a focus on resources in m-a successs

A Focus on Resources in M&A Success: A Literature Review and Research Agenda to Resolve

Two Paradoxes

Margaret Cording Petra Christmann

L. J. Bourgeois, III

Darden School University of Virginia

To be presented at

Academy of Management, August 12, 2002

2

A Focus on Resources in M&A Success: A Literature Review and Research Agenda to Resolve

Two Paradoxes

This paper reviews the empirical literature on mergers and acquisitions with an eye

towards identifying research questions that have not yet been addressed and that may help

resolve two paradoxes that emerge from the literature review. Despite the empirical evidence

that, on average, mergers fail to create value for the acquiring firm’s shareholders, corporations

continue to employ this strategy at ever-increasing rates (the “success paradox”.) The

diversification theory claim that related acquisitions should outperform unrelated ones has not

withstood the empirical test (the “synergy paradox”.) We suggest that the resource-based view

of the firm can be leveraged to illuminate the nature and characteristics of resources that present

difficulties in both the target valuation and integration processes, helping to resolve these two

paradoxes. Specifically, we argue that certain qualities of resource bundles are more challenging

when valuing target resources and resource combinations, as well as presenting ex post

uncertainties about acquired resources. Other resource characteristics, such as embeddedness,

tacit value creating routines, and human qualities, present an enigmatic integration process. It is

hypothesized that failures to understand these characteristics lead to a tendency to overvalue

targets and the possibility of destroying during the integration process the very value purchased.

By being consciously aware of these resource characteristics, and the difficulties encountered

when valuing and integrating target firms, firms may be better able to preserve and leverage the

value creating mechanisms of the acquired firm. Research propositions are proposed to test

these hypotheses.

3

Words such as “Herculean”, “heroic”, “ultimate change management” and the like are

often used to describe the requirements for a successful merger or acquisition. Empirical

evidence has shown that creating value for the acquiring firm’s shareholders is a 50/50 bet at

best. Despite this dismal record, mergers and acquisitions continue to set records. In 1989,

3,407 m&a deals were completed with a total value of $230 billion (Mergers and Acquisitions,

1990); by 2000, the number of deals grew to 8,505, valued at over $1.7 trillion (Sikora, 2001.)

Moreover, the average purchase price of transactions has grown dramatically; the bets are getting

bigger.

For more than thirty years, scholars have researched mergers and acquisitions. Early

empirical work sought to identify the characteristics of successful mergers, especially as it relates

to diversification theory. Results were mixed, but most agree that, on average, mergers and

acquisitions fail to generate above normal returns for the acquiring firms’ shareholders. Why,

then, do corporate CEOs continue to employ this strategy? And what can they do to improve the

odds of success? Attention has also focused on understanding the variables that managers can

manipulate to bolster a given transaction’s probability of success: ways to improve the quantity

and quality of information gathered during due diligence, and potential impediments to the

integration of two firms.

This paper explores the literature with an eye towards identifying research questions that

have not yet been addressed and that may help resolve two paradoxes that emerge from the

literature review: the m&a success paradox and the synergy paradox. The literature is segmented

into three separate, but related, critiques: the measurement of success of a merger; empirical

evidence with respect to strategic diversification theory; and, empirical testing of integration

factors that may drive a transaction’s success. We then argue that a resource-based view of the

4

resource bundle that an acquiring firm purchases and integrates can better illuminate the sources

of valuation and integration problems than the traditional approaches. We conclude with a

suggested research agenda that seeks to further develop and operationalize the resource-based

view of the firm in the context of mergers and acquisitions.

MEASURING M&A SUCCESS

It is widely agreed that the “success” of a merger or acquisition may be defined as the

creation of synergy: the value of the combined firm is greater than that of the two firms operating

separately. This reflects the simple observation that the price paid for a strategic asset must be

lower than its expected value if it is to add economic value to the acquiring organization.

Because the efficacy of a corporate combination is, at least in part, a function of how its outcome

is calculated, this section reviews the empirical literature with respect to measuring success in

mergers and acquisitions. Four principle methodologies have been employed: event study,

accounting-based measures, survey data and case studies.

- - - - - - - - - - - - - - - - - - Insert Table 1 about here - - - - - - - - - - - - - - - - - -

Traditionally, the capital asset pricing model (CAPM) has been the primary measurement

tool for determining the degree to which mergers and acquisitions create economic value.

Utilizing the “event study methodology” (Fama, 1968), the stock prices of both acquiring and

acquired firms are examined shortly after the merger announcement. The “cumulative abnormal

returns” are calculated (the increase in stock price over and above that which CAPM would

predict absent the merger), and the results assessed. The central underlying assumption is that

investors are capable of accurately predicting the combined firm’s future cash flows.

The event study methodology has several attractive features. First, the data is publicly

available, permitting empirical studies on large data samples. Second, it relies upon the well-

5

respected efficient market hypothesis. Third, because “abnormal” returns are calculated, the data

is not subject to industry sensitivity, enabling a broad cross-section of firms to be studied.

These studies have provided support for the view that mergers and acquisitions create

economic value (Jensen & Ruback, 1983; Seth, 1990b; Singh & Montgomery, 1987.) Later

studies examined the distribution of this new wealth, and concluded that the stockholders of

acquired firms capture most of the gains (Chatterjee, 1986; Datta, Pinches & Narayanan, 1992;

Seth, 1990a; Singh & Montgomery, 1987; Sirower, 1997.) Indeed, the stock price performance

of acquiring firms raises serious concerns: only about 35% of acquirers report positive stock

market gains on the announcement date (for a useful review of these analyses, see Sirower,

1997.)

These event study results, however, may be due to its reliance on the assumption that

investors can accurately predict the combined firm’s future cash flows. This assumption

embodies the attractive feature of ensuring that non-m&a related factors are not influencing the

incremental stock behavior. Abandoning this assumption represents a direct challenge to the

efficient market hypothesis (Shleifer & Vishny, 1991.)

Over the past fifteen years, scholarly attention shifted to exploring different dependent

variables. Perhaps the issue was not one with m&a “success”, but rather with the event study

methodology’s assumptions regarding success. Studies began using accounting-based measures

of performance, market share data, and survey responses, and regressed these against various

factors hypothesized to drive financial performance. The definition of “success” began to take on

a longer-term perspective: perhaps it took three to five years to fully reap the benefits of the

combined firm. Krishman, Miller and Judge (1997), for example, hypothesized that the ability of

top management teams to work effectively together would drive m&a success, measured by

6

return on assets. Ramaswamy (1997) explored the impact of strategic similarity in mergers

occurring in the banking industry. Again, return on assets was used to measure performance

over a three-year period.

But accounting measures are subject to one of the same limitations as are long-term stock

price measurements: factors other than the merger or acquisition may be driving the numbers. In

addition, accounting measures reflect the past, rather than present financial performance

expectations (Montgomery & Wilson, 1986.) Nor do they reflect changes in the firm’s risk

profile. Some academics have opted to use survey measures to elicit the management team's

views on whether or not the merger was a success (Cannella & Hambrick, 1993; Capron, 1999;

Chatterjee, Lubatkin & Weber, 1992.) In theory, a merger or acquisition should be deemed a

“success” if the objectives identified during the due diligence process are met. In other words,

the key question may be, “Did we accomplish what we set out to accomplish, regardless of other

exogenous or endogenous factors simultaneously at work?” Capron’s recent survey-based work

claims: “…traditionally available financial data are too gross to permit differentiation between

the types of fine-grained value-creating mechanisms…” (Capron, 1999: 993.) While these

approaches rely on self-reported perceptions of long-term performance, they reduce some of the

noise that may accompany publicly available information.

