Reasons for Frequent Failure in Mergers and Acquisitions. A Comprehensive Analysis

Thomas Straub Reasons for Frequent Failure in Mergers and Acquisitions

GABLER EDITION WISSENSCHAFT

Thomas Straub

Reasons for Frequent Failure in Mergers and Acquisitions A Comprehensive Analysis

With a foreword by Prof. Dr. Dr. José-Carlos Jarillo

Deutscher Universitäts-Verlag

Bibliografische Information Der Deutschen Nationalbibliothek Die Deutsche Nationalbibliothek verzeichnet diese Publikation in der Deutschen Nationalbibliografie; detaillierte bibliografische Daten sind im Internet über abrufbar.

Dissertation Universität Genf (HEC), 2006 Board of examiners: Prof. Gilbert Probst, University of Geneva, Managing Director WEF (President) Prof. Carlos Jarillo, University of Geneva, Managing Partner Strategic Investment Advisors S.A. (Director) Prof. Bernard Morard, University of Geneva, President of the International Organisation MBA (IOMBA) Prof. Yves Flückiger, University of Geneva, vice president of the Anti Trust Committee Switzerland Prof. Peter Gomez, University of St. Gallen, Dean of the Executive School of Management, Technology and Law; Chairman of the Board, SWX Swiss Exchange La Faculté des sciences économiques et sociales, sur préavis du jury, a autorisé l’impression de la présente thèse, sans entendre, par là, émettre aucune opinion sur les propositions qui s’y trouvent énoncées et qui n’engagent que la responsabilité de leur auteur.

1. Auflage Juli 2007 Alle Rechte vorbehalten © Deutscher Universitäts-Verlag | GWV Fachverlage GmbH, Wiesbaden 2007 Lektorat: Frauke Schindler / Britta Göhrisch-Radmacher Der Deutsche Universitäts-Verlag ist ein Unternehmen von Springer Science+Business Media. www.duv.de Das Werk einschließlich aller seiner Teile ist urheberrechtlich geschützt. Jede Verwertung außerhalb der engen Grenzen des Urheberrechtsgesetzes ist ohne Zustimmung des Verlags unzulässig und strafbar. Das gilt insbesondere für Vervielfältigungen, Übersetzungen, Mikroverfilmungen und die Einspeicherung und Verarbeitung in elektronischen Systemen. Die Wiedergabe von Gebrauchsnamen, Handelsnamen, Warenbezeichnungen usw. in diesem Werk berechtigt auch ohne besondere Kennzeichnung nicht zu der Annahme, dass solche Namen im Sinne der Warenzeichen- und Markenschutz-Gesetzgebung als frei zu betrachten wären und daher von jedermann benutzt werden dürften. Umschlaggestaltung: Regine Zimmer, Dipl.-Designerin, Frankfurt/Main Gedruckt auf säurefreiem und chlorfrei gebleichtem Papier Printed in Germany ISBN 978-3-8350-0844-1

Foreword This is an important book. The topic is important, and Dr. Straub approaches it with a new approach. In fact, one could say that the book’s importance stems from its lack of disciplinary focus, relying instead on a holistic understanding of the phenomenon. Too often, academic research is pursued within a narrowly defined academic “field”, necessarily blinding researchers to realities whose essence is inter-disciplinary. This is typically the case with research on Mergers & Acquisitions, making most of the “findings” relatively unimportant for practice. Yet M&A are a crucial part of business development. It is evident that companies’ long-term success is at least partially dependent on their strategic actions. And these are often shaped in practice by merger and acquisition activity. Thus phenomena as varied as globalization, value-chain optimization, or product diversification are often implemented as M&A operations. In no few cases, M&A activity constitutes the company’s strategy. If, as noted above, strategic moves do have an impact on longterm success, it follows that M&A activities are at the core of many business successes… and failures. As such, they play an important role in the development of the whole society: wealth is created (or destroyed) mostly by companies. Perhaps the most remarkable aspect of the phenomenon is its very high failure rate. Study upon study (well summarized in this book) show value destruction in about two thirds of the operations. And those are not the smallest ones: from America Online/Time Warner to Daimler/Chrysler, literally dozens of billions of euros are routinely destroyed. Why is such an apparently dangerous exercise pursued with ever greater intensity and why, being so crucially important for their companies, do managers fail almost systematically? Evidently, given the sums in play, one feels like asking everybody to stop until these questions are answered. Straub’s book tries to do just that. He takes a very broad approach, which allows him to look for very different but interrelated conditions necessary for M&A success. Reading his book, it becomes obvious why it is so difficult to succeed: for an

V

operation to add value, it has to meet many different requirements, in many different areas. It’s enough to have one shortcoming for the whole enterprise to fail. But Straub’s book also shows, indirectly, why the issue has not been well-covered in the past: since the requirements are in many different areas, they have been studied by scholars from very different traditions, who tend to be ignorant of the other specialties. Since the key for success is the simultaneous satisfaction of all requirements, they necessarily miss the important points. Thus this study draws from the fields of finance, industrial organization and sociology to try to understand what the conditions for success are. In the end, it is remarkable how important personal considerations are (the desires of top management) in what should be a relatively analytical exercise. The book is not, of course, a “how to” manual. In the end, the reader will clearly understand why such a book could not exist, given the myriad different situations in which M&A happen, and the importance of specifics. But if the main requirements for success are well understood, the reader will have a deeper understanding of the phenomenon in general, and how to engage in a specific one, should the need arise. Prof. Dr. Dr. José-Carlos Jarillo

VI

Acknowledgements This doctoral thesis is the work of several years at the HEC of the University of Geneva. It results from many contributions from a number of individuals to whom my thanks and gratitude are due. I would like to acknowledge especially the assistance of the following people and institutions: Fist of all I would like to express my gratitude and big thank to my PhD supervisor Professor José-Carlos Jarillo from the HEC of the University of Geneva for his friendship, his helpful comments, the liberty he gave me and his confidence which enabled me to organize and to make this thesis a coherent and especially an original contribution to the body of literature on the subject of performance determinants of Mergers and Acquisitions. I have particularly benefited from his vast experience knowledge on this subject matter. I also would like to express my thankfulness and show grateful appreciation to the president of my thesis Professor Gilbert J. B. Probst from the HEC of the University of Geneva for his notable help, his guidance, his incisive comments as well as his faithfulness. Even though I was officially part of the chair of strategic management he integrated me in his team of assistants. His friendship and his moral and encouraging support has been a powerful engine in the progress of my work. Furthermore, I would like to thank the other members of my dissertation committee, Prof. Bernard Morard from the HEC of the University of Geneva, for his support regarding the statistical part of my work, Prof. Yves Flückiger from the Department Political Economy of the University of Geneva and Prof. Peter Gomez from the University of St Gall, for their valuable critical comments, their advise, their reflexions, as well as for serving on my committee. I would like to thank Professor Susan Schneider from the University of Geneva, Dr. Jean-Yves Mercier from the ProMan Consulting company in Geneva, Dr. HansJürgen Ott and Christian Ott from Heidelberg for their support and help regarding my questionnaire, Dominique Couturier and Alex Stancu, both from the University of VII

Geneva for their statistical support, Benoit Lecat and finally Ilse Everts, for her precious advise. In addition, as my survey was anonymous I do obviously not know the informants around the globe who helped me in filling out my questionnaire. A special thanks also goes to them. I wish everybody had colleagues like mine. I want to thank Stefano Borzillo, Heidi Armbruster, Achim Schmitt, Eva Simeth, Katty Marmenout, Gaëtan Devins and Patricia Klarner for a great time at the HEC of the University of Geneva as well as to Dr. Sebastian Raisch for his support and very useful advice during the writing of my work. Their huge kindness and the good atmosphere in the group have been a source of strength and joy. Finally, I convey my sincere thanks to my parents, my family and my friends from Geneva and the rest of the world for their patience and understanding during the course of my thesis.

Thomas Straub

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Table of Contents 1

Introduction ....................................................................................................... 1 1.1

2

3

4

5

Research Interest ......................................................................................... 4

1.2

Research Objectives .................................................................................... 6

1.3

Foundation of a Comprehensive Model........................................................ 8

1.4

Comprehensive Model and Hypothesis ........................................................ 9

1.5

Research Methodology .............................................................................. 11

1.6

Structure..................................................................................................... 12

Literature Review ............................................................................................ 15 2.1

Definitions .................................................................................................. 15

2.2

Prior research on M&As’ performance ....................................................... 18

2.3

Rationale for mergers and acquisitions ...................................................... 37

2.4

Conclusion ................................................................................................. 62

Why M&A fail so often - a comprehensive model ......................................... 63 3.1

Criticism of traditional approaches ............................................................. 63

3.2

A comprehensive M&A model and hypothesis ........................................... 93

3.3

Conclusion ............................................................................................... 101

Research Methodology ................................................................................. 103 4.1

Research design ...................................................................................... 103

4.2

Questionnaire development ..................................................................... 109

4.3

Survey implementation ............................................................................. 123

4.4

Sample demographics.............................................................................. 126

4.5

Analysis of data ........................................................................................ 129

4.6

Conclusion ............................................................................................... 140

Research Findings ........................................................................................ 141 5.1

Determinant analysis................................................................................ 143

5.2

Outer model analysis................................................................................ 166

5.3

Inner model analysis ................................................................................ 174

5.4

Implications .............................................................................................. 178

IX

6

Conclusions ................................................................................................... 183 6.1

Discussions of the major findings ............................................................. 183

6.2

Limitations of the research ....................................................................... 190

6.3

Suggestions for Future Research ............................................................. 192

6.4

Concluding Remarks ................................................................................ 193

7

Annex ............................................................................................................. 195

8

References ..................................................................................................... 201

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List of Figures

Figure 1.1: Mergers & Acquisitions 1985-2005.......................................................... 1 Figure 1.2: Overview of M&A Failure Rates by Consulting Firms and Scientific Studies ..................................................................................................... 3 Figure 1.3: Comprehensive Model: 3 Integrative Perspectives.................................. 9 Figure 1.4: Comprehensive model with variables .................................................... 10 Figure 1.5: Structure ................................................................................................ 13 Figure 2.1: Perspectives of research on M&A performance .................................... 19 Figure 2.2: Calculation of the Net Acquisition Value ................................................ 33 Figure 3.1: Comprehensive Model: 3 integrative dimensions .................................. 94 Figure 3.2: Research Model (second order) .......................................................... 102 Figure 4.1: Classification of Descriptive Studies .................................................... 104 Figure 4.2: Response Distribution per Country ...................................................... 126 Figure 4.3: Response Distribution per Year of M&A Completion ........................... 127 Figure 4.4: I nformant Competence ....................................................................... 128 Figure 4.5: Research Model (first order model) ..................................................... 139 Figure 5.1: Simple Regression Analysis – Market Similarity (structural diagram) .............................................................................. 145 Figure 5.2: Simple Regression Analysis – Market Complementary (structural diagram)............................................................................................... 146 Figure 5.3: Simple Regression Analysis – Production Operation Similarity (structural diagram) .............................................................................. 147 Figure 5.4: Simple Regression Analysis – Production Operation Complementarity (structural diagram) .................................................. 148 Figure 5.5: Simple Regression Analysis – Market Power (structural diagram) ...... 149 Figure 5.6: Simple Regression Analysis – Purchasing Power (structural diagram) .............................................................................. 150 Figure 5.7: Simple Regression Analysis – Acquisition Experience (structural diagram) .............................................................................. 151 Figure 5.8: Simple Regression Analysis – Relative Size (structural diagram) ....... 152 Figure 5.9: Simple Regression Analysis – Cultural Differences (structural diagram) .............................................................................. 153 XI

Figure 5.10: Simple Regression Analysis – Acquisition Premium (structural diagram) ........................................................................... 154 Figure 5.11: Simple Regression Analysis – Bidding Process (structural diagram) ........................................................................... 155 Figure 5.12: Simple Regression Analysis – Due Diligence (structural diagram) ... 156 Figure 5.13: Multiple Regression Analysis – Strategic Factors (structural diagram) ........................................................................... 160 Figure 5.14: Multiple Regression Analysis – Organizational Behavior Factors (structural diagram) ........................................................................... 162 Figure 5.15: Multiple Regression Analysis – Financial Factors (structural diagram) ........................................................................... 163 Figure 5.16: Outer Model Analysis – Strategic Logic (structural diagram) ............ 167 Figure 5.17: Outer Model Analysis – Organizational Behavior (structural diagram) ........................................................................... 169 Figure 5.18: Outer Model Analysis – Financial Aspects (structural diagram)........ 170 Figure 5.19: Inner Model Analysis (structural diagram) ........................................ 175

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List of Tables

Table 2.1: Theories of merger motives ................................................................... 38 Table 3.1: Evaluation Frameworks ......................................................................... 85 Table 3.2: Advantages and disadvantages of M&A valuation techniques .............. 85 Table 3.3: The benchmarking process ................................................................... 86 Table 4.1: Market similarity ................................................................................... 110 Table 4.2: Market complementarity ...................................................................... 111 Table 4.3: Production operation similarity ............................................................. 112 Table 4.4: Production operation complementarity ................................................ 112 Table 4.5: Market power ....................................................................................... 113 Table 4.6: Purchasing power ................................................................................ 114 Table 4.7: Acquisition experience ......................................................................... 115 Table 4.8: Relative size ........................................................................................ 115 Table 4.9: Cultural compatibility ............................................................................ 116 Table 4.10: Acquisition premium ............................................................................ 117 Table 4.11: Bidding process ................................................................................... 117 Table 4.12: Due diligence ....................................................................................... 118 Table 4.13: Synergy realization .............................................................................. 120 Table 4.14: Relative performance........................................................................... 121 Table 4.15: Absolute performance.......................................................................... 122 Table 4.16: Informant competence ......................................................................... 123 Table 4.17: Sample Search Criteria ........................................................................ 124 Table 4.18: Reliability Analysis ............................................................................... 130 Table 4.19: Convergent Validity Analysis ............................................................... 133 Table 4.20: Discriminant Validity Analysis .............................................................. 136 Table 5.1: Simple Regression Analysis – Market Similarity (outer loadings) ........ 145 Table 5.2: Simple Regression Analysis – Market Complementary (outer loadings) .................................................................................... 146 Table 5.3: Simple Regression Analysis – Production Operation Similarity (outer loadings) .................................................................... 147 Table 5.4: Simple Regression Analysis – Production Operation Complementarity (outer loadings) ........................................................ 148 XIII

Table 5.5: Simple Regression Analysis – Market Power (outer loadings) ............ 149 Table 5.6: Simple Regression Analysis – Purchasing Power (outer loadings)...... 150 Table 5.7: Simple Regression Analysis – Acquisition Experience (outer loadings) .................................................................................... 151 Table 5.8: Simple Regression Analysis – Relative Size (outer loadings) .............. 152 Table 5.9: Simple Regression Analysis – Cultural Differences (outer loadings) ... 153 Table 5.10: Simple Regression Analysis – Acquisition Premium (outer loadings) .. 155 Table 5.11: Simple Regression Analysis – Bidding Process (outer loadings) ......... 156 Table 5.12: Simple Regression Analysis – Due Diligence (outer loadings) ............ 157 Table 5.13: Simple Regression Analysis - Summary .............................................. 158 Table 5.14: Multiple Regression Analysis – Strategic Factors (model loadings)..... 161 Table 5.15: Multiple Regression Analysis – Organizational Behavior Factors (model loadings) .................................................................................. 162 Table 5.16: Multiple Regression Analysis – Financial Factors (model loadings) .... 164 Table 5.17: Multiple Regression Analysis - Summary ........................................... 165 Table 5.18: Outer Model Loadings: Strategic Logic ................................................ 167 Table 5.19: Outer Model Loadings: Organizational Behavior ................................. 169 Table 5.20: Outer Model Loadings: Financial Aspects ........................................... 171 Table 5.21: Outer Model Loadings - Summary ....................................................... 173 Table 5.22: Outer Model Loadings: Inner Model..................................................... 176 Table 5.23: Hypothesis testing for latent variables: Conclusion.............................. 178 Table 5.24: Hypothesis testing for determinants: Conclusion ................................. 180 Table 6.1: Hypothesis testing: Strategic Logic, Organizational Behavior and Financial Aspects .......................................................................... 185 Table 6.2: Hypothesis testing: Strategic Logic ...................................................... 185 Table 6.3: Hypothesis testing: Strategic Logic Determinants................................ 186 Table 6.4: Hypothesis testing: Organizational Behavior ....................................... 187 Table 6.5: Hypothesis testing: Organizational Behavior Determinants ................. 187 Table 6.6: Hypothesis testing: Financial Aspects ................................................. 188 Table 6.7: Hypothesis testing: Financial Aspects Determinants ........................... 188

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1 Introduction Discussions on the increase in the volume and value of Mergers and Acquisitions (M&As1) during the last decade have become commonplace in the economic and business press (Jarillo 2003; Gaughan 2002; Jansen 2001, and Picot 2000). According to an article in the Neue Zürcher Zeitung, the merger-and-acquisition carrousel turned faster in 2005 than at any other time during the last five years (Neue Zürcher Zeitung 2005). According to the Dealogic research institute in New York, deals worth a total value of US$ 2.04 billion were announced worldwide in the first nine months of 2005. This is 43% more than during the same period in 2004. It seems that more and more companies are merging and thus growing progressively larger. The following figure 1.1 supports this impression.

Figure 1.1: Mergers & Acquisitions 1985-2005 4000 3500

Billion US $

3000 2500 2000 1500 1000 500 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Y ear

Source: Thomson International Securities and Dealogic

M&As are not regarded as a strategy in themselves, as stated by Hitt et al. (1991), but as an instrument with which to realize management goals and objectives (Jarillo 1

The terms merger and acquisition are “used interchangeably to mean any transition that transforms one economic unit from two or more previous ones” (Lubatkin & Shrieves 1986).

1

2003). These goals and objectives have, for decades, been of central interest to research on M&A (Trautwein 1990; Brouthers et al. 1998; Reid 1968; Steiner 1975; Jensen and Ruback 1983, and Simon 1964). A variety of motives have been proposed for M&A activity, including: increasing shareholder wealth (Salter and Weinhold 1979), creating more opportunities for managers (Meeks 1977; Mueller 1969, and Reid 1968), fostering organizational legitimacy, and responding to pressure from the acquisitions service industry (Jemison and Sitkin 1986 and 1986(a)). Among others, Edith Penrose contributed significantly to our understanding of firm-level growth, and corporate diversification strategy (Penrose 1995). According to Grant (2002), she provided a fundamental model of the firm as a collection of firm-specific resources, with diversification being driven by excess capacity in these resources. If resources and capabilities are drivers of corporate strategy, their essential characteristics are that they can be applied across product markets and that they are subject to some form of indivisibility so that the marginal cost of deploying them in an additional application is less than their initial use’s marginal cost. In other words, they are subject to ‘economies of scope’, which is formally defined in terms of ‘sub-additivity’ (Baumol et al. 1982). In Competitive Strategy, Michael Porter’s (1980) work on the tradition of industrial organization, he provided a summary of strategic management objectives (see Bain 1959; Caves 1982, and Spence 1977). The overall objective of strategic management is to understand the conditions under which a firm could obtain superior economic performance (Barney 2002)2. Eckbo (1983) and Halpern (1973) consequently analyzed efficiency-oriented motives for M&As. Accordingly, the dominant rationale used to explain acquisition activity is that acquiring firms seek higher overall performance (Bergh and Holbein 1997; Hoskisson and Hitt 1990; Sirower 2000, and King et al. 2003). Despite the inherent goal of performance improvement, results from acquisitions are often disappointing. A strategy of external growth through acquisitions can produce results ranging from outstanding success to dismal failure, as indicated by a number 2

2

In the present work the variable M&A performance will represent the company’s owner perspective and exclude other perspectives like social or managerial interests of a deal.

of studies ranging from Dewing’s (1921) pioneering research to the present (Agrawal and Jaffe 2000; Haspeslagh and Jemison 1991; Sirower 2000 and King et al. 2004). It is thus evident that M&As do not reliably yield the desired financial returns (Jensen and Ruback 1983; Lubatkin 1983; Ravenscraft and Scherer 1987(b); Agrawal et al. 1992 and Loughran, and Vijh 1997). Studies by Porter (1987) and Young (1981) also suggested that M&As have a high failure rate. According to these studies, managers of the acquiring firms rated half of all acquisitions as unsatisfactory. Kitching (1974) stated that 47 per cent of acquisitions failed or were not worth undertaking; a survey by Lybrand (1992) indicated that 54 per cent of acquisitions fail; Hunt et al. (1988) suggested a failure rate of 45 per cent. More recently, Sirower (2000) concluded that about 65 per cent of acquisitions fail to benefit the acquiring companies whose shares subsequently underperform in their sector. Child et al. (2001) stated that as many as 50 per cent of acquisitions fail. Figure 1.2 underlines this tendency.

Figure 1.2: Overview of M&A Failure Rates by Consulting Firms and Scientific Studies

Source: (Jansen 2002)

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Haspeslagh and Jemison (1987, 55) even argued that “nothing can be said or learned about acquisitions in general.” In fact, Barney (1988) concluded that successful bidding firms might simply be “lucky”. Agrawal and Jaffe (2000) also stated that the mixed results are still an unsolved puzzle (King et al. 2003). While this may be partly true, it would be unfortunate if this were the only wisdom we could offer executive teams gambling with shareholder resources, or other stakeholders having to deal with this subject.

1.1 Research Interest Consequently, there is a recognized need for research to identify a theoretical framework that could help explain acquisition performance (Hitt et al. 1998; King et al. 2003; Hoskisson and Hitt 1994, and Sirower 2000). Although there is a large body of research on M&A performance, very little research has concentrated on helping us better understand how M&As could be undertaken (Hitt et al. 1998). What distinguishes the successful cases from the failures? What lessons can be learned? Prior research on acquisitions has only partially addressed the question of why so many well intended and well advised acquisition efforts end in disappointment. It could therefore be useful to focus on M&A performance (Jemison and Sitkin 1986). Most previous research on M&As3 focused on individual aspects of the acquisition process, such as the motives for or objectives of the acquisition, post-acquisition performance (either stock returns or operating performance), sources of shareholder wealth in the corporate acquisitions process, influences on post-acquisition integration, and others. Sirower (2000, 13) stated that “despite a decade of research, empirically based academic literature can offer managers no clear understanding of 3

4

See Asquith 1983; Barney 1988 and 1991; Bradley 1983; Cannella and Hambrick 1993; Cartwright 1993; Chatterjee et al. 1992(a); Chatterjee 1986; Datta et al. 1992; De Noble et al. 1997; Hansen 1987; Eckbo 1983; Martin and McConnell 1991; Napier 1989; Pablo 1994; Ravenscraft 1988; Schweiger 1987 and 1991; Trautwein 1990; Walter 1990; Weber 1996; Salter 1979, and Porter 1987.

how to maximize the probability of success in acquisition programs”. Previous studies have investigated corporate acquisition issues within uni-dimensional frameworks, i.e. one issue at a time. In order to pursue more rigorous and practical studies in future, it is necessary to take a comprehensive viewpoint that includes the most critical

corporate

acquisition

issues

in

a

multi-dimensional,

comprehensive

framework. Generally, the reasons for the failure of prior strategic management research on M&A activity can be clustered into three fields: the acquiring firm may select the wrong target4 (strategic logic), the target firm may be poorly integrated5 (integration) and the acquiring firm may pay too much (price) (Hayward 2002; see also Gilson and Black 1995; Haspeslagh and Jemison 1991, and Eccles et al. 1999). In fact, one can find as many published studies that have a positive conclusion regarding the impact of a good ‘strategic fit’ on M&A performance (Lubatkin and Srinivasan 1987; Chatterjee 1986, and Elgers and Clark 1980) as those that do not (Singh and Montgomery 1988 and Shelton 1988). However, Jemison and Sitkin (1986 and 1986(a)) stated that empirical research concerning the impact of M&A Integration on M&A performance is notably lacking. Furthermore, Ravenscraft and Scherer (1987(b)) revealed that an important reason for the bad post-takeover returns was the write-up of asset values stemming from the payment of high acquisition premiums. Following the same stream of argument, Salter and Weinhold (1979) argued that acquirers frequently overestimate the target’s value, while underestimating the costs of realizing synergies, and therefore pay too much. Consequently, it could be useful to regard strategic logic (i.e. strategic management) as a necessary (but not sufficient) condition for M&A success, and consider integration (i.e. organizational behavior) and an appropriate price (i.e. finance school) as important complementary issues.

4 5

See e.g. Chatterjee 1986; Lubatkin 1987; Salter 1979; Seth 1990; Shelton 1988, and Singh 1987. See e.g. Buono 1989; Datta 1991; Davis 1986; Leighton and Tod 1969; Marks 1982, and Sales and Mirvis 1985.

