Case Study 17

Possible Acquisition Not Subject to Sufficient Due Diligence

Intended audience: Professional Accountants in Business


You are a non-executive director of X Ltd, a listed company. You joined the company 8 months ago and viewed yourself as very fortunate to obtain a role with this rapidly growing biotech company. The company has been performing well and the most recent trading update statement was met with much approval by market analysts and the company’s share price rose accordingly. On the face of it, everything appears rosy. Mr A, the Chief Executive, was recruited by the current Chairman two years ago and by all accounts is a big favourite with the analysts. The two of them had previously worked together at a smaller listed company.

However, the more time you spend at the company, the more you become concerned over the way it is run. The Chairman appears to be the Chief Executive’s “poodle” and the board is actually run by the Chief Executive. The roles of Chairman and Chief Executive, although held by separate individuals, are effectively held by the same individual. Furthermore, there is a lack of debate at board meetings, which in your eyes appear to be more of a rubber-stamping exercise rather than a forum to have some serious strategic discussions. You have heard rumours that your predecessor “resigned” because he was one of the few individuals to have challenged the Chief Executive. However, the official line is that he was a trouble maker and did not fit into the balance of the board. You also have concerns that the board papers are only sent out 5 days before the meeting, which in your opinion is not sufficient time to allow yourself and the other non-executives to thoroughly review them.

At the next meeting of the board you are very surprised to find out that the company is in discussions to purchase a major competitor based in the US. In the board papers this was only briefly mentioned and it appeared as though X Ltd was merely looking at a number of possible acquisition targets based primarily in the Asia region. You are surprised – both by the location of the target company – but even more by what it is likely to cost.

The Chief Executive proceeds to give a powerful presentation on the pros and cons of the proposed deal. His talk consists of an overview of the target company, the likely cost of acquisition and strongly highlights the benefits of “doing the deal”. Although mentioned briefly, the risks attached to the deal are significantly downplayed. The price mentioned is in the region of SGD250 million, although the price will be paid in US dollars which is a very significant sum for X Ltd and which confirms your earlier fears. Although X Ltd has performed very well in recent years, in order to finance this type of deal, considerable debt capital will be required and the company’s level of gearing will be significantly increased. You have to hand it to the Chief Executive though, he is very enthusiastic and it would take a brave person to question what is clearly his pet project. It has always been clear that he wants to be in charge of a much larger entity.

The problem though, as explained by Mr A, is that there will not be time to do a great deal of due diligence, because: “The value of the SGD is falling against the US dollar by the day.”

A fact he repeats to give added impetus: “By the day, and the longer we as a board spend dithering, the higher the price will become”.

The Chief Executive then issues his rallying call to the board: “This is the time for this board to show its mettle and deliver true shareholder value.”

The Chairman applauds loudly, followed by the rest of the board. That is from everyone except you – and this is noticed by all of the other board members.

It should be the Chairman who addresses you, but you are not surprised to find that the first person to question your apparent lack of enthusiasm for the proposed deal is Mr A.

“You appear rather quiet. At this moment in time there is no room for non-believers on this board. We stand at the most crucial point in this organisation’s history and time is of the essence.”

Mr A then adds ominously: “Are you with us?”

What do you do now?

Analysis of Scenario: What are the readily-identifiable ethical issues for your decision?

I. For You Personally

Can you allow this proposed acquisition to go ahead without raising your concerns? Everything is happening very fast and it appears as though the board has not had sufficient time to analyse the proposed costs and benefits of this deal in detail. Could the company not purchase a currency option or similar type instrument which would remove the risk of the price increasing due to currency fluctuations? This would then allow time for the deal to be considered in greater detail and further due diligence to be undertaken if required. Obviously, there would be a cost attached to purchasing such an option. However, the costs of an ill thought through acquisition would be significantly higher.

You appear unhappy with the performance of the Chairman. Have you considered raising your reservations with the senior independent director? Additionally, have you raised your concerns at the late delivery of the board papers?

The annual board appraisal process will also provide you with the opportunity to raise any reservations you may have with the manner in which the board is run.

If the board decides to go ahead with this acquisition without further due diligence etc, should you ensure that your reservations are minuted? Where would this leave you if the board does decide to go ahead?

II. Who are the key parties who can influence, or will be affected by, your decision?

‘You’; the other board members; the shareholders; the employees; and potentially other stakeholders.

III. What fundamental ethical principles for accountants are most applicable and is there an apparent conflict between them?

-          Integrity: Can you allow this proposed acquisition to go ahead without raising your concerns and asking for additional time for the board to consider this proposed acquisition in more detail?

-          Objectivity: You are fairly new to the company. Whilst you were obviously pleased to get this role you must ensure that you properly challenge the board as and when necessary.

-          Professional behaviour: This is a major strategic decision for the board – can you satisfy the criteria as to why you were appointed to this role if you do not voice your concerns and encourage the board to have a full and proper debate and advocate that all board members are given sufficient time to properly assess the available information on the target company?

IV. Is there any further information (including legal obligations) or discussion that might be relevant?

What due diligence has been performed on this proposed acquisition?

This case study was published by the Technical Policy Board of The Institute of Chartered Accountants of Scotland (ICAS), and adapted by the Institute of Singapore Chartered Accountants (ISCA) with the permission of ICAS.