Because every merger and acquisition is a unique event, occurring in a unique

environment that is subject to innumerable influences, case studies have also provided a rich

stream of research (Haspeslagh & Jemison, 1991; Marks & Mirvis, 1998; Shanley & Correa,

1992.) While it is not possible to generalize to other specific situations, the case study

methodology does enable one to generalize to theoretical constructs. This analytic device

7

enables the analysis of processes of value creation, rather than simply events seeking to create

value.

These results, combined with the observation of continued growth in merger and

acquisition activity, gives rise to the “m&a success paradox.” If we assume that managers are

rational, and that corporate governance structures serve as a check and balance on poorly

conceived strategic actions, we would expect the level of m&a activity to taper off, which has

not been observed. To date, scholars have been unable to unravel the m&a success paradox.

TESTING DIVERSIFICATION THEORY IN M&A

While the event study literature demonstrates that the acquired firm’s shareholders reap

above-normal returns (due to the payment of a premium for the firm), this represents value

capture, not value creation (Seth, 1990a.) The newly combined entity is left with the task of

creating value in excess of the premium paid. Strategy theory tells us that value is created in an

m&a through the identification and exploitation of synergy. While different terminology is used,

three broad classes of synergy are the usual focus of researchers. First, operating synergies arise

when economies of scale or scope are captured across a variety of the firm’s activities. Financial

synergies are driven by reductions in the cost of capital due to a reduction in bankruptcy risk, an

increase in the size of the firm, or internal funding of the target’s investment projects at a cost

lower than that available in the capital markets. Collusive synergies – sometimes called “market

power” – enable the firm to either extract a higher price for its products or services or pay

suppliers a reduced price. (Chatterjee, 1986.)

Diversification theory claims that related acquisitions should have greater potential for

synergy creation than unrelated acquisitions (Rumelt, 1974; Salter & Weinhold, 1978.) This is

because the greater the points of contact and overlap between two firms’ value chains, the higher

8

the potential for capturing operational synergy. Singh and Montgomery (1987) hypothesize that

because all three forms of synergy are theoretically available in related acquisitions, and that

because only financial synergies and administrative efficiencies are available in unrelated

mergers, related acquisitions will create more value than unrelated ones.

Given this model of value creation possibilities, scholars sought to understand what types

of mergers might lead to above normal shareholder value. While the above diversification

theory is intuitively appealing, Lubatkin (1983) noted that the concept of “synergy” had never

been tested. Attention therefore focused on measuring the results from related versus unrelated

mergers, again using the event study methodology. The presence of a related skill, market,

resource or purpose of two merging firms was the usual definition of relatedness employed

(Rumelt, 1974.) Researchers operationalized this concept generally by using the U.S. Federal

Trade Commission’s Standard Industry Classification at either the two- or four-digit level.

In a review of these empirical studies (all using the event study methodology),

conflicting results have been achieved. For example, Lubatkin (1987) found no statistically

different results in related versus unrelated mergers, while Elgers and Clark (1980) found that

unrelated mergers outperformed related ones. However, Singh and Montgomery (1987) found

that total dollar gains, standardized on the value of acquired assets, showed statistically

significant differences between related mergers and unrelated ones at the .05 level, with related

mergers outperforming unrelated ones. However, target firms obtained the lion’s share of these

gains, while the acquiring firm did not experience any statistically significant wealth gains.

Chatterjee (1986) attempted to empirically isolate the effects of various sources of

synergy. Arguing that the type of synergies captured cannot be classified based on the type of

merger due to the potential presence of multiple sources of synergies in, say, a related merger,

9

Chatterjee examined non-horizontal related mergers versus non-related, conglomerate mergers.

His hypothesis was that if horizontal mergers were excluded from the study, he could eliminate

the impact of any collusive synergies and zero-in on operational and financial synergies.

Financial synergies may be present in any type of merger, but operational synergies would only

be available to a firm that acquired a related business. Furthermore, Chatterjee argued that the

observation that two sources of synergy may be present in a related merger while only one in an

unrelated merger does not logically lead to the expectation that the former type of merger will

outperform the later. Using event study methodology, he found, counter-intuitively, that firms

acquired by non-related acquirers fared much better than their counterparts acquired by related

firms. Interpreting the results of targets involved in a related acquisition, Chatterjee suggests that

operational synergies may prove very difficult to implement.

Seth (1990a) built upon Chatterjee’s argument that there is no a priori theoretical reason

to suppose that value creation is a function of the number of potential synergies. She found

“overwhelming evidence” that mergers and acquisitions create value when the target and bidder

firm are viewed together, but only “limited evidence” that this value creation occurs to a greater

extent in related acquisitions versus unrelated. Seth concludes that, “…the finding that related

acquisitions do not unequivocally outperform unrelated acquisitions provides evidence that the

sources of value creation associated with unrelated acquisitions provide similar magnitudes of

synergy compared with the sources of value creation associated with related acquisitions.”

(Seth, 1990a: 112.)

Methodologies other than event study have also been used to test diversification theory in

mergers and acquisitions. In an analysis that controls for industry, Hopkins (1987) found that all

firms pursuing an acquisitive strategy in fact lost market share, suggesting that improving a

10

firm’s market position via acquisitions may be an unrealistic goal. He states, “Managers

concerned with the position of their firms may want to consider internal growth as an alternative

to growth through acquisitions.” (Hopkins, 1987: 544.) However, firms with a strong marketing

position (i.e., brand loyalty) lost less market share than those with a particular strength in

technology, and in conglomerates. Hopkins hypothesizes that this is due to the relative

attractiveness of industries that have high marketing related barriers to entry. Supporting this

view is Lubatkin’s (1983) observation that predicted synergistic benefits are highest for

marketing concentric mergers.

Seeking to operationalize certain views of diversification that may be classified under the

resource-based view of the firm, Farjoun (1998) argues that the above studies on related versus

unrelated acquisitions suffer from too narrow a view of relatedness. Examining diversification

activity in the manufacturing sector, Farjoun explored degrees of relatedness with respect to

physical assets (e.g., production lines) and human skills (e.g., similar engineering skills), and

how these factors of relatedness might be correlated with financial performance (operationalized

as return on assets, return on sales, market-to-book ratio, and Jensen’s alpha measure.) He found

that when viewed separately, the existence of neither physical asset relatedness nor skill

relatedness was correlated with financial performance. However, when viewed together – i.e.,

the presence of both related physical and skill bases – and controlling for industry effects, a

strong effect on performance emerged. Farjoun concludes that the joint effects of relatedness are

synergistic in nature: “each base thus extends the other.” (Farjoun, 1998: 614.)

