Corporate Governance When a merger the size of the AOL Time Warner merger takes place and then disintegrates, it is time to look for what went wrong. Both companies were regarded as important in their fields; both had been successful, one for many years (Time Warner), the other for only a short while (AOL), but that success was extreme.

What did go wrong? The simple answer is that is was probably a classic clash of old paradigm vs. new paradigm.

In fact, the simple answer is the whole answer, and it appears in graphic detail on the 91st page of Alec Klein's book, Stealing Time: Steve Case, Jerry Levin, and the Collapse of AOL Time Warner. On that page, Klein describes the scrambling of the lawyers for both firms -- AOL and Time Warner -- when operation Alpha Tango is revealed to them. (Both Case and Levin chose to keep the plans a big secret, even after there was an agreement in principle. One could easily ask why. Who was uncomfortable?

Like people not sure they were marrying the right person, did they fear 'relatives' would try to derail the deal? And if so, which one viewed the other as unworthy?)

The lawyers pawed through piles of paper, and they conducted a completely remote due diligence process to find out -- on paper -- what the other company is all about. They then proceed to talk to people. Their own people. Not the people in the other company. In short, attorneys for both parties to the merger were firm believers in preaching to the choir. It's a good thing they aren't criminal attorneys; it's difficult to find out what the other side knows if you don't ask, and therefore difficult to defend that client. If the same rules of 'discovery' applied to corporate mergers, this one might never have taken place.

But there is reason to believe that the Time Warner lawyers were acting out of the old paradigm, assuming that the company they were dealing with would -- especially in light of SEC and federal reporting requirements -- have kept their books in at least an acceptably workmanlike fashion.

AOL. What was their assumption in not further investigating Time Warner? One can only surmise that they also believed Time Warner had not cooked the books because Time Warner was an old-style company, and not one given to creating scandalous headlines about itself. At least the Time portion of that equation had a virtual mandate to stay clean; it was in the news business and couldn't afford to lose credibility.

In fact, AOL seems, throughout the pages of Stealing Time, to have been looking for a way to steal legitimacy. Time Warner was it. Case had decided that beforehand, and to anyone involved in the relatively fly-by-night world of dot-coms, it certainly appeared to be true. Why upset that golden goose by looking under its tailfeathers?

Had the Time Warner attorneys extended their due diligence beyond reading papers full of current numbers, they might have found some unsettling details about AOL and its principals.

For example, it appeared that the inmates were in charge of the asylum, not a good omen for a positive business arrangement. As AOL was moving into its spiffy new HQ in northern Virginia, even the staff was running around calling AOL a "Mad Max machine, wrapped in duct tape, hurtling into its future."

The building itself was problematical, not built on a human scale. In fact, it had been used to house airplane parts for British Aerospace. Gone was the instant camaraderie that probably had made the geeks and kooks cook, not the books, but good cyberspace ideas.

And here's a really scary, prescient part: the new building's conference tables had futuristic flakes embedded in the surface. The flakes were bits of crushed old AOL diskettes.

And then there was the divorce of Steve Case to consider. Granted, that's his personal life. But he had stamped AOL with his identity (Gap ads, etc.) and vice versa. For him to divorce the wife who had come through the lean years with him in favor of the wife of one of his own executives...well, it could be assumed to be a red flag. If a person's new offices are on an inhuman scale, if his personal life is in flux, or even shambles depending on one's point-of-view, if the company's own staff is referring to it condescendingly...is this a good candidate for a merger with a very traditional and, in terms of U.S. business, old and venerable company...

It was not a matter of horizontal integration looking good to either party, or vertical integration looking good to one and being the saving grace for another. It was a matter of the CEOs of both companies wanting to make one of those youthful marriages wherein one partner is trying to acquire at attribute lacking. AOL wanted to become a trillion-dollar company; Time Warner wanted to enter the dot-com fray. Neither desire had anything to do with the core mission of either company. (It may be important to note, however, that whatever the original mission of AOL, by the time of the merger, it had become the shallow chorus, Get Big Fast.
Neither desire had anything to do with providing anything new or additional or exciting that the marketplace would climb bodies to get to. Neither desire had anything to do with mission or integrity, and everything to do with aggrandizement in its most naked form, a characteristic not lost on Alexander Haig, Collin Powell and even Ted Turner when the chips were down. (But Turner, in style closer to Case than Levin, over-rode his own heebie-jeebies and cast his lot with the philistines, so to speak. Indeed, he cast the first vote; may as go down in flames if one goes down at all.)

What was classic was the negotiations between AOL (that is, Case, the flamboyant, over-confident king of a business existing mainly in the etheric) and Time Warner (that is, Levin, the button-down chief of a corporation the main business of which was also intellectual property, but which at least came out on DVDs and other tangible stuff). To begin, Time Warner wanted a fifty-fifty share of ownership. AOL wanted 60-40, with AOL holding the larger share. In the end, the compromise was 55 AOL, 45 Time Warner. The error? Levin being so hot for a presence in cyberspace that he forgot to value his bricks and mortar business properly and got led down the garden path -- and a holographic one at that -- by Case.

Perhaps holographic is not the right word. In a hologram, each tiny morsel holds all the information to produce the entire image. In the case of the $183-billion-all-stock transaction, it is doubtful that each AOL 'stock dollar' represented the whole company in real terms. Or maybe it did. Because those stock dollars, as unreal as they turned out to be, were 'earned' on the basis of unearned income, cooked books, flamboyance, youth and not a little bit of greed. Indeed, one Time Warner executive had mentioned AOL's stock contained a lot of fluff.

Indeed, it did, and by the time Case began courting Time Warner in September 1999, Case probably had a feeling about it, even if he didn't see it on paper until a report in November.

AOL had signed forty-seven deals worth $694 million from July to September, but from October to December, only $457 in deals was signed. By the time the merger was announced to the world, on January 10, 2000, there had been no improvement.

While the world at large didn't know this, investors reacted in ways that cost both companies money. After the announcement, AOL stock declined 17%, and Time Warner's dropped 12%. AOL got much of its income from dot-coms, and those were in free-fall, having run out of cash with nothing much to show for it.

Freefall is a term that could easily be used to describe most of what went on with AOL Time Warner from long before the moment the ink on the merger deal was dry. And in the end, by July 14, 2002, when investigative business reporter Alec Klein delivered a letter to AOL Time Warner describing his personal probe of the problematical accounting practices at AOL, the company's market cap had nose-dived from $240 billion in January 2001 to just $90 billion.

It is ludicrous that Time Warner could not have known, or at least suspected, that there were irregularities of the Enron kind in the company it intended to merge with. But a look at the cultures of the two companies suggest why that was so.

First, Time Warner was itself the combination of two venerable companies. Time, the publishing company, had been an upstart in the early 20th century, with such magazines as Time, and Life. Warner was a venerable entertainment company. While some may have thought information and entertainment strange bedfellows, that the two were becoming indistinguishable in the public mind was more and more apparent each…