5

Thus, one cannot merely address an acquisition’s strategic logic without understanding that the price and the target’s integration into the parent firm are also important prerequisites for M&As’ success. By means of a comprehensive method that includes all the three dimensions, the purpose of this study will therefore be to identify and understand those conditions and attributes that contribute to M&A success and failure. The study is based on the hypothesis that wealth creation in mergers and acquisitions is influenced by the simultaneous impact of a number of factors. The findings of this study should consequently provide guidance that has not hitherto been available. What can a comprehensive perspective contribute to the understanding of corporate M&As? The approach taken in this thesis emphasizes the above-mentioned three fundamental dimension clusters’ combined influence. To date, these three dimensions have only been examined separately. These prior approaches therefore failed to provide the full picture. Consequently, the collective impact of all three dimensions as a whole on M&As’ outcome has never been tested. A comprehensive emphasis of all three main dimensions - strategic logic, integration, as well as price – as dependent key determinants of M&As’ outcomes does not, however, imply a rejection of the research made in each of these areas to date. On the contrary, strategic logic, integration and price are themselves the fundamental elements through which this author’s comprehensive approach will be built.

1.2 Research Objectives As mentioned above, several studies have been done on specific areas, which have indicated that post-M&A performance6 is possibly influenced by factors derived from various management schools of thought: the strategic management school, organizational behavior and the financial school (Haspeslagh and Jemison 1991; Larsson and Finkelstein 1999; Datta et al. 1992, and King et al. 2004).

6

6

M&A performance will be seen in the perspective of the owner of a firm.

The overall research objective of this work, which is to understand the reasons for frequent failures in M&A, can be summarized as follows: M&A performance = ƒ (strategic logic; organizational behavior; financial aspects) The main hypothesis of the study is therefore: Strategic logic, organizational behavior and financial aspects are positively related to post-M&A performance. In order to divide the overall hypothesis into manageable tasks, the author continues by specifying three subordinate research objectives. Multiple studies show that M&A performance is influenced by M&As’ strategic logic (Rumelt 1986; Williamson 1975; Salter and Weinhold 1979; Lubatkin 1983 and 1987; Larsson and Finkelstein 1999, and Barney 1988). The first research objective is to integrate the most relevant determinants of M&A performance that have been derived from strategic management into a single model. Other studies have shown that the integration aspect of M&As is a very important field of research in respect of post-M&A performance (Fowler and Schmidt 1989; Chatterjee et al. 1992(a); Weber and Piskin 1996; Hitt et al. 1993; Cartwright and Cooper 1995; Buono and Lewis 1985, and Schein 1985). The second research objective is to integrate the most relevant determinants of M&A performance that have been derived from organizational behavior (integration) into a single model. Other studies have shown that financial aspects, especially the price paid for the M&A, are a very important field of research in respect of post-M&A performance (Ravenscraft and Scherer 1987(a); Sikora 2002; Dogra 2005, Kusewitt 1985; Eccles et al. 1999; Jarrel et al. 1988; Jensen and Ruback 1983, and Datta et al. 1992). The third research objective is to integrate the most relevant determinants of M&A performance in the financial field (especially regarding price) into a single model.

7

1.3 Foundation of a Comprehensive Model A number of theories have been developed to explain M&As and their success or the lack thereof, most of which are, however, relatively limited, and while a few are complementary, others are autonomous or even conflicting. Due to their inadequateness, none of these theories capture the essence of M&As as a complex phenomenon (Hitt et al. 1998). It is therefore obvious that the research on the determinants of M&A performance is highly fragmented. Furthermore, the various research streams are based on limited assumptions. In order to integrate valuable ideas from different perspectives, we first need to establish a common foundation of fundamental assumptions, or a frame of reference for our model. This frame of reference has to integrate the distinctive research streams that focus on the determinants of M&A performance. It is obvious that distinctive perspectives are based on distinctive epistemological assumptions (Raisch 2004). Although conventional approaches are thoroughly grounded in realism as well as positivism, other modern approaches are located in constructivism (Malik and Probst 1982; Nelson 1995). To improve the pragmatism as well as to further develop theories, it is therefore crucial for our research to build frameworks and lean on in-depth empirical studies (Porter 1991). Simultaneously, we are conscious that no theory can at any time try to characterize or describe the full complexity of various phenomena (McKelvey 1999). In order to establish a comprehensive model, the present study thus suggests combining different theoretical research perspectives on the determinants of M&A performance. This is the only practical approach with which to achieve our research objective: the establishment of a more integrated approach to the analysis of the determinants of post-M&A performance. A single research perspective could never by itself capture the essence of the complex phenomenon of M&A to the same extent, and thus wouldn’t allow the same degree of generalization and validation.

8

1.4 Comprehensive Model and Hypothesis Following these research objectives, the comprehensive model can be visualized as shown in figure 1.3:

Figure 1.3: Comprehensive Model: 3 Integrative Perspectives

Strategic ManagementPerspective

OrganizationalBehavior Perspective

M&A Performance

Financial Perspective

This framework responds to the first research objective by addressing the problem of fragmentation through the integration of the most important competing research perspectives on determinants of M&A performance. The model’s main hypothesis suggests that the integrated model is an improvement on any single perspective approach. Based on a thorough literature review, the most important determinants of post-M&A performance are derived from the different perspectives (see Haspeslagh and Jemison 1991, Jarillo 2003). More exactly, we analyze the influence of strategic logic, organizational behavior and financial aspects on M&A performance within a single model. Based on the literature, strategic logic is represented by six variables based on Larsson and Finkelstein (1999): (1) market similarities and (2) market complementarities (e.g., Chandler 1977; Teece 1982; Williamson 1975, and Rumelt 1986); (3) production operations’ similarities and (4) complementarities (e.g., Bain 9

1959, and Lloyd 1976) and, finally, (5) market and (6) purchasing power (e.g., Caves and Porter 1977; Chatterjee 1986, and Scherer 1990). Organizational behavior is reflected by three variables: (1) acquisition experience (e.g., Fowler and Schmidt 1989; Kusewitt 1985, and Bruton et al. 1994), (2) relative size (e.g., Kusewitt 1985; Seth 1990; Larsson and Finkelstein 1999, and Bruton et al. 1994), and (3) cultural compatibility (e.g., Schein 1985 and Chatterjee et al. 1992(a)). In conclusion, financial aspects are reflected by the following three variables: (1) acquisition premium (Sirower 1994 and Hayward and Humbrick 1997), (2) bidding process (Datta et al. 1992), and (3) due diligence (Rappaport and Sirower 1999). All twelve variables are presumed to be positively or respectively negatively linked to M&A performance, as illustrated by figure 1.4.

Figure 1.4: Comprehensive model with variables

Strategic Management Perspective Market Similarities

Market Compl.

Prod. Op. Similarities

Prod. Op. Compl.

Market Power

Purchasing Power

M&A Performance Synergy Realization

Organizational Behavior Perspective Acquisition Experience

Relative Size

Cultural Difference

Relative Performance Absolute Performance

Financial Perspective Acquisition Premium

Bidding Process

Due Diligence

Based upon the present literature as well as criticism thereof, we generated a framework that integrated the most important competing research perspectives on determinants of M&A performance. The model comes close to what managers have always had to do in practice: Define the strategic reasons for an M&A, deal with the

10

integration of both companies and estimate an appropriate price in order to successfully manage an M&A.

1.5 Research Methodology In keeping with this research study’s basic research objectives, the following method was applied: in accordance with Churchill (1999), a descriptive method was utilized, which is also a cross-sectional research method based on a sample survey with which to test a comprehensive model. The established hypotheses regarding the framework’s independent and dependent variables were empirically tested. In order to test the proposed model, the key informants, each of which represented a single M&A deal, were chosen on the basis of the Thomson One banker database. The sample used in the present study contains only completed, strategically significant M&As with a majority stake of more than 50% (Haleblian and Finkelstein 1999) in companies headquartered in France, Germany (East and West), Switzerland, the United Kingdom and the United States of America, and in which the transaction’s value was at least US$ 200 million. Furthermore, the date of completion lay between 1998 and 2003. The questionnaire was developed on the basis of measures and scales for each variable that had already been deployed and tested in prior studies. Furthermore, two pre-test phases were carried out for the further refinement and improvement of the questionnaire. Using an Internet survey method, an e-mail survey was conducted between May and July 2005. By means of various statistical methods, including simple and multiple regression analysis and structural equation modeling based on PLS Graph Software, the respondents’ data were then analyzed (Chin 1998).

11

1.6 Structure This section describes the structure of the 6 major parts of this study. The first three parts focus on the theoretical discussion, while the last three parts are devoted to the empirical examination of the study’s approach. The general, theoretical part is based on extensive literature studies, while the empirical part is based on extensive quantitative analyses of 102 M&A deals. In chapter two, a literature review of the existing literature on the motives for M&As as well as the research on the determinants of post-M&A performance will be provided. The literature review forms the theoretical basis of this study’s comprehensive model. Chapter three examines criticism of traditional research studies on determinants of post-M&A performance. This chapter forms the basis of the comprehensive model’s framework as well as providing the representative factors that arise from each dimension, which leads to the development of the subsequent hypotheses. Chapter four discusses the research methodology that allows the developed model and hypotheses to be evaluated. The chapter is composed of five sections: The research design, the questionnaire development, the survey implementation, the sample demographics and the data analysis methods. Chapter five presents and discusses the results of the hypothesis testing. The chapter is composed of four sections: The analysis of the various determinants, the outer model, the model and concludes with a description of the theoretical implications are described. Chapter six concludes the study, and discusses the major findings related to the subsequent hypotheses. In addition, it points out the limitations of the present empirical study, provides suggestions for further research and end with concluding remarks.

12

For a better understanding, figure 1.5 depicts the structure:

Figure 1.5: Structure

Introduction Literature review Strategic Management Perspective + Organizational Behavior Perspective + Financial Perspective

Comprehensive Model & Hypotheses Strategic Management Perspective Market Similarities

Market Compl.

Prod. Op. Similarities

Prod. Op. Compl.

Market Power

Purchasing Power

M&A Performance Acquisition Experience

Organizational Behavior Perspective Acquisition Experience

Relative Size

Relative Size

Cultural Difference

Cultural Difference

Financial Perspective Acquisition Premium

Bidding Process

Due Diligence

Research Methodology Prosuction similarity and/or complementarity:

How similar and complementary were the production operations between the combined firms, as primarily based on: a) Their required resources (raw material, man power, know how…)?

Very low

Similarity Very high

Complementarity Very low Very high

1….2….3….4….5….6….7

1….2….3….4….5….6….7

b) Their production process?

1….2….3….4….5….6….7

1….2….3….4….5….6….7

c) Their product range?

1….2….3….4….5….6….7

1….2….3….4….5….6….7

d) The overall complementarity of the production operations?

1….2….3….4….5….6….7

1….2….3….4….5….6….7

Market and Purachsing Power

How extensive do you think were the changes in the combined firms’ market and purchasing power, as primarily based on: a) Competition due to the changes in the number of competitors? b) The decrease in purchasing costs? ) Th i

i

lli

i

Market Power

Purchasing Power

Very low Very high 1….2….3….4….5….6….7

Very low Very high 1….2….3….4….5….6….7

1….2….3….4….5….6….7

1….2….3….4….5….6….7

?

Research Findings 0.45

Figure 62: Outer Model Loadings: Inner Model

Market Sim.

Variables

0.61

Market Com.

0.74***

0.52

0.59

Prod. Op. Sim. Prod. Op. Com. Market Power

Strategic Logic Market

0.72***

0.69***

Similarity

Strategic Logic

Market Complementarity Operation

0.64***

0.83

Purchasing d Power

0.62

Acquisition Exp.

0.62**

0.72

Relative Size

0.53**

R2 = 0.75

Operation

Synergy d Realization

0.23

Power Purchasing Power

M&A performance

0.65**

Relative Performance

0.57

0.70**

Absolute Performance

0.52

Organizational

0.42

Acquisition Experience Relative Cultural Differences Financial

0.80

0.26

Due Diligence

T-statistic

Significance

8.4956

;;;

13.6685

;;;

0.0705

8.8197

;;;

0.7174

0.7083

0.0616

11.6504

;;;

0.6919

0.7116

0.0567

12.2079

;;;

0.6370

0.6305

0.0753

0.4181

8.4591

;;;

4.0345

;;;

0.3130

0.3101

0.0669

4.6757

;;;

0.6188

0.3843

0.4567

0.1036

0.3374

1.8339

0.5297

0.5741

0.2432

2.1779

0.4205

0.3540

0.2711

1.5508

Behavior

0.29*

Bidding Process

error

0.0797 0.0544

0.6273

Complementarity

0.88*** 0.31***

Behavior

Size

d Premium

Standard

0.6820 0.7330

0.6217

Production

Market

0.88

Mean of subsamples

0.6770 0.7432

Similarity

0.68***

Organizational

Cultural Differences

sample

Production

0.42***

0.82

Original estimate

0.62*** 0.48

0.2920

0.2719

0.1257

2.3227

0.3423

0.2814

0.3852

0.8887

0.4436

0.4035

0.2774

1.5992

0.8590

0.7872

0.1964

4.3743

;

;

Aspects

0.34

Acquisition Premium

0.44

Financial Aspects

Bidding Process Due

0.86***

Diligence

;;;

Conclusions 13

2 Literature Review A review of the existing literature on the determinants of post-M&A performance as well as on the motives for M&As is presented in this chapter. The reviewed literature forms the theoretical basis of the present study’s comprehensive model. In business, management and organizational literature, one can find a large number of explanations for the occurrence of mergers and acquisitions. Sometimes, these explanations are not restricted to mergers and acquisitions, but are also applicable to related forms of interindustrial links such as joint ventures, strategic alliances or strategic networks (Jarillo 1988). The purpose of this chapter is to briefly introduce the most prominent theories. This framework will help to highlight the different perspectives on which the diverging explanations are based. In addition, it will indicate how the author’s comprehensive approach differs from other theories, and to what extent it constitutes a new approach to the rationale for mergers and acquisitions. First of all, however, the term merger and acquisition will be defined as it is used throughout this dissertation.

2.1 Definitions In its strictest sense, the term merger and acquisition describes two different phenomena. A merger is the unification of two or more firms into a new one, while an acquisition is one company’s purchase of the majority of the shares from another (Bressmer et al. 1989, Pausenberger 1990, and Brauchlin 1990). An M&A is thus characterized by the fact that after unification there are fewer firms than before.7 After an acquisition, however, the target firm can either remain autonomous, or be partially or wholly integrated into the new parent company, although the firms remain independent entities from a legal point of view. In the legal sense, true mergers are rare (Pausenberger 1990). In most instances, one company acquires a majority or minority equity stake in another. The two companies are not legally united; instead, they form an economic unit with both firms 7

For different types of mergers, see Bressmer et al. (1989).

15

remaining legally independent. Since the financial results of such a transaction are comparable to those of a true merger, this is called a quasi-merger (Bressmer et al. 1989). The term acquisition is often only used when more than 50% of a company’s equity has been purchased with the buyer consequently gaining complete control over its target (Clever 1993 and Cable et al. 1980). Equity stakes of a lesser percentage are referred to as minority holdings. Subject to the distribution of voting shares, however, small shareholdings can also exert considerable control (Morgan 1989). Despite the legal differentiation between mergers and acquisitions, the two words are often used together. Internationally, the expression merger and acquisition – abbreviated as M&A, or simply as mergers, or acquisitions – has become a general term that refers to all kinds of activities related to the buying and selling of a company. It alludes to classical mergers and acquisitions as well as to management buy-outs and management buy-ins, minority equity purchases, divestitures, spin-offs, and joint ventures (Frank 1993 and Bressmer et al. 1989). Sometimes, strategic alliances and other forms of cooperation such as strategic networks are also subsumed under this expression (Gösche 1991). In general, however, strategic alliances have a temporal character and from a strategic point of view, they are frequently considered as an alternative to acquisitions (Müller-Stewens and Hillig 1992). In this dissertation, the term will be used in its broadest sense as described by Kootz (1996). The expression has therefore been defined in the following way for the subsequent analyses’ purposes: The terms ‘mergers and acquisitions’, ‘M&A’, ‘mergers’ or ‘acquisitions’ refer to all forms of interindustrial relationship and cooperative activities involving the purchase or exchange of equity stakes. Thus, joint ventures are included in this definition, whereas strategic alliances are only subsumed when they are more than just a declaration of good intentions. Longterm contracts, however, are not included, even though they present one of the potential embedding strategies mentioned by the theory.

16

M&As can be typified in terms of various criteria.8 Some definitions distinguish acquisitions on the basis of, for example, strategic criteria, and equity purchases on the basis of financial or speculative criteria (Müller 1990). Others distinguish between mergers for geographic or temporal reasons (Brauchlin 1990; Clever 1993). Distinction is also frequently based on the way an M&A is financed (Sautter 1989). For this dissertation, however, a very important classification characteristic is the merger’s direction as well as the “relatedness” of the businesses that have been joined together. Generally,

one

distinguishes

between

horizontal,

vertical,

concentric,

and

conglomerate activities (Frank 1993; Schubert and Küting 1981). In a horizontal merger, the buyer and the seller firms operate in the same or very similar product or market segment. Through a horizontal acquisition, the active firm increases its market share (market extension merger) and/or its product line (product line extension merger). Strictly speaking, the definition of a horizontal merger only refers to activities that are geared towards a firm’s existing product line. In general, however, the extension into related products is also included in the definition. Contrary to a horizontal merger, a vertical merger or acquisition leads to an increase in the buying company’s value added. The buying firm tries to strengthen its position through the inclusion of preceding or succeeding stages in the industry chain. With vertical mergers, one distinguishes between downstream vertical mergers or acquisitions - those in which posterior activities, such as the distribution or further refinement of the product, are subsumed - and upstream vertical mergers or acquisitions - those in which prior activities, such as the extraction of raw materials or the production of components, are acquired. Concentric mergers or acquisitions concern the participating firms’ know-how potentials such as their production technology, distribution system, or research and development capacities (Sautter 1989). In a concentric merger, they can be combined in a useful way so that new core competencies are created, or already existing ones are complemented. 8

For a thorough presentation of distinctive classification criteria see Bressmer er al. (1989). A more conceptual overview is provided by Schubert and Küting (1981).

17

Finally, there are conglomerate or diversification mergers and acquisitions. Within this merger category, there are no similarities or complementarities between the buyer and the target firm. Conglomerate mergers are often part of a diversification or portfolio strategy. Sometimes, this merger type is broadly defined, so that it also subsumes concentric mergers and strategic networks (Hermsen 1994). When one takes a closer look at the existing literature on research on M&As’ performance, three basic research streams can be discerned in respect of literature related to reasons for M&A failure or success. According to Jarillo (2003) and Hitt et al. (2001), and in keeping with these works’ conclusions, successful acquisitions generally involve a well-conceived strategy to select the target, an effective integration process, and avoiding paying too high a premium. Hence, the theoretical arguments and empirical findings of those three dimensions will be further analyzed in the following sections devoted to prior research on M&As’ performance.

2.2 Prior research on M&As’ performance The increase in M&A frequency, volume, and size have drawn the interest of many groups of scholars, each of whom has studied the subject from a unique perspective. Section (2.2) provides an overview of prior research on M&As’ performance. 9 The extent of the research on M&A is far too wide to cover it completely in this limited doctoral thesis. The aim is therefore to present a representative, up to date sample of the research and the various basic areas’ contributions. The following three perspectives related to M&A performance and illustrated in figure 2.1 will be discussed:

9

18

The content of this chapter is mainly based on Haspeslagh and Jemison (1991) who provide an excellent overview of prior research on M&A.

Figure 2.1: Perspectives of research on M&A performance

Strategic Management Perspective + Organizational Behavior Perspective + Financial Perspective

M&As have been studied through several theoretical lenses (Larsson and Finkelstein 1999). There are three - largely limited - schools of thought that offer insights into M&A. In line with Haspeslagh and Jemison’s (1991) classification, they are called the capital market school, the strategy school, as well as the organizational behavior school. Each of these three schools relates to topics that concern M&As, although each school is grounded in a different fundamental question, and each school approaches its question from a distinct viewpoint by means of distinctive sets of hypotheses, as well as by means of a distinctive set of methodologies. Financial economists, whose research is based on the capital market view, are first of all concerned with the major questions of whether M&As create value and, if so, for whom as well as all questions related to the purchase price (e.g. the premiums paid). Their wide-ranging conclusion after examining acquirers and target firms’ stock prices throughout the period around the announcement of the M&A is that, generally speaking, acquired firms’ shareholders do profit from the M&A, but acquiring firms’ shareholders do not. In general, they infer that M&As create value, and that a lively market for corporate control should therefore be encouraged. Strategy scholars, on the other hand, explore which form of M&As is more likely to be successful from an acquiring firm’s perspective. M&As are regarded as a method of diversification, focusing on both the motives for different types of combinations

19

(Ansoff et al. 1970; Salter and Weinhold 1981; Trautwein 1990, and Walter 1990) as well as on those types of combinations’ performance effects (Lubatkin and Srinivasan 1997; Seth 1990; Shelton 1988, and Singh and Montgomery 1987). This group frequently concentrates on the degree to which an M&A is related to the company’s existing business (e.g. Hitt et al. 2003 and Anand and Singh 1997). Research in this field has also emphasized factors such as economies of scale and market power as motives for mergers and has examined M&A performance - mostly by means of accounting-based measures (Ravenscraft and Scherer 1987(b) and Steiner 1975). Other strategy scholars concentrate on supplying firms with practical advice on how to find and value M&As in order to achieve a proper “strategic logic” (e.g. Jarillo 2003; Hitt et al. 2001, and Picot 2000(a)). In contrast, organizational behavior scholars are concerned with the broad question of what effect acquisitions have on individuals and organizations. Research in this area commonly concentrates on analyzing the impact of M&As on the persons in each individual company as well as on the difficulties relating to a lack or scarcity of “organizational fit” (Datta 1991), “cultural fit” (Weber 1996), or “managerial reasons” (Marks and Mirvis 2000). Some scholars link organizational and strategic concerns to address the ways in which the M&A process impacts the realization of strategic objectives.

2.2.1 The Financial School Capital market economists’ perspective on M&As focuses on the net wealth revenues that are attained when a company’s assets are bought by other investors. The ownership is changed, because the new investors assume that they could use the assets better than the actual management could. By means of the subsequent changes in the share price, and after compensating for general market fluctuations, these researchers try to discover if wealth has been produced as an outcome of an M&A. Financial economists base their efforts on numerous basic concepts: the agency theory, the efficient markets hypothesis, a market for corporate control, the capital asset pricing model and free cash flow. 20

The agency theory regards managers as the agents of shareholders and argues that agency problems arise when managers and stockholders’ interests are not congruent (Fama 1980 and Holmström 1979). It has long been acknowledged that managers’ interest may possibly differ from those of the company’s owners (Berle and Means 1932), because a manager’s salary, power, as well as his prestige are usually strongly correlated to the firm’s size. Accordingly, the manager may decide to invest the firm’s resources in projects that will increase the firm’s size through pure self-interest, although doing so would not necessarily be profitable (Mueller 1969). Furthermore, Ravenscraft and Scherer (1987(a)) found that a major reason for declining post-takeover returns was the payment of acquisition premiums, and, therefore, an excessive purchase price. Slusky and Caves (1991) and Caves (1989) conclude that together, real and financial synergies evidently contribute less to explaining the variance in premiums than agency factors do. Hayward and Hambrick (1997) conducted a study to determine the factors involved in a decision to pay a premium over market value for an acquisition, and the impact that this could have on post-acquisition performance. According to other researchers, acquisition goodwill plays a major role in the evaluation of the purchase price (Dogra 2005). Furthermore, You et al. (1986) as well as, for example, the research of Datta et al. (1992) emphasize the impact of the bidding process on M&A performance. To reduce this self-interest behavior, companies must incur costs in order to supervise the agent’s behavior.10 The efficient market theory argues that the market value of a company’s share price represents an unprejudiced estimate of all publicly available information about the company’s future cash flows as well as their associated risks. It is therefore claimed that any M&A that results in an instantaneous increase in market value (after adjusting for normal market fluctuations) is positive, and that an M&A that results in an instantaneous decrease in market value is negative. Using this point of view, and after doing widespread research, capital market researchers have concluded that M&As do not usually increase the acquiring company’s shareholder value. Similar

10

For a review of the agency theory and its application in strategic and organizational research, see Eisenhardt (1989).