Perhaps these conflicting conclusions speak more to measurement and classification

problems than to the true economics underlying mergers and acquisitions. Indeed, the above

researchers would often group the various FTC classification schemes differently. Hence, an

11

underlying problem may be one the definition of related versus unrelated acquisitions.

Alternatively, the potential synergy gains available in related acquisitions may be priced out

during negotiations (particularly to the extent that it is based on publicly available information)

making value creation in horizontal mergers a particularly difficult task (Barney, 1988.) There

may in fact be no a priori reason to expect greater abnormal returns from a related acquisition

than from an unrelated one (Zollo, 1998.)

To sum up so far, the empirical evidence has been conflicting as to what type of

diversification strategy can in fact create value for the acquiring firm’s shareholders.

Diversification theory has not yet been empirically confirmed. Assertions that mergers and

acquisitions are a useful and productive method for diversification and growth, and that

synergies are more readily and easily captured in related acquisitions, do not withstand the

empirical test. Difficult as they may be, mergers are often viewed as a more favorable strategy

than, say, building the business internally (Singh & Montgomery, 1987), giving rise to the m&a

synergy paradox.

FACTORS INFLUENCING M&A OUTCOMES:

EIGHT SCHOOLS OF THOUGHT

While the above empirical work focused on the average distribution of various

performance measures, scholars have also sought to isolate those variables that may drive

superior performance. The question then turns to what obstacles are faced in generating wealth

for the acquiring firm’s shareholders; i.e., what variables management should manipulate to

improve the odds of success? This section reviews eight schools of thought that emerge from the

literature regarding the key issues that must be tackled to make a strategic acquisition work in

terms of financial performance. These schools are: Overpayment; Agency Problems; CEO

12

Hubris; Top Management Complementarity; Experience; Employee Distress; Conflicting

Cultures; and, Process.


The School of Overpayment

Most researchers assume, either implicitly or explicitly, that acquisitions occur in a

highly competitive market (i.e., the market for corporate control) and that prices are bid up to

their “fair” value. Sirower (1997) presents a direct challenge to this assumption: “The first step

in understanding the acquisition game is to admit that price may have nothing at all to do with

value. I call this the synergy limitation view of acquisition performance. In this view, synergy

has a low expected value and, thus, the level of the acquisition premium predicts the level of

losses in acquisitions.” (Sirower, 1997: 14, emphasis in original.) While the premium is known

and paid up-front, the synergy gains are uncertain, derived in the future, and difficult to obtain.

When calculating the net present value of these future synergies, a relatively high discount rate

should be used, reflecting the risk of actually generating the synergistic effects.

Pointing out the risks involved in paying a premium, Sirower (1997) urges executives to

be clear about how synergy gains are to be extracted and the strategies for doing so. Some

researchers warn executives to “walk away” if the price exceeds what they were originally

prepared to pay (Haspeslagh & Jemison, 1991; Kusewitt, 1985.) Sirower (1997) argues that the

presumption of outcomes should be failure.

Others have pondered why managers may overpay for an acquisition. The process of

identifying a suitable acquisition candidate and negotiating its price is riddled with problems.

The analyses often occur in secrecy and under significant time constraints. Complete data is

often not available. Haspeslagh and Jemison (1991) report that a majority of executives feel that

13

a breakdown in the due diligence process led to a poor purchase decision. One aspect of the

problem is the occurrence of “fragmented perspectives”; due to the complexity and speed

required, it is difficult for any one person to develop a broad, but detailed, view of the acquisition

opportunity (Jemison & Sitkin, 1986.) Given the bounded rationality (Cyert & March, 1963;

Lubatkin, 1983), the opportunity to misjudge qualities in this due diligence environment is quite

high.

The building of momentum to complete the transaction further exacerbates this danger

zone. Momentum builds in an unpredictable way, reflecting increased personal commitment on

the part of the due diligence participants, the environment of secrecy and intensity, and the

influence of outside advisors. (Haspeslagh & Jemison, 1991.)

The School of Agency Problems

Researchers began to query the role of agents in the acquisition process, especially those

involved in negotiating the transaction’s price. Kesner, Shapiro and Sharma (1994) investigated

how investment bankers’ influence the size of the premium. Because compensation paid to these

bankers is positively related to the purchase price, managers may harm the long-term health of

their firms rather than securing the best possible value. (Kesner, et al, 1994.)

Focusing on a possible agency problem between the interests of the chief executive

officer and shareholders in mergers and acquisitions, several studies have found that CEO

compensation increases with the size of the firm, regardless of firm performance. (Lubatkin,

1983, Schmidt & Fowler, 1990.) There thus seems to be an incentive for CEOs to increase firm

size rather than firm profitability.

Kroll, Wright, Toombs and Leavell (1997) investigated the nature of acquisition

decisions from the perspective of corporate ownership and control. They categorized firms along

14

three dimensions. Manager-controlled firms are those firms with diffused external shareholder

ownership; no single shareholder owned more than 5% of the firm. Owner-controlled firms had

at least one shareholder with a 5% or greater stake. Owner-manager-controlled firms were those

firms where at least one senior manager owned 5% or more of the company. Kroll, et al (1997),

using the event study methodology, found that acquisitions purchased by manager-controlled

firms generated significant negative returns. For owner-manager-controlled and owner-

controlled firms, these transactions generated positive returns.

The School of CEO Hubris

Another stream of research attempting to explain the dismal track record of acquisitions

has focused on hubris of chief executive officers (Roll, 1986.) Hubris, or exaggerated self-

confidence, may lead to otherwise unsound decisions. Premiums paid represent a significant

signal of the amount of value that the acquiring firm believes it can create via the acquisition

(Hayward & Hambrick, 1997.) If CEOs believe that they can defy all odds and efficiently

extract above normal returns from an acquisition, then those CEO are likely to overpay. Clearly,

the role of the board of directors should serve as a check on this behavior, but when the board

has a significant number of insiders on it, and when the CEO is also the board’s chairman,

Hayward and Hambrick (1997) found that the relationship between CEO hubris and the size of

premiums paid is particularly striking.

The School of Top Management Complementarity

Some scholars have investigated the influence of two distinct top management teams’

ability work together after a corporate combination. Shanley and Correa (1992) queried whether

agreement between top management teams improves expectations for post-acquisition

performance. Following Bourgeois (1980), the researchers hypothesized that if the two top

15

management teams perceived agreement and actually agreed on the strategic objectives of the

acquisition, that post-acquisition performance would improve through healthy cooperation.

Alternatively, if perceived and actual agreement were low, then conflict may arise that could

thwart the achievement of objectives. Shanley and Correa’s (1992) results confirm these

hypotheses. Datta (1991) also found that differences in top management styles had a negative

influence on merger performance.

Walsh (1988) investigated whether the conflict among top management teams involved

in an acquisition leads to a higher turnover rate than in firms that have not gone through a

merger. He found a significantly higher rate of turnover within five years of a merger. In

addition, the type of acquisition – related versus unrelated – did not mitigate this relationship.

