The Illusion of Objectivity: How Deal Incentives Skew Due Diligence Outcomes
This article critically examines the inherent biases within the due diligence process, particularly in mergers and acquisitions. It argues that due diligence, while ostensibly designed to uncover problems, often serves to validate pre-existing decisions due to the strong incentives of all parties involved to close the deal. Internal audit and assurance professionals should be aware of these structural limitations and the potential for scope manipulation, as they can significantly impact the reliability of due diligence findings and the overall risk profile of a transaction.
The Inherent Bias in Due Diligence
The article highlights a critical flaw in the common perception of due diligence: while it is presented as an independent and rigorous examination to identify problems, its actual function is often to support a decision that has already been made. The author argues that the very act of commissioning due diligence is a commitment signal, indicating that the acquiring party has largely decided to proceed with the transaction. This pre-commitment creates a powerful incentive structure where all stakeholders—from bankers and legal advisors to the deal team—are aligned towards closing the deal, rather than objectively assessing its risks.
Scope Manipulation and Unseen Risks
A significant takeaway for audit and assurance professionals is the concept of scope manipulation. The article asserts that the scope of due diligence is not independently determined by the advisors but is defined by the deal team. This means that due diligence reports will only find what they were asked to look for, potentially overlooking critical issues that were not included in the scope. The author provides an anecdote of an acquisition where the ultimate failure was caused by an issue explicitly outside the due diligence scope, demonstrating how this limitation can lead to significant, unforeseen problems.
Implications for Internal Audit and Assurance
For internal audit and assurance functions, this analysis underscores the need for a deeper understanding of the context surrounding due diligence reports. It's crucial to recognize that the independence of the due diligence process is often compromised by the commercial and strategic pressures of the deal. When reviewing such reports, professionals should critically evaluate:
- Who commissioned the due diligence and what were their underlying motivations?
- How was the scope defined, and what potential material risks might have been intentionally or unintentionally excluded?
- Are there any structural incentives that could have influenced the findings or the emphasis placed on certain issues?
By asking these questions, internal auditors can provide a more robust and realistic assessment of the risks associated with a transaction, moving beyond the surface-level findings of a potentially biased due diligence report.
Read more