21

studies nevertheless show that normally the acquired firm’s shareholders acquire an important premium.11 Manne (1965) was the first to establish the concept of a market for corporate control, and suggested that the control of companies possibly constitute an important asset, that there is a functioning market for corporate control and that many M&As are possibly the outcome of its successful function. According to Fama and Jensen (1983; 1983(a)) and Jensen and Ruback (1983), corporate control can be defined as the privilege of determining how corporate assets should be managed, including the right to employ, fire, and set top-level management payment rates. There is a market for corporate control because one group of investors is ready to pay more than another group for the right to control a firm. Therefore, the market for corporate control is the platform on which different teams of managers compete for the privilege to run corporate resources (Jensen and Ruback 1983). The CAPM (capital asset pricing model) offers a frame for evaluating the rate of return that the market presumes an asset will earn, subject to its specific risks.12 Risk is perceived to be composed of a non-systematic factor, which is firm specific and can be diversified away by investors, and a systematic factor, which cannot be diversified away. To evaluate the latter factor, the model balances the instability of firms’ profit with the market’s instability in respect of shares. This evaluation of systematic risk is designated the beta coefficient. Basically, the model hypothesizes that equity’s opportunity costs are equivalent to the risk-free rate of earnings, plus the company’s systematic risk (beta) multiplied by the market price of risk.13 If a company still has cash after finishing all its activities, the costs of its assets have been funded. It is then claimed to have a free cash flow (Jensen 1987). Given that any investment beyond this could be expected to ruin the stockholder value, financial economists claim that stockholders must be given the free cash flow so that they can 11

12 13

22

Jensen and Ruback (1983) summarize the financial economists’ research issue. They found that, in general, acquiring firms’ shareholders do not profit or profit only marginally, while acquired firms’ shareholders enjoy solid abnormal returns on their shares. Jarrell et al. (1988) also come to the same conclusion on this issue. Weston and Copeland (1986) and Brealey and Myres (1988) present comprehensive discussions on the CAPM. An overview can be found in Mullins (1982). The market risk premium is the difference between the average market return on equity, and the risk-free rate.

reinvest it in further, more productive, activities. To the degree that agency costs are costly, and firms have a free cash flow, the menace of a takeover might be an efficient disciplining method to oblige managers to return the free cash flow to the stockholders. Financial economists’ method in use is to examine the performance impact of M&As by measuring the changes in the share prices that occur during the short period around the M&A announcement. They subsequently determine the net share price gains or losses through event studies.14 If the acquiring and target firms’ market values change after the M&A announcement, and the net change, which is also attributed to market movement in general, is positive, the capital market school presumes that wealth has been created. The rationale for concentrating on the period of time surrounding the announcement of the M&A is rooted in the efficient market hypothesis. As soon as an M&A becomes known or is announced, the present value of the anticipated profits of a bidder’s M&A activity is regarded as instantaneously integrated into the buying and target companies’ stock prices (Malatesta 1983; Schipper and Smith 1983). The key results of the capital market school’s researchers are firm: in general, target firms’ stockholders make considerable profits, while stockholders of acquiring firms make neither profits nor losses. Jarrell et al. (1988) and Jensen and Ruback (1983) collected a range of different examinations and discovered that, in general, target firms’ stockholders profit around 25% in the US. Bidding firms’ stockholders, on the other hand, profit around 2%. Comparable outcomes were found in other countries.15 Consequently, the capital market school’s researchers deduce that M&As benefit society by creating wealth.

14 15

Brown and Warner (1980) provide an overview of event study methodology. Husson (1987) provides an overview of those studies.

23

2.2.1.1 The origins of earnings through M&As

Another of the capital market school’s field of study is the origins of earnings in general. When earnings are just the outcome of somebody else’s disprofit, the capital market school’s researchers cannot confirm that assets have been redistributed so as to create wealth by picking up profitability. However, although financial economists cannot reasonably explain the gains in M&A targets as somebody else’s disprofits, researchers deduce that it is logical to suppose that value is not just re-allocated through M&As, but is produced. Some researchers believe that shareholder profits come from bondholders’ losses. Dennis and McConnel (1986) do not uphold this opinion. An additional perspective is that profits are derived from tax manipulations of the target firm’s resources. In the literature, the evidence for this is, however, ambiguous. Auerbach and Reishus (1987) surmised that in possibly 20% of cases tax benefits are sufficiently important to affect the M&A decision. Gilson et al. (1988) nevertheless found that a multitude of problems concerning definitions of tax benefits, transaction costs, and information costs complicate the claim that tax profits are definitely the reason for M&A activities, or that M&As are the most suitable method for companies to realize tax benefits. In an evaluation of several studies, Jarrell et al. (1988) found that much of the M&A activity could not be attributed to tax reasons. Shleifer and Summers (1988) claim that profits are derived from M&As because a new board breaches the embedded employment conditions between the company and the stakeholder groups. Studies that link M&As to poor target company management performance were examined by Shleifer and Vishny (1988c). Their study shows that firms have not succeeded in establishing controls to prevent managers from carrying out activities that do not increase the stockholder value. Moreover, Morck et al.’s (1988) analysis of hostile takeovers claims that such takeovers take place in swiftly changing or declining businesses and in firms where the management is not able to minimize procedures fast enough, or model other adaptations. The results verify the fact that there are agency costs that the new shareholders think they will be able to decrease.

24

The negative consequences of M&As for the buying companies raise the question why M&A activities are undertaken at all. A number of potential explanations for this apparent puzzle are offered by Lubatkin (1983), who suggests that the administrative difficulties associated with M&As could erase potential profits. His further assertion that the methods in use have possibly not been sufficient to uncover profits is consistent with Jensen’s (1986) argument of the complexity of quantifying profits for M&A bidder companies. As a concluding explanation for M&As’ permanence despite the lack of profits for the bidders, Lubatkin (1983) suggests that just specific types of M&A strategies might profit the buying company’s shareholders. Besides these arguments, Roll (1986), while agreeing with the efficient market hypothesis, claims that the empiric work that evaluates the target and bidding companies’ collective value after an M&A is unconvincing. He consequently formulated the “hubris hypothesis” which states that M&As’ aggregate profits are in no way related to the bidders’ supposition that their estimations are correct (Roll 1986). In other words: managements continue to over valuate target firms. These results demonstrate how the financial school’s researchers combine the hypotheses of free cash flow, a market for corporate control, the agency theory and efficient markets with the event studies method to improve the rationalization in respect of M&A activity. However, a number of financial researchers refute the financial economists’ central hypothesis as well as the hypothesis that a market for corporate control is a key instrument for disciplining managers, that event studies are a valid method of quantifying value creation, and that the share market is capable of precisely valuing firms. Scholars who use other methods than event studies of existing data make specific deductions with regard to M&A profits. Ravenscraft and Scherer (1987(b)), for example, claim that long-term-based results usually reveal that M&A targets perform above the industry average - at around 8% - compared to their home market standards. Furthermore, their financial income performances neither increased nor declined considerably after the M&A. Those researchers who do not believe that the share market is always efficient – a basic assumption - suggest different explanations for M&A performance than the 25

ones offered by financial scholars. Scherer (1988) hypothesizes that because the stock market does not always properly value stock, some firms will be overvalued at any given point in time, enabling them to purchase other firms, but some firms will be undervalued, which renders them interesting targets. Companies that are overvalued, will examine possible target companies to find out if they have been underestimated, causing their share price to increase. Firms that are discovered to be underestimated are purchased and their new share price simply expresses a market correction. Firms that are not purchased after being examined were not underestimated, and their share prices return to the level prior to their being possible M&A targets.

2.2.1.2 The impact of the capital market school

There are two main difficulties with using a capital market view while considering M&A from a strategic point of view. On the one hand, this viewpoint’s essential hypothesis does not reflect the reality of the world of management. On the other hand, there is the concept of the firm that this perception implies. The capital market school’s vision proposes numerous essential hypotheses concerning inner company workings and external market effectiveness. With respect to market effectiveness it takes for granted that stockholders can anticipate the way in which a company’s strategy will develop and thus price the company in relation to each stockholder’s preferred risk for that strategy. This hypothesis is contrary to a good deal of what we know in relation to strategy, in the way it is generated, and in the way it proceeds. The latest studies mention that strategy is not a predictable, programmable process, but a set of decisions’ effect on how a company will communicate with its surroundings.16 Nevertheless, as can be expected, many management decisions regarding the way the company will behave towards its environment are classified information. Making them public to investors would certainly decrease the company’s competitive position on the market.

16

26

Lindblom (1959); Quinn (1980); Mintzberg (1973), and Wrapp (1967) offer stimulating discussions on as well as support for strategy making as a progressive and incremental procedure.

Besides hypothesizing that a company’s strategy is foreseeable, the financial school assumes that acquisitions’ potential cash streams are predictable. However, even though analysts might present excellent evaluations, these evaluations might not be based on sufficient or robust enough information to satisfactorily reveal from where the predicted cash streams from an M&A will be derived. As a result, the less able we are to value or foresee the activities required to modify the company’s cash stream, the less able we are to foresee if an M&A will create wealth. In conclusion, the financial point of view supposes greater inner company effectiveness than there is in the world management. Especially the supposition that executives as well as staff always act in the stockholders’ interest, is contrary to an influential wave of studies that provides numerous motivations for managerial behavior other than increasing the stockholder value. Donaldson and Lorsch (1983) point out that executives are obligated to ensure a company’s continued existence as well as the maximization of its corporate value, i.e. its human assets, financial assets, and competitive position. Additional studies mention the ethically dangerous problems faced by decision makers, executives’ inability to increase results, as well as the predominance of satisfactory behavior.17 The increase in completed buyouts in 2005, as well as in the average size and value of European management buyouts (Harding 2003) could reveal the intrinsic capital market hypothesis to some extent. Those managers who know their companies’ potential regard buyouts as occasions to obtain company shares at a relatively cheap rate. Such companies are valued below their true worth, as investors either do not comprehend their industry portfolio sufficiently well enough to price it correctly, or they lack the vision or patience to keep the stocks long enough for the management’s strategy to bear fruit. Consequently, those managers who have better knowledge of the strategy as well as its impacts are ready to invest their own money in support of their belief in the company’s correct value. Regardless of those as well as additional problems, the American and British business world mainly uses the capital market assumptions and the influence of the existing stockholder value as the dominant standard with which to evaluate M&A 17

Simon (1957) and Cyert and March (1963) examine managers’ usual non-value-increasing conduct.

27

activities’ value. This perspective is probably prevalent due to the majority of M&A studies’ financial orientation when focusing on evaluating M&A outcomes. Changes in the stock value offer a handy, although dangerous and single-minded, scale. Outside the U.S. (and together with a minority inside the U.S.), these assumptions are certainly not common. Managerial practices in, for example, Japan, Germany, and Switzerland, reveal that management is largely averse to employing this index with its emphasis on the short term. Most of the relevant scales used by managers in this area have a tendency to center on a company’s long-term performance in addition to the realization of strategic goals in the end. Acquiring firms usually pay a premium above the market value. Hogarty (1970) discovered that the price premium paid is one of the principal determinants of profitability in mergers. Other authors emphasize the importance of the valuation and pricing of M&As. It is logical that the acquirer firm’s financial performance will eventually suffer if the acquisition price is more than it is worth, even if the synergistic benefits are taken into account (Kusewitt 1985).

2.2.2 Strategic management perspective Unlike the financial school that is focused on M&As’ productivity effect on the market, the strategic perspective is interested in M&As’ effect on individual companies. Strategic management researchers studying M&As can be divided into two subgroups. One stream of scientists shares the financial school’s concern regarding productivity, occasionally applying event studies as an approach to reveal variables that might make a distinction between diverse kinds of M&As and the resultant degree of ratability. This stream can be termed the M&A performance group. Another stream of researchers develops strategic analysis constructs to increase M&As’ productivity. This large stream can be called the “acquisition planning group”. The group is composed of a number of consultants, academics, and reflective practitioners. Based on their own experience of M&As, they recommend an improved way of examining them.

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2.2.2.1 Strategy and performance

The strategic school argues that the financial school’s studies are of only little relevance to a company’s strategists. Researchers of strategic performance explore the influence of the target, the acquirer and their relationship’s various attributes on profitability. The attributes that are assumed to be positively related to profitability are: market share, relative size, pre-acquisition performance, pre-acquisition experience, and preacquisition growth (e.g. Kitching 1974; 1967, and Fowler and Schmidt 1989). The topic of relatedness has received the most interest from academics. Theories on strategic management suggest that related mergers can create synergistic value and enhance the performance of merged firms. Previous studies of mergers and acquisitions, however, show inconclusive and controversial empirical findings. The origins of the studies on relatedness in M&As are based on corporate diversification research (Gort 1962; Rumelt 1986; 1982; Berry and Candia 1979; Bettis 1981; Christensen and Montgomery 1991, and Bettis and Hall 1982). Ramanujam and Varadarajan (1989) as well as Kim (1989) offer a broad review of diversification and performance. The research examined an obvious relationship - the relatedness of a company’s activities with its performance. Rumelt (1986; 1982) provides theoretical arguments that predict the relatedness that will remain once the effects of the varying industry profitability are disregarded. Empirical tests verify this prediction and support distinguishing between the industry and diversification18 strategy’s effects on profitability. The majority of recent research has likewise affirmed the vigor of Rumelt’s categorization scheme (Montgomery 1982) and its fundamental result (Bettis 1981 and Palepu 1985). Nevertheless, defending relatedness as a determining factor of M&As’ profitability is fruitless at best. Previous M&A research, which employed management opinion to quantify performance, argues that related M&As surpass unrelated ones in performance (Kitching 1974). These findings are not supported by studies 18

According to Rumelt (1982), diversification takes place when the firm expands to make and sell products or a product line that have no market interaction with any of the firm's other products, industry and performance.

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concentrating on stock market or operating efficiency figures. Based on an event study, Elgers and Clark (1980), for example, discovered that conglomerate M&As create more value by likewise acquiring and selling shareholders’ value than nonconglomerate M&As. Chatterjee (1986) states that targets in unrelated M&As outperform related ones, thus supporting these findings. However, based on their events study, Singh and Montgomery (1987) claim that related targets achieve abnormally high profits. Shelton (1988) achieved comparable results in his research, and found that completely unrelated M&As reveal a negative, but not significant, relationship. Lubatkin (1987), on the other hand, contends that related M&As do not create more wealth than unrelated M&As. Various researchers offer numerous explanations for the diverse results pertaining to relatedness (Haspeslagh and Farquhar 1987(a); Seth 1990, and Kim 1989). Some of the research, for instance, centers on acquirer profits instead of the total profits to both targets and bidders, which confuses the issue of M&As’ wealth creation through appropriation by the acquirer. The method used to investigate the results of relatedness contributes to the confusion, with bias being frequently demonstrated during the measurement and sampling. The controlling methods could furthermore overlook several key variables. Kim et al., for instance, argue that the large firms involved in the investigations of diversification have extremely dissimilar profiles regarding international diversification, and none of the investigations analyzed the level of internationalization (Kim 1989, and Kim et al. 1993). To date, only the solid relationship between international diversification and performance has been examined (Wolf 1975; 1977). A further question is related to the various M&A types’ relatedness. M&A types were initially differentiated to study concepts of corporate-level relatedness, Rumelt’s classification of M&A-relatedness at the industry stage being exemplary. Except for measuring

corporate-

and

business-level

diversifications

simultaneously,

classification into M&A types fail to determine the fundamental differences between them because, for example, a diversified firm’s unrelated M&A is not the same as a conglomerate’s similarly unrelated M&A.

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A pervasive leitmotiv in this study, though, is the strategic performance literature on M&As’ finding of an inherent link between relatedness and managerial issues. As alleged by Haspelagh et al. (1986; 1987), relatedness is a signal of possible sources of wealth creation, but it does not affect the scope, nature, or performance of concrete wealth creation. The strategy school’s essential limitation lies in it presuming that synergies are evident in relatedness, its unbalanced accent on the strategic part, and not including the practical aspects of wealth creation such as the human, organizational, and cultural aspects. Even where the use of relatedness in terms of the management of synergies is anticipated, M&As are characterized by greatly varying degrees of success in achieving relatedness (Haspeslagh and Farquhar 1987(a)). Various strategic management researchers and managers have mentioned the problem of M&A integration by way of an interest in good pre-acquisitions examination and planning (Searby 1969; Howell 1970; Salter and Weinhold 1979; Bradley and Korn 1981 and Berman and Wade 1981), or post-acquisition planning (Howell 1970). Their instructions regarding good pre-M&A or post-M&A examination and planning essentially amount to a logical analysis of the M&A process. This includes actions like determining the M&A’s objectives, searching for and screening the M&A, choosing suitable measures, a screening/search technique, a strategic estimation, financial evaluation as well as negotiation. A major contribution to this field was made by Salter and Weinhold’s (1978; 1981) articles on how to choose compatible acquisitions. They comprehensively discussed and illustrated every step and were the first to associate strategic choice with wealth creation, as current financial approaches do. They specifically raised interest in the risk aspect (change in cash flow), and in the return aspect (degree of cash flow) of creating wealth in such a manner. M&A analysts find strategic planners’ instructions logical as well as practical, but limited, because M&As do not ultimately fit into a planning or implementation theory (Mintzberg 1994). I could therefore be argued that despite the fact that the acquisitions were related to wealth creation, the benefits might not match the original motivation for the M&As, nor the anticipated profits.

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2.2.2.2 The synergy hypothesis

The most frequently mentioned buzzword in relation to M&As in general, and to the strategic perspective in particular, is “synergy”. A key argument for synergy is that by combining the two business units, the united firm can enhance value through economies of scale and cost savings. Nevertheless, Chatterjee (1992) pointed out that the merged company could achieve increased shareholder value through the restructuring of the target by the acquirer, rather than through the expected synergies between the acquirer and the target. From a theoretical point of view too, the strategic reasons for M&As seem to be more complex than simply focusing on “synergy”. This term will therefore be only briefly illustrated. The following sections of this chapter will focus on explaining the strategic reasons for M&As in more detail. According to Gaughan (2002, 113ff.), the term “synergy” is often associated with physical sciences. It indicates the type of reaction that occurs when two substances or factors combine to produce an effect that is superior to that which the two could provide if operating independently. In chemistry, for example, synergy occurs when two chemicals combine to produce a more potent total reaction than the sum of their separate effects. Simply stated, synergy refers to the phenomenon of 2 + 2 = 5. In mergers, this translates into a corporate combination’s ability to be more profitable than the individual parts of the combined companies. The expected presence of synergistic advantages encourages companies to invest in the costs associated with the M&A process as well as pay specific shareholders a premium for their shares. The benefits associated with synergy may result in a combined company having a positive net acquisition value (NAV).

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Figure 2.2: Calculation of the Net Acquisition Value

NAV = VAB - ( VA + VAB) – P – E where : VAB = the combined value of the two firms VB = the market value of the shares of B P

= premium paid for B

E

= expenses for the acquisition process

VA = A’s measure of its own value Reorganizing this equation, we get: NAV = (VAB - (VA + VAB)) – (P + E) Source: Gaughan (2002)

The term in brackets is the synergistic outcome. This outcome must be superior to the sum of P + E to motivate continuing with a merger. If the bracketed term is not superior to the sum of P + E, the bidding firm will have paid too much for the target. What should be included under synergistic effects? Some researchers view synergy broadly and include the elimination of inefficient management by installing the acquiring firm’s more capable management (e.g., Asquith et al. 1983 and Bradley et al. 1983). Sirower (2000), for example, defines synergy as “increases in competitiveness and resulting cash flows beyond what the two companies are expected to accomplish independently”. Synergy, as mentioned by Sirower (2000) may, however, be a too nebulous concept to be a core element in models purporting to explain post-acquisition performance. Consequently, this study will not discuss the concept of synergy further.

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2.2.3 The organizational behavior school An important insight of the last two decades is that acquisitions are often associated with implementation problems and unsatisfactory post-acquisition performance (Vermeulen and Barkema 2001). Important reasons for such a disappointing performance are the problems associated with the integration of acquisitions (Haspeslagh and Jemison 1991). In comparison to M&As’ strategic aspects, post-merger integration issues have received considerably less attention (Jemison and Sitkin 1986). Despite the fact that the strategic school has not ultimately taken the area of post-merger integration into account, comprehensive and diverse research has concentrated on the human side of post-merger integration, frequently disregarding strategic claims completely. While financial researchers are concerned with M&As’ influence on the economy, and strategic scholars focus on their influence on a specific company, organizational behavior scholars are interested in their influence on human beings. Organizational research has primarily focused on the post-combination integration process (Haspeslagh and Jemison 1991; Pablo 1994 and Larsson and Finkelstein 1999), emphasizing the culture clash and cultural fit (Buono and Lewis 1985 and Nahavandi and Malekzadeh 1988) as well as conflict resolution (Blake and Mouton 1985 and Mirvis 1985). Human resource management studies have focused on psychological issues (Astrachan 1990; Levinson 1970 and Marks 1982), how M&As affect careers (Hambrick and Cannella 1993, and Walsh 1989), and the significance of effective communication (Schweiger and DeNesi 1991). Since there is no common paradigm in any of these contributions, this author used a classification largely based on Haspeslagh and Jemison (1991), who have capriciously classified this literature into three areas. Human resource management research has concentrated on the people problems produced by M&As as well as methods to avoid or reduce them. Crisis researchers have concentrated on M&As as an example of organizational crisis. Finally, the culture literature has concentrated on the cultural compatibility aspects between the two organizations. Research has been guided by numerous variables, like the target firm and acquirer’s relative size

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(Kitching 1967; 1985; Larsson and Finkelstein 1999, and Ravenscraft and Scherer 1987(b)), the advantage of symbolism in M&A language (Hirsch 1987), and the consequences of communication on M&As (Bastien 1987; Schweiger and DeNisi 1987, and Napier et al. 1989).

2.2.3.1 Human resource effect of M&As

Much research has been done on the human resource effect of M&As as well as on the question of how to handle this effect. Research varies from practitioners (Leighton and Tod 1969 and Pritchett 1985) to academics (Bastien 1987; Buono and Bowditch 1989; Hayes 1979; Ivancevich, Schweiger and Power 1987; Levinson 1970; Marks and Marvis 1985; Sinetar 1981, and Walter 1985). The pre-acquisition period, and the effects of post-merger events are both examined. Only the negative effect is usually tested. This type of research is not concerned with career opportunities, and financial or non-finacial progress. It is more likely to discuss peoples’ characteristic feelings of alienation, tension, and conflict, problems of improper behavior, lack of career stability, stress, loss of performance, questions concerning financial security, co-worker trust and geographic relocation (Sutton 1983; Sales and Mirivs 1985; Marks and Mirvis 1985 and Buono et al. 1988). Specific research has concentrated on the relationship between M&As and staff turnover, but not on the effect on those who stay (e.g. Walsh 1988). Schweiger and Walsh (1990) argue that this relationship is influenced by a multitude of related variables. It is remarkable to see how the interpretation of staff turnover differs between financial economist scholars and organizational behavior scholars. Financial economists regard staff turnover as a possible cause of wealth creation for the acquirer’s stakeholders, suggesting that unproductive managers are substituted with wealth-increasing new managers. Conversely, organizational behavior researchers are likely to view staff turnover as the final sign of a deteriorating working environment caused by an unsuccessfully managed integration (Prichett 1985). The question of whether the new proprietors and managers have been approved by the acquired firm’s employees has also been examined (Graves 1981). The

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fundamental theory of this research is that the detection of key human problems in an M&A will help to provide a logical and more peaceful solution to integration problems.

2.2.3.2 Crisis literature

An additional stream of research on organizational behavior concentrates on individual members’ shared experience in an acquired firm. Concentrated on crisis research, this literature reveals pessimistic results in respect of M&As, at worst an M&A is a rite of passage, a necessary crisis in an organization that requires individuals

to

experience

various

periods

of

shock,

defensive

retreat,

acknowledgement, and, finally, adaptation (Jick 1979; Marks 1982 and Devine 1984). This viewpoint is regarded by various advisors as a “mourning” period for the firm, which should be properly observed (Pritchett 1985).

2.2.3.3 Cultural compatibility

Many researchers regard M&As’ post-integration as primarily a culturally driven phenomenon. This research is essentially based on an analysis of organizations’ inter- and intra-cultural differences (Martin and Siehl 1983). The literature claims that decisions regarding an M&A should mainly focus on cultural compatibility between the merging companies (Sales and Mirvis 1985). From this point of view, an M&A can be a conflictive phenomenon in that it potentially includes a cultural compulsion by a stronger firm, despite the weaker firm’s opposition (Sales and Mirvis 1985). Therefore, the way a firm’s culture is changed becomes an essential M&A factor (Bastien and Van de Ven 1986, and Napier 1989). Besides firm culture, firm history is a significant variable to the extent that every group of employees’ history conditions its activities and its interpretation of its environment. Groups that repeatedly have to deal with conflict situations are also more likely to cooperate successfully during difficult conditions in future (Blake and Mouton 1985).

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An acquired firm’s concern is focused on the degree to which it will be allowed to keep its personal identity (Sales and Mirvis 1985). A suggested solution to similar cultural worries is to encourage an understanding of the main components of both companies’ cultures, the companies’ reciprocal comprehension of the other’s culture as well as considerations beyond the two firms (Sales and Mirvis 1985). A further answer is the establishment of a high-quality standard of communication regarding the forthcoming change (Buono et al. 1988). Despite the fact that this research offers a solution to the strategic and financial schools’ limitations regarding M&As, it is nevertheless ineffective for divergent reasons: it ignores organizational topics besides those related to M&A strategy’s potential, and it largely regards implementation topics from the perspective that a company’s employees will accept the new status quo. Having defined the major terms used in the present thesis and having analyzed possible reasons for M&A failure, it is of major interest to know why M&As in general occur. The following section will therefore focus on frequently cited motives for M&As.

