Land of Opportunity

1 June 2005

Lawrence White is the Arthur E Imperatore Professor of Economics at New York University's Stern School of Business. He talks to Steve Coomber about the challenges for European companies looking to expand into US markets and the state of play in terms of corporate governance.

Before we talk about the challenges facing European companies planning to expand in the US, there's an implicit assumption we need to deal with. Why would a European company want to move into the US?

LW: Well, for a start, the US economy is a moderately growing economy. It's not stagnant. It may not have the explosive growth of China or, more recently, India, but it is a stable, moderately growing economy.

Then there is the rule of law, an important component of the US economy. You don't have to worry that your assets will be grabbed overnight by some klepto-bureaucrat, or anything like that. And so I think the US is an attractive place to be thinking about doing a deal, to be buying a company or buying assets.

What are the main challenges facing the US economy at the moment?

LW: Inadequate domestic savings and large budget deficits, which have led to large current account international trade deficits and growing indebtedness to non-US claims holders.

"Good local legal counsel is invaluable."

And in the long run, there is the question of what to do about our ageing population and our social security, Medicare, Medicaid, growing claims on the federal budget and growing claims on the US economy.

We don't seem to have a good political process for dealing with these claims.

What about expanding in China, or elsewhere in Asia? Should it be the US first?

LW: Yes. With China you are getting in on not necessarily the ground floor, but on the lower levels of a rapidly growing economy. There is still a lot of risk and uncertainty that goes along with that rapid growth.

The growth in the US is going to be slower, but like I said before, you are not going to discover that your assets have evaporated, grabbed by some government agency somewhere.

So I'm an ambitious Euro-based company thinking of expanding and moving into the US. I can acquire another company, or I can do a greenfield site, correct?

LW: That's right. By acquiring an organisation, you are getting just that. You've got something that is already up and running. And that is a big plus. On the other hand, you are also acquiring a culture. That may or may not be a big plus.

Doing greenfield essentially is a slower process. But you are building it from the ground up, literally. And you get to shape it, and shape the culture, in a much more direct way.

So that is a more organic way of doing it?

LW: That is exactly the right word, organic. And under different circumstances, one is just as valid as the other.

Assuming you do want to expand in the US, what are the main challenges?

LW: It is one thing to make a great greenfield investment. It is another thing if you are acquiring a going concern. In the latter case, you're acquiring an organisation, complete with its culture.

As is true of any transaction, you must be sure, or at least extremely confident, that there is going to be a fit, a match, between the organisation you're acquiring and your existing organisation.

"The US is an attractive place to do a deal, buy a company or buy assets."

Too many mergers do not so much fall apart as turn out not to be worthwhile because of a culture clash or because the two organisations really don't mesh very well.

This is even more of a problem when you are buying an organisation where the value is not so much its physical assets but the human assets, the human capital – where, as some people have it, 'the assets walk out of the door every day at 5pm'.

If things go wrong, people just leave. The value of what you have bought has literally gone out of the door and isn't coming back. So you must do the due diligence, making sure that there is harmonisation between your existing organisation and what you have bought.

And how would you go about that? What due diligence needs to be done?

LW: An awful lot of walking around, talking, looking, smelling if you will, to get a sense of the organisation – not only what it produces but who it really is. How does it go about doing things? What values are important?

To some extent you can get that by looking at written materials, by looking at its annual reports and other documents (if it is a publicly traded company), and obviously by looking at its website. But I think, ideally, a lot of this just has to be a case of walking around and talking to people.

Is there any fundamental difference in European business culture and US business culture?

LW: This may be betraying my cultural bias, but I think there is a tendency in the US, certainly at medium-sized companies, maybe even at large companies, to have more of an entrepreneurial spirit and less of a bureaucratic environment. There is a greater willingness to take risks.

These are very broad generalisations, but I think they hold up. So I would say that that was one of the main cultural issues.

There is a lot of evidence to suggest that mergers don't create value.

LW: Over half do not.

So why do they go ahead? Where does the impulse to merge come from?

LW: I think it is twofold. Firstly, I think that CEOs tend to be optimistic by nature. Even if you tell them that over half of mergers are going to fail, CEOs will say: "Well, I am going to be the exception. I'm going to be the person to make it work."

"The growth in the US is going to be slower than in China or elsewhere in Asia."

