivating their external networks and might be able to help them land a seat on the board of another company or an organization to which they are connected.

CFOs imbued with greater social influence are likely to have greater control of the M&A process from the outset, and to find it easier to voice their concerns and challenge the assumptions about the value creation and the price of the deal. As Holley observed: “By leveraging their influence with business leaders and the expertise of their finance team, CFOs can help keep M&A on strategy and avoid chasing ‘shiny balls’ that may look good on paper or in headlines but fail to achieve their intended outcomes.”20

Overpaying for acquisitions has long been a problem for corporations seeking to expand through M&As, and our research shows that power dynamics in the C-suite are a significant factor. When companies bolster the CFO’s informal power, they can mitigate the risk of overpaying for the target company. Corporate CFOs with generalist skills, sufficient independence from the CEO, and high status will be more likely to have the levers needed to address the weaknesses that make companies vulnerable to overpaying for acquisitions, such as managerial agency problems and behavioral biases in M&A decision-making.

As companies have faced increasingly complex and volatile environments disrupted by digitalization and the COVID-19 pandemic, as well as urgent demands from a broader group of stakeholders for sustainable value creation, the responsibilities of CFOs have become more strategic, more dynamic, and broader in scope. The lessons we gleaned from our research can provide companies with guidance to create more optimal corporate governance systems in which CFOs can carry out their dual roles of both partnering with CEOs and providing expert, independent guidance to boards making important strategic decisions.