2.3 Rationale for mergers and acquisitions As shown in figure 1.1, M&As are becoming increasingly popular and ever more important for today’s economy. Nevertheless, as shown in section 1.1, at the same time the rate of failure is very high. It should be mentioned that M&As are not strategies in themselves, but rather ways of implementing a company’s given strategy (Jarillo 2003). Due to M&As’ high failure rate, the first logical question in this context is, “Why do companies still carry out M&A activities?” In other words, “What is the logic behind M&A activities?” In the extant literature, there are multiple theories that try to explain the motives for M&A activity. The most relevant theoretical explanations for M&A will be summarized and described in the following section, focusing on the theoretical clusters into which justifications for M&As have been grouped. Those rationales that are most dominant in business and economic research are discussed first. This is followed by an

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explanation of organizational approaches (2.3.2). How these rationale differ is explained in section 2.3.3, followed by the conclusion of this chapter.

2.3.1 Business and economic explanations According to Salter and Weinhold (1982), the upswing in merger and acquisition activity has rekindled an interest in motives for mergers. Since any discussion of such motives inevitably leads to an assessment of managerial motives, the analysis of the current merger activities starts with a brief digression to managerial goals. This will provide some important clues for interpreting the current activities. Most observers agree that mergers are driven by a complex pattern of motives, and that no single approach can render a full account (Ravenscraft and Scherer 1987(b), and Steiner 1975). Authors like Ravenscraft (1987(c)) identified up to 15 motives for acquisitions that ranged from tax savings and monopoly power to empire building and hubris. Other authors, like Hayward and Hambrick (1997), identified just three main motives for M&As: poor target company management, synergy and hubris (Berkovitch and Narayanan 1993; Walsh 1990). An overview of the basic motives for undertaking M&A activity has been provided by Trautwein (1990) as shown in the following table:

Table 2.1: Theories of merger motives Merger as a rational Merger benefits bidders Net choice

gains

through Efficiency theory

synergies Wealth transfers from Monopoly theory customers Wealth transfers from Raider theory target’s shareholders Net

gains

through Valuation theory

private information Merger benefits managers

Empire-building theory

Merger as process outcome

Process theory

Merger as macroeconomic phenomenon

Disturbance theory

Source: (Trautwein 1990, 284)

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The motives for M&As, on which this study focuses, are those that are often quoted in the M&A literature. They are usually clustered into three different groups: real motives (the monopoly and efficiency theories), speculative motives (the speculation and raider theories) (Hughes et al. 1980), and managerial motives (the managerial or agency as well as the empire-building theories). Meanwhile, the number of potential merger motives has been increased by approaches that consider capital markets’ lack of efficiency as the fundamental cause of M&As. The following discussion of the most important theories does not, however, group the different approaches, but presents them independently. Every explanation includes a short description of the major motives for M&As as well as the relevant empirical evidence. 2.3.1.1 The efficiency theories

In the strategy and industrial organizational research, M&As are frequently described in terms of synergies or efficiencies. These descriptions are based on the hypothesis that due to operational, managerial and financial synergies, combined companies produce more benefits than two companies working independently. Operational synergies produced by an M&A refer to economies of scale, scope, as well as experience. The theory of economies of scale is based on decreasing marginal production costs while increasing the output volume (Hughes et aI. 1980) through which plant-specific and product-specific economies of scale can be achieved. If a company is below the minimum efficient size, it can decrease its costs by increasing or reorganizing its manufacturing output after an M&A. Cost savings can also be obtained because a bigger production volume allows the utilization of another, more efficient manufacturing technology. Contrary to the theory, actually achieving these advantages is quite difficult. According to Scherer and Ross (1990, 164), manufacturing plants already exist when two companies merge and "not much can be done in the short run to inbuilding them and achieve the principal plantspecific economies of scale." If just the most efficient plant is used after an M&A, it could be asked why the other plant had been acquired in the first place. However, horizontal M&As can help to realize economies of scale in the longer term. To begin with, a merged firm "is likely to have more capacity due for replacement at any interval in time" (Scherer and Ross 39

1990, 164). In the second place, a firm with a superior market share can expect to benefit from being larger as this might help it to buy many new plant units (Scherer and Ross 1990). In comparison to production-specific economies of scale, productspecific economies are simpler to realize. At this point, the fused companies’ manufacturing process just needs to be reorganized and not totally replaced. The term economy of scale is often utilized in an extremely wide sense, referring to a wide-ranging decline in costs by increasing manufacturing volume. By removing duplicate operations, fixed costs, such as those for advertising, R&D and administration, can then be assigned to a larger number of products, thus decreasing the product costs. Economies of scope can also generate operational synergies that arise from the advantages provided by a multi-product company and lacking in a single-product company. This is, however, only relevant where an M&A enlarges a firm’s product line and where there are complementarities, such as the multiple usages of brand names (e.g., Nestlé sells different types of product under the same brand name), distribution channels, or a customer base. These complementarities might simplify the process of entering other markets, or just help to achieve a larger market share. Besides this, companies can lower prices through bundling strategies, which means linking the sales of various products. An additional competitive advantage produced by M&As is economies of experience. This term refers to the learning curve outcomes and the exchange of management know-how between the two firms involved in an M&A. According to Scherer and Ross (1990, 166), benefits can be achieved from R&D as soon as "ideas and money...are brought together through a merger". This reason for M&As is frequently mentioned in respect of M&As in the pharmaceutical industry when small research-based firms are acquired by larger firms. Although economies of scale and economies of experience frequently go well together, they are evidently different. Strictly speaking, economies of scale indicate the efficient utilization of production technologies and machinery throughout a certain time, while economies of experience are difficult to grasp and refer to each company employee’s cumulative knowledge.

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Managerial synergies are sometimes coupled with economies of experience and constitute another possible motive for a merger (Hughes et al. 1980, Trautwein 1990, and Ravenscraft 1987(c)). This occurs when it is presumed that the bidding company has greater management skills, which will allow it to run the acquired company more efficiently. In addition, a change of ownership and management could streamline a firm’s managerial overheads (Scherer and Ross 1990). Despite the fact that, theoretically, this could also be obtained through change in management styles, it is usually a lot easier and more beneficial to alter the management itself. Differing completely from M&As being undertaken to achieve managerial synergies is the concept of undertaking M&As to achieve a market for corporate control.19 The market for corporate control can be defined as "a market in which alternative managerial teams compete for the rights to manage corporate resources" (Jensen and Ruback 1983, 6). Contrary to M&As being undertaken to achieve managerial synergies as mentioned above, this concept concentrates on a firm’s market valuation and the optimal utilization of its assets. The hypothesis that a management’s main objective is to maximize shareholder value is also fundamental to this motive. If a firm’s management invests in disadvantageous projects instead of returning the money to the stockholders, rival companies’ management teams, who identify these management inefficiencies, will try to buy the particular company and replace the executives. Jensen and Ruback (1983, 6) claim that the "competition among managerial teams for the rights to manage resources limits divergence from shareholder wealth maximization by managers and provides the mechanism through which economies of scale or other synergies available from combining, or reorganizing control and management of corporate resources are realized." To summarize, M&As are used as a disciplinary measure exerted by the capital market as a replacement for the lack of internal control by the stockholders (Jensen and Ruback 1983). As the last of the efficiency theory cluster, achieving financial synergies will be discussed as a possible cause of M&As (Jensen and Ruback 1983, Ravenscraft 19

The concept of a market for corporate control was initially presented by Manne (1965). It was also examined by Jensen and Ruback (1983), who established the empirical evidence for this concept.

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1987(c), and Trautwein 1990). A company could try to systematically increase its business or safety through a strategy of diversification. An M&A could also allow a small company to gain the right to use a larger company's lower cost of capital. Furthermore, efficiencies could be obtained through the founding of an internal capital market after an M&A. As the internal market has access to better information, this implies that it can allocate capital more efficiently (Trautwein 1990). Potential tax savings are another reason that is often cited as a motive for M&A activities (Ravenscraft and Scherer 1987(b), and Steiner 1975). Internal capital transfers, as well as the pooling of losses might lessen the acquirer's tax obligations. Compared with the other efficiency benefits mentioned above, these tax advantages are only for the companies involved, but do not benefit the economy in general (Hughes et al. 1980). As with M&As motivated by monopoly intentions, there is little statistical proof to underpin the various efficiency theories. The achievement of financial synergies by means of an M&A has been criticized from a theoretical point of view. If anyone presumes that efficient capital markets actually exist, these synergies cannot be real. Empirical research has in fact indicated that M&As do not lessen risks systematically, nor improve internal capital markets (Ravenscraft 1987(c)). In capital markets, only benefits relating to size could be identified after an M&A (Trautwein 1990). The research undertaken to examine possible M&A benefits is unsatisfactory, too. In an study of 318 M&As during the period 1968 to 1983, Auerbach and Reihus (1988) could not identify any key tax savings as a result of these M&As. In fact, only 20% of their sample demonstrated tax savings large enough to have potentially acted as a stimulus for an M&A. And even where they discovered tax savings, they found no evidence that "they have played an important role in the structure and frequency of mergers and acquisitions" (Auerbach and Reihus 1988, 81). One of the empirical research’s main streams is dedicated to operational and managerial synergies as a possible motive for M&As. According to case studies and interviews, the efficiency rationale is the most often cited motive to explain M&As (Trautwein 1990). The interviews in the Ravenscraft and Scherer (1987(a)) M&A study of the U.S. market showed that some efficiency was achieved through M&As. 42

Simultaneously, though, they also indicated that often the expected synergies were not realized. In general terms, the statistics regarding post-M&As’ success and efficiency gains point in the same direction: efficiency usually decreases after an M&A (Scherer and Ross 1990, Trautwein 1990, and Ravenscraft 1987(c)). However, it has to be acknowledged that there are substantial deviations from this fundamental trend, as almost all of the recognizable efficiency benefits have to a certain extent been proven in principle. Jensen (1984, 120), for instance, explored empirical evidence for his model of a market for corporate control and states that "the scientific evidence indicates that activities in the market for corporate control almost uniformly increase efficiency and shareholders’ wealth." Generally speaking, event studies’ results confirm the efficiency hypotheses, whereas research based on a firm’s concrete productivity rejects the efficiency motives (Trautwein 1990). For anyone who assumes that capital markets are efficient, it seems that the publicly available information to be found in financial statements differs from that with regard to share prices, although these distinctions ought not to exist. In addition, in respect of the legitimacy of the efficiency motivation, there is no empirical proof of the efficiency theory’s management substitution motivation as a reason for M&As. According to the M&A sample in Ravenscraft (1987(c)), acquirers typically looked for well-managed firms and attempted to keep this management. This tendency was also established by other empirical research, so that Scherer and Ross (1990, 162) stated that "as a rule, merger makers seek healthy acquisition targets, not basket cases." This result obviously does not support the managerial synergies motive.

2.3.1.2 The monopoly theory

The oldest M&A rationale in the literature of industrial organization is based on the monopoly power theory, which takes a company’s market share and its barriers to entering other markets into account. There is a clear relationship between barriers to entry, market share, and a company’s profits. The greater the market share, and thus a company’s monopoly power, the greater autonomy it has to fix its prices and increase its profitability. 43

M&As, especially horizontal M&As, imply a quick and easy ability to increase a company’s market share and reduce rivalry in a specific industry. Vertical and conglomerate M&As could help to increase a firm’s market power by hindering possible market entrants. Vertical M&As could, for instance, present a barrier to entry for any potential entrant, because to successfully compete with the vertically integrated company, a potential entrant would have to simultaneously enter all markets in which the vertically integrated company has acted. In terms of the required management know-how and resources, this could be well beyond the possible entrant's abilities (Hughes et al. 1980). An additional advantage of the diversified or vertically integrated company lies in its ability to cross-subsidize products. The financial gains from one market could be utilized to start and survive a potential price war in another market (Trautwein 1990). The monopoly motivation was previously more dominant than it is at present. This motive, together with the speculative motive, is usually regarded as one of the main motivations for the first big wave of mergers in America, which occurred from 1887 to 1904 (Scherer and Ross 1990). Nevertheless, since M&As with the objective of achieving market power are just advantageous for the companies concerned and not for the economy in a general sense, as they lead to distorted markets, stifle competition as well as transferring wealth from the company’s clients to the company itself, many regulations have been enacted to limit this kind of action.20 Empirically, little proof has been found of the monopoly motivation. It is therefore not surprising that according to managers, M&As are not undertaken in order to realize monopoly power (Trautwein 1990). The performance- and event-based research done in this regard either couldn’t, or could just partially, verify the monopoly motive (Trautwein 1990; Ravenscraft and Scherer 1987(b), and Steiner 1975). According to Ravenscraft and Scherer (1987(b), 211), "one that can be given low weight for our sample is the monopoly power theory .... Most of the horizontal acquisitions involved market shares too small to confer much monopoly power, in part because larger horizontal acquisitions were under intense antitrust scrutiny."

20

44

In 1890, the Sherman Antirust Act, the first American anti-trust legislation, was passed as a reaction to the first wave of M&As (Scherer and Ross 1990).

Therefore, according to Jensen (1984), M&A gains are not derived from the M&As’ construction of monopoly market power.

2.3.1.3 The speculation and raider theories

Historically, particularly throughout the large American wave of M&As between 1887 and 1904, the speculative theory played a major role.21 Those who usually organized M&As also did so when these activities only had a modest probability of securing substantial monopoly power. Another ruse that these promoters employed to obtain additional large earnings for themselves was to manipulate the market by distributing fake information, such as rumors, or other suspect techniques. In America, these misuses led to the promulgation of the Securities Act of 1933 and the Securities Exchange Act of 1934 (Scherer and Ross 1990). Although promoters are no longer as influential as they were, speculation could still be an issue affecting M&As. Hughes et aI. (1990), for instance, maintain that currently inside managers occasionally take on the role that outside promoters had historically taken. Earnings not based on real economic profits, could, for example, be made through pre-M&A speculation with the target company’s shares by managers of both the acquirer and the acquiree company. It is evident that these actions, like the historical ones, are illegal from the perspective of current legal norms. Scherer and Ross (1990), however, contend that throughout the conglomerate American M&A wave between the 1960s and 1970s, investing in a diversified firm was truly a game of pure chance, and that only some people were able to earn very big profits. But even in respect of those companies that had organized and led conglomerate M&A activities, the charge of unsatisfactory performance was not published for years, or even decades, if at all. “And meanwhile, the living was good" (Scherer and Ross 1990, 162). A contemporary form of the speculative theory is Trautwein’s (1990) raider motive. This M&A theory is theoretically not very complex, but is, nevertheless, frequently cited in the business literature. Here, M&As are regarded as a few people’s outcome, 21

This M&A motive is mainly relevant for stock-based firms.

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in other words raiders, who attempt to obtain some of the wealth of the stockholders of the firms for which they bid. This objective could be accomplished, for instance, by way of greenmailing22, or exorbitant payment demands following a prosperous M&A. On the whole, Trautwein nevertheless dismisses this M&A motive as being irrational and discredited by empirical research, which discovered that normally it is not the acquiring company or its stakeholders, but the target's stakeholders who gain from an M&A (Trautwein 1990, and Jensen 1984). 2.3.1.4 The valuation or information theory

Studies explaining M&As from a financial instead of a strategic point of view presume that a company’s present market price does not mirror its proper value.23 Expectations in respect of a firm’s future as well as market inefficiencies due to an asymmetric distribution of information can lead to undervaluation.24 The acquiring firm may know more about the target company’s financial state than the market itself, and may be more knowledgeable regarding how to manage the company productively. As a result, it regards the target firm’s proper value as being higher than its current market price, in which case, the acquirer is stimulated to buy the company. The primary motive for such an M&A activity is therefore the market’s inefficiency and not the gaining of synergies. This does not mean that the valuation and the efficiency assumptions are not linked to each other. A firm that purchases an undervalued company does so because it presumes it could manage the acquiree better than the existing management. This hypothesis therefore partially includes the gaining of synergies. There is, however, a difference between the two theories. The efficiency motive centers on real profits resulting from synergies, whereas the valuation motive emphasizes M&As from a financial point of view. Currently, corporate trading activities are based on financial markets’ assumptions and not on an individual company’s financial circumstances.

22

23 24

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The expression greenmailing applies to a situation where a raider holds a significant number of a firm’s of shares and threatens to ruin the firm and strip it of its assets after an M&A unless he is paid a premium for his shares (Bressmer et al. 1989). Trautwein (1990) refers to this M&A theory as the valuation theory. This M&A theory is mostly important for stock-based companies.

Related to this assumption, the valuation motive opposes the efficient capital markets approach and, consequently, the capital market theory, completely rejecting the theory. Despite this rejection, there is a potential to link this M&A motive to the efficient market theory. If, for example, one were to assume that private information regarding the company is available, a possible acquirer could value a company differently than the rest of the market. However, through his bid, the share price will nevertheless increase, and he would lose the advantage he had by possessing critical information. Consequently, the supposition of an efficient market does not "preclude the existence of undervalued target firms, but only the possibility of capitalizing on revealed private information" (Trautwein 1990, 287). Quite a few research studies have revealed that those firms whose share prices had increased before an M&A, failed to make good the promise of the pre-M&A announcement level when the M&A was realized. However, if the buying firm made private information known during its offer, the share prices stayed at their superior pre-M&A announcement levels. Despite these pessimistic outcomes, Trautwein (1990) does not completely discard this M&A motive, because the belief in capital markets’ inefficiency is widely found among managers. In addition, this M&A motive recognizes the consequence of uncertainty in all future-directed decisions. Therefore, in Trautwein’s opinion, the private information concept ought to be an additional consideration as a basis for M&As, since it shows “the problematic assumption of capital market efficiency” (Trautwein 1990, 28).

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2.3.1.5 The managerial or empire-building theories

An important characteristic of the speculative theory, in other words that managers could try to realize insider advantages contrary to the stockholders’ interests, leads to the cluster of managerial M&A motives.25 This cluster’s central focus is the manager and his benefits, which could clash with the stockholders’ interests. The oldest descriptions of this cluster in the literature are the two models by Marris (1963) and Baumol (1967). Both claim that managers attempt to maximize revenues and assets’ growth rates as well as that of sales - two objectives that do not automatically lead to the maximization of stockholders’ wealth. The motive for this conduct could be managers’ efforts to guard their personal interests. These motives, like those of power and prestige, cannot be measured in monetary terms.26 Since the desire to maximize revenues and assets as well as sales’ growth rates is more strongly linked to a firm’s size and growth rate than to its profitability, "managements are likely to see the growth of their own organization as one of the best methods for satisfying personal needs and ambitions, an attitude which is reinforced by psychological tendencies to identify the ego with the organization" (Marris 1963, 187). A further point of diverging interests could be viewpoints regarding risk. Managers are usually regarded as more risk averse than shareholders. Their whole livelihood, non-monetary rewards, human capital as well as financial rewards are contingent upon the advantages that the company enjoys, while stockholders can spread their risk. A further management-oriented theory often mentioned in the context of M&As, is Roll's (1986, 212) hubris motive, which claims that generally the “decision makers in acquiring firms pay too much for their targets.” Managers may overestimate their capabilities to positively integrate and better manage the target company, with the 25

26

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Two terms are used for this cluster of reasons for M&As. Hughes et al. (1980) refer to them as the managerial theory, while Trautwein (1990), Ravenscraft and Scherer (1987), and Scherer and Ross (1990) call them the empire-building motives. It is, however, possible to express them indirectly in monetary terms. The quest for advantages in the form of prestigious investments, a company car, and more staff could, for example, be utilized as an indirect measurement of prestige and power.

result that their M&A activities ultimately do not prosper. Failure is compounded when corporate managers are motivated by the wish to build an empire by means of numerous M&As (Scherer and Ross 1990). This motive fails to explain M&A activities, but it could suggest a reason why, despite past failures and predicted difficulties, they do not stop acquiring companies. The managerial M&A theory has received wide attention, mainly in the business literature during the M&A wave in the 1980s. Taken as a whole, the empirical results in respect of these M&A motivations are positive.27 The statistical evidence is, nevertheless, quite limited. In the majority of analyses, the motives are treated as a matter of less significance. In research which fails to confirm the efficiency motives, researchers refer to the management motives, frequently claiming that if the former cannot be proven then the latter, which cannot be objectively tested, must have been the motivation behind the investigated M&As. Ravenscraft and Scherer’s (1987(b) study of M&A activities are examples of this practice. Based on the outcomes of their study of U.S. mergers between 1974 and 1977, they concluded that the hubris and empire-building theories are logical motives, both of which could have been responsible for the poor financial outcomes of the majority of the M&As that they examined. In spite of their credibility and positive research results, the managerial motives do not provide a satisfactory explanation for M&As. They do explain an individual M&A, however, but as a universal explanation for diverse M&A over time, they are unsuccessful (Steiner 1975). Furthermore, the managerial theory has been rejected for not taking the managerial labor market’s effects on corporate leaders’ behavior and the market’s controlling effects on corporate control into consideration (Jensen and Ruback 1983).

27

Not all studies support this M&A motive, however. Jensen (1984), for instance, dismisses the empire-building motive in favor of the synergy motive for M&As, which is in direct conflict with the majority of analyses. Trautwein (1990) provides a summary of the empirical evidence.

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2.3.1.6 The agency theory

Strongly associated with the managerial motives, but frequently mentioned independently, is Jensen's (1986) free cash flow motive, which adds another theory to the rationale for M&As. This theory is based on a principal-agent relationship perspective, and centers on the conflicts of interest between a firm’s managers and owners. It is argued that each of the groups acts in its own interest. Difficulties occur because managers apparently follow interests that differ from those of the shareholders, although they are appointed to run the firm in the interest of the shareholders. This diverging conduct is made possible by the disconnection between control and ownership. The principal, i.e. the owner, could, however, simply acquire a style of management based on his or her interests, and then subject this management style to a comprehensive monitoring system. However, putting such a system in place is not practicable: from a certain point of view, it is quite costly, from another point of view it isn’t feasible to totally control agents, and executives do have some flexibility in managing companies. According to Jensen (1986, 322), it is exactly this principal-agent relationship that leads to difficulty in respect of the utilization of free cash flows. “Free cash flow is the cash flow in excess of that required to fund all projects that have positive net present values when discounted at the relevant cost of capital.” It is claimed that managers tend to control these capital flows instead of giving them to the stockholders. Acquiring a firm is therefore a technique through which to achieve control of such capital flows (Jensen 1986). Therefore, increased free cash flows can impact M&A activities. Having empirically proven this hypothesis, Jensen regards it as the main reason for the growth of conglomerates in America. 2.3.1.7 The process theory

Another M&A theory has its origins in the research on strategic decision processes. According to this theory, decisions are not rational choices, but rather the results of existing processes characterized by the persons concerned and their environment. Organizational routines, political interests, and managers’ former experiences are, for

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instance, essential contextual and environmental motives that could impact the process of decision making and its outcomes.28 As a result, M&As are not regarded as outcomes of rational strategies, but rather as negotiated results of in-house decision-making processes. Jemison and Sitkin (1986 and 1986(a)) even suggest treating M&As as processes that influence firm activities and results. Consequently, the choice point of view, which is predominant in the majority of M&A studies, is complemented by a process viewpoint, "which recognizes that the acquisition process itself is a potentially important determinant of acquisition activities and outcomes" (Jemison and Sitkin 1986, 145). According to these assumptions, this motive for M&As largely contradicts the efficiency motive, which interprets M&As as decisions based on rational choices. In comparison with other theories, this motive is not well developed, and lacks direct evidence (Trautwein 1990). Its rare and frequently unclear outcomes could simply be attributed to the fact that managers attempt to rationalize their decisions. This would also explain the overall complexity associated with researching this motive for M&As. Trautwein (1990), however, supports this motive as one of the most promising for explaining M&As, which justifies additional analysis. Trautwein’s standpoint is that together with the empire-building and valuation motives, it has the highest degree of logic and ought therefore to be paid more attention by academics examining M&As. 2.3.1.8 The disturbance theory Gort's (1969) disturbance theory29 has its origins in the difference in expectation between the current shareholders and the current non-holders concerning a firm’s future profits. According to Gort (1969), the principal disturbances or economic shocks that modify the composition of expectations, are rapid changes in technology as well as changes in security costs. According to the valuation motive, information could also be diffused asymmetrically, and it is therefore possible for shareholders to have access to diverse information that non-holders do not. The two groups would therefore make different conclusions in respect of the firm’s future evolution.

28 29

A discussion of the different contextual and environmental motives can be seen in Jemison and Sitkin (1986). This M&A theory is generally relevant to stock-based firms.