A charitable term for it would be CEO optimism, but it could also be described as CEO hubris.

Another explanation is that CEOs don't really care whether mergers create value or not. All they want is to be the head of a larger organisation.

Being part of a larger organisation means more heads will turn and more invitations to places like the World Forum in Davos will follow. All they care about is size and bulking up, even if it doesn't create value for shareholders.

So whose role is it to put the brake on?

LW: That's where the board of directors, which represents the company and has a fiduciary obligation to its shareholders, comes in. This is where boards ought to be doing their job.

Unfortunately, all too often they do not; instead they simply roll over and go along with anything the CEO wants to do.

And presumably the CFO should be holding their hand up if they don't think the deal is going to create value?

LW: Yes, for sure.

So I should be thinking of the interests of my shareholders when I'm considering doing a deal in the US?

LW: That's right. The shareholders are going to be European, and the board has to ask: "Is this really in the interests of the owner shareholders?" That's the first question you ought to be asking.

So culture is one issue when you are doing a deal. What else?

LW: Say you are a bank thinking of buying a US bank. If you are going into a regulated market, make sure you understand the regulatory environment.

"Too many mergers do not so much fall apart as turn out not to be worthwhile."

This is partly a federal issue and partly a local state issue, whether it is New York, Illinois or California. Both the federal government and the state government have extensive regulatory powers. In some areas, however, it is entirely within the state domain.

Insurance, for example, is regulated by the state, and the federal government has no regulatory powers at all. In terms of securities, it is a mixed, shared phenomenon, so you have to understand the regulatory environment.

Again, it is partly a matter of due diligence and partly about getting yourself some good local legal counsel. Good local legal counsel is invaluable.

Still focusing on acquiring a US company as a means of gaining a foothold in the US, what other issues are there?

LW: Securities laws, particularly if is a publicly traded company. Where you are buying out the shareholders of the target company, getting good local counsel is, once again, extremely important.

What about Sarbanes-Oxley compliance?

LW: Sarbanes-Oxley applies to companies that have their shares traded on the US exchange. So you can buy a US company, buy a publicly traded company; in effect, if you buy out the shareholders, you don't have to be listed on a US exchange.

If you choose to have your shares listed in New York, either as part of this process or separately, then Sarbanes-Oxley will apply.

In this situation you are essentially subject to all the securities laws, whether it is adhering to US GAAP (Generally Accepted Accounting Principles), accepting insider-trading restrictions or certifying that your financials are correct and that you have direct knowledge that they are correct.

All that kicks in once you decide to be a publicly traded company in the US.

And there are other cost implications, such as healthcare and currency fluctuations?

LW: Right, and that is part of the due diligence. You need a good accountant to figure out not only the assets but also the liabilities you're taking on. As well as strictly financial matters, things like promises of healthcare may be part of the package.

With currency you've got a hedging issue. You are exposed to currency fluctuations that you would otherwise not be exposed to. And then you have to ask whether you want to hedge the risk. And hedging has a cost to it.

Can you think of any examples where European companies have done a good job expanding into the US? Or where things have not got so well? And why?

LW: If I think of banks, for example, HSBC has done particularly well. In 1992, it bought Marine Midland, a major New York state bank with an extensive branch network, and it has been able to use that as a good basis for expanding its franchise in the US.

"The board has to ask: 'Is this really in the interests of the owner shareholders?'"

By contrast, 15 years ago, Barclays fell on its face here. It acquired a local branch network, but it just couldn't seem to make it work. And eventually it had the wisdom to pull out.

A deal I was initially quite sceptical about was DaimlerChrysler. I didn't think that Daimler was really going to understand the US market. Sure, it knew how to make Mercedes cars and address the luxury end of the US market, but did it really understand the full breadth of the US automobile market?

With a combination of understanding and willingness to provide flexibility and autonomy to local executives in Detroit, the DaimlerChrysler deal has proved a good diversifying transaction for Daimler.

There has tended to be an offsetting – a smoothing-out effect. So when Germany was doing well, the US may not have been doing so well, and vice versa.

You may not want it to be that way. Management likes to be hitting the target everywhere all the time. But one of the values of diversification is this smoothing-out, the good offsetting the bad. And I have been pleasantly surprised at the DaimlerChrysler deal.