The resource-based view of the firm (Barney, 1986; Kogut & Zander, 1992; Wernerfelt, 1984)

claims that knowledge specific to a firm is often tacit, and not easily replaced. Losing a majority

of the combined firms’ top management team may represent a hurdle so high that it is difficult to

overcome. This conclusion was reinforced by the work of Cannella and Hambrick (1993). In an

analysis of 96 large acquisitions, the authors conclude that, “…executives from acquired firms

are an intrinsic component of the acquired firm’s resource base, and that their retention is an

important determinant of post-acquisition performance.” (Cannella & Hambrick, 1993: 137.) In

addition, top management retention was important in related acquisitions as well as unrelated

ones.

Closely related to culture-based studies (see discussion below), Krishnan, Miller and

Judge (1997) explored the relationship between post-merger performance and the

complementarity of top management teams, where complementarity was defined as differences

in functional backgrounds. Krishnan, et al (1997) found that a complementary management

16

team was positively related to post-acquisition performance, and negatively related to the

acquired firm’s top management team turnover. Organizational learning led to a successful

acquisition process, according to the authors, and this learning occurred more readily and easily

when the top management teams were blended. Krishnan, et al conclude that, “…it appears that

organizational learning, and hence synergy, appears to be most enhanced by acquiring firms that

are run by complementary top management teams and then by limiting the turnover with the two

teams after the acquisition.” (Krishnan, et al, 1997: 371.) Singh and Zollo’s (1998) study of the

U.S. banking industry also concluded that high levels of replacement of acquired firm’s

executives had a negative impact on performance.

The School of Experience

It seems natural to assume that the greater the experience with acquisitions, the lesser the

risk that potential value will not be captured. Haleblian and Finkelstein (1999) argue that the

experience curve associated with mergers and acquisitions is U-shaped. In this study,

“antecedents” refer to present conditions, while the past determinants of behavior are termed

“consequences”. When an antecedent is similar to past situations, generalization of past

behavior should be observed. When an antecedent is dissimilar to past experience,

discrimination should occur. During the first acquisition, managers have no prior experience and

will therefore interpret events as unique. As experience builds, however, managers may assume

that past situations are at play, failing to appropriately discriminate the current situation from

previous ones. Once experience with this failed generalization is assimilated, managers develop

the ability to discriminate when appropriate, resulting in the U-shaped distribution. It was also

found that firms who acquired firms similar to those it had acquired in the past were better

performers.

17

Singh and Zollo (1998) demonstrate that for firms in the banking industry, the tacit

knowledge acquired from previous acquisitions positively impacts performance provided that the

two integration experiences are homogenous. When the type of acquisition or integration

process is substantially different, caution is warranted. They argue that, “Learning curve effects

in the context of highly infrequent and heterogeneous events…are heavily taxed….” (Singh &

Zollo, 1998: 30.)

The School of Employee Distress

Researchers also began to focus on the process of merger integration, and on the impact

mergers have on employees. Buono and Bowditch (1989) hypothesized that:

Some mergers do fail because of financial and economic reasons. However, because of

the myriad questions about merger and acquisition success, attention has begun to shift

toward human resource concerns, the cultural ramifications of merger activity,

management of the overall combination process, and specific efforts aimed at post-

combination integration. In fact, most of the problems that adversely affect the

performance of a merged firm are suggested to be internally generated by the acquirers

and by dynamics in the new entity. The reality may be that many merger- and

acquisition-related difficulties are simply self-inflicted. (Buono & Bowditch, 1989: 10.)

Buono, trained as an organizational sociologist, and Bowditch, an industrial and

organizational psychologist, provide a much different perspective from the scholars referred to

above. Their focus is on the individual experience, and how the organization can either help or

hinder that experience. Because mergers and acquisitions precipitate major life changes for

organizational members, and because it is these same members that can harm or enhance the

outcome of the merger, they argue that attention to the human side of mergers is imperative.

18

Basic human responses such as lowered commitment, drops in productivity, organizational

power struggles, office politicking, and loss of key organizational members, represent hidden

costs to a merger. If managed well (i.e., in an open, honest and participative way), Buono and

Bowditch (1989) argue that these costs, while not eliminated, can be minimized.

Haspeslagh and Jemison (1991) also focus on the employee side of the m&a integration

process. They argue that an atmosphere that stimulates peoples’ willingness to work together is

critical, and that the barriers to cooperation in an m&a context that ought to be managed include

fears about job security, a loss of power and resources, process changes, reward system changes,

and fear of the unknown.

The School of Conflicting Cultures

Another school of thought centers on the role that the two cultures, and the closely related

acculturation process after a merger or acquisition, play in determining the financial success of

the merger. The above human problems get exacerbated when the underlying national, corporate

or business unit cultures of the two organizations are incompatible. As it relates to m&a

research, however, Nahavandi and Malekzadeh (1988) provide a broad definition of culture:

“…the beliefs and assumptions shared by members of an organization.” (Nahavandi &

Malekzadeh, 1988: 80.) There are two broad layers, or sources, of organizational culture. First

is how the organization accomplishes its objectives, and the values and beliefs that underlie these

routines. Also informing this “corporate” culture, however, is national culture. In addition, an

organization may have multiple cultures within it. The challenges encountered when merging

two different cultures is that either one or the other (or both) needs to change. The issue, then,

becomes not just culture awareness, but culture change management during the integration

period. The process of acculturation follows a three-stage process: contact, conflict and

19

adaptation (Berry, 1983.) Clearly, the more quickly one can achieve adaptation, the lower the

risks of unproductive conflicts.

One stream of research presupposes that the more similar the cultures of the target and

bidding firms, the fewer the integration and acculturation problems that will be encountered.

Indeed, Chatterjee et al (1992) found a strong negative correlation between the perceived cultural

differences between the two top management teams and stock market gains to the buying firm.

Nahavandi and Malekzadeh (1988) argue that the process of acculturation is a function of

the preferred approach for both the acquired and acquiring firm. From the perspective of the

acquired firm, the desired process is driven by the degree to which it values its own culture and

seeks to preserve it, and its perception of the attractiveness of the acquirer. If, for instance, the

acquired firm highly values its culture and does not rate the acquirer as highly attractive, then its

acculturation is likely to be "separation”, in which it will seek to avoid the acquirer’s culture.

From the perspective of the acquirer, the two dimensions driving the acculturation process are

the degree of tolerance for multiculturalism versus seeking one, unified culture, and the degree of

relatedness between the merging firms. Nahavandi and Malekzadeh (1988) generate several

hypotheses about how the integration process will proceed for each possible pair of processes.

For instance, “If there is congruence between the two companies regarding the preferred mode of

acculturation, minimal acculturative stress will result and the mode of acculturation … will

facilitate the implementation of the merger.” (Nahavandi & Malekzadeh, 1988: 87.)

Cartwright and Cooper (1992) performed empirical analyses of firms involved in

horizontal mergers that required a significant degree of integration. They conclude that it is not

cultural differences that matter per se, but rather that the two companies can work together.

This, in turn, is driven by the extent to which employee individual freedom is affected. If the

20

two cultures are distinctly different, and individual freedom declines, Cartwright and Cooper

(1992) assert that problems will likely arise. They acknowledge that the closer the two cultures

are to each other, the easier the acculturation process.

