Governing Board’s Role in Mergers and Alliances: New Issue of Great Boards

Healthcare reform is expected to drive a new round of mergers, acquisitions, and strategic alliances among hospitals and other providers.

As a white paper last summer from The Governance Institute noted, “Since the recent passage of healthcare reform, nonprofits have demonstrated much more interest in achieving scale. Also, a number of free-standing hospitals and small hospital systems are questioning whether they can thrive post-healthcare reform, without becoming part of a large system.”

A consolidation strategy goes to the core of a governing body’s fiduciary duty to preserve the organization’s long-term viability to sustain its mission. Directors should ask whether consolidation will strengthen the organization’s finances, operations, market position, growth potential, and core values, and thus support its mission. Or conversely, will consolidation dilute resources and damage stakeholder relationships?

The new issue of Great Boards is designed to orient directors to the key governance issues involved with mergers and strategic alliances. It includes the steps boards should take to prepare for a consolidation strategy; the seven key questions at the heart of almost every deal; and the right timing for engaging a small task force and the full board.  Read and download it now at http://greatboards.org/.

Hospital consolidators need to take accountability for results

As hospital consolidation increases and health systems grow, some researchers and policy makers are airing concerns that hospital mergers actually increase healthcare prices and don’t deliver promised savings to their communities.  As an article co-published by Kaiser Health News and The Washington Post, “As Hospitals Consolidate, They Get Pricier” put it, “The Federal Trade Commission found rapidly rising prices in some markets after hospitals joined.”  The Federal Trade Commission’s view is that “the increasing consolidation of hospital markets (is) of national concern. “

My view: Big health insurers have gotten a bye on anti-competitive consolidation, and they have the upper hand negotiating with independent hospitals and small systems, which have have no pricing power for the bulk of their other business with Medicare and Medicaid.  So hospital consolidation and physician integration merely level a presently unequal playing field.

That said, resistance to mergers from insurers and skeptical regulators will grow. Hospitals that seek to merge need to do more than make the legal case to regulators that consolidation isn’t anticompetitive. They will have to take a value proposition, not merely market clout, to payers at the bargaining table.  They will need to take a community benefit case to the public and also be willing to accept accountability for merger results.  To be precise, merging hospitals will need to demonstrate they are successful in delivering on their promises to increase efficiency and improve the quality and value of their care.

One model: The “certificate of public advantage (COPA)” issued by the State of North Carolina to the Mission Health System in Asheville, NC.  The COPA requires the health system to file financial reports with the state every year showing its keeping costs in line. Mission has done a good job and is ready with the facts to prove it. Others will have to do the same.

Hospitals in Distress Find Success

Hospitals that have a challenging payer mix can in fact achieve profitability.  That’s the finding of a new study done by the University of California, Berkeley and funded by the California HealthCare Foundation.  Leadership teams at five such California hospitals identified five key, interdependent factors as the primary contributors to their financial success:

  • Quality: strengthening the hospital’s negotiating position with payers
  • Strategic Growth: increasing the volume of patient services
  • Management discipline: intense monitoring and control over expenditures and efficiency of operations
  • Culture: establishing organizational values and beliefs supportive of collaboration, trust, achievement and accountability
  • Relationships: developing strong, positive hospital-employee and hospital-physician relationships

My view: These strategies apply in any market, they’re just more important with a poor payer mix.  Although healthcare reform promises broader coverage for the uninsured, if that happens, reimbursement rates are likely to be insufficient to sustain safety net providers.  That’s already happening in Massachusetts, according to an outstanding analysis by the Center for Studying Health System Change.  Low state rates are jeopardizing safety net providers like Boston Medical Center.  So these case studies are compelling, but for many hospitals serving poor communities, strategic partnerships and improved relationships with state Medicaid officials will be equally critical.  Directors can help build both of these bridges.

Part II: Mergers and Alliances: How soon and how much to engage the board?

Executives face the challenge of determining how soon and how much to engage the board in discussions before a final deal is consummated and ready for formal approval.

