The role of directors in acquisitions: directors should do more than is minimally required under the business judgment rule.

• Author: Lipman, Frederick D.

Directors are often requested to approve significant acquisition proposals, which typically are accompanied by rosy management projections which more than justify the purchase price. Directors should be skeptical of acquisition proposals which promise significant cost savings, major synergies and considerable growth potential. A recent example is the purchase by a specialty retailer of another specialty retailer for approximately $517 million in February 2006, with a press release claiming "significant growth potential,' enhanced "shareholder value," and "cost synergies," and the subsequent sale announced on June 2009 of that same company for approximately $75 million, which was claimed to be a "significant strategic step forward " to enable the acquirer to focus on its core of business.

[ILLUSTRATION OMITTED]

Director skepticism is more than justified by numerous academic and other studies which indicate that more than a majority of mergers and other acquisitions "fail," depending upon your definition of failure. Moreover, some have argued that the rise in CEO and other executive compensation is directly linked to the size of the organization, thereby providing a management incentive for mergers and other acquisitions and may be partially motivated by CEO "hubris."

In considering any significant acquisition proposal, directors must comply with the minimum legal duties under the business judgment rule and conscientious directors should do much more. Directors can satisfy their minimum legal requirements and nevertheless still approve an acquisition which is disastrous to shareholder value. Not unimportantly, directors who approve disastrous acquisitions are less likely to be invited to serve on other boards of directors.

For purposes of this article, we will assume that the management acquisition team does not have a demonstrated track record of having completed a large number of successful acquisitions, such as General Electric. We will also assume that the board is considering a significant merger or acquisition opportunity, with substantial cost to the company, that the proposed opportunity does not involve a change in control of the company itself, and that there is no conflict of interest because of the board or management involvement with the target.

At minimum

To comply with the minimum legal requirements of the business judgment rule in order to protect the directors from personal liability, the board should have several meetings to...