In an effort to assess each firm’s cultural preferences before agreeing to merge,

Forstmann (1998) developed a “cultural analysis” to be performed during the merger

negotiations. Arguing that the process by which cultural acculturation occurs determines the

success of the merger, he recommends, “...the integration strategy should be made dependent on

such cultural differences, rather than only portfolio goals, as is typically done currently.”

(Forstmann, 1998: 58.)

The School of Process

Perhaps the most comprehensive research on post-merger integration is the work done by

Haspeslagh and Jemison (1991.) In discussing the challenges involved in effectively combining

two firms, the authors note that, “Integration is an interactive and gradual process in which

individuals from two organizations learn to work together and cooperate in the transfer of

strategic capabilities” (Haspeslagh & Jemison, 1991: 106.) The key to success lies in creating

an atmosphere in which this transfer can occur. Implicitly, the authors believe that even if the

profitability targets are well conceived, if the process of resource or capability transfer is flawed,

value creation will be seriously limited.

Haspeslagh and Jemison (1991) identified three types of problems that stand in the way

of capability transfer. While all acquisitions wrestled with these problems, the successful ones

actively managed the underlying dynamics, while unsuccessful ones did not. “Determinism”

occurs when management is unable to adjust its integration strategy in light of new information.

Flexibility in acquisition integration is therefore important. Value destruction is the flip side of

21

the value creation coin. In the process of creating value for shareholders, employees may be

asked (or perceive to be asked) to destroy value for themselves. The authors report that in

situations in which (employee) value was destroyed, individuals’ commitment to the firm or to

making the acquisition work declined because they perceived a qualitative change in the nature

of their relationship with the firm. One central decision, therefore, is when to accommodate

peoples’ needs and concerns and when to press ahead. Managing the people process then

becomes critical. Finally, the third integration problem is a “leadership vacuum”; unless both

institutional and interpersonal leadership were provided, the possibilities for creating the

atmosphere necessary for capability transfer were limited.

THE ROLE OF RESOURCES

The “best practices” that emerge from the literature indeed represent a Herculean task.

Simultaneously – and while running an existing business – managers are advised to not overpay,

beware of self-interest, check over-confidence, ensure management complementarity, develop

experience and competence in valuation and integration, manage employee and other stakeholder

emotions, acquire a similar culture, focus on the integration process, and so on. Perhaps a clearer

idea of the cause of the difficulties encountered could better inform management practice.

Underlying each of these best practices is the role of resources. How much should a firm

pay for another firm’s bundle of resources? How can the board of directors ensure that the

resource of the chief executive officer and other top managers and advisors are acting in the best

interest of the firm? What can managers do when certain human resources begin acting contrary

to what “rational” behavior would dictate? How can the firm adequately evaluate the target’s

organizational culture? How can managers ensure that they do not destroy the very value they

have purchased during the integration process?

22

This section explores the attributes of specific resources through the lens of valuation and

post-merger integration. We narrow our focus to horizontal acquisitions in which the acquiring

firm must integrate the resources and activities of the target. Following Barney (1991), we

define resources as “…all assets, capabilities, organizational processes, firm attributes,

information, knowledge, etc., controlled by a firm that enable the firm to conceive of and

implement strategies that improve its efficiency and effectiveness.” (Barney, 1991: 101.) Those

resource characteristics that make valuation and/or integration particularly treacherous are

summarized in Table 3.


Broadly speaking, acquiring firms fail in their merger or acquisitions due to one or two

(or both) errors. First, the acquirer either overvalues the target – in which the hoped for

synergies simply cannot be attained – or it ineffectively integrates the target into its operation –

in which synergies that were theoretically available are not realized. We hypothesize that the

resource-based view of the firm can productively inform the problems of mergers and

acquisitions from both a valuation and integration perspective. With its emphasis on resource

rarity, value, heterogeneity and inimitability (Barney, 1991), the RBV has the potential to

facilitate understanding of the valuation and integration issues that arise in a merger or

acquisition.

In the resource-based view tradition, sustainable competitive advantage is achieved when

a firm is able to identify and leverage imperfections in factor markets when acquiring and

combining resources (Barney, 1986, 1988.) A necessary (but not sufficient) condition for

achieving this competitive advantage is the ability to acquire private and uniquely or inimitable

23

cash flows that are more valuable to it than to other firms, and that cannot be purchased in a

competitive market (Barney, 1986; Dierickx & Cool, 1989; Peteraf, 1993.)

Capron (1999) examined horizontal acquisitions from a resource-based perspective,

exploring how post-acquisition resource redeployment and asset divestiture influence acquisition

performance. In an extensive survey, she concluded that “…there is a significant risk of

damaging acquisition performance in the process of divesting and redeploying the target’s assets

and resources.” (Capron, 1999: 988.) We hypothesize that this result reflects a lack of thorough

understanding on the part of the acquirer as to the value creating mechanisms employed by the

target.

Valuation

As Penrose (1959) asked, “In the general case, that is to say, in the absence of special

individual circumstances, should we not expect the price of existing firms (i.e., their value to

themselves) to be, if anything, above their value to other firms?” (Penrose, 1959: 157.) Valuing

resource bundles can prove difficult in three broad ways: lack of information necessary to

accurately value the target firm; the potential uniqueness and inimitability of particular resource

bundles embedded in the target firm; and, ex post uncertainties about certain acquired resources.

Each of these qualities, when present, makes the identification and quantification of synergy

elusive. If the value of a target is a function of the synergy created for the combined firm, then

the presence of these broad characteristics makes that valuation highly difficult. As Penrose

(1959) observed, the decision propensity should lean towards caution rather than optimism. The

following discussion considers each characteristic in turn.

When valuing a target firm, the potential acquirer needs a wealth of information about the

target’s resources and their value creating capability. However, the absence of strategic factor

24

markets for many resource bundles (Barney, 1986) means that there is no competitive market

against which to check valuation. Combined with the second factor – information asymmetry

between seller and potential buyers (Barney, 1988) – leads to the necessity of making

uninformed assumptions, and relying on managerial discretion without the ability to objectively

check that judgment, during the valuation process. As Sirower (1997) points out, the

preponderance of evidence requires the assumption of failure that anticipated synergies will not

be realized. Tacit knowledge (Nelson & Winter, 1982) also presents difficulty in valuing target

resources.

The degree of difficulty presented by these factors is a function of the characteristics of

certain resource bundles. If, for example, the acquirer is purchasing a bundle of physical assets

in which the productive capacity can be (relatively) easily measured, then the absence of a

strategic factor market, information asymmetry and even tacit knowledge are weaknesses that are

(relatively) easily overcome. Other resource bundles, however, are more challenging to value.

Resource embeddedness (Nelson & Winter, 1982) – in which value creation capability is a

function of complex interactions with other resources of the target and/or acquirer – makes the

valuation process a function not only of a particular resource, but also of its reliance on, and

contribution to, the performance of other resources. We also hypothesize that synergy associated

with the creation of new capabilities is more difficult to estimate than that arising from the

addition and/or consolidation of existing capabilities (O’Shaughnessy & Flanagan, 1998.) In

addition, synergies arising from cost-reduction actions are considered more easily captured than

those related to revenue increases (Anand & Singh, 1997; Lubatkin, Avisnash, Schulze &

Cotterill, 1998.)