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For an M&A to occur, the existing anticipations have to alter. According to this theory, it is presumed that differences in anticipations increase in times of economic turbulence. If, for instance, anticipations do indeed alter, so that outsiders - the acquirers’ management - turns out to be more optimistic and the insiders - the acquiree’s management, shareholders, as well as the acquirer’s shareholders become rather more pessimistic, large numbers of shares will change hands and an M&A will take place. M&As are therefore ultimately brought about by economic turbulence, which then leads to the various economically active groups’ future anticipations. According to the hypothesis of diverging anticipations, Gort's theory opposes the capital-asset pricing theory, which presumes that shareholders and non-holders’ assumptions are similar. Alterations in the expectations of future profits lead to instant changes in the market price as well as instant adaptations within the entire portfolio holdings. Therefore, according to the capital-asset pricing theory’s supposition as well as the supposition regarding efficient capital markets, M&As cannot be undertaken when anticipations diverge (Hughes et al. 1990). According to the disturbance motive, M&As should be anticipated in periods of changing market prices. In fact, in periods of market downtrends even greater discrepancies in stockholders and non-stockholders’ expectations should be anticipated, and thus, in comparison with a bull market period, an even more active M&A market. Nevertheless, M&A rates are in fact much higher in periods of increasing share prices, whereas they decrease during economic recessions and periods of falling share prices (Hughes et al. 1980). The fact that the M&A wave at the end of the 1960s cannot be ascribed to any major economic turbulence, although the first oil crisis could have influenced M&A activities, throws further doubt on the motive’s explicative power. Moreover, as the majority of turbulences are related to a specific industry, one should be able to discover M&As’ patterns and learn from them (Trautwein 1990). Nonetheless, there may not be much opportunity to study such patterns. This motive is also examined because it does not assume that there are any learning impacts. If one agrees with Gort’s theory on differing motivations being the reason for the M&A boom during the 1960s, one should only expect comparable 52

behavior under similar conditions if one presumes that owners do not learn and are thus eternally overoptimistic (Steiner 1975). Steiner’s comment is mostly important with regard to the results of a later research study in which Gort, in accordance with Steiner (1975), found that the divergent motives that caused M&As were not related to the benefits that firms obtained following M&As.

2.3.2 Organizational approaches explained In general terms, organizational approaches try to illustrate organizational differences and behavior by means of companies. Accordingly, some studies concentrate on people in firms as well as on internal processes, whereas others focus on companies and their external relationships with the larger environment. The subsequent M&A rationales originate entirely from the organizational literature. Compared to prior approaches, organizational M&A theories do not center totally on M&As. They also explain general organizational behavior, with M&As being just one of numerous distinctive behavioral outcomes. The following explanations have been limited to three distinctive theories (the resource dependence theory, the population ecology approach, and transaction cost economics). They will be described in more detail than the business and economic explanations in the preceding section. 2.3.2.1 The resource dependence theory

The resource dependence approach regards the environmental context as critical for understanding organizations’ activities (Pfeffer and Salancik 1978). Of particular importance is the resource environment on which organizations depend for their survival. Firms are engaged in exchanging relationships with other firms in the economy. These relationships are not equal; often they are characterized by an unequal distribution of power and dependence between the transaction partners. Pfeffer and Salancik (1978, 68) identify three elementary, structural characteristics in the environment that determine the relationship among social actors: the degree of concentration, the abundance of critical resources and the interconnectedness of the actors involved. 53

The concentration of resources creates power. However, it is not the existence of power as such that counts, as it could be met with a countervailing power, but the extent to which power and authority are dispersed. If there is much asymmetry in the exchange relationship, organizations are potentially subject to external control by other organizations. Power also stems from having discretion over resources. The organization that possesses the resources, or controls either their use or access, can control other organizations that are dependent on this resource. However, in assessing an organization's dependence, two other factors are of equal significance. These are the importance of a resource for an organization’s continuous operations, and the extent to which there are alternatives for this resource. The importance of the resource is determined by the relative magnitude of the exchange and the importance of the resource, which is a function of the environment's instability. Considering all these aspects, dependence can be defined "as the product of the importance of a given input or output to the organization and the extent to which it is controlled by a relatively few organizations" (Pfeffer and Salancik 1978, 51). In other words, it measures the strength of external organizations or groups in a "given organization's environment.” Since the environment of an organization consists of other organizations that are themselves dependent on their environment, dependence is generally bilateral and not unilateral. Therefore, Pfeffer and Salancik (1978) also use the term interdependence. "In social systems and social interactions, interdependence exists whenever one actor does not entirely control all of the conditions necessary for the achievement of an action or for obtaining the outcome desired from the action" (Pfeffer and Salancik 1978, 40). The two researchers differentiate between outcome interdependence - in a market with two players, for example, the profits earned not only depend on the one's output quantities and prices, but also on those of the other player - and behavior interdependence, which arises when the activities themselves are dependent on other social actors’ actions. To sum up, the significance of dependence and interdependence stems from the facts that they impose constraints on an organization’s field of actions, and that they create uncertainty in an unstable environment. In a certain and stable context, it would be feasible to manage these dependencies optimally. Under changing conditions, however, it remains difficult to obtain an optimal degree of interdependence.

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The resource dependence approach nevertheless views firms as active and open elements that can optimize their environment by changing and adapting to it. Firms are assumed to develop strategies to secure resources without becoming unnecessarily dependent on their transaction partners. Environmental constraints are thus not predestined and irreversible, but can be changed over time. In this process, management can take on three different roles (Pfeffer and Salancik 1978). The most important one concerns its symbolic function. Even if management has little control over activities and outcomes, it serves as a scapegoat. The other two management functions concern its active or discretionary role with respect to changes in environmental conditions, and its passive or responsive role with respect to external constraints. The three roles are not mutually exclusive; at times, they could even be enacted simultaneously. They are interdependent and represent different facets of the managerial task. Among the strategies for managing dependence, one can distinguish between two general categories. First, organizations can comply or adapt to a given situation. Secondly, they can either try to avoid any manipulation attempts, or actively respond to them by changing their environmental context. They then thus mainly seek stability and certainty in their own resource exchanges. However, coping with these aspects simultaneously, organizations face a dilemma: to gain control of some activities, they have to surrender some autonomy. The more they secure their environment, the more they are constrained in future, a fact that could eventually threaten their survival (Pfeffer and Salancik 1978). Strategies of the second type involve various forms of intercorporate and environmental linkages such as the formation of federations, associations, long-term supply relationships, joint ventures, and interlocking directorships. All of these strategies are geared toward negotiating the environment, either individually or collectively. Strategies with the goal of directly shaping one's environment also involve the active creation of legal restrictions and regulations, and the legitimization of an organization. Through lobbying and other political activities, a firm can, for example, attempt to shape its environment up front. Identifying with legitimate social actors often helps a firm to gain credibility and thus increase its influence on the environment. Furthermore, Pfeffer and Salancik (1978) also view executives’ 55

succession and recruitment decisions as a strategic response to the need for interorganizational coordination among competitors. Finally, mergers are interpreted as a potential strategy for the restructuring of interdependence. Diversification mergers help to reduce reliance on a single exchange. They are thus a strategy for the avoidance of dependence, while the alleged benefits of vertical and horizontal mergers lie in the extension of a firm's control into vital areas and increasing a firm's dominance in a certain market (Pfeffer and Salancik 1978). Most of the resource dependence theory’s empirical research concerns interlocking directorships. There are, however, also a few studies on mergers and joint ventures that are described in detail in the fourth part of this dissertation. Overall, the empirical results are supportive of the theory. Pfeffer's (1972) study of American mergers, for example, showed that they occurred more often between firms that were highly interdependent with regard to the flow of resources between them. However, as Pfeffer and Nowak (1976) admitted in their joint venture study, a lot of variance remains unexplained. Other analysts criticized the empirical findings in this research field because other investigators could not replicate the results, and no statistical control procedures were available to confirm competing merger hypotheses (Davis and Powell 1992, and Sydow 1992). In addition, empirical studies are usually conducted at the aggregate industry level, whereas the theory operates at the level of the individual organization (Davis and Powell 1992). Despite the fact that Pfeffer and Salancik (1978) claimed that their theoretical approach could be applied to all forms of organizations, most research has focused on profit-making firms.

2.3.2.2 The population ecology theory

The population ecology approach is an ecological theory about the analysis of organizations that is likened to biological population approaches (Hannan and Freeman 1989). As in the resource dependence theory, the motives for organizational behavior and forms are acquired from the environment. Contrary to the resource dependence approach, the population ecology approach does not examine a distinct organization and its strategic reactions to environmental changes, but centers on all organizational populations and their alteration over time. The theories 56

examine to what extent changes in wider systems, like the political and social economic system, influence the shapes of organizations and their mixture across populations in society (Hannan and Freeman 1977; 1989). Consequently, its objectives are to comprehend organizations’ allocation in respect of the environmental situations and organizational structures’ restrictions in specific environments. Contrary to the preceding approaches, the population ecology approach supposes that organizational change is based on selection (choice) and not on a process of adaptation. Diversity in companies’ inner structures therefore stem from the construction of new structures and the discarding of old ones. In addition, structural immobility restricts a firm’s capacity to change, although existing firms seldom change their structure or strategy (Hannan and Freeman 1977). Although the supporters of the population theory do not deny the existence of adaptation, they nevertheless believe selection is a better way of describing organizational change. The relationship between the two is such that selection processes could be reshaped to a standard superior to those of adaptation processes (Hannan and Freeman 1977). According to Darwin’s theories, the idea of selection as the facilitator of structural change does not automatically promote progress (Davis and Powell 1992). It simply incorporates the concept that the environment selects the combinations of firms that are to survive and that managers just briefly impact a company’s destiny. Ultimately, though, they cannot fundamentally influence a firm. "The macroeconomic, social, and political forces...overwhelm strategic management action in the long run, since only a few powerful and politically well-connected organizations can significantly counteract these forces" (Astley and Van de Ven 1983, 256). The major areas of interest regarding the population ecology theory lie in the birth and death rates of firms, as it is believed that examining these will advance understanding of selection processes. The majority of studies are geared towards specific environmental phenomena’s impact on the change rates. The organizational and environmental factors examined are, for instance, a population's density ratio,30 size, the niche width, and age as a liability factor. The initial concept was interested in

30

The density is the number of firms in a given population.

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the number of firms competing for the same resources and in the environments’ carrying capacity31, both of which could have negative and positive effects on companies’ founding ratio. The concept of the tendency toward newness states that new companies have a greater probability of dying than older companies. According to Davis and Powell (1992), this assumption has been empirically proved. New companies are frequently also small institutions, because in keeping with the age liability, there is also a size liability. The concept of an organizational niche as well as the impact of the niche’s width on a company’s survival affects the survival ratio of specialist firms versus generalist firms. Subject to the environment’s stability, and the degree to which it could change, the possibility of survival varies for these two clusters of companies. Specialist companies do better in a stable environment, whereas generalists companies almost always do better in an unstable environment. The exception is an environmental condition during which changes happen very fast. A specialist company could therefore sit out bad periods and wait for the moment when its qualities are in demand again. In comparison, the generalist company will not at all be able to adapt to the circumstances properly, as the environment alters too fast. Unlike all the approaches presented up to this point, this theory is not an active recommendation in favor of undertaking M&As. To some extent, though, the population ecology theory focuses on M&As’ nature. The density ratio, for instance, is presumed to impact a population's M&A rate. "Since availability of potential partners seems likely to increase the rate, the merger rate is likely to increase with increasing density in the lower range" (Hannan and Freeman 1989, 139). M&As are also examined to some extent, as they represent one type of organizational mortality (Ravenscraft and Scherer 1987(b)). Consequently, Hannan and Freeman’s (1989) general conclusions regarding the dying of firms also apply to M&As. Consequently, the causes of this type of organizational behavior cannot be found at the firm level, but at the population level. M&As are motivated by dominant environmental changes and are therefore not the outcome of managerial decisions as in almost all the other theories.

31

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It is presumed that there is a limit to the number of firms that the environment can tolerate.

2.3.2.3 The transaction cost economics theory

Transaction cost economics could be regarded as a bridge connecting economic and organizational M&A theories. It is also an interdisciplinary explanation that unites economics with specific aspects of contract law and organizational motive (Sydow 1992). Based on Coase's (1937) crucial work on the theory of the firm, Williamson (1975; 1985, and 1989), the best known promoter of transaction cost economics, concentrated on the transaction as the basic unit of examination. This emphasis sets him apart from the majority of other economic and organizational researchers who utilize the organization or the market as the basic unit of examination. Williamson (1985, 1) stated that "a transaction occurs when a good or service is transferred across a technologically separable interface." A transaction therefore comprises all the preliminary stages for the trade of services and goods, the trade itself as well as the required monitoring steps to fulfill the contract correctly (Picot 1982). Each of these steps incur costs known as transaction costs. They are explained as the economic counterpart of friction in physical systems (Williamson 1985). In fact, major transaction costs may be the search costs for a suitable transaction partner, for a good business environment, and contractual costs for the closing of a contract, the costs of having the accurate completion of a deal controlled and, finally, the correction costs that occur as a result of a changing environment (Picot 1982). Contrary to neoclassical economists, Williamson (1975; 1985, and 1989) presumes that the company is not a profit-maximizing entity, but above all, a costeconomizing entity. Its organizational challenge is arranging transactions in the best possible way, and exploring the best governance structure for them in order to reduce all the costs related to a transaction. This is done by means of neoclassical economics’ marginal cost theory. The optimal governance structure is therefore not affected by product or technological costs, but by its associated transaction costs, which are subject to numerous environmental situations. These are separated into two groups: the behavioral and situational factors. Initially, Williamson (1975) agreed with Simon's (1955; 1957) idea of human beings’ bounded rationality. This idea suggests that economic actors aim to be rational, and are therefore rational, but in a limited way. The concept of economic actors’ bounded rationality as well as their restricted cognitive capacities negate the reality of perfect 59

contracts.

Consequently,

transaction

costs

occur

constantly,

despite

the

environmental circumstances and the existent governance structure, but they differ in volume. The other logical behavioral point of view in Williamson’s (1989) model concerns opportunism. Human beings are viewed as primarily looking after their personal interests, even though this could include some types of fraud. Opportunism does, after all, mostly include subtle types of fraud, both passive and active. The theory also involves intentional forms of deception like stealing, cheating and lying. The situational motives affecting transaction costs’ volume are dependent on the infrastructure in which the transactions occur and on the transaction itself (Picot 1982, and Sydow 1992). First of all, transactions vary in respect of their frequency, complexity, and uncertainty. Second, they differ according to their need for assetspecific investments. Equally significant is the number of potential transaction partners, also known as the small number problem. The fewer the partners in the market, the stronger their individual power, and therefore their capability to increase transaction costs, are. Besides these transaction-related factors, transaction costs are also affected by the existing economic, technological and legal environment (Picot 1982). The different forms of governance structures available to a company are regarded as being positioned on a continuum with the market as the platform for transactions on the one end and the inner firm on the other end (Williamson 1985). Markets are an excellent platform for spot transactions during which entire obligations are realized immediately. Nevertheless, the larger the asset-specific investments are, the more probable a market crash is, as acquiring a firm is one way of incorporating activity and integrating transactions, and, therefore, of decreasing the related transaction costs. Williamson's theory is therefore most suited for an examination of vertical M&As and the associated make-or-buy decisions (Picot 1982). According to this theory, vertical integration takes place when it is beneficial for a company to incorporate the activity inside its hierarchy as an alternative to contracting for the activity on the market. Similar circumstances arise when the transaction’s uncertainty and complexity are increased. Examples are when there is just a small number of suppliers and, 60

consequently, the small number problem becomes relevant; when asset-specific investments are required; when information isn’t asymmetrically diffused among the transaction partners, and when the entire transaction atmosphere is so insecure that there is no legal confidence and no sufficient market information system (Sydow 1992). Empirical studies on transaction costs often concentrate on the degree of vertical integration (Williamson 1985). It should, nevertheless, be remembered that as quantifying transaction costs directly is extremely complex, this research utilizes transaction costs’ determinants as independent factors and not transaction costs. Consequently, transaction costs are only quantified indirectly (Sydow 1992). The lacking operationalization of the theory of transaction costs is one of the key criticisms presented to refute this approach (Sydow 1992),

2.3.3 How the various rationales for merger differ The summary of the M&A theories presented above has revealed that there are many approaches that try to explain this kind of organizational behavior. Most of the arguments presented in the theories are logical, and, in the light of the existing evidence, none of them can be entirely rejected (Ravenscraft and Scherer 1987(b)). “One can, if one looks hard enough, find facts to support almost any hypothesis” (Scherer 1970, 122). In addition, the majority of researchers agree that M&As cannot be restricted to only one M&A cause. According to Steiner (1975, 30), “there may be many parties with an interest in and ability to affect the decision to consummate a particular merger, there may be many motivating forces.” The reason for the diversity of M&A motives can also be found in the numerous theories on organizational behavior. To differentiate between the various theories, it will be helpful to indicate their fundamental theoretical assumptions. As business companies are organizations and M&As are a specific type of organizational behavior, an organizational categorization method has been utilized for this task (Astley and Van de Ven 1983).

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In the introduction of this section (2.3) it was mentioned that M&A motives can be clustered into those based on M&As’ consequences and those that aren’t. Moreover, these approaches can be clustered according to their degree of exploration and their fundamental assumptions regarding the nature of action. For instance, a number of theories consider M&As from a specific organization’s perspective, whereas others focus on wider systems. As far as the nature of action is concerned, several approaches regard the organization as a rational, decision-making unit that can impact its environment, whereas other approaches take a more deterministic position.

2.4 Conclusion In chapter 2, summaries have been provided in respect of the viewpoint of researchers in financial economics, strategic management, and organizational behavior regarding M&As and their performance. Furthermore, different motivations for M&As have been presented. It has been demonstrated that the motivations for M&As are not only oriented towards strategic efficiency, Because every school of thought addresses different questions, uses different methodologies and has different objectives. Scholars from each of the schools continue to examine their incomplete, albeit important, research questions in relation to M&As’ performance. Because a comprehensive answer to the research question regarding the reasons for frequent M&A failures cannot only focus on one single perspective, an understanding of the diverse schools’ findings and those findings’ limits can be an important aid in understanding the origins of acquisition performance.

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3 Why M&A fail so often - a comprehensive model This chapter criticizes traditional approaches. The need for a comprehensive model as well as for representative factors is also revealed. The required comprehensive model, based on representative factors arising from important research dimensions on M&A performance, is then developed. The chapter is concluded with a summary. With M&As’ increasing frequency, number, and size, they have inevitably drawn the attention of many groups of scholars, each of whom studies the subject from a unique perspective. Kusewitt (1985) and Lubatkin (1983), however, suggested that researchers should employ a contingency approach with respect to post-acquisition strategic performance. As described in the previous chapter, a number of theories have been proposed to explain M&As and their success, or the lack thereof. The majority of these is relatively limited, and while a few are complementary, others are autonomous or contradictory. Regrettably, the incomplete nature of these theories means that none of them captures the essence of M&As as a complex phenomenon (Hitt et al. 1998), with the resultant inadequate comprehension. An investigation of M&As’ empirical findings makes this very obvious.

3.1 Criticism of traditional approaches The previous chapter illustrated that there has, to some extent, been research on M&As’ performance. Yet King et al. (2004) suggest that the number of studies is not nearly sufficient to allow their results to be accumulated by means of meta-analysis. This indicates that additional theory development and empirical research on M&As are required.

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3.1.1 The need for a comprehensive model Trillions of dollars have been wasted on the acquisition of tens of thousands of firms (Gupta and Gerchak 2002), with quite a few studies having been produced on postacquisition performance. These studies do not, however, universally confirm managers’ obvious enthusiasm for the practice, as M&As’ influence on postacquisition firm performance remains ‘inconclusive’ (Agrawal and Jaffe 2000; Haspeslagh and Jemison 1991, and Sirower 2000). Moreover, the existing empirical post-acquisition performance studies have not recognized any prerequisites that would be useful in forecasting post-acquisition performance (Hitt et al. 1998; and Sirower 2000). All this emphasizes that M&As are relative complex events that involve the interaction of a large number of company life variables and are insufficiently comprehend. The reason for this is, to some extent, because researchers have tended to consider only certain explanations for M&As. As stated in Hayward (2002), acquiring companies could be following an incorrect strategy: choosing the wrong target, paying too much for it and then integrating it poorly (Gilson and Black 1995, and Haspeslagh and Jemison 1991). According to Cartwright and Cooper (1993, 58), “financial and strategic considerations dominate the selection of a suitable acquisition target or merger partner. Decisions are driven by issues of availability, price, potential economies of scale, and projected earning ratios. Consequently when the combination fails to realize financial expectations, the post-mortem analysis of merger failure or underperformance tends to focus on reexamination of the factors that prompted the initial selection decision. Typically, poor selection decisions are attributed to an over inflated purchase price, managerial incompetence in achieving projected economies of scale, or that the organizations are strategically mismatched.” Also when viewed as a whole, the various studies indicate that strategic, organizational behavior and financial variables play a very important role. To date, M&As’ performance has been mainly examined through three theoretical lenses. First, as was described in the previous chapter, the field of strategic management, basically embedded in an economic paradigm, has studied M&A as a method of diversification, concentrating on both the motives for different types of

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combinations (Salter and Weinhold 1981, and Walter 1990), and their performances’ effects (Lubatkin 1987; Seth 1990; Shelton 1988; Singh and Montgomery 1987; Datta et al. 1992, and King et al. 2004). This research has emphasized factors such as economies of scale and market power as motives for M&A, and their findings of the studied M&As’ performance are mainly based on the relevant accounting results (Ravenscraft and Scherer 1987(b), and Steiner 1975). In contrast, finance scholars have usually studied M&A performance by relying on stock market-based methods (Jarell et al. 1988; Jensen and Ruback 1983, and Weston and Kwang 1983). Furthermore, they focus on the acquisition premium (Slusky and Caves 1991, and Ravenscraft and Scherer 1987(a)) in order to calculate the price paid for post-acquisition performance. In the area of integration, the organizational behavior school has basically concentrated on the post-integration process (Haspeslagh and Jemison 1991, and Pablo 1994) by emphasizing the company culture (Nahavandi and Malekzadeh 1988; Buono and Lewis 1985; Larsson and Lubatkin 2001; Lubatkin and Calori 1998, and Chatterjee 1992(a)) as well as conflict resolution (Blake and Mouton 1985, and Mirvis 1985). In this area, studies on human resource management have also emphasized psychological factors (Levinson 1970; Astrachan 1990, and Marks 1982), the importance of effective communication (Schweiger and DeNesi 1991), and how M&As affect careers (Hambrick and Cannella 1993; Walsh 1989, and Lubatkin et al. 1999). Although these various fields of research do not exclude one another, there has not been much mutual exchange or consideration of the others’ information (Larsson and Finkelstein 1999). The division into different research streams has, in fact, resulted in limiting the development of integrative studies on M&As. There is therefore a recognized need for research to present a theoretical framework that can help explain acquisition performance (Hitt et al. 1998; King et al. 2003; Hoskisson and Hitt 1994, and Sirower 2000). Such a theoretical framework is sorely required to resolve the ongoing controversy between researchers using a strategic management perspective, thus reporting a lack of M&A performance as a whole, and those using a financial perspective, and often show the opposite (Slusky and Caves 1991; Caves 1989, and Jensen and 65

Ruback 1983). Furthermore, as stated by Lubatkin (1983), there is a gap between the frequently untested contingency frameworks found in strategy and industrial organization, and the empirical work in the area of finance that tends to disregard strategic differences across M&As. Lane and Cannella (1999) also argue that there are important differences between financial economics and strategic management, leading to different beliefs, norms, methods and interpretations of empirical results. Nevertheless, more recent studies have started to reconcile the differences between the strategy and finance perspectives (Lubatkin 1987; Shelton 1988; Singh and Montgomery 1987; King et al. 2004, and Kusewitt 1985), although they generate opposing outcome (Seth 1990). A major explanation for these different outcomes is based on a third problem regarding M&A studies’ non integrative character: strategic and financial M&A studies tend to ignore the integrating issues that are a fundamental part of the M&A process, and that could play an enormous role in determining M&A failure or success (Chatterjee et al. 1992(a), and Datta 1991). On the other hand, from an implementation perspective many of these studies do not integrate essential concepts from the research on strategy or finance (Schweiger and Walsh 1990). However, according to Hayward and Hambrick (1997), acquisition premiums, defined as the ratio of the ultimate price paid per target share and the price prior to the takeover news, have also been generally ignored by strategy and organization researchers. It can therefore be concluded that M&As are clearly a complex area that is poorly understood as a result of the partial use of theories in specific areas (Larsson and Finkelstein 1999). The fragmented studies on M&As may, in fact, encourage a theoretical synthesis. M&As’ strategic incentives can be viewed as potential benefits that are realized through good integration management, all of which will influence the resultant performance. The research question regarding the way in which potential strategic intent can be achieved through M&As’ organizational integration without it being ultimately too costly, is reason enough to cross different streams of research. The small number of studies in this direction reveals the potential importance of 66

integrative research, and includes approaches connecting the different viewpoints (Haspeslagh and Jemison 1991; Larsson and Finkelstein 1999; Hitt et al. 2001(a); King et al. 2004, and Kusewitt 1985). Although these works’ contributions are substantial, the studies are limited in scope, and scarcely test M&A performance relationships across all research streams empirically.

