In conjunction with the retention of key leadership and talent – total rewards is a critical aspect in the valuation and realization of deal synergies
The design and the execution of the rewwards packages for key talent determine the likelihood of their retention in the new organization
Sharad Vishvanath, Principal, Aon Hewitt M&A Solutions and Jaidev Murti, Senior Consultant, Aon Hewitt M&A Solutions, disclose the strategic importance of Total Rewards successful people integration in an M&A deal
The past decade has seen unprecedented Mergers & Acquisitions (M&A) activity globally. Our research indicates that we are at the beginning of another boom cycle (the last one peaked in 2007). In fact, as per published research, the first quarter of 2011 witnessed the highest M&A activity (~USD 800 Bn) since 2007 and if, as likely, sustained at the same level, will surpass the 2007 levels this year. Another key shift we have observed is that upto 25% of the total deal flow is now in APAC or from APAC firms. This trend is projected to strengthen in the near future with a bias towards increased inbound activity by MNCs (87% firms indicated increased APAC M&A activity) and outbound M&A activity by Asian corporations. That is a significant indicator of the levels of M&A activity and thus the complexity that firms coming into or APAC firms acquiring outside will face, given their relative inexperience with M&A and integration challenges. Couple this with the increasing trend of integration being a stated strategy for many M&A deals, and it creates a perfect storm of challenges that can risk both the short and long term success of these deals.
As the global focus on inorganic growth continues, it is interesting to examine some of the key people and human capital factors that can influence the realization of the deal objectives and synergies in a transaction. In a research that was recently conducted by Aon Hewitt across 103 global companies, the number one factor that assumed importance in the minds of acquiring companies was “Total Rewards”. In conjunction with the retention of key leadership and talent – total rewards is a critical aspect in the valuation and realization of deal synergies.
We also looked at the difference in practices and execution between the self confessed “overachievers” & “underachievers” on deal success which throws light on some interesting facts.
As an example, the design and execution of the rewards packages for key talent and leaders can often determine the likelihood of their retention in the new organization. With nearly three quarters (71%) of organizations providing a retention package to targeted employees in the acquired firm, 57% of these companies continue to lose critical employees at the same or a higher rate than the non-critical staff. Given these rates of key talent loss, it is easy to understand that less than 50% of the deals have successful outcomes, and they actually realize the deal objectives and synergy targets that were originally forecasted.
Total rewards is typically defined as the package of monetary and non-monetary elements of value delivered to employees to drive performance. Though, for the purpose of the study, total rewards was defined as compensation and benefits programs only, excluding levers such as organization culture, work environment, etc.
Core DNA elements that firms need to embed a total rewards perspective
Aon Hewitt research shows that traditional elements of rewards—pay benefits and stock awards—are no longer the differentiating factors for organizations. And with employee trust and engagement at a low, focusing on the total “package” of pay and rewards—and not just the pay—provides acquiring companies with a more compelling platform to engage and retain key talent.
In the context of a merger deal, there is an even greater opportunity and need to address total rewards—both for incumbent employees and new employees from the acquired organization. It is insightful to note that even with “total rewards” cited as a top human capital lever of deal success, only half of the companies indicated their total rewards initiatives as effective. It is clear that the opportunity exists for better leverage of a total rewards lever during deals.
There was a clear distinction in the total rewards strategy of overachievers versus Underachievers. In fact, the research corroborated this by demonstrating the ability of overachievers to retain critical talent at a rate two and a half times (2.5 times) higher than that of underachievers due to a rigorous focus on total rewards amongst other aspects.
So, what are these DNA strands that a firm should weave into its M&A strategy?
DNA Strand #1: Overachievers are more laser-focused on key total rewards liabilities while doing due diligence
There is a wide range of human capital considerations in due diligence. It includes the review of leadership and key talent, assessment of total rewards liabilities and comparability of designs, cultural analysis, and assessment of compliance. However, overachievers not only spend a higher amount of time on total rewards liabilities and costs in due diligence, they are laser-focused on specific liabilities during this phase.
As opposed to evenly spreading their efforts across total rewards elements in due diligence, overachievers put additional efforts against (a) employment contracts as well as change in control and severance agreements; (b) executive compensation; (c) executive benefits/perquisites; and (d) defined benefit retirement plans. These areas are most likely to create total rewards liabilities, and overachievers give them the appropriate extra effort to ensure that their deal model has captured these liabilities and costs.