25

The ability of a firm to retain the resources it purchases is a function of the mobility of

those resources. When a significant degree of value is created with highly mobile assets (e.g.,

human capital), the risk of those resources exiting the combined organization increases. In

addition, resources acquired that have no role in the newly combined firm must be jettisoned, but

often there is a significant amount of uncertainty surrounding their disposal value, also hindering

the ability of the potential acquirer to accurately value the resource bundle.

The presence of one or more of these characteristics makes valuing a target’s resources

particularly enigmatic, jeopardizing the probability of the acquisition’s success. The greater the

presence of these attributes, the greater the risk that the potential acquirer will overvalue the

target (leading to overpayment, or the direct destruction of shareholder value) or undervalue it

(which, if the target will not sell, leads to an opportunity cost incurred by the potential acquirer

from not purchasing the target.) To minimize these risks, managerial attention should be focused

on the types of resource characteristics embodied in the target firm during the due diligence

process.

Proposition 1-A: In horizontal mergers and acquisitions, the absence of strategic factor

markets for the target’s resources bundles, the greater the degree of information

asymmetry, and the importance of tacit routines, the greater the probability that the

acquirer will overpay for the target.

Proposition 1-B: In horizontal mergers and acquisitions, the greater the degree to which

valuation is a function of embedded resources, the ability to create new capabilities, and

the objective of revenue increases, the greater the probability that the acquirer will

overpay for the target.

26

Proposition 1-C: In horizontal mergers and acquisitions, the greater the degree of

resource mobility and the greater the necessity to dispose of some of the target’s

resources, the greater the probability that the acquirer will overpay for the target.

Integration

Once a purchase decision has been made and agreed to, the resource-based view also

enables a focus on the required degree of integration as a function of the nature of the two firm’s

resource relationships. When merging similar resource bundles, value creation may be

considered through the lens of consolidation, making the integration process simpler. Here,

value is often a function of cost reductions, as excess resources are eliminated and economies of

scale and scope are secured. (A recent study by Capron (1999), however, suggests that even

cost-based synergies are more difficult to achieve than previously thought.) When acquiring

complementary resources, however, value creation typically occurs through resource

combination, seeking to enhance revenues and/or reduce costs. This category can be segmented

into two sub-parts: sequential resources (e.g., sales force, product line) require relatively less

integration versus resources employed at the same point in the value chain (e.g., product

development teams with complementary capabilities) requiring higher level of integration.

This focus on the degree of integration required reflects the hypothesis that certain types

of resources are more difficult to integrate than others. In general, as the degree of required

integration increases, so too does the complexity of the integration process (Jemison & Sitkin,

1986; Kitching, 1967; Pablo, 1994.) Capron (1999) showed that, “Overall, the acquirer is better

skilled at rationalizing its own resources than rationalizing and using the target’s assets and

resources.” (Capron, 1999: 1010.) When purchasing a bundle of resources that require a high

level of integration, therefore, attending to the nature of those resources can help identify

27

potential problems, where the risk of destroying the value purchased during the integration

process is relatively greater. Characteristics that raise the question, “How should these resources

be integrated to avoid destroying their value creating capabilities?” include a high degree of

resource embeddedness and tacit value creating mechanisms.

Acquired resources based on human interactions and/or human capabilities tend to

exhibit these characteristics. In addition, they present the risk of a high level of mobility and

potential exit. Embedded tacit routines (Nelson & Winter, 1982) employed by employees and

other stakeholders are particularly at risk for value destruction during the integration process.

Due to their embeddedness, value creation can be harmed through failing to understand and

preserve the linkages across resources. Tacit routines are, by definition, inexpressible (Nelson &

Winter, 1982), creating a substantial risk of misunderstanding the very value creating

mechanisms that the firm sought to acquire.

We hypothesize that firms sometimes fail to understand the nuances of these resource

characteristics, and thereby actually destroy value during the integration process rather than

simply failing to secure the intended value. When engaging in a merger that requires a

significant level of resource integration for value realization, and which exhibit embeddedness,

tacit value creating routines, and a reliance on human interactions and capabilities, attention

should be focused on the avoidance of destroying the value creating mechanisms, developing a

thorough understanding of those mechanisms in the target, early planning (Haspeslagh &

Jemison, 1991), flexibility (Haspeslagh & Jemison, 1991), risk reduction, and careful

management of conflicts (Buono & Bowditch, 1989.) Capron (1999) supports this hypothesis

through demonstrating that the divestiture of the target’s resources does not reduce costs and

damages capabilities.

28

By being consciously aware of these resource characteristics, and the difficulties

encountered when integrating them, firms may be able to better preserve and leverage the value

creating mechanisms of the acquired firm. While other factors may lead to integration problems

as reviewed above, scholars have not yet studied the link between pre-merger routines, value

creation and the preservation or disruption of those routines in a merger or acquisition. Perhaps

the synergy paradox could be clarified by this focus on resources.

Proposition 2-A: In horizontal mergers and acquisitions involving the integration of

complementary resource bundles, the greater the degree of embedded, tacit value creating

mechanisms in the target, the greater the risk that the acquirer will fail to secure the

anticipated synergy gains.

Proposition 2-B: In horizontal mergers and acquisitions involving the integration of

complementary resource bundles, the greater the degree of reliance on human interactions

and/or human capabilities for value creation, the greater the risk that the acquirer will fail

to secure the anticipated synergy gains.

CONCLUSION

Empirical tests have not yet examined the driver of horizontal merger failures: Are they

typically driven by overpayment or by integration problems? An analysis of those transactions

in which the failure is in the valuation process should examine the prevalence of particular

resource characteristics to determine if some types of resource bundles lead to overvaluation

more often than others. When a fair value was paid for the target firm, what role did a failure to

understand and accommodate the embedded, tacit and human routines play in the inability of the

acquirer to secure the value it purchased? The concepts outlined herein can be empirically

tested, although operationalization of some of the variables may prove challenging. We suggest

29

that an emphasis on the degree of the resource characteristic – rather than on its presence – could

prove useful.

Depending on the empirical results, possible management prescriptions include:

Acquirers who are targeting firms that exhibit a relatively low degree of enigmatic resource

characteristics in both valuation and integration (i.e., valuation and integration are relatively

easy) should gain comfort that the transaction’s probability of success is relatively high. An

emphasis on due diligence should be employed when the target resources are difficult to value.

Characteristics that present difficulties in the integration process should be managed with

caution. Finally, targets that embody difficulties in both valuation and integration should be

avoided.

- - - - - - - - - - - - - - - - - - Insert Figure 1 about here - - - - - - - - - - - - - - - - - -

30

REFERENCES

Anand, J. & Singh, H. 1997. Asset redeployment, acquisitions and corporate strategy in

declining industries. Strategic Management Journal, Summer Special Issue, 18:

99-118.

Barney, J.B. 1986. “Strategic factor markets: Expectations, luck, and business strategy.”

Management Science, 32: 1231-41.

Barney, J.B. 1988. Returns to bidding firms in mergers and acquisitions: Reconsidering

the relatedness hypothesis. Strategic Management Journal, 9 (special issue): 71

-78.

Barney, J.B. 1991. Firm resources and sustained competitive advantage. Journal of

Management, 17 (2): 151-166.