It’s tempting to keep information about a potential merger or strategic alliance in a small, management-driven circle, but surprising the whole board with a done deal is a never a good idea. Pre-cooked mergers and alliances that trample on some stakeholders’ turf can trigger a backlash from powerful directors, physicians and other stakeholders – and could scuttle a sensible strategic partnership. It also deprives the executive team of the insights and M&A experience that directors may have.

Conversely, fishbowl negotiations are a prescription for disaster. Getting a lot of directors enmeshed in the details of deal making or letting news leak out prematurely to stakeholders, especially medical staffs, also will kill a deal and embarrass the other partner.

The answer is finding the right balance, consistent with a board’s unique culture — some boards are accustomed to having a lot of involvement, while others vest great discretion in their CEOs and board leaders. The CEO and board leaders should clearly think through the right process for engagement of directors so the final decision has broad stakeholder support and benefits from the insights and experience of directors.

Whether an organization is joining a larger system, engaging in a merger or alliance of equals, or adding a new member to its existing system, the board’s involvement in the negotiation process usually involves these steps:

1. Get general consent from the full board to look at strategic alliances. This is best done as part of the ongoing strategic planning process. Directors may ask, “Why do we need to engage in a merger or alliance – can’t we do well just as we are?” A five-year, strategic financial projection can help answer that question. The full board should buy into the rationale for why the organization needs to grow and what it hopes to achieve through a merger or strategic alliance – e.g., access to capital, critical economic mass, market strength, improved quality. The strategic planning process may involve directors in broadly analyzing a number of potential strategic partners to determine who would be the ideal fit. The amount of detail the full board gets into at this early, pre-negotiation stage, will vary and requires careful judgment by the CEO and board leaders.

2. Choose a small group of the board’s leaders to be more closely informed about merger and alliance discussions. This could the board’s executive committee, strategic planning, or an “ad hoc strategic partnerships task force.” The group should draw from the board’s most influential leaders, including the chair and the board’s best strategic thinkers in terms of mission, strategy, business, finance, culture, and quality. Although merger and alliance talks occur mostly between the parties’ CEOs and senior executives, this committee or task force is the CEO’s “Governance A-team” for the board’s engagement in merger and alliance discussions.

3. Form a steering committee of leaders from both or all parties. The steering committee will include some of each board’s “A-teams.” The steering team should be small, probably 3-4 directors from each party plus the CEOs. Each member must sign a confidentiality agreement. It’s this group that addresses the key questions common to all partnership discussions, such as who will be the CEO and who’s on the board. It will identify and then answer questions specific to each deal, such as, will all parties be part of an obligated financial group, what will happen to existing foundation assets, and will a specific amount of capital be invested in particular facilities? Mergers with Catholic organizations must address the impact of the Ethical and Religious Directives of the Catholic Church and the values of religious sponsors.

4. Prepare the committee to address the key questions. The steering committee should be briefed on the range of structural options for joining organizations, and the pro’s and con’s of each option. It should also examine the case for a merger or alliance, including a strategic and financial analysis projecting what a combined organization might look like. And of course, the parties should learn about each other’s mission, values, culture, facilities, programs and people. If a partnership is the right thing to do, trust and a sense of cultural compatibility should build during the course of the steering team’s learning process.

5. Candidly explore the key questions (deal points) and options. This is the steering committee’s major work, to explore options and reach agreement on a vision and the key “deal points,” including the most appropriate type of corporate structure to achieve the strategic and financial aims, governance structure and authority, board composition and selection method, management succession plan, and other key issues.

6. Go back to each board at appropriate “plateaus” in the process. The leaders on the steering committee can’t get so far ahead that other board members feel they have no voice – but again, everyone can’t be involved in the negotiations. So, at one or more key places in the negotiation process, the board chairs should update their boards, seek feedback if appropriate, and ensure the board is still behind the partnership efforts.

7. Reach agreement on the key questions. The steering committee should reach agreement on the key deal points. All the key issues must be addressed. Such potentially controversial issues as the governance structure and the management succession process should be settled here, not left to due diligence.

