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Introduction

Great Men, Not So Great Decisions

MORE OFTEN than any of us might care to admit, the course of human affairs relies on great judgment. Even in this age of abundant data and rocket-science analytics, many, many decisions force people to draw on their accumulated wisdom to make the right call. Sometimes that's because the absolute right answer can't be known; the question at hand relates to a future too full of uncertainty. Other times, the optimal solution could be determined based on accessible information, but the urgency of the situation means it can't be assembled in time. In still other cases, conflicting values come into play and the trade-offs defy easy quantification.

As societies and their organizations experience ever-accelerating rates of change, we suspect all these conditions will apply more often, and more decisions than ever will come down to judgment calls.

The question is, how can we make sure those calls are made well? Is it enough to choose smart leaders who seem to have their people's interests at heart, and trust their wisdom?

A look at one particularly pure example of that approach, firms' pursuits of mergers and acquisitions (M&A), suggests the answer is no. This is a realm where we see top leaders of enterprises making the highest-stake decisions with the least input from others, and the results hardly vindicate the process. Estimates based on reliable studies indicate that between 50 and 70 percent of M&A deals fail to realize their goals, and many destroy value outright. As we embark on a book about how good judgment happens in some situations, it might be useful to reflect on why, in M&A decision making, it so reliably doesn't.

Take, for example, the 2000 decision by Time Warner CEO Jerry Levin to merge his company with America Online (technically a purchase of Time Warner with inflated AOL stock). While AOL had been a high-flying Internet access company in the 1990s, by 2000 it was already beginning to look stale. But Time Warner was a media conglomerate without a lot of online assets, and the prevailing notion was that it had to have Internet-related businesses to compete.

When Levin began to explore options with AOL's founder and chief executive, Steve Case, however, he'd had little discussion with the rest of his management team. By reputation, Levin was something of a loner to begin with. He was also wary about heavy involvement of his board in the decision, in part because of tensions with board member Ted Turner, whose company Time Warner had acquired in 1996. Levin and Case eventually concocted a $164 billion deal, the largest in history at the time. Having arrived at terms satisfactory to himself, Levin prevailed upon his board, persuading even Turner, to support the acquisition.

Normally, in volatile markets like those during the dot-com boom, deal makers would put a “collar” on the deal so that one party could back out if the other's stock declined too much. And AOL's stock was tanking on almost a daily basis before the deal closed. But Levin neither sought nor obtained a collar.

Indeed, even as the shares of the combined company began to decline in value almost immediately after the deal, Levin wore his missing collar as a badge of honor and commitment. In an interview ten months down the road—by which time AOL's stock had already declined 38 percent—Levin was asked about the matter and gave this explanation:

With a collar, the implication is that you are really not sure—your commitment to the valuations is somewhat insecure, and you need this kind of protection. I wanted to make a statement that I believe in it. It … means a total commitment to the deal come hell or high water.¹

No doubt Time Warner shareholders were greatly comforted by the leader's unwavering faith. But by 2002, the combined company declared a $99 billion loss from a write-down of its goodwill value—at that point the largest corporate loss in history. Levin was forced to resign in 2002, with Ted Turner's calls for his head ringing loudest. AOL Time Warner never thrived with the decline in AOL's fortunes, and the company's stock value decreased from $226 billion to as low as $20 billion. Eventually AOL was spun off as a separate company in 2009.

Once that happened, even Levin got the picture that he had used poor judgment. By 2010, on the decade anniversary of the deal, he admitted it:

“I presided over the worst deal of the century, apparently, and I guess it's time for those who are involved in companies to stand up and say: you know what, I'm solely responsible for it,” said Mr. Levin. “I was in charge. I'm really very sorry about the pain and the suffering and loss that was caused. I take responsibility.”²

Better late than never, we suppose.

Bad choices about acquisitions and what to pay for them get egged along by ego, pressures to grow, and the well-known phenomenon of “deal fever.” But it's interesting to note that decisions made in isolation not to deal can be just as poorly judged. Consider the acquisition of Yahoo! by Microsoft that never happened.³

By 2008 Microsoft had been circling Yahoo! for several years for the same reason Jerry Levin had wanted AOL: to add some Internet assets. Also like AOL, Yahoo! wasn't quite the catch it would have been earlier; the exclamation point in its name seemed sadly inappropriate. By the time of the Microsoft offer, the company's stock was trading at 44 percent below its fifty-two-week high, and Yahoo! had recently shed 10 percent of its staff.

By all accounts (except apparently one), the Microsoft offer was a heck of a deal for Yahoo!. On February 1, 2008, Microsoft proposed a friendly takeover of Yahoo! Inc. for $31 per common share—a $44.6 billion offer. The proposed price was 62 percent above the previous closing price for Yahoo!.

In this story, the Jerry Levin role was played by Jerry Yang, a cofounder of Yahoo! who had taken over as CEO a few years earlier. Yang, who was obviously enamored of the company he led, turned down the $31 offer in discussions with Steve Ballmer, Microsoft's CEO. Microsoft upped the offer to $33 a share—a 70 percent increase above the closing price preannouncement.

Yang, however, felt that the right price for the deal was at least $4 per share higher. He was so confident in the price he was holding out for that he didn't put either the $31 or the $33 offer to a proxy vote. Why ask the owners of the company what their investment was worth?

On May 3, 2008, Ballmer pulled the offer, which was probably his smartest move. Yahoo! stock slid, and has never found its way back out of its trough. The only event that lifted it significantly after the Microsoft offer was the announcement that Jerry Yang was being replaced as CEO by Carol Bartz (who was herself fired in 2011). Just after assuming the job, Bartz was asked in a CNBC interview whether she would have taken the Microsoft offer. “Sure,” was her reply, “you think I am stupid?”⁴