Christel Karsten will soon be obtaining her doctorate based on her research on the role played by lawyers in company acquisitions. It turns out they have significant influence: their personal style and personality play a large part in the final agreement and sometimes even the price.
Mergers and acquisitions (M&A) specialists from the legal profession hold a prominent position among top earners in the Netherlands. Based on Christel Karsten’s doctoral research, this is for a good reason. Her research shows that differences in the expertise of lawyers during the negotiation process work to the advantage of the party with the better lawyer. Karsten: “It appears that, when lawyers are drafting acquisition contracts, they do not limit themselves to codifying the legal elements of the economic circumstances of the deal. Their personal style and character traits - such as their willingness to take risks – have significant influence on the form of the final agreement, such as the number and scope of warranties and covenants. Personal characteristics of a lawyer can even influence the acquisition price. The more expertise a lawyer has compared to the counter party, the greater the advantage for his or her client.”
Karsten thought that lawyers could perhaps take offence from the conclusion that they take on a role that goes beyond simply defining the legal aspects of a deal. “I was surprised when they said ‘This is good news – it shows that we make a real difference’.” This reaction could be due to the benefits lawyers have from the race for better - and thus more expensive - lawyers. However, the advantage for clients vanishes when both parties have lawyers with similar levels of expertise. “Instead, lawyers could also work together to conclude the best contract for both parties combined. But, in practice, this probably only happens with acquisitions within a family”, says Karsten.
Karsten is both an economist and a law graduate. “I like to look at legal issues from an economics perspective. This makes contracts very interesting, because the parties are then effectively making the law that will govern their agreement. And acquisition contracts are prepared with a great deal of care, since they govern important transactions, often involving large sums of money.” There is a considerable amount of theoretical economic literature studying optimal contract solutions. Karsten’s research rather focuses on how contracts are applied in practice. There is little research on this, as the content of contracts is typically not observed. Karsten studied 151 agreements of private acquisitions, which were made available by a major Dutch law firm. She looked at whether the contracts purely reflected the economic deal circumstances, or whether they also reflected the influence of the individual lawyers.
The research consists of three components. First, Karsten analysed the contracts based on economic factors and their influence. These economic factors turned out to explain about one-third of the variation in the number of warranties and covenants in the contracts. The style of the law firm drafting the agreement also had significant impact, as did the individual lawyers. In the second component, Karsten looked for a relationship between the content of the agreements and the premium, the price paid. “More warranties means that the buyer enjoys more protection and this is associated with a higher price”, said Karsten. The third part of her research demonstrated the influence of the experience and education of individual lawyers. Karsten: “For example, a lawyer with more expertise can, when representing the buyer, introduce extra protection without accepting a higher price”. Moreover, the expert lawyer often submits the first draft contract with stipulations favouring his client. Third, when representing the buyer, a more experienced lawyer will accelerate the negotiation process. Conversely, when representing a seller, the lawyer will delay the process. Either way, the lawyer can influence the process for the benefit of his or her client.
Interestingly enough, Karsten found a negative correlation between a lawyer’s willingness to take risks and the number of warranties in the contracts they draft: the more a risk averse a lawyer was, the fewer warranties. An explanation for this, suggested by lawyers, is that a more cautious lawyer is less likely to add new clauses to a model contract. Karsten was also surprised at the high degree of economic content in the agreements. “I thought I would be looking at purely legal texts. I was surprised by the number of economic problems dealt with in the contracts. Mergers and acquisitions lawyers need much more financial and economic knowledge than I expected. For example, contracts frequently use clauses that are based on strong economic assumptions. Here I thought: with more in-depth economic knowledge, lawyers could perhaps achieve even better results. However, that is my personal view, I do not have the scientific research to back that up yet.”