3.1.2 The need for representative factors There is no doubt that M&As have been and continue to be a popular strategic alternative to organic growth. It was mentioned above that strategic management, the organizational behavior school, and the financial school provide all the important general prerequisites required for M&A performance. Taken individually, none of these dimensions and factors are new to the literature. Together, however, they provide a synthesis of the present state of research on strategic, organizational and financial influences on M&As. In addition, a fundamental contribution of the integrative model developed by this author is its ability to present the three dimensions’ important influence simultaneously. It therefore not only provides an understanding of how the primary prerequisites of M&A success are interrelated, but facilitates the examination of how M&As’ critical aspects affect their performance. Dependent on a number of factors, acquiring firms could either gain or lose from their acquisition activity, which is similar to what the contingency approach - which includes variables from strategic, organizational and financial perspectives – proposes, and is also related to post-acquisition strategic performance effects. Knowing that no combination of factors could, in fact, fully capture a phenomenon as complex as M&As, this author has included each dimension’s most representative factors.

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3.1.2.1 Strategic factors

Park (2003) argues that the causal relationship between strategy and M&A performance is not clear. According to Lubatkin (1983), selecting the proper merger candidate may be more an art than a science. Hence, a brief review of some of the important aspects that are presumed to influence post-M&A performance is presented from the strategic literature. Strategic management theories suggest that related firm mergers can create synergistic value and enhance the performance of the merged firms. Previous studies of mergers and acquisitions, however, show inconclusive and controversial empirical findings (Ravenscarft and Scherer 1987 (b), Loughran and Vijh 1997, and Campa and Kedia 2002). According to Rumelt (1986), strategic management research normally defines conglomerate companies as those exhibiting significant unrelated product-market diversification32. A wider definition of conglomerates is provided by the Federal Trade Commission (FTC) database (for the period 1948 to 1979) of M&A activity, which is used in very many of the existing studies on the outcome of conglomerate diversification on post-M&A performance. Conglomerate M&As, as defined by the FTC, involve the acquisition of completely unrelated companies, companies in different geographic markets, or companies whose products do not directly compete with those of the acquiring company. Nevertheless, empirical research on the influence of diversification on post-M&A performance is contradictory,

with

research

indicating

that

some

companies

profit

from

diversification, but that most firms generally do not (Loughran and Vijh 1997). On one hand, Ravenscraft and Scherer (1987(b)) note that the 13 most acquisitive conglomerate companies account for 16 percent of all FTC-recorded M&A activity, experienced returns 3.6 times greater than the S&P500 between 1965 and 1968, and 2.7 times greater than the SP500 between 1965 and 1983. Campa and Kedia (2002) additionally infer that diversification is a value-increasing strategy for companies. They surmise that conglomerate companies have a positive influence on 32

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Relatedness is also often used as a synonym for research that links M&As’ diversification topics to performance issues. In this thesis the terms “relatedness” and “diversification” are both used in the same context.

performance, as they seem to possess a business integration competence that allows them to create value rather than just obtaining it through M&A activity (Salter and Weinhold 1978). The assumed presence of what might be termed a ‘conglomerate effect’ on post-acquisition performance has led to several studies in this area (Agrawal et al. 1992, and Lubatkin 1987). On the other hand, some research indicates that there is a ‘diversification discount’ (Agrawal et al. 1992; Anand and Singh 1997; Berger, and Ofek 1995; 1999). Berger and Ofek (1999), for example, studied the situation prior to and the outcomes of refocusing episodes by 107 diversified companies that were not taken over between 1984 and 1993. These companies had more value-reducing diversification policies than diversified companies that did not refocus. The cumulative abnormal returns above the latter companies’ refocusing-related announcements averaged 7.3%, and were significantly related to the value reduction associated with the refocuser's diversification policy. In 1995, Berger and Ofek (1995) estimated the effect of diversification on firm value by attributing stand-alone values to individual business segments. By comparing the sum of the independent values with the firms’ values, there was an implied 13% to 15% average value loss due to diversification. An example of the logic that suggests that conglomerate firms’ stock performance is discounted is that there is more uncertainty in predicting their cash flow, since their financial performance depends on that of several divisions. Within the same context, this subject is also often discussed under the heading ‘relatedness’. Acquired firms’ relatedness to their acquirers - with relatedness defined in term of resource or product-market similarity, or complementarity - is often assumed to impact the acquiring firms’ post-M&A performance. The bulk of M&A literature specifically suggests that acquiring related firms leads to increased postacquisition performance (Capon et al. 1988; Kusewitt 1985; Palich and Cardinal 2000, and Rumelt 1982; 1986). Business relatedness is said to enable the acquiring firm’s

managers

to

effectively

employ

their

dominant

logic,

or

common

conceptualization of the requirements for success in an acquired business (Prahalad and Bettis 1986). Industry familiarity could eliminate or significantly diminish the acquiring firm managers’ need to ‘learn’ the acquired firm’s business, and facilitate learning from the acquisition process itself (Hitt et al. 2001). In the context of acquisitions that require significant managerial involvement, familiarity with the 69

acquired firm’s market is often key to the acquired business’s successful postacquisition integration (Roberts and Berry 1985). In a study of 98 large European bank M&As between 1985 and 2000, Beitel et al. (2004) investigated the drivers of excessive returns for the target companies’ shareholders, for the bidders, and for the combined bidder and target entity. Their findings are largely consistent with the US experience and confirm stock markets’ preference for focused transactions and not specifically for diversification. Related acquisitions could moreover productively leverage the acquiring firm’s pre-existing resources to new business in which those resources are more likely to be valued and relevant. These arguments are not meant to suggest that related acquisitions are without risk. As observed by Berg (1997), acquisition relatedness may simply reduce the financial risk inherent to acquisitions. It is thus obvious that empirical research on diversification, or relatedness’s influence on post-M&A performance is contradictory (Loughran and Vijh 1997), with research indicating that some companies profit from diversification but that generally most firms do not, and should therefore rather focus on related companies. According to Singh and Montgomery (1987), value creation in related acquisition can arise from three sources: Economies of scale, economies of scope, and market power.

3.1.2.1.1 Economies of scope

Economies of scope are achieved when a given set of resources are utilized in the joint production of two or more products. For example, if some of the assembly facilities in an automobile plant (body production) are used for both cars and light trucks, economies of scope could be achieved. It is important to mention that the resource’s indivisibility provides economies of scale as soon as capacity is improved through the production of two or more products. Economies of scope are therefore provided by the utilization of the indivisible shared resource.

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It is furthermore important to mention that economies of scope can arise outside the production field. Distribution systems as well as intangible assets, like trade names, can be the basis of economies of scope if they are utilized for more than one product. The act of sharing focused know-how is a further important basis of economies of scope (Teece 1982, and Williamson 1979). Knowledge management (Probst et al. 2000), or strategic knowledge management (Leipold et al. 2002) therefore offers practical tools and concepts with which to increase these economies within a firm. Market imperfections could, however, lead to this know-how being unavailable to other companies in the market place at the same cost.

3.1.2.1.2 Economies of scale

Economies of scale are achieved when productivity develops from a specific product’s increased production. In a resource-based framework, this would suggest that a given set of resources and assets is being used more comprehensively. Economies of scale can occur in specific fields, e.g. research, manufacturing, and development, distribution and selling - the traditional fields used to identify related M&As (Salter and Weinhold 1979, and Rumelt 1986) - as well as in more general financial management and administration fields.

3.1.2.1.3 Market power

Within industrial organization economies’ conventional framework, market power’s effects occur when a competitor in the market has the ability to influence a product’s quantity, price, as well as its nature (Sheperd 1970). Consequently, market power could lead to excessive returns. In related M&As, a company’s market power could be increased through horizontal acquisitions, which means that both companies, i.e. the acquiring and the acquired company, operate in the same product market, or through product and market extension acquisitions, which means that a company’s effective size is augmented relative to that of its competitors.

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3.1.2.2 Organizational behavior factors

According to Lubatkin (1983), administrative problems (inefficiencies) could occur when two firms merge and nullify an M&A’s benefits. He furthermore states that there are no practical methods with which to measure these inefficiencies. In order to measure what is “inefficient”, what is “efficient” must first be measured, and there is no common acceptable measurement for efficiency (Sheperd 1979). These inefficiencies appear to be a common problem, although some firms are apparently able to avoid them (Kitching 1967, and Lubatkin 1983).

3.1.2.2.1 Relative size

According to Larsson and Finkelstein (1999), a target and acquiring firm’s relative size could be an important consideration for M&As’ success. First of all, because the combination potential is inevitably limited by size constraints if the acquirer is much larger than the target, (Kusewitt 1985, and Seth 1990). Without the necessary critical mass, relatively small acquisitions are less likely than larger M&As to offer a full range of a combination potential. Second, smaller M&As could receive insufficient managerial attention to turn the potential benefits into realized ones (Diven 1984, and Ravenscraft and Scherer 1987(b)). In an early study by Kitching (1967), a strong positive relationship was indicated between target and acquiring firms’ sizes and organizational performance. In a sample of 69 acquisitions, he found that in 84% of the transactions classified as failures, the sales of the acquired firm constituted less than 2% of the acquirer’s sales. Soon after these findings, Kitching (1974) corroborated them after interviewing CEOs involved in M&As. The executives suggested that the prospect of success is improved if a target firm is larger rather than smaller than the acquiring firm. Other research also supports these arguments. Empirically, Kusewitt (1985) and Clark and Ofek (1994) found a negative correlation between relative size of acquisition. Biggadike (1979) found that large-scale entries into new ventures resulted in better performance than small-scale entries. These results are inconsistent with the belief

72

that it is desirable to enter a new area in a small way, to learn, and then expand (Lubatkin 1983). In contrast, Kuehn (1975) suggested that acquiring a large firm requires more integration effort and, could strain the purchaser’s financial position even more. Newbould et al. (1976) found no relationship between relative sizes in acquisitions and returns for shareholders. Later, Kusewitt (1985) found significant negative relationships between the acquiree and acquirer’s relative sizes and performance measurement, but some evidence of a peaked (quadric) relationship. Kusewitt concluded that excessively small or large acquisitions should be avoided. Fowler and Schmidt (1989) also found that the relative size variable had a negative correlation in both the performance measurements that they had undertaken. Research by Bieshaar et al. (2001) started with a sample of 479 corporate deals announced by 36 companies in the telecommunications, petroleum, and European banking industries over a five-year period. They found that the frequency with which companies pursue M&As does not have a positive effect on a company’s market cap at the time of such an announcement. Conversely, Larsson and Finkelstein (1999) found that the relative size variable is positively associated with organizational integration, combination potential and synergy realization. These authors’ results suggest that bigger acquisitions do better because they offer greater synergy, not because managers pay more attention to the integration process when the target companies are large. As noted, previous studies on the relationship between relative size and organizational performance were inconclusive. Some of them found a significant positive relationship, while others observed a significant negative relationship.

3.1.2.2.2 Cultural compatibility

As in broader organizational contexts, culture is an important “internal variable” in M&A situations (Smircich 1983). That is, culture is critical in the configuration of a total organizational system, influencing the organization’s effectiveness in its environment (Pablo 1994). Thus, cultural integration and cultural compatibility are 73

expressions used throughout the literature on M&As (Marks 1999; Cartwright et al. 1999; Larsson and Lubatkin 2001, and Veiga et al. 2000). Weber (1996) argues that although cultural fit has been acknowledged as a potentially important factor in M&As, the concept has been ill-defined, which is why its relationship with other M&A aspects has not been rigorously examined. Further, the relationship between cultural differences and performance has not been subject to rigorous research with respect to relatively large M&A samples. Levinson (1970) was the first to compare the M&A process to a marriage in which the partners’ compatibility is fundamental to the new or revamped company’s healthy growth. The analogy is appropriate, and exemplified in the imagery and terminology used to describe a merger, which are characteristic of a highly emotional personal relationship. Jick (1979), for instance, proposed an exploratory model of the M&A process consisting of five stages: the courtship, the marriage, the honeymoon, the establishment of a material allegiance and, finally, interdependence. In decision makers’ predominant view, compatibility is only a matter of ensuring a good strategic fit, while management styles (Barrett 1973) and corporate cultures’ compatibility are not M&A issues that attract much consideration. The following are definitions utilized as they relate to the M&A process. According to Cartwright and Cooper (1992, 71), “Cultural compatibility between combining organization would seem to imply similarity. If this is so, making a successful merger and acquisition hinges on the ability of decision-makers to identify a potential merger partner or acquisition target which represents both a good strategic and cultural match.” According to behavioral studies, support of the acquired firm’s employees is contingent upon cultural fit, or the degree to which they perceive their culture to be compatible with that of the buying firm. For Veiga et al. (2000), organizational culture represents an imperfectly shared system of interconnected understandings molded by its members’ jointly held history and expectations. It describes the “shoulds” and “oughts” of organizational life. In research studies, culture is defined in various ways, but the majority of the definitions concentrates on the beliefs, assumptions, and values that members of a group share regarding rules of conduct, leadership styles, administrative procedures, rituals, and customs (Schein 1985). However defined, organizational culture is regarded as being essential in determining an individual’s 74

commitment, satisfaction, productivity, and longevity within a group or organization (O'Reilly et al. 1991; Holland 1985, and Kilmann et al. 1985). This is because individuals tend to select groups that they perceive as having values similar to their own, while trying to avoid dissimilar others (Schneider and Goldstein 1995). When a good fit happens, a psychological bond is created that is not easily broken (Ashforth and Mael 1989). For Hambrick and Cannella (1993, 735), the full power of this person-culture fit can be observed when two different cultures are brought into close contact with each other, as typically happens in M&As. In general, acquisitions are “surrounded in an aura of conquest”, with considerable pressure being placed on the acquired firm’s managers to break their bond with the “way things were” and conform to the buying firm’s culture. In addition, cultural differences may influence the acquired managers’ perceptions of their employment status. Extending Frank’s (1985) theory of social comparison, which he termed ‘relative standing’, to the domain of acquisitions, Hambrick and Cannella (1993, 757) speculate that “the greater the cultural gap between the acquired and the acquiring firm, the greater the diminishment of relative standing of the acquired executives.” This is because the “acquired executives are placed in a new social setting in which comparisons to their acquirers, as well as comparisons to their prior situation are inevitable and salient” (p. 736). Once a “big fish in a small pond”, the acquired executives could feel a strong sense of alienation from their new group, inferior in status to the acquiring top managers, and/or unappreciated by them – what Mirvis and Marks (1992) refer to as a “superiority syndrome”. Like cultural clashes, these feelings could cause those executives to minimize their responsibilities, show inferior commitment to the job, intentionally depart, or behave in aggressive ways that lead to involuntary departures in the end. Nevertheless, the obvious fact that cultural differences do exist, does not necessarily imply that the acquired executives will resist any post-merger consolidation attempts (Elsass and Veiga 1994). A number of cultural differences can in fact promote an “assimilation” integration (Nahavandi and Malekzadeh 1988). The acquired executives could, for example, hope for more opportunities for themselves, and could also hold the buying company in high esteem, regarding it as a world-wide leader, a very prestigious firm that commands the local community’s respect, and/or a firm with a reputation for being brilliantly managed. On the other hand, members of the selling 75

company could also perceive their culture and practices as being dysfunctional, thus decreasing organizational performance and less in line with their perceptions of what ought to be than they perceive in the acquiring company. Whatever the case, the acquired managers could believe that the buying company’s culture addresses their normative expectation better, and thus enthusiastically choose its culture (Veiga et al. 2000). In a study of a merger between two mutual banks, Buono and Lewis (1985) emphasized

the

impact

of

organizational

culture

on

M&A

performance.

Organizational culture’s full influence can be observed when two opposite cultures are forced to become one during an M&A. Because organizational members are so embedded in their own culture, they seldom fully recognize its influence on their behavior. Throughout the cultural "collision" that occurs during an M&A, the shock that organizational members receive by having to live in a different organizational world could therefore disturb the newly shaped company’s entire function. Datta (1991) also stresses the importance of cultural compatibility. He argues that while compatibility in management styles facilitates post-acquisition assimilation, major differences in management styles and philosophies could be a serious impediment to acquisition success. Differences in management styles may be a major reason why M&As often fail to achieve the level of performance predicted by pre-combination feasibility studies. According to Lees and Taylor (2004), even small M&As have important consequences. Their case study, which examined two emergency departments’ amalgamation,

demonstrates

that

even

in

small

organizational

subunits,

organizational change has a complex nature, and provides important insight for managers and leaders who have completed or are considering such mergers. The goal of this study was to examine the aspects of change associated with these consequences in greater detail, as change in hospitals has been shown to have negative consequences for nurses. Quantitative and qualitative techniques were used to analyze the planning, implementation, and outcomes of the amalgamation on the nursing staff. The case study draws upon the literature pertaining to the changesurvivor syndrome, prescribed approaches to change, and the difficulties of changing cultures and making complex decisions. The study’s findings suggest that the 76

amalgamation’s planning was consistent with rational decision-making, and that the goals of changing to a single emergency unit and cost savings were achieved. However, the nurses experienced stress due to the pace of work and the newly renovated department’s physical layout. The findings also suggest that the personallevel problems that the nurses experienced were consistent with the consequences of survivor syndrome and communication issues. It was recommended that the organization undertake initiatives to alleviate these stresses. Weber (1996) states that while lack of cultural fit has been frequently mentioned as a potential factor in M&A failures, specifically in respect of the creation of human resource problems (Weber and Schweiger 1992; Hambrick and Cannella 1993, and Nahavandi and Malekzadeh 1988), empirical studies that examine the role of cultural fit in M&As remain a rarity. Moreover, relatively little has been done in terms of the specification and operationalization of cultural fit measures. Cartwright and Cooper (1993) suggest that “culture fit and culture compatibility are well used but ill-defined expressions”. The existent literature therefore does not provide systematic empirical evidence, based on a large M&A sample, of cultural differences’ effects on the postmerger integration process’s effectiveness, or on the acquiring company’s financial performance. Nevertheless, the culture clash in merging organizations has received increasing attention from both practitioners and academics (Cartwright and Cooper 1993; Chatterjee et al. 1992(a); Weber and Shenkar 1996, and Davis 1968). According to Weber (1996), however, the literature on the culture clash in M&As has three important limitations. Primarily, most of it is based on practitioners and consultants’ observations, with little theoretical or empirical support (Barrett 1973; Davis 1968, and Levinson 1970). Secondly, the empirical work that has been conducted, examined the culture clash in just one M&A (Buono and Lewis 1985; Graves 1981, and Sales and Mirvis 1984). Moreover, although M&As vary in respect of factors such as relatedness and type of industry (Lubatkin 1983; Shrivastava 1986; Nahavandi and Malekzadeh 1988, and Lubatkin et al. 1999), most prior studies were conducted under the assumption that M&A are homogeneous. These studies had therefore failed to consider the possibility that the impact of a culture clash on M&As’ effectiveness could differ from one situation to another. These analyses nevertheless 77

underscore essential factors regarding M&As’ integration that could be affected by cultural differences. Due to the present thesis’s interdisciplinary nature and limited volume, only the two first limitations will be described in more detail.

3.1.2.2.3 Acquisition experience

Acquisitions produce complex organizational challenges, and both individual and organizational experience are essential to avoid integration difficulties (Haspeslagh and Jemison 1991, and King et al. 2004). For example, on the individual level, the absence of acquisition experience could make a CEO particularly vulnerable regarding the escalation of commitment that could lead to the completion of deals at unreasonably high costs (Haspeslagh and Jemison 1991). Experience from previous acquisitions could lead to facilitating procedures being built for the identification (Hitt et al. 1998) and integration of the acquired firm’s resources, which may be required to improve the post-acquisition performance (King et al. 2004). According to Hayward (2002), acquisition experience is a principal mechanism through which companies obtain the necessary skills. A large part of studies on organizational experience adopts a learning-curve perspective that predicts positive returns on experience. This work has been restricted, however, to the narrow context of manufacturing settings where gains in manufacturing experience are associated with a decrease in unit costs (Yelle 1979, and Dutton et al. 1984). Outside manufacturing settings, the effect of organizational experience could be more difficult to predict, and studies have often produced contradictory outcomes. This is especially true of the effects of an organization’s prior acquisition experience on an acquisition’s subsequent performance. Extrapolating findings from manufacturing settings to other organizational situations could mislead organizational researchers, because it assumes that manufacturing contexts will be found wherever organizational experience is applied. For acquisitions, however, the outcome of organizational experience could depend on the similarity between the past acquisitions and the present acquisition, which, in turn, could determine the appropriateness of applying or disregarding past acquisition experience in respect of 78

managing a new acquisition. Hence, experience with a dissimilar acquisition might not be relevant. Although acquisitions are often unsuccessful (Porter 1987), the business press and academicians have often argued that companies with previous acquisition experience will do better than those without (Lubatkin 1983). While these arguments appear intuitive, especially in the light of the literature on experience and learning curves (Lieberman 1987, and Dutton et al. 1984), empirical work on acquisition experience and performance shows mixed results regarding such experience’s ability to ensure superior acquisition performance. On the one hand, research often fails to positively relate acquisition experience to acquisition performance (Haleblian and Finkelstein 1999; Kusewitt 1985; Zollo and Leshchinskii 2000, and Bieshaar et al. 2001). Beitel et al. (2004), for example, find that less active bidders create more value than more active/experienced bidders. This differs from some US research, and could indicate that the managers of European banks that bid frequently may be motivated by other objectives than creating shareholder value. On the other hand, popular and scholarly accounts hail experienced acquirers, like BancOne, Cisco Systems and General Electric, for their superior acquiring skills (Szulanski 1999, and Harvey 2000). According to Hayward (2002), it seems that, on balance, acquirers have great potential to learn from their experience, but generally fail to realize that potential. In one of the first examinations of acquisition experience and acquisition performance, Lubatkin (1982), for example, analyzed the acquisition experience of companies listed on the Federal Trade Commission’s Large Merger Series between 1948 and 1979. Contrary to his expectations, Lubatkin failed to find a significant relationship between acquisition experience and performance. Even though his study is one of the most complete examinations of acquisition experience to date, it was constrained by its reliance on monthly market returns, instead of daily returns, to measure acquisition performance. As Chatterjee (1986) mentioned, monthly market returns potentially weaken a study’s result because this measure’s use of a large window around an acquisition event, increases the likelihood of capturing information that is unconnected to the acquisition. In a later in-depth analysis, Hitt et al. (1993) examined twelve prosperous acquirers and proved acquisition experience to be positively related to acquisition performance. They classified acquirers as prosperous 79

if they showed positive changes in industry-adjusted returns on assets as well as industry-adjusted research and development intensity following an acquisition. They discovered that an acquirer’s experience of M&As drives it to achieve a greater synergy between its assets and the acquired company’s assets as well as a faster and more effective acquisition integration process. But, as the sample was small, the authors suggested that a large sample study was required to explore the relationship further. Research by Bieshaar et al. (2001) started with a sample of 479 corporate deals announced by 36 companies in the telecommunications, petroleum, and European banking industries over a five-year period. They found that the frequency with which companies pursue M&As does not have a positive effect on a company’s market gap at the time of an announcement. Two further studies employing narrower sub samples examined the effects of organization experience on performance. The first was by Bruton et al. (1994) and examined the effects of acquisition experience on a sample of distressed companies. They limited the sample to companies that had had two sequential years of declining net income and return on investment before the acquisition. They argued that experienced acquirers know when to acquire and when not to, know when outside financial legal, or other resources are needed, and know more than inexperienced acquirers about the key success factors of successful integration. Although the authors measured acquisition performance subjectively, they failed to prove a significant connection between acquisition experience and performance. The second study was by Fowler and Schmidt (1989), who selected a sample of acquisition and discovered that acquisition experience in the four-year period preceding the year of the offer was positively connected with acquisition performance. Both Bruton et al. (1994) and Fowler and Schmidt (1989) provided some proof of the link between acquisition experience and performance, but given the narrow samples in these two studies, and in keeping with Haleblian and Finkelstein (1999), it should not be concluded that experienced acquirers’ acquisition performance is automatically better. Still, when carefully contemplated in the light of behavioral learning theory, these findings possibly do make more sense. Behavioral learning theory predicts an individual’s behavioral outcomes by analyzing environmental influences. According to the theory, there are both present and past 80

environmental influences on behavior. The present influences on behavior are referred to as antecedents, while the past determinants of behavior are referred to as consequences (Reynolds 1975). Ample research has been conducted on the influence of both antecedents and consequences on behavior with research having shown, for example, that behavior is controlled by its past consequences (Bower and Hilgard 1981). Thorndike’s (1893) early work demonstrated two important principles: (1) rewarded behavior tends to diminish and weaken. Although the idea that rewards increase and punishments decrease the likelihood of behavior has been discussed for centuries (Hobbes 1651), it was Thorndike’s demonstration in well-controlled experimental contexts that triggered the study of how consequences influence behavior. Subsequently, an overwhelming amount of evidence has accrued confirming Thorndike’s basic findings (Schwartz 1978). Research has also shown that current antecedent conditions influence behavior. When an antecedent condition is similar to a previous condition, the behavior that has come to dominate in the previous situation will likely be generalized to the current situation (Pinder 1984). Invoking the same behavior in response to a variety of similar antecedent conditions is referred to as generalization, which provides a ready-made response so that each new antecedent condition does not require new learning (Nye 1979). When an antecedent condition is dissimilar to previous situations, generalizing past experience could, however, lead to detrimental outcomes (Mazur 1994). For example, prejudice may develop as people generalize from prior encounters with people of a particular race to subsequent encounters with other people from the same race. This sometimes leads to spurious conclusions (e.g. “They are all similar.”).