Berry, J. W. 1983. Acculturation: A comparative analysis of alternative forms. In R. J.

Samuda and S. L. Woods (Eds.), Perspectives on immigrant and minority

education. Lanham, MD: University Press of America.

Bourgeois, L.J. III. 1980. Performance and consensus. Strategic Management Journal, 1:

227-48.

Buono, A. F. & Bowditch, J.L. 1988. The human side of mergers and acquisitions:

Managing collisions between people and organizations. San Francisco: Jossey-Bass.

Cannella, A.A. Jr. & Hambrick, D.C. 1993. Effects of executive departures on the

performance of acquired firms. Strategic Management Journal, 14 (Special Issue): 137-

153.

Capron, L. 1999. The long-term performance of horizontal acquisitions. Strategic

Management Journal, 20: 987-1018.

31

Cartwright, S. & Cooper, C.L. 1992. Mergers and acquisitions: The human factor.

Oxford: Butterworth-Heinemann Ltd.

Chatterjee, S. 1986. Types of synergy and economic value: The impact of acquisitions on

merging and rival firms. Strategic Management Journal, 7: 119-140.

Chatterjee, S. 1992. Sources of value in takeovers: Synergy or restructuring –

Implications for target and bidder firms. Strategic Management Journal, 13: 267-287.

Chatterjee, S., Lubatkin, & Weber, Y. 1992. Cultural differences and shareholder value in

related mergers: Linking equity and human capital. Strategic Management Journal, 13:

319-34.

Cyert, R.M. & March, J.G. 1963. A Behavioral Theory of the Firm. Malden, MA:

Blackwell Publishers Inc.

Datta, D.K. 1991. Organizational fit and acquisition performance: Effects of post

-acquisition integration. Strategic Management Journal, 12: 281-298.

Datta, D.K., Pinches, G.E. & Narayanan, V.K. 1992. “Factors influencing wealth creation

from mergers and acquisitions: A meta-analysis. Strategic Management Journal, 13: 67-

84.

Dierickx, I. & Cool, K. 1989. Asset stock accumulation and sustainability of competitive

advantage. Management Science, 35: 1504-10.

Elgers, P.T. & Clark, J.J. 1980. Merger types and stockholder returns: Additional

evidence. Financial Management, 9: 66-72.

Fama, E.F. 1968. Risk, return, and equilibrium – Some clarifying comments. Journal of

Finance, 23: 29-40.

Farjoun, M. 1998. The independent and joint effects of the skill and physical bases of

32

relatedness in diversification. Strategic Management Journal, 19: 611-30.

Forstmann, S. 1998. Managing cultural differences in cross-cultural mergers and

acquisitions. In M. C. Gertsen, A.M. Soderberg& J. E. Torp (Eds.), Cultural dimensions

of international mergers and acquisitions. Berlin: deGruyter.

Haleblian, J. & Finkelstein, S. 1999. The influence of organizational acquisition

experience on acquisition performance: A behavioral perspective. Administrative Science

Quarterly, 44: 29-56.

Haspeslagh, P.C. & Jemison, D.B. 1991. Managing acquisitions: Creating value through

corporate renewal. New York: The Free Press.

Hayward, M.L.A. & Hambrick, D.C. 1997. Explaining the premium paid for large

acquisitions: Evidence of CEO hubris. Administrative Science Quarterly, 42: 103-127.

Hopkins, D.H. 1987. Acquisition strategy and the market position of acquiring firms.

Strategic Management Journal, 8: 535-548.

Jemison, D.B. & Sitkin, S.B. 1986. Corporate acquisitions: A process perspective.

Academy of Management Review, 11: 145-154.

Jensen, M.C. & Ruback, R.S. 1983. The market for corporate control: The scientific

evidence. Journal of Financial Economics, 11: 5-50.

Kesner, I.F., Shapiro, D.L. & Sharma, A. 1994. Brokering mergers: An agency theory

perspective on the role of representatives. Academy of Management Journal, 37: 703-21.

Kitching, J. 1967. Why do mergers miscarry? Harvard Business Review, 45(6): 84-102.

Kogut, B. & Zander, U. 1992. Knowledge of the firm, combinative capabilities,

and the replication of technology. Organization Science, 3: 383-97.

Krishnan, H.A., Miller, A. & Judge, W.Q. 1997. Diversification and top management

33

team complementarity: Is performance improved by merging similar or dissimilar teams?


Kroll, M., Wright, P., Toombs, L. & Leavell, H. 1997. Form of control: A critical

determinant of acquisition performance and CEO rewards. Strategic Management

Journal, 18: 85-96.

Kusewitt, J.B., Jr. 1983. Mergers and the performance of the acquiring firm. Academy of

Management Review, 8: 218-26.

Lubatkin, M. 1983. Mergers and the performance of the acquiring firm. Academy of

Management Review, 8: 218-226.

Lubatkin, M. 1987. Merger strategies and stockholder value. Strategic Management

Journal, 8: 39-53.

Lubatkin, M., Avisnash, M, Schulze, W. & Cotterill, R. 1998. Three empirical cases of

multifaceted product reorientations: How much does strategic adaptation matter?

Paper presented at the Academy of Management Conference, San Diego, CA.

Marks, M.L. & Mirvis, P.H. 1998. Joining forces: Making one plus one equal three in

mergers, acquisitions, and alliances. San Francisco: Jossey-Bass Publishers.

Mergers and Acquisitions. 1990. The M&A rosters. 24(5): 123.

Montgomery, C.A. & Wilson, V.A. 1986. Mergers that last: A predicable pattern?


Nahavandi, A. & Malekzadeh, A.R. 1988. Acculturation in mergers and acquisitions.

Academy of Management Review, 13: 79-91.

Nelson, R.R. & Winter, S.G. 1982. An evolutionary theory of economic change. Cambridge,

MA: The Belknap Press of Harvard University Press.

34

O’Shaughnessy, K.C. & Flanagan, D.J. 1998. Determinants of layoff announcements following

M&As: An empirical investigation. Strategic Management Journal, 19: 803-36.

Pablo, A. 1994. Determinants of acquisition integration level: A decision-making perspective.

Academy of Management Journal, 37: 803-36.

Penrose, E. 1959. The theory of the growth of the firm. Oxford: Oxford University Press.

Peteraf, M.A. 1993. The cornerstones of competitive advantage: A resource-based view.


Ramaswamy, K. 1997. The performance impact of strategic similarity in horizontal

mergers: Evidence from the U.S. banking industry. Academy of Management Journal,

40: 697-715.

Roll, R. 1986. The hubris hypothesis of corporate takeovers. Journal of Business, 59:

197-216.

Rumelt, R. P. 1974. Strategy, Structure and Economic Performance. Boston: Harvard

University Press.

Salter, M.S. & Weinhold, W.A. 1978. Diversification via acquisition: Creating value.

Harvard Business Review 56 (4): 166-176.

Schmidt, D.R. & Fowler, K.L. 1990. Post-acquisition financial performance and

executive compensation. Strategic Management Journal 11: 559-570.

Seth, A. 1990a. Value creation in acquisitions: A re-examination of performance.


Seth, A. 1990b. Sources of value creation in acquisitions: An empirical investigation.