DNA Strand #2: Overachievers look at total rewards in the aggregate
Increasingly, leading companies are managing total rewards as an integrated portfolio and in alignment with the broader employee value proposition. When we examined overachievers and underachievers, we found that overachievers consider total rewards in the aggregate when negotiating the purchase agreement and determining their go-forward total rewards approach.
For example, 67% of overachievers most often agree to provide compensation and benefits that are substantially similar in the aggregate to the existing target company plans for a stated period after closing (compared to 50% of underachievers). They are also more likely to require this commitment for their employees in a divestiture situation (69% of overachievers vs. 41% of underachievers,). Further, 63% of overachievers, compared to 34% of underachievers, consider design changes “across all total rewards programs” when integrating acquired organizations.
DNA Strand #3: Overachievers make performance-based retention a key element of total rewards in acquisitions
Organizations have not lost sight of the importance of leaders and critical talent in driving deal success. In fact, respondents to our study indicate a strong commitment to retaining key employees with 70% of them always using personal communications and/or conversations with acquirer leaders in these efforts and 71% typically providing a retention package to acquired employees. 66% of all respondents identify addressing and implementing retention plans as one of the top three actions in total rewards contributing most significantly to acquisition success.
One striking finding from the study results is the basis for payment of retention incentives. Years ago, the payment of retention incentives was invariably based on the passage of time—stay with the combined organization for a period of time. The data now shows that at almost all levels, retention incentives include some element of post-closing performance or achievement of deal objectives as a partial basis for payment.
What drives the success of overachievers is how they structure their retention package. Not only do overachievers tend to develop a special retention vehicle using a mix of cash and stock above the individual contributor level, and uniformly pay retention within one to three years (and not beyond), they also measure their success more deeply in the organization - below the executive level, with a combination of time and achievement of post-closing metrics.
DNA Strand #4: Overachievers are more equipped, more focused and more effective
Overachievers ensure they have capable and adequate resources (internal or external) to support total rewards during the life cycle of a deal and drive their effective execution. While most organizations in our study indicate relevant experience in different aspects of total rewards in both acquisitions and divestitures, 72% characterize capabilities to address total rewards challenges in M&As as “inexperienced” or “building capability.”
In our study, overachievers not only indicated higher levels of experience for negotiating total rewards approaches when compared to underachievers, they were more than twice as effective at executing these initiatives in transactions. Perhaps, more importantly, overachiever organizations were most effective at retention planning, addressing retirement benefits, and addressing executive compensation plans—all consistent with the areas of focus in due diligence provided in DNA Strand #1.
The emerging market perspective
The DNA elements outlined are critical for, and very applicable to, emerging markets like India and China as well. But there are nuances that are pronounced due to the dynamic nature of these markets. Let’s examine a few of the emerging market’s DNA strands.
Firstly, retention of talent in emerging markets is even more critical, given the severe talent crunch and rising cost of talent. An interesting insight is that, most successful firms look equally closely at the “mighty middle” or “solid performers” rather than just high performers. This results in two specific strategies. One, their retention strategies have to also focus on the non-cash lever of “career and growth” without which pure cash based retention levers can easily be bought out in the market especially if the talent is disengaged with the merger story. Two, successful firms will have an articulated retention strategy and fanatical execution for the larger ~ 50% of their solid performer population as well, because attrition at any level can be crippling for the growth strategy, which is inevitably a key rationale for the deal.
Secondly, our research indicates that in deals involving family-owned businesses in emerging markets, successful firms spend a lot more time and give more attention to rewards compliance and liability issues than in normal deals. This is critical as sometimes the “operating in the grey area” factor for such targets can have significant compliance and monetary consequences.
Thirdly, in emerging markets, executive compensation design though not always complex, is very important, given the leadership talent crisis in these markets (Aon Hewitt research predicts a 75% shortfall of leaders in these markets). Thus, successful firms, who are overachievers, spend a lot of time in the design of executive compensation with sometimes granular details.
Our research clearly illustrates the strategic importance of total rewards as a critical aspect of M&A activity. By being able to identify material liabilities in due diligence and drive better retention of employees through total rewards designs and retention packages, overachievers have a clear advantage over their counterparts. In a nutshell, overachievers are simply better at managing their money, saving it in due diligence through liability identification and in integration through holistic, performance-driven, cost-based designs and also spending it through well-designed, timely stay-and-play retention approaches. This leads to a retention rate and transaction success for overachievers, that is materially higher than that of their competitors.