Here,

given

dissimilar

antecedent

conditions,

discrimination

(i.e.

distinguishing between a range of conditions and responding distinctively to each condition) is the appropriate behavior. The four effects of behavior on antecedents demonstrated at the individual level could also affect behavior at the firm level (Haleblian and Finkelstein 1999). Hayward (2002) later used an organizational learning point of view to analyze how the nature, performance and timing of a company’s acquisition experience helps it to 81

learn how to select the right acquisition. He predicted the performance of 214 acquisitions made by 120 companies in 6 industries between 1990 and 1995. His outcome shows that a company’s focal acquisition performance relates positively to prior acquisitions that are a) not highly similar or dissimilar to the focal acquisition, b) associated with small losses, and c) not too temporally close to or distant from the focal acquisition. Taken together, these results identify the broad conditions in which firms generate adaptive and timely inferences from acquisition experience. According to his outcome, acquisition experience is therefore a necessary but not sufficient condition for acquirer learning. M&A generate complex organizational challenges, and individual as well as organizational experience may be necessary to avoid integration problems (Haspeslagh and Jemison 1991). For instance, on the individual level, a lack of acquisition experience could possibly make a CEO particularly susceptible to an escalation of commitment that could lead to the completion of deals at unreasonably high costs (Haspeslagh and Jemison 1991). Additionally, experience from past acquisitions could build facilitating processes for the identification (Hitt et al. 1998) and integration of the acquired firm’s resources, which could be required to improve post-acquisition performance. Lubatkin (1983) maintained that the ability to consolidate effectively could stem from a literal application of Chandler’s thesis on strategy and structure. He suggested that firms with prior acquisition experience could become more adept at necessary structural changes and could therefore avoid administrative problems that could have a negative impact on M&A success. He cited, for example, differences in managerial styles, threats of layoffs, initial inequalities in compensation, authority superimposed on an acquired company, and an acquiring company’s increase in size as administrative factors that could negate the potential benefit of M&As. Consolidation tends to be resisted by existing hierarchies (Kitching 1967), and performance could thus be damaged (Fowler and Schmidt 1989). As indicated by Kitchen (1967), however, these problems can be avoided if management knows how to consolidate firms successfully - a skill that is presumably enhanced by experience (Fowler and Schmidt 1989). 82

De Noble et al. (1987) reviewed the literature that examined the relationship between acquisition experience and performance. They concluded that further empirical analysis is needed. Power (1982) found previous acquisition experience to be a good predictor of future acquisition success. Paine and Power (1984) suggested that management needs experience in order to produce successful acquisitions. Also Fowler and Schmidt (1989) found a significant positive correlation for the acquisition experience variable, with the change in abnormal returns for shareholders’ performance measure indicating that organizational performance improved as the number of acquisitions increased. In contrast, De Noble et al. (1987), Lubatkin (1982), and Newbould et al. (1976) found no relationship between previous acquisition experience and performance. Kusewitt (1985) reported a significant negative relationship between previous acquisitions and organizational performance, proposing more support for the possibility of ‘corporate indigestion’ and inefficient consolidation than for the ability to learn to integrate productively. Acquisition experience can be measured in terms of acquisition rate in respect of acquisition events over time (Kusewitt 1985). A very early study was done by Booz and Hamilton (1960) who analyzed 128 acquisitions by Chicago area firms. The study concluded that higher acquisition rates led to greater success due to the greater experience. Rockwell (1968) and Lubatkin (1983) also express the belief that experience improves merger performance. On the other hand, McCarthy (1963), Reid (1968) and Terry (1982) suggest that very high acquisition rates lead to corporate indigestion. It may be that both these views are correct in that there is also an optimal relationship between acquisition rate and acquirer performance. There are, however, no consistent findings on the relationship between acquisition experience and post-acquisition performance. Prior acquisition experience has been found to predict success in later acquisitions (Bruton et al. 1994, and Fowler and Schmidt 1989), to predict a decline in performance as the number of acquisitions increase (Finkelstein and Haleblian 2002, and Kusewitt 1985), and to have no impact on acquisition performance (Lahey and Conn 1990). Nevertheless, Hitt et al. (2001) caution that “the importance of the link between managerial experience and M&A 83

success should not be underestimated” (p. 55). According to Fowler and Schmidt (1989) further investigation is clearly needed since few studies have to date examined this relationship.

3.1.2.3 Financial factors

Financial aspects play a major role in M&A literature. Many different factors are discussed, e.g. Number of bidders, Mode of payment, Price paid, Mode of payment, Premium and Goodwill, Due Diligence. Most of them try to evaluate the importance and impact of the price paid in relation to the performance of M&A in a direct or indirect way. In respect of this issue, Salter and Weinhold (1979) argued that the acquirers frequently overestimate the value of the target, while underestimating the costs of realizing synergies. In his study, Eccles et al. (1999) also underlined the fact that many M&A failures occur simply because the acquiring firm paid too much for the acquisition. According to Rappaport (1998), to calculate the value-adding opportunities from an acquisition for the acquirer, evaluation should be classified into: a) stand-alone value of the target b) the value of acquisition gains c) the acquisition purchase price The four essential evaluation frameworks can be expressed as shown in table 3.1.

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Table 3.1: Evaluation Frameworks

-

Value created by acquisition = Value of combined firm – (Stand alone value of acquirer + Stand-alone value of target)

-

Maximum admissible acquisition price = Stand-alone value of target + Value of potential synergies

-

Value created for acquirer = Maximum admissible acquisition price – Actual purchase price

-

Acquisition premium paid = Value of synergies

Source: Rappaport (1998)

There are some popular methods used to estimate the value of firms and guide them in setting acquisition prices. The following table summarizes the advantages and disadvantages of some evaluation techniques. Among them, shareholder value analysis and value-based management models are most often utilized.

Table 3.2: Advantages and disadvantages of M&A valuation techniques

Method Discounted cash flow

Advantages -

Comparable transactions

-

Comparable companies

-

Adjusted book value/liquidation analysis

-

Provides a method to model expected performance and to understand sensitivities Aids understanding of performance, cash flow, and balance sheet relationships Provides a comparison with actual acquisitions – what other people are paying Reveals who other buyers are and may offer insights into potential competitive bidders Provides a benchmark of how the public markets view particular industries May be the most relevant if a business is being acquired for its underlying assets as opposed to goingconcern value

Disadvantages -

-

-

May not reflect the reality of pricing trends in the markets Methodology may be cumbersome and may involve “soft” numbers relative to residual values Transaction data may be incomplete; the most similar; the most similar deals may not be published; the published deals may not be similar; every deal is unique May ignore the reality of expected future performance May not reflect economic value of the business, especially if the target generates strong earnings

Source: Ernst&Young (1994); Kim (1998)

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Abate (1993) argued that “benchmarking should be used to determine what probable competitors are likely to pay for the same target, thus allowing a bidder to develop a price that both generates value and pre-empts the field” (Abate 1993, 24). Table 3.3 indicates some crucial points in the benchmarking process as:

Table 3.3: The benchmarking process 1. Identify the group of potential competing bidders 2. Execute buy-side discounted cash flow analyses for your own company and each potential bidder 3. Perform comparable exercises based upon various market multiples. Source: Abate (1993)

Abate (1993) suggested the following in calculating purchase price: “Putting yourself in the other guy’s shoes is the essence of rational acquisition pricing. A rational price is the minimum a bidder must pay to beat out competing contenders for a target and still realize value from the deal. By benchmarking against the field, a savvy acquirer has a chance to carry off the prize without overpaying. How does benchmarking work? In brief, it starts by identifying a “peer” group of likely companies that can gain strategic and synergistic values from the target. The process then moves on to size up the optimum bid for each by running its key value drivers through a discounted cash flow (DCF) model. The company that knows its own industry or analogous fields should be able to adjust the competitor’s value drivers in the DCF work-ups” (Abate 1993, 25). As Barney (1988, 73) states, “Bidding firms that complete a merger or acquisition in (a perfectly competitive market) will not obtain abnormal returns, even if they are completely successful in exploiting anticipated relatedness with a target, for the value of relatedness will be reflected in the price of the target, and thus distributed as abnormal returns to the shareholders of acquired target firms.” At times, price therefore has a quite mysterious and specific fundamental dimension in the M&A literature. As acquirers frequently pay more (and seldom less) for victims (Meeks 1977), this factor should be taken into account. According to Jarillo (2003), the reason is simple: if one company pays too much for another, it will never recover the investment, no matter how well things go. In its desire to close the deal and

86

access all the improvements in its competitive position, as well as to eliminate an inconvenient competitor, the purchasing company’s managers have a strong tendency to be overoptimistic. They want to believe that synergies will be significant, for this will justify the high price usually asked by the seller. Logically, the seller knows this, so the price tends to go up to the maximum justifiable by optimistic expectations of synergies. Datta et al. (1992) recognize that “most strategic decisions are investment decisions (i.e., they describe the pattern of resource allocation needed to enhance shareholder wealth)”, their meta-analysis of M&A research shows that this potentially important variable has received almost no attention. There is, therefore, a need for ongoing progress in the area of investment decisions in the management literature. Sirower (2000) states that the problem could be that the resource allocation (pricing) decision becomes completely detached from any synergies that may be realizable under any conditions, even if all post-merger management-issues were thoroughly considered. In a study of acquisition performance by Kusewitt (1985), the price paid (i.e., market value/book value of the target at the time of the acquisition) was found to be insignificant. However, the alternative measure for this factor, the price paid for acquirees’ assets was significantly related to accounting ROA (r = 0.21, p < 0.05), but far from significantly related to market return. Eccles et al. (1999) states that the question is not whether an acquirer has paid too high a price in an absolute sense. Rather, it is whether an acquirer has paid more than the acquisition was worth to that particular company. Lubatkin (1983) suggests that managers of acquiring firms may make mistakes and acquire the wrong company at the wrong price. Sirower (2000, 158), on the other hand, states that no attempt has been made to formalize the concept of “wrong company” or “wrong price”. If value is destroyed, then, by definition, the wrong price was paid. Therefore that which is relevant about the price needs to be considered so that the ex-ante importance of the concept “wrong price” can be developed in the context of the acquiring firm’s performance environment (Sirower 2000). Premium and goodwill, bidding process and due diligence were therefore chosen to predict the price paid for a target company and will be discussed further.

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3.1.2.3.1 Acquisition premium and goodwill

Acquisition premium and goodwill are often-mentioned variables that are repeatedly associated with high prices paid for a target company. According to Hayward and Hambrick (1997, 103), acquisition premiums are defined as “the ratio of the ultimate price paid per target share divided by the price prior to takeover news.”

Hayward and Hambrick (1997) further states, that acquisition

premiums, defined as the ratio of the ultimate price paid for the target’s share divided by the price prior to the takeover news, have in general been ignored by strategy and organization researchers (Sirower (1994) and Haunschild (1994) are the exceptions). In general, one of the distinctive characteristics of acquisition investments when compared to other internal growth investments is that acquisitions should pay a premium over the target’s current market value. Premiums averaged between 40 and 50 percent in the first half of the 1990s. Sirower (2000, 4) stated that “like a major R&D project or plant expansion, acquisitions are a capital budgeting decision. Stripped to the essential, an acquisition is a purchase of assets and technologies. But acquirers often pay a premium over the stand-alone market value of these assets and technologies.” Any premium a company pays beyond a reasonable market value decreases the buyer’s prospective gain, since the seller absorbs this part of the value created. The sellers are often motivated by non-financial considerations, e.g. their wish to pass ownership of the company on to their children, or, if they work in the company, to retire or do something else. If there are such non-financial considerations, it is especially important that the share owners know the financial consequences of decisions made for personal motives. According to Sirower (2000), the acquisition premium represents that component of the price that executive teams choose to allocate and that pre-acquisition shareholders do not have to pay. Thus, this component of the resource allocation decision is inherently strategic in nature and could be a significant predictor of acquisition success or failure. He found that the higher the acquisition premium paid, the higher the value lost.

88

Hayward and Hambrick (1997) conducted a study to determine the factors involved in the decision to pay a premium over market value for an acquisition, and the impact that this could have on post-acquisition performance. The study attempted to determine if a CEO’s exaggerated self-confidence influenced the decision to pay a premium for an acquisition. It found that the acquiring company’s recent performance, media praise for the acquired company, and the self-importance of the CEO tended to result in the payment of a substantial premium over market value for the acquisition. The study also tested the hypothesis that the larger the premium that was paid, the worse the performance of the acquiring firm would be. The findings of the study indicate that in all situations, the acquiring firm’s shareholders lost wealth in a one-year period after the acquisition, with the degree of loss having a direct relationship to the size of the premium that was paid. The study attempts to establish a non-financial basis for the decision to pay a premium for an acquired firm, but does not fully explain the full range of factors that could influence this type of decision. In addition, it uses an increase in shareholder wealth within the first year after the acquisition as a criterion of success, and does not consider the possibility of longterm financial benefits, or the gain of competitive advantage or new competencies as a result of the acquisition as a criterion of success. According to Davenport (2004) there is also the issue that a number of of the big acquisitions that have occurred at huge premiums have not worked out for stockholders. While the first response may be great, when the transaction is completed you're going to own a share of a firm that just overpaid for the stock you owned. Studies in the area of industrial-organization economics (Alberts and Varaiya 1989) has utilized the market value/book value ratio to acquire the sustained performance improvement requirements needed to compensate for an acquisition premium and create value for the acquiring firm. These researchers calculate the extent of the uniform annual equivalent (UAE) between total return and required rate of return that managers should achieve to justify a given stock price. A premium therefore increases the extent of this UAE. Alberts and Varaiya (1989) propose that, given a competitive economy and past industrial performance, the premiums being paid (65 percent average in their sample) indicate that it will be difficult to attain and support

89

performance objectives. The prices – and particularly, the premiums – that managers are ready to pay and directors are ready to support for M&As are possibly the largest resource allocation decision that management can make. In the light of the large premiums paid in the past as well as with the astonishing volume of acquisition activity, it is necessary to understand the economics and potential consequences of this resource allocation decision in the context of M&As. This will ensure that the relevant consequences of other variables related to choice - insufficiently supported empirically - will again be thoroughly considered. Alberts and Varaiya found that premiums were highly related to the associated hubris factor. Furthermore, they found that large premiums harm the acquirer’s shareholder wealth and that premiums were significantly negatively related to one-year returns, but that there was no association with immediate returns. Ravenscraft and Scherer (1987(a)) conclude that for a certain period of time acquisition offer targets enter their acquirers’ organizations with a profit record slightly inferior to that of their two-digit industry peers. Nine years later, on average, they perform appreciably less well. A main reason for their deteriorating post-takeover profits was the write-up of asset values stemming from the payment of acquisition premiums. Those premiums were hypothetically paid in anticipation of improved profitability, which is not obvious in their post-M&A operating income, or in their cash flow regression. This is an anomaly in respect of the theory of M&As as an efficiencyincreasing mechanism. Eccles et al. (1999, 138), however, show that the relationship between the size of the premium and the success of the deal is not linear. Based on 20 deals, he concluded that “deals with low premiums often fail – and vice versa.”

3.1.2.3.2 Bidding process

The bidding process is another often-mentioned variable that is frequently linked to high prices paid for a target company. A major reason for considering the bidding process as important is the argument “if you don’t acquire a target, a major competitor will” (Eccles et al. 1999). According to Datta et al. (1992), there is an improvement in the level of competitiveness in a 90

situation with multiple bidders, which arises from the negative impact on the bidding firms’ stockholder gains. On the other hand, target companies are expected to benefit when there are multiple bids. As an extreme, the rivalry between bidding companies could even result in the price of the target being bid up until the takeover is a zero (or, sometimes, even a negative) net present value investment for the bidders. In a study by You et al. (1986), the presence of multiple bidders and the number of insiders on the board of directors had a weak negative relationship to performance (Sirower 2000).

3.1.2.3.3 Due diligence

Due diligence is a process through which a potential acquirer evaluates a target firm for acquisition (Hitt et al. 2003). In an effective due-diligence process, hundreds of items are examined in areas as diverse as the financing for the intended transaction, the differences in cultures between the acquiring and target firm, the tax consequences of the transaction, and actions that could be necessary to successfully merge the two workforces. Due diligence is commonly performed by investment bankers, accountants, lawyers, and management consultants specializing in that activity, although firms actively pursuing acquisitions may form their own internal duediligence team. The failure to complete an effective due-diligence process could easily result in the acquiring firm paying an excessive premium for the target company (Hitt et al. 2003). In fact, research shows that without due diligence “the purchase price is driven by the pricing of other ‘comparable’ acquisitions rather than by a rigorous assessment of where, when, and how management can drive real performance gains. In theses cases, the price paid has little to do with achievable value” (Rappaport and Sirower 1999). Sometimes strategic alliances are used to test the potential of a future merger or acquisition between the involved firms (Reuer 2001). Barnes (1996) states that, “determining the largest part of most purchase prices requires complete understanding of the target’s competitive position in its market”, this can only be done in accordance with the use of an adequate due diligence. Due diligence could also be a practical tool to avoid the “shopper mentality” of managers 91

suffering from the “I don’t know what I want until I see it” syndrome (Eccles et al. 1999). It ensures that there is a relationship between a good strategy and the price paid for a target company. Eccles et al. suggest the high M&A failure rate is due to a lack of organizational discipline.

3.1.2.4 Measures of performance

The question whether M&As are related to firm performance has been examined for more than 50 years and there is still no consensus in the research literature (Larsson and Finkelstein 1999). As shown in the introduction of this study, research reviews have shown that M&As are often unsuccessful (Jensen and Ruback 1983; Lubatkin 1983; Ravenscraft and Scherer 1987(a), and Jansen 2002), but some researchers have argued that the scientific evidence shows that M&A activities in the market for corporate control almost consistently enhance efficiency and shareholder wealth (Jensen 1984). Despite the fact that success, especially in the area of finance, is mostly quantified by relying on stock market-based methods (Jarell et al. 1988; Jensen and Ruback 1983, and Weston and Kwang 1983), there are several studies, mainly based on the strategy perspective, that base M&A performance on accounting-based methods (Ravenscraft 1987(b), and Steiner 1975). Alternatively, Larsson and Finkelstein (1999) use synergy realization to measure performance. Much of the controversy is rooted in M&A performance’s dependency on accountingbased measures – first on economics and, secondly, on event studies of stock returns in finance - that are subject to significant error (Ravenscraft and Scherer 1987(b); Bradley and Jarell et al. 1988, and Larsson and Finkelstein 1999). This indicates that with respect to post-acquisition performance’s measurement, there is still some level of disagreement regarding the way M&As’ success and failure should be measured. Furthermore, there is relatively little consensus regarding the time period in which the increase in performance should occur, or the magnitude of the increase that can unequivocally be called success. Consequently, there is a range between clearly identifiable failure and clearly identifiable success in which the 92

majority of post-M&A firms fall, with some degree of researcher judgment crucial to categorize the value created by the combined firm.

3.2 A comprehensive M&A model and hypothesis It has been mentioned that historically most studies on performance and M&A have been fragmented and merely focused on a specific research perspective and not an integrative one. It has also been pointed out that it is therefore of common interest to develop an integrated approach that includes the field’s most important factors. The model that emerges from the present research indicates that strategic, organizational and financial research factors exert a comprehensive influence in determining M&As’ success or failure. This work therefore presents a conceptual framework that integrates theoretical perspective from all three dimensions to offer a wider

process-oriented

integrative

model.

The

integrative

model

describes

performance as a function of the three dimensions: strategy, organizational behavior and finance.

3.2.1 Towards a comprehensive model As emphasized in the previous chapter, and following Haspeslagh and Jemison’s (1991) clusters, basic research streams in the field of M&As stem from 3 different areas: strategic management, organizational behavior as well as finance. Furthermore, as already revealed in the first chapter, strategic management’s overall objective is to understand the conditions under which a firm could obtain superior economic performance (Barney 2002). Each of the three research streams on M&A performance contributed significantly to the understanding of this phenomenon. Still, as Sirower (2000, 13) stated, “despite a decade of research, empirically based academic literature can offer managers no clear understanding of how to maximize the probability of success in acquisition programs”. Previous studies have investigated corporate acquisition issues within uni-dimensional frameworks, i.e. one issue at time. In order to pursue more rigorous and practical studies in future, it is necessary to take a comprehensive viewpoint that simultaneously includes the most 93

critical

corporate

acquisition

issues

in

a

multi-dimensional,

comprehensive

framework. Explaining variance in M&A performance requires a comprehensive model embracing the most important determinants from competing perspectives in research on M&A performance. Based on the previous argumentation in this chapter, the main hypothesis of the comprehensive model is as follows: HYPOTHESIS Ho: Strategic logic, organizational behavior and financial aspects are positively related to post-M&A performance. This lead hypothesis can be summarized as shown in figure 3.1:

Figure 3.1: Comprehensive Model: 3 integrative dimensions

Strategic Logic

Organizational Behavior

Financial Aspects

94

Post M&A Performance

3.2.2 Representative factors stemming from each dimension

3.2.2.1 Strategic factors

In related acquisitions, there are several mechanisms that could lead to the combination of the two companies being more valuable than the sum of their preacquisition values. The joining potential is generally understood as the extent of their relatedness (Datta 1991; Kusewitt 1985; Singh and Montgomery 1987, and King et al. 2004) as determined by the bidder and target’s industry affiliations (SIC Codes) (Morck et al. 1990). Nevertheless, traditional conceptualizations of relatedness in combining firms concentrate on the similarity of their operations (Shelton 1988, and Singh and Montgomery 1987), with strategic differences frequently regarded as less valuable than similarities or even as dysfunctional elements (Shanley and Correa 1992). As an outcome, traditional conceptualizations of relatedness do not completely comprehend the complementary sources that could exist in every part of the value chain. Such synergistic complementarities – market access, different products, or know-how that suit and enhance one another – have been discovered to be key success factors in M&A qualitative research (Hitt et al. 1993). Therefore, apart from possible gains from cost cutting, acquisition performance could also be influenced by the capacity to improve revenues by having access to complementary resources (Capron 1999). The economic logic of realizing revenue-based synergies is as well known as sharing complementary

resources,

mobilizing

invisible

assets,

or

leveraging

core

competencies. Its theoretical source can be found in the resource-based view of the firm (Penrose 1995). Consequently, performance can be obtained by way of equal “economies of sameness” (from accumulating similar operations) as well as “economies of fitness” (from joining different, but complementary, businesses). Assessing a combination potential in terms of both similarities and complementarities is considerably more direct than relying on SIC codes or classification schemes that cannot differentiate among potential sources of value creation (Dess et al. 1995). The 95

strongly positive and significant relationship between combination potential and synergy realization as examined by Larsson and Finkelstein (1999) provides some support for this perspective. Lubatkin (1983) as well as Larsson and Finkelstein (1999) argued in favor of a contingency framework from a strategic point of view in order to measure two firms’ combination potential. The combination potential can be concluded from the contingency framework for diversification strategies in strategic management research (Rumelt 1986), because M&As are an act of diversification. Coherent with the framework for diversification, an M&A contingency framework proposes that whether a firm gains or loses from a merger is contingent on a number of conditions. One reason for the mixed results on relatedness in former research could be that they failed to determine M&As’ explicit characteristics (Larsson and Finkelstein 1999). Therefore, in general, studies of M&As that stress performance are likely to emphasize the consequence of efficiency gains resulting from a variety of variables (Chatterjee 1986, and Lubatkin 1983). The author of this thesis consequently conceptualizes the strategic logic of a merger as follows: - Operational synergies stemming from market similarity or complementarity achieved through economies of scope, and vertical or transaction economies (Chandler 1977; Harrigan 1984; Teece 1982; Williamson 1975; 1979, and Rumelt 1986) - Operational synergies stemming from production operation similarity or complementarity achieved through economies of scale (Bain 1959; 1956, and Lloyd 1976) - Collusive synergies stemming from market and purchasing power (Caves and Porter 1977; Chatterjee 1986, and Scherer 1990) Therefore, HYPOTHESIS 1.1 The greater the market similarity, the better the performance. 96

HYPOTHESIS 1.2 The greater the market complementarity, the better the performance. HYPOTHESIS 1.3 The greater the production operations’ similarity, the better the performance. HYPOTHESIS 1.4 The greater the production operations’ complementarity, the better the performance. HYPOTHESIS 1.5 The greater the market power, the better the performance. HYPOTHESIS 1.6 The greater the purchasing power, the better the performance.

3.2.2.2 Organizational behavior factors

In this section hypotheses related to the organizational behavior perspective will be developed and formulated.

3.2.2.2.1 Acquisition experience

Successfully integrating a business combination is a complex and complicated procedure (Haspeslagh and Jemison 1991, and Jemison and Sitkin 1986). A number of past acquisition experiences could offer helpful lessons for top managers (Fowler and Schmidt 1989; Haspeslagh and Jemison 1991; Hitt et al. 1993, and Paine and Power 1984). Not just integrating, but also target selection abilities could be improved by experience (Hitt et al. 1993). In the frequently intense negotiation period, experienced acquirers understand better when to withdraw and when outside financial, legal, or other resources are needed. Nevertheless, experienced acquirers recognize that the integration phase is even more complex than the negotiation phase. At that point, organizational flexibility (Hitt et al. 1993), sensitive treatment of the acquired firm’s employees (Hitt et al. 1993, and Lubatkin 1983), and cooperation among line managers in the combining groups are key factors for success (Haspeslagh and Jemison 1991). Experienced acquirers should therefore be better able than inexperienced acquirers to quickly move through the negotiation phase and normal integration concerns to focus on the special problems of the distressed asset (Bruton et al. 1994). 97

Kusewitt (1985) argued that frequent acquisition might not allow sufficient time for integration, which suggests a curvilinear relationship between acquisition experience and acquisition performance. Nonetheless, Fowler and Schmidt (1989) found a simple positive correlation between past acquisition experience and returns on equity. Therefore, HYPOTHESIS 2.1: Prior acquisition experience is positively associated with the performance.

3.2.2.2.2 Relative size

The relative size of a target firm may be an important consideration in explaining an M&A’s success or failure. First, when the acquirer is much larger than the target company, the combination potential will necessarily be limited by size constraints (Kusewitt 1985, and Seth 1990). Without the necessary critical mass, relatively small acquisitions are less likely than larger ones to offer the full range of potentials that a combination could provide. Second, smaller M&As may not receive sufficient managerial attention to turn their potential benefit into a realized benefit (Diven 1984, and Ravenscraft and Scherer 1987(b)). Consistent with this logic, Kitching (1967) found that in a sample of 69 acquisitions, the sales of the acquired firm constituted less than 2% of the acquirer’s sales in 84% of the transactions classified as failures. More recent research has confirmed those findings (Larsson and Finkelstein 1999), suggesting that relative size is positively associated with organizational integration, combination potential and performance. Again, our integrative model enables us to investigate the relative importance of the following argument. HYPOTHESIS 2.2 The greater the target’s relative size is in relation to the acquirer’s, the better the performance. 98

3.2.2.2.3 Cultural compatibility

According to Weber (1996), culture has been defined in different ways (Bhagat and McQuaid 1982, and Beyer and Trice 1994). Many researchers perceive culture as a set of frequently unspoken essential assumptions that members of a group share in common (Sathe 1985, and Schein 1985). Every community, corporate or otherwise, has a single culture that is formed by its members’ shared history and experiences (Schein 1985). In general terms, culture basically affects every aspect of the way in which people within a community interact with one another. Furthermore, culture is not easily modified; its full influence can be seen as soon as two independent cultures gather together, as characteristically happens in M&A activities (Schein 1985). Thus, ideally, the measuring of culture and, specifically, cultural differences or cultural compatibility should be operationalized during M&A activities. Little research has methodically attempted to measure cultural differences and their influence in the context of M&As. Cartwright and Cooper (1993) used a questionnaire to measure cultural compatibility, along with other attitudinal variables that integrated job satisfaction, commitment, as well as stress. Because the cultures of the merging companies appeared to be relatively similar, and the study was based on only one merger case, the effects of cultural differences on managers’ attitudes and behavior could not be discovered. Other research used questionnaires to determine the cultural differences in large samples of M&As (Chatterjee et al. 1992(a), and Weber 1996). Chatterjee et al (1992(a)), for example, analyzed the influence of cultural fit on merging companies and their shareholder gains following their merger. Based on a sample of 30 companies, cultural differences between the two top management teams engaged in a merger were found to be inversely related to the stock price after the merger. However, the effects of cultural differences on the integration process’s effectiveness and on financial performance, such as return on assets, were not explored. Therefore, HYPOTHESIS 2.3: Cultural compatibility is positively related to post-M&A performance. 99

3.2.2.3 Financial factors

In this section hypotheses related to the financial perspective will be developed and formulated.

3.2.2.3.1 Acquisition Premium

According to Hayward and Hambrick (1997), past research on the acquiring firm’s performance is extensive, with evidence showing that, with some exceptions (Lubatkin 1987), M&As tend to destroy value for the acquiring firms’ shareholders. In an exhaustive study on the topic, Agrawal et al. (1992) found that shareholders of acquiring firms suffer a 10 percent loss over a five year post-M&A period. The findings were robust across various specifications of acquirer and acquisition conditions. Sirower (1994) used post-acquisition periods ranging from three days to four years and found a consistent significant negative association between premium size and subsequent returns. In support of Hayward and Hambrick’s (1997) hypothesis “The larger the premium paid for an acquisition, the worse the subsequent performance of the acquiring firm” (p.111), they found that premiums were significantly negative related to one-year returns. Following this research, I expect that HYPOTHESIS 3.1: Acquisition premium and goodwill are negatively related to postM&A performance. 3.2.2.3.2 Biding process

Since the number of bidders does not stimulate the market for corporate control and has a negative influence on shareholder wealth creation as far as the bidders are concerned, whereas it has a positive influence on the targets’ shareholder wealth creation (Datta et al. 1992), I expect that 100

HYPOTHESIS 3.2: The bidding process is negatively related to post-M&A performance.

3.2.2.3.3 Due Diligence

As was previously discussed, research on a due diligence’s impact on M&A performance shows that in the absence of due diligence, the price paid for an M&A is not rationally driven (Rappaport and Sirower 1999). HYPOTHESIS 3.3: Due diligence is positively related to post-M&A performance.

3.3 Conclusion Strategic management, organizational behavior as well as the area of finance’s different foci have fragmented M&A research into largely separate research fields. The current chapter has been dedicated to generating a research framework with which to identify the reasons for mergers and acquisitions’ frequent failure. Based on the existing research streams as well as on criticism of these streams, the author has developed a comprehensive framework that integrates different schools of thought. He has, moreover, tried to obtain an overview of the complex world of management. His intention was to develop both the theoretical rationale for a comprehensive framework as well as a specific hypothesis to test the model. The final value of the present framework will depend significantly on its applicability and usefulness to empirical research. Having developed the theoretical basis in the past two chapters, the author will present the research methodology in the following chapter. The research model can be summarized as follows:

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Figure 3.2: Research Model (second order)

e

Integrated Model

Market Sim.

e

Market Com.

e

Prod. Op. Sim.

e

Prod. Op. Com.

e

Market Power

e

Purchasing d Power

e

Acquisition Exp.

e

Relative Size

e

Cultural

(2nd order Model)

Strategic Logic

Organizational Behavior

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d Premium

e

Bidding Process

e

Due Diligence

e

Relative Performance

e

Absolute Performance

Differences

e

M&A performance

Synergy d Realization

Financial Aspects

e

4 Research Methodology This chapter discusses the various aspects of the methodology employed by this thesis to evaluate the developed model and the resulting hypotheses. The chapter is divided into 5 parts: It starts off by describing the overall scheme of the empirical research, focusing on the data collection and analysis. The second part focuses on the questionnaire development, the pretesting procedures, and the main constructs’ measurement, while the following part describes the survey implementation. The penultimate part emphasizes the demographics of the responses. The chapter is concluded with an overview of the statistical procedures applied during the hypothesis testing, and a discussion of the reliability and viability of the constructs in this research.

4.1 Research design The first section describes the overall scheme of the empirical research. It concentrates on common research methods, data collection, the company sample, the unit of analysis, and the study’s key informants. Research setting According to Churchill (1999), there are many research design frameworks, just as there are many distinctive house designs. Fortunately, just as house designs can be broken down into basic types (e.g. chalet, ranch, split-level, two-story), research design too can be classified into several fundamental types. A very useful classification is in terms of the research’s fundamental objective: exploratory, descriptive, or causal. The major accent in exploratory research is on the discovery of concepts and perceptions. A soft drink producer faced with decreased sales might, for instance, conduct an exploratory research to detect possible explanations. The descriptive research study is characteristically concerned with exploring the frequency of something, or the relationship among two or more variables. Descriptive research is basically guided by an initial hypothesis. An example of descriptive 103

research would be an examination of trends in the consumption of soft drinks with regards to characteristics such as geographical location, age, sex etc. The causal research design is concerned with exploring cause-and-effect relationships. Basically, causal research is done in the form of experiments, as they are best suited to explore cause and effect. A soft drink producer may, for example, be interested in ascertaining the effectiveness of different advertising approaches. In this empirical study, a descriptive method was used. Based on the partial testing of existing research, a descriptive method expects that relationships hypothesized in theoretical models will be proved. Churchill (1999) also distinguished between two different types of descriptive research: cross-sectional and longitudinal. From a certain point of view, cross-sectional research characteristically includes several variables from a sample of the population measured at a certain point in time. This means that cross-sectional descriptive research provides a snapshot of the relevant variables at a single point in time. This method is also often called a sample survey. From another point of view, longitudinal studies repeatedly measure variables from a fixed sample. This provides a series of pictures that form a movie of the changes accruing over time.

Figure 4.1: Classification of Descriptive Studies

True Panel Longitudinal Omnibus Panel

Descriptive Studies Cross-sectional

Sample Survey

Source: Churchill (1999)

In the present research, a cross-sectional research method based on a sample survey was used to test a comprehensive model. According to Churchill (1999), cross-sectional study is the best-known and most important type of descriptive design if measured by its frequency of use compared to those of other methods. It is the

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predominate mode of analysis in empirical strategy research (Bowen and Wiersema 1999). Data-collection method A cross-sectional analysis relies on cross-sectional data. According to Churchill (1999), the required data can be collected from primary or secondary sources. The researcher specifically accumulates primary data for the research at hand, whereas secondary data have been accumulated for some other objective, and is reused for the research at hand. Due to time and cost economies, researchers use available secondary data as far as possible (Churchill 1999). Unfortunately, there were no secondary sources available for the author of this thesis that could provide the breadth of data that he regarded as essential to capture the complexity of his model. There were, for example, no reliable data regarding cultural differences, or synergy realization in databases, or other publicly available sources. The author thus reverted to primary data acquired in a sample survey. According to Churchill (1999), primary data can be acquired through communication or observation. The suggested procedure for descriptive research is communication by way of the direct questioning of informants. A structured and standardized questionnaire is considered the most productive to examine specific hypotheses. Furthermore, survey methodology facilitates generalization from a representative sample of companies (Creswell 1994). In addition, all the information required for the comprehensive model’s multiple variables could be collected via this method. Nevertheless, survey samples also have limitations. Key informants in the participating companies could, for example, provide reliable information in respect of just a limited period of time. The present study’s survey was thus limited to companies that had completed an M&A between 1998 and 2003, although Cartwright and Cooper (1990) maintain that integration at the physical and procedural levels is likely to be achieved within a shorter time scale than managerial and wider sociocultural integration (Berry 1980). The latter two, it has been suggested, occur on a time scale of three to five years (Cartwright and Cooper 1990 and Walter 1985), or even longer (Levinson 1970). The author of this study therefore considered it safe - if 105

the key informant was willing and could remember - to acquire data referring back to a minimum period of 3 years, in order to measure the acquisition integration’s impact on the post-merger performance. Despite these limitations, the author is confident that the chosen observation period provided valuable results. Sample frame Once the researcher has clearly specified the problem and developed an appropriate research design and data collection instrument, the next step in the research process is to select those elements from which the information will be collected (Churchill 1999). According to Churchill (1999), the area sample is one of the most important types of sampling. In order to test the proposed M&A model, companies with headquarters located in France, the eastern part of Germany, Switzerland, the United Kingdom, the western part of Germany, and the United States of America were therefore chosen. Language barriers were taken into account during the selection process. These countries nevertheless represent a large share of the global M&A market. All other markets were excluded, reducing the overall scope to a manageable sample33. Another restriction with regard to the sample frame was to include only M&As that had already been legally completed. Fortunately, the databases used have the option for a search process to exclude all M&As activities that have not yet been concluded. Moreover, in accordance with Haleblian and Finkelstein (1999), the majority of M&As included in the survey had a major stake of more than 50% of the company’s shares, so that aspects of M&A integration as well as the transaction’s strategic intent could be measured. The data from various sources were compiled and crosschecked in order to minimize errors in the generation of the sample.

33

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Further limitations in order to reduce the overall scope to a manageable sample size can be found in section 4.3.

Unit analysis Based on the recommended structure to carry out performance measurement (Caves 1964), Veiga et al. (2000) emphasize that most studies on merger performance measure performance with corporate-level data drawn from the buying company. Although these data are generally available, they offer little understanding of any change in the acquired business’s capacity to compete in its own product/market arena due to it being acquired. It is therefore not surprising that in order to advance the field, theory (Gupta and Govindarajan 1991) and research (D’Aveni and Ravenscraft 1994) suggest the importance of investigating strategic phenomena at the business level - as the author of this thesis does - rather than at the corporate level. In order to fulfill this important task, post-merger performance was assessed by asking the managers to describe their perceptions of their company’s performance since the M&A in comparison to that of their largest competitor. On the basis of Veiga et al. (2000), the basic unit of analysis for the present thesis is the acquiring/resulting company. Target informants In keeping with Campbell’s (1955) recommendation, a key informant survey strategy was used for the present study. This is often also called an experience survey (Churchill 1999), and attempts to tap the knowledge and experience of those familiar with the subject under investigation. Selltiz et al. (1976) state that usually a large number of informants know something about a given problem, although not all of them need be contacted. Research economy thus requires that the respondents for a key informant survey be carefully selected. The objective of a key informant survey is to obtain an understanding of the various variables’ relationships, rather than obtaining a precise picture of common best practices in use. Consequently, the choice of respondents should be based on the likelihood that they could offer the contributions sought. In other words, only a selected sample of people working in the area on which data is required should be chosen as key informants (Selltiz 1976). When aspects of firm strategy are studied, a generally accepted appropriate

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approach is to study managerial perceptions, rather than the organization’s objective characteristics (Pettigrew 1973). A single key informant was chosen for each type of M&A. The selection of the three groups of informants was made in accordance with (a) who the respective persons were who had the information required, and (b) the size of the firm. In smaller firms, member of the board were preferred as informants, whereas in larger firms the heads of M&A were contacted. The contact data were assembled from a variety of sources, including databases and firm websites. The data were controlled and updated by way of phone calls to the respective firms. As has been mentioned, according to Campbell (1955), key informant should be: 1. most knowledgeable, 2. willing, motivated, or 3. able to answer the questions of interest. Phillips et al. (1983) developed a set of measures to minimize potential informant bias. Due to the actual risk of measurement bias, the most important of these measures were adopted for the research at hand. As a first set of measures, the key informants in this study were members of the respective company’s management. They consisted of three groups: (1) a member of the board, (2) the head of M&A, and (3) a manager. These three groups were considered as most knowledgeable regarding the broad set of issues covered in the questionnaire. Three questions that would measure the informant’s degree of competence were also included. As a second set of measures to counteract the risk of low willingness to respond to the questionnaire, the benefits that the study would have were emphasized in the covering email. Besides this, confidentiality and anonymity were guaranteed, and the time specified that would be required to fill out the questionnaire. The results would, furthermore, be shared with all the key informants. As a third set of measures to guarantee the survey’s high quality and to reduce any misunderstandings by the respondents, structured questions were employed and a detailed pre-test conducted. A question to measure the respondent’s degree of confidence in answering the questionnaire was also added. 108

4.2 Questionnaire development In a first step, the pre-testing phase of the questionnaire development is discussed. Thereafter the operationalization and measurement of the model’s main constructs are focused on. Four construct categories are taken into account: Strategic factors, organizational behavior factors, financial factors and performance factors. Each category consists of three constructs that are used to test for the relevant category. Finally, the building of the informant competence category with which to test the collected data’s quality is described, followed by the capturing of the respective constructs, general measures and scales, based on existing, well-validated and tested research. It should be noted that almost all items were measured on a sevenpoint Likert-type scale. Exceptions are justified and explained later. Pretesting According to Churchill (1999), the objective of pretesting is to minimize the questionnaire and the used measurement instruments’ lack of clarity as well as their bias. Consequently, two pre-test phases were carried out. In the first pre-test phase, a group of academics, experts on strategic management, organizational behavior, finance, empirical research methodology as well as statistics, was asked to review the questionnaire for inconsistencies. In personal interviews, they provided valuable comments that were used to improve the questionnaire’s clarity and quality. After the first pre-test, the questionnaire was sent to 12 executives with M&A experience. The executives were chosen on the grounds of being personal contacts of the author; nevertheless, they closely matched the profile of the survey’s final target informants. Ten executives responded fully to the questionnaire and were afterwards interviewed by phone or personally. Their detailed feedback on the questionnaire was utilized for further refinement and improvement of the questionnaire. Many changes were made to the wording, as well as the questions’ sequence and the questionnaire’s structure. Some phrases were reformulated and constructs had further items added in order to clarify the questionnaire and improve its quality.

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The questionnaire can be found in Appendix A. It is composed of a cover page and three and a half additional pages of questions. The entire questionnaire was also available on the Internet. It consists of five parts: (1) Strategic factors, (2) Organizational behavior factors, (3) Financial factors, (4) M&A performance factors and (5) Informant details. The measures and scales utilized are described below.

4.2.1 Strategic factors In this section the different items to measure the strategic dimension will be defined.

4.2.1.1 Market similarity

On the basis of Larsson and Finkelstein’s (1999) study, operational synergies arising from market similarity achieved through economies of scope, and vertical or transaction economies (Chandler 1977; Harrigan 1984; Teece 1982; Williamson 1975; 1979, and Rumelt 1986) were measured as the sum of the following items, ranging from “very low” (1) to “very high” (7) on a 7-point Likert-type scale):

Table 4.1: Market similarity

How similar and complementary were the markets

Similarity

between the combined firms, as primarily based on:

Very low

a) Their geographic markets?

1….2….3….4….5….6….7

b) Their customer groups?

1….2….3….4….5….6….7

c) Their product segments?

1….2….3….4….5….6….7

d) The overall complementarity of the markets?

1….2….3….4….5….6….7

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Very high

4.2.1.2 Market complementarity

On the basis of Larsson and Finkelstein’s (1999) study, operational synergies arising from market complementarity achieved through economies of scope, and vertical or transaction economies (Chandler 1977; Harrigan 1984; Teece 1982; Williamson 1975 1979; Rumelt 1986) were measured as the sum of the following items, ranging from “very low” (1) to “very high” (7) on a 7-point Likert-type scale:

Table 4.2: Market complementarity

How similar and complementary were the markets

Complementarity

between the combined firms, as primarily based on:

Very low

e) Their geographic markets?

1….2….3….4….5….6….7

f)

1….2….3….4….5….6….7

Their customer groups?

Very high

g) Their product segments?

1….2….3….4….5….6….7

h) The overall complementarity of the markets?

1….2….3….4….5….6….7

4.2.1.3 Production operation similarity

On the basis of Larsson and Finkelstein’s (1999) study, operational synergies arising from production operation similarity achieved through economies of scale (Bain 1959; 1956, and Lloyd 1976) were measured as the sum of the following items, ranging from “very low” (1) to “very high” (7) on a 7-point Likert-type scale:

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Table 4.3: Production operation similarity

How similar and complementary were the production operations between the combined firms, as primarily

Similarity Very low

Very high

based on: a) Their required resources (raw material, man power, know how…)?

1….2….3….4….5….6….7

b) Their production process?

1….2….3….4….5….6….7

c) Their product range?

1….2….3….4….5….6….7

d) The overall complementarity of the production operations?

1….2….3….4….5….6….7

4.2.1.4 Production operation complementarity

On the basis of Larsson and Finkelstein’s (1999) study, operational synergies arising from production operation complementarity achieved through economies of scale (Bain 1959; 1956, and Lloyd 1976) were measured as the sum of the following items, ranging from “very low” (1) to “very high” (7) on a 7-point Likert-type scale:

Table 4.4: Production operation complementarity

How similar and complementary were the production operations between the combined firms, as primarily based

Complementarity Very low

Very high

on: e) Their required resources (raw material, man power, know how…)?

1….2….3….4….5….6….7

f)

1….2….3….4….5….6….7

Their production process?

g) Their product range?

1….2….3….4….5….6….7

h) The overall complementarity of the production operations?

1….2….3….4….5….6….7

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4.2.1.5 Market power

On the basis of Larsson and Finkelstein’s (1999) study, collusive synergies arising from market power (Caves and Porter 1977; Chatterjee 1986, Scherer 1990) were measured as the sum of the following items, ranging from “very low” (1) to “very high” (7) on a 7-point Likert-type scale:

Table 4.5: Market power

How extensive do you think were the changes in the

Market Power

combined firms’ market and purchasing power, as primarily based on:

Very low

Very high

a) Competition due to the changes in the number of competitors?

1….2….3….4….5….6….7

b) The decrease in purchasing costs?

1….2….3….4….5….6….7

c) The increase in selling prices?

1….2….3….4….5….6….7

d) The access to new and/or larger customers?

1….2….3….4….5….6….7

4.2.1.6 Purchasing power

On the basis of Larsson and Finkelstein’s (1999) study, collusive synergies arising from purchasing power (Caves and Porter 1977; Chatterjee 1986, and Scherer 1990) were measured as the sum of the following items, ranging from “very low” (1) to “very high” (7) on a 7-point Likert-type scale:

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Table 4.6: Purchasing power

How

extensive do you think were the changes in the

Purchasing Power

combined firms’ market and purchasing power, as primarily based on:

Very low

e) Competition due to the changes in the number of competitors?

1….2….3….4….5….6….7

f)

1….2….3….4….5….6….7

The decrease in purchasing costs?

Very high

g) The increase in selling prices?

1….2….3….4….5….6….7

h) The access to new and/or larger customers?

1….2….3….4….5….6….7

4.2.2 Organizational behavior factors In this section the different items to measure the organizational behavior dimension will be defined.

4.2.2.1 Acquisition experience

In keeping with Bruton et al. (1994), acquisition experience was measured by the number of M&As undertaken by an acquiring firm during the four years prior to the relevant M&A.

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Table 4.7: Acquisition experience

Please estimate your companies’ acquisition experience compared

Much

Much

to that of your companies’ largest competitor in terms of:

lower

higher

a) The number of other major M&As made by the acquiring firm in the 4-year period preceding the M&A

1….2….3….4….5….6….7

b) The proven tools in respect of due diligence.

1….2….3….4….5….6….7

c) The existence of procedures in use for the target company’s integration

1….2….3….4….5….6….7

d) Your company’s reputation as a successful acquirer

1….2….3….4….5….6….7

e) The existence of a proven M&A process in use?

1….2….3….4….5….6….7

4.2.2.2 Relative size

In keeping with Bruton et al. (1994), relative size was measured as the ratio of the acquired firm’s revenue to that of the acquiring firm’s.

Table 4.8: Relative size

Please estimate the relative size of the acquired firm’s revenue (or, alternatively, its assets or employees) as a

Size of Acquired firm:

ratio of that of the acquiring firm’s revenue (or,

---------------------------- X 100 = ____%

alternatively, its assets or employees) at the point that it

Size of Acquiring firm:

legally united with the acquirer.

4.2.2.3 Cultural compatibility

The instrument used by Chatterjee et al. (1992(a)) - an often-cited questionnaire to measure corporate culture differences - was also used in the present study. The

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questions were obtained directly from one of Chatterjee’s co-authors, Prof. Yaakov Weber34. Based on the assumption that relative phenomena are best suited for comparisons, particularly in contrast situations (Louis 1983), the respondents were asked to indicate the degree of pre-merger similarity between the acquired and acquiring firm in respect of each item. Each of the items was therefore constructed to elicit responses concerning cultural differences on a 7-point Likert-type scale, ranging from “very similar” to “very different”.

Table 4.9: Cultural compatibility

Please indicate the most appropriate answer for each item: “1” means very similar, while “7” means very different. How similar were the two joining firms’ cultures in terms of

a) At the time of the M&A?

a) Information sharing and communication within the firm? b) Managers’ risk taking? c) The measures with which to judge managerial performance? d) Managers’ autonomy in decision making e) Managers’ transparency in conflict solving? f)

The procedures in decision making?

g) The clear communication of each manager’s responsibility?

4.2.3 Financial factors In this section the different items to measure the financial dimension will be defined.

34

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Dr. Weber is Professor at the School of Business Administration, Hebrew University of Jerusalem, Mt. Scopus, Jerusalem, Israel.

4.2.3.1 Acquisition premium

In keeping with Hayward and Hambrick (1997) and expert interviews, premium and goodwill were measured as the sum of the following items on a 7-point Likert-type scale, ranging from “very low” (1) to “very high” (7):

Table 4.10: Acquisition premium

Please estimate the following items

Very low

a) Evaluation of the goodwill in comparison to the enterprise value

1….2….3….4….5….6….7

Very high

b) EBIT multiple paid in comparison to industry EBIT multiple average

1….2….3….4….5….6….7

c) Evaluation of acquisition premium

1….2….3….4….5….6….7

4.2.3.2 Bidding process

In keeping with Datta et al. (1992) and expert interviews, the target price, number of bidders and resistance were measured as the sum of the following items on a 7-point Likert-type scale, ranging from “very low” (1) to “very high” (7):

Table 4.11: Bidding process

Please estimate the following items

Very low

a) The increase of the final target price compared to the first non binding bid (generally before due diligence).

1….2….3….