The economics of pride

The economics of pride

There’s a common thread that runs through the expansive salaries, grandiose expansion plans, expensive foreign acquisitions and soaring stocks that so characterized the period between 2005 and 2008: hubris. By some calculations, Indian companies were involved in almost one foreign acquisition every day they worked (assuming they followed five-day weeks) in 2007. As companies falter in raising money to pay for these acquisitions—in the past weeks, two rights issues by companies involved in so-called big ticket acquisitions, Hindalco Ltd and Tata Motors Ltd, have had to be bailed out by promoters and underwriters, and a third, by another such company, Suzlon Ltd, has had to be scrapped—it is time to revisit these buys and see whether they make sense in the new economic context.

If hubris is removed from the equation, not all of these acquisitions work. To be sure, this isn’t something that applies just to foreign acquisitions, but acquisitions in general. One rule of thumb says that one in three acquisitions adds significant value—one neither adds nor destroys any significant value, while one actually ends up destroying value for shareholders.

Research by consulting firms is even less reassuring because it points to a lower rate of success. In 2004, McKinsey and Co. calculated that only 23% of acquisitions have a positive return on investment.

Another study, a June 2007 one by the Boston Consulting Group that studied around 3,200 transactions, showed that 60% of mergers and acquisitions between 1992 and 2006 actually destroyed shareholder value.

It’s too early to predict which way the large overseas acquisitions made by Indian companies will go, but they are quite likely to follow the same math.

The underlying numbers do not bode well for Indian firms. According to a report by PTI, citing data from audit firm Grant Thornton’s Indian arm, Indian companies acquired 240 overseas companies in transactions worth $32 billion in 2007.

Surely, 80 failed acquisitions costing at least $10.6 billion (not including what integration efforts cost) is too high a price to pay for pride? Or isn’t it?

Were overseas acquisitions of Indian firms driven by pride? Tell us at