Shanley, M.T. & Correa, M.E. 1992. Agreement between top management teams and

35

expectation for post acquisition performance. Strategic Management Journal, 13: 245-

267.

Shleifer, A. & Vishny, R.W. 1991. Takeovers in the ‘60s and ‘80s: Evidence and

implications. Strategic Management Journal, 12: 51-59.

Sikora, M. 2001. 2000 M&A profile. Mergers & Acquisitions, 36: 2-3.

Singh, H. & Montgomery, C.A. 1987. Corporate acquisition strategies and economic

performance. Strategic Management Journal 8: 377-387.

Singh, H. & Zollo, M. 1998. The impact of knowledge codification, experience

trajectories and integration strategies on the performance of corporate acquisitions.

Academy of Management Proceedings.

Sirower, M.L. 1997. The synergy trap: How companies lose the acquisition game. New

York, The Free Press.

Walsh, J.P. 1988. Top management turnover following mergers and acquisitions.


Wernerfelt, B. 1984. A resource-based view of the firm. Strategic Management Journal,

5: 171-180.

Zollo, M. 1998. Strategies or routines? Knowledge codification, path-dependence and

the evolution of post-acquisition integration practices in the U.S. banking industry.

Working paper no. 97-10-C, The Wharton School, University of Pennsylvania,

Philadelphia, PA.

36

TABLE 1 Methodologies for Measuring M&A Success

Dimension Event Study

Accounting Measurements

Case Study

Survey Based

Basic Approach

Capital Asset Pricing Model used to calculate “abnormal returns” shortly after merger announcement

Return on equity, return on sales, return on assets over a multi-year period used to measure improvements in financial performance

In-depth analysis of a few acquisitive firms to determine if merger objectives were met

Managers involved in M&A are asked to rate the success of the merger

Strengths

Efficient market hypothesis; unbiased rational expectations of future cash flows; extraneous factors eliminated; data publicly available

Permits a multi-year perspective reflecting belief that it may take years before merger benefits are realized; data publicly available

A more robust and fine-grained understanding of the drivers of m&a success or failure

Recognizes the complexity and multi-dimensional nature of measuring m&a success

Weaknesses

Assumption that market participants are able to quickly and accurately calculate cash flow impact of the merger

Reflects the past, not the future; no adjustment for changing risk profiles; factors other than the m&a may be driving the numbers

Small sample size; inability to generalize to other situations; possible researcher bias

Self-reporting biases

Conclusions

At best a 50/50 bet for acquiring firm shareholders; mixed results on related vs. unrelated performance; m&a theory not empirically supported

Same as “Event Study”

The due diligence process, price paid and management of integration all must be deftly managed to ensure m&a success

Recommendations Beware of overpaying

Be prepared to “walk away”; be clear on sources of synergy; manage the integration process

Retain top management team of the acquired firm, regardless of whether it is a related or conglomerate merger

37

TABLE 2 Schools of M&A Success

School Key Authors Central Propositions Recommendations

Sirower (1997) Price does not equal value (i.e. the market for corporate control is not efficient); probable loss is equal to the amount of premium paid

Use a high discount rate when valuing future synergies to reflect risk of capture; presume failure Overpayment

Haspeslagh & Jemison (1991)

Escalating commitment and complexity, speed and secrecy of due diligence process can lead to overpayment Be highly aware of the potential pitfalls. Think.

Kesner & Shapiro (1994)

Acquiring firm’s investment bankers have an incentive to negotiate the highest possible price

Restructure typical contract so that bankers’ fees are not a function of the size of the deal

Lubatkin (1984); Schmidt & Fowler (1990)

Because CEO compensation tends to increase with the size of the firm, CEOs may engage in m&a to increase their own compensation

The board should seriously consider if this motive is driving the m&a recommendation Agency

Problems

Kroll, et al (1998)

Firms managed by substantial owners will generate positive returns from m&a; those managed by non-owners will experience negative returns

Boards of firms managed by non-owners should beware.

Hubris

Roll (1986); Hayward & Hambrick (1997)

Hubris, or exaggerated self-confidence in one’s management capability and/or ability to generate and capture synergies, may lead to poor purchase decisions

Shareholders of acquiring firms should be highly concerned with the degree of board vigilance when making acquisition decisions

Shanley & Correa (1992)

If top management of both the acquiring and acquired firms perceives agreement vis-à-vis merger goals, and in fact do agree, then post-acquisition performance will improve via healthy cooperation

Pay attention to the dynamics of the top management teams during due diligence and during integration Top

Management Complemen-tarity

Walsh (1988); Cannella & Hambrick (1993)

Top management turnover will be higher in firms that have merged than in firms that have not; retention of top management of the acquired firm is critical to the m&a success, even in unrelated mergers

Carefully manage these relationships to minimize any conflict and flight

Experience

Haleblian & Finkelstein (1999); Kusewitt (1985)

Experience with acquisitions improves management’s ability to productively integrate two firms Learn from your experience

38

TABLE 2 (Continued) Schools of M&A Success

School Key Authors Central Proposition Recommendations

Buono & Bowditch (1989)

Employees have the power to make the merger more or less successful; because a merger represents a major life event for employees, if handled poorly from the employee perspective, hidden costs may go up

Manage the merger process in an open, honest and participative way; focus on the employee distress level to achieve a healthy and strong new entity Employee

Distress Haspeslagh & Jemison (1991)

Merger success can be heightened in a cooperative environment, but must overcome barriers such as fears about job security, loss of power and resources, changes in reward systems, fear of the unknown

Recognize that these human emotions are at play, manage them effectively

Conflicting Cultures

Nahavandi & Malekzadeh (1988); Cartwright & Cooper (1992); Forstmann (1998) Chatterjee et al (1992)

Cultural differences between acquired and acquiring firms have the potential to thwart the effective integration of the two firms, and hence the achievement of merger goals

Asses cultural fit before agreeing to merge if possible; be highly sensitive to how cultural differences may affect the achievement of merger goals; actively manage the process of acculturation; base the integration plan on an understanding of cultural differences

Process Haspeslagh & Jemison (1991)

The key to merger success is to create an atmosphere in which the transfer of strategic capabilities can occur

Ensure reciprocal organizational learning; push cause-effect understanding of benefits down to the middle management level; clearly identify the resources and capabilities to be transferred; develop cooperation and trust

39

TABLE 3 Enigmatic Resource Characteristics

Valuation Integration Difficulties valuing target resources:

- No strategic factor market - Information asymmetry - Tacitness

Difficulties valuing resource combinations: - Embeddedness - New capability creation - New revenue creation

Ex post uncertainties about acquired resources: - Resource mobility - Disposal value of undesired resources

Uncertainties regarding integration process:

- Embeddedness - Tacit value creating mechanisms

Resource value based on human interactions and/or human capabilities:

- Difficulties in transferring resources (e.g., stakeholder relationships)

- High level of mobility and risk of exit

40

FIGURE 1 The Role of Resources in Valuation and Integration

Ease of Valuation High Low

High

Ease of Integration

Low

Buy it! Extreme focus on

due diligence

Proceed with

caution Walk away!

a focus on resources in m-a successs

Documents