Future-Casting Culture in M&A Due Diligence

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Originally published in NAVEX Global's Top 10 Risk & Compliance Trends for 2020 eBook.You can download the full eBook here


Despite global economic uncertainty, M&A activity is expected to accelerate in the years to come. According  to market research in Deloitte’s “The State of the Deal: M&A Trends 2019,” 79% of corporate executives expect M&A deals to increase over the next 12 months. This is up from already vaulted numbers in 2018.

Along with an uptick in deal volume, corporate executives believe M&A will be defined by  higher dollar  amounts and more diversity of targets. Technology acquisition has reigned supreme as of late, but companies are expecting to pivot to using acquisition as a means to expand their customer bases into existing markets as well as diversify product and service offerings.

As M&A due diligence continues to mature, I believe we will begin to close the gap of cultural alignment and assessment. Here practices will evolve to accurately assess a target’s corporate culture today and, more importantly, tomorrow.

While M&A outlooks are optimistic, there is a data point that should not be glossed over: “About 40% of survey respondents say that half their deals fail to generate the value they expected at the onset of a transaction.” That is a significant failure rate. Failures can often be tied to unfavorable economic or market forces or a change in the regulatory landscape, which can curtail initial plans for expansion or integration. However, one aspect for failure or success is often downplayed – culture. One in five corporate and private equity buyers highlighted “not achieving cultural alignment” as a limiting factor  of success. I believe we will see this change in the years to come.

Using Cultural Insights to Maximize M&A Deal Success

At its base, M&A due diligence is an exercise in determining valuation and actualizing liability. Risk and compliance professionals often focus on the latter, but can also play a part in future valuation and deal success when the right intelligence is uncovered.

Most M&A due diligence processes perform a thorough evaluation of the compliance program, its policies and procedures, its code of conduct, and its ethics and compliance training curriculum. Just as in an external audit of your own internal compliance programs, no stone should be left unturned – no program outcome left unreviewed. This process generally results in a narrative for liability to be weighed against risk tolerance; however, as deal success rates indicate, there is room for improvement.

As M&A due diligence continues to mature, I believe  we will begin to close the gap of cultural alignment and assessment. Here, practices will evolve to accurately assess a target’s corporate culture today and, more importantly, tomorrow.

Steps for Organizations to Take

Go Beyond Substantiated Reports to Find Unfiltered Information Streams

Corporate culture is hard enough to evaluate in our own organizations, let alone trying to assess the culture of an entirely different company. This is where organizations can turn to aggregate, unfiltered internal hotline reporting data for a complementary stream of due diligence intelligence. And I’ll emphasize “aggregate” and “unfiltered.” Internal whistleblower hotline and incident management data is likely already part of most M&A due diligence processes, but this is usually relegated to substantiated case reports.

According to NAVEX Global’s 2019 Ethics & Compliance Hotline Benchmark Report, 42% of internal reports were substantiated. While those reports, cases and resolutions are important, I also want insight into the 58% of reports that were not substantiated. Who made them? What part of the organization did they come from? Why were they unsubstantiated?

This is where we get into the future-casting state of   due diligence. The facts we could derive from process review and the substantiated facts we could see from aggregate incident management records may help determine the target’s corporate culture and risk at  time of purchase. Corporate culture, however, can also inform future risk. One could get a hint at that culture through substantiated case files, but it is a curated view of the culture prepared by the target. That is not to say there is anything suspicious about that curation, but it will always be an interpretation. And I am positive that compliance officers out there prefer to make their own interpretations.

Better Define Cultural Valuation Based on Speak-Up Track Record

Use aggregate hotline data to get a better understanding of what a speak-up culture is like at a target. Do employees feel empowered to report misconduct? Are they properly trained on values and expectations for the corporation? Does the company really know what risk looks like, and is the culture equipped to support enterprise-wide hygiene? Or is their potential cynicism or distrust brewing beneath the surface?

Aside from the cultural intelligence that aggregate hotline data provides, the volume of reports can be just as informative. Recent research out of George Washington School of Business provides empirical evidence that internal hotline reporting activity and business performance are positively correlated. While the long list of performance indicators included in the research is impressive, I am most intrigued by the finding that, “firms that actively utilized their hotlines received, on average, 46% fewer negative news stories than businesses with low or infrequent internal reporting use.”

The last thing one would want during a post-acquisition phase is a reputation-damaging news cycle, so the first thing a compliance officer should be looking at is whether they can have a clear-eyed view of the future liability embedded within the corporate culture they are integrating.

M&A activity shows no signs of slowing in 2020 or in the years to come. To  keep pace confidently, organizations will have to prioritize cultural alignment and assessment and explore new ways to do that effectively. Internal whistleblower hotline data is surfacing as one of the most elucidating information streams we have at our disposal when assessing and cultivating our own corporate cultures. Now that we are seeing the predicative benefits of that data, there is no reason compliance should not be incorporating it as a standard part of M&A processes, in addition to just “digging” at substantiated reports.

 

Chat with a solutions expert to learn how you can take your compliance program to the next level of maturity.



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