8. Sign an MOU. The deal points form the basis of a Memorandum of Understanding, which generally states that the parties have agreed to merge or align, and will enter a period of due diligence to iron out final financial and legal aspects of the deal. Since MOUs are often made public, the steering committee should ensure that a communications plan to key stakeholders and the public is ready to go. The plan should stress the vision and benefits of the proposed arrangement.

9. Review the results of the due diligence. Each board, through its committee structure, should thoroughly review the results of the due diligence process and the proposed affiliation agreement.

10. Grant final approval. Each board votes final approval of the combination.

Outside experts in three areas – law, finance, and governance — generally make valuable contributions to a merger or alliance process. The governance consultant often also serves as a facilitator for the process.

If the negotiation process strikes the right balance of governance input but not meddling, it will build trust and a positive culture for successful governance and operation of the emergent organization.

First of two parts: Board’s Role in Mergers and Alliances — The 7 questions boards always ask

First of two parts
Board’s Role in Mergers and Alliances: The 7 questions boards always ask

Just as in the early 1990s, hospitals and health systems are seeking advantages of size and scale to prepare for the uncertain but undoubtedly difficult aftermath of healthcare reform. Last week, Modern Healthcare reported that Central Connecticut Health Alliance, a 330-bed hospital with two campuses, has signed a memorandum of understanding with Hartford (Conn.) Healthcare to become the system’s fourth hospital. Earlier, two major Dakota health systems — Sioux Falls, S.D.-based Sanford Health and Fargo, N.D.-based MeritCare Health System – announced plans to merge. Modern Healthcare says 28 deals were announced in the first half of 2009, according to Irving Levin Associates, Norwalk, Conn.—but “a spate of announcements” has come since July 1, signaling heightened interest.

Sometimes alliances rather than mergers are the best match to achieve strategic goals. In May, 19-hospital Banner Health, the largest not-for-profit system in Arizona, announced a partnership with the prestigious University of Texas M.D. Anderson Cancer Center in Houston, to build a $90 million outpatient clinic and cancer hospital at one of Banner’s suburban hospitals.

Approval of a merger or major alliance is clearly a governance responsibility. I’ve had several clients ask about the best approaches to facilitating the board’s involvement in a partnering process. I advise them that there are seven questions that boards always ask, and which require their engagement to reach the best answers:

1. Why are we doing this? The rationale must have a strong fit with the mission and the strategic vision. It must fill critical gaps – e.g., capital, geographic scope, clinical integration, administrative efficiencies. The financial and market share benefits should be quantified, not just rhetorical. In addition, why is this partner the right one? Have we looked at all the options?

2. What’s the best corporate structure? A range of structures, from full asset mergers to joint ventures to clinical affiliations and more –can be used to gain the benefits of combining organizations. Boards should be educated in the range of options and weigh in on the one that’s best suited to achieve the strategic intent of a deal.

3. How will the authority of our board be affected? Hospital boards often don’t want to sacrifice autonomy but consolidations often fail when the governance structure impedes a tough but necessary strategic or final decision (case in point – the recent breakup of Health Alliance in Cincinnati). Failure to choose a sustainable governance model can doom a new system from the start.

4. How will board members be chosen? Current board members may want to preserve their seats but the most successful systems minimize representational governance in favor of competency-based board composition. Getting the “right people on the bus” can make or break eventual success.

5. Who will be CEO? Boards understandably want to protect their CEO, but co-CEO models rarely work. The management succession process should be clearly laid out in advance. Current executives should be treated fairly, and the resulting organization should have strong leadership to get the job done.

6. What will happen to our most treasured facilities or programs? Sometimes specific protections are appropriate to include in an affiliation agreement, sometimes not, and sometimes it’s agreed super majorities will be necessary to close facilities, integrate clinical product lines, or divest assets. It all depends and requires candid discussion.

7. Is it legal? FTC is displaying renewed interest in the anti-trust potential of hospital mergers. Boards will want to know in advance if there’s a good case to be made to federal and state regulators.

Of course, there will be other many other issues specific to each deal. Mergers and alliances with Catholic systems pose particular challenges. But these seven questions must always be addressed up front.

In Part II next week, I’ll discuss how soon and how much to engage the board, including the most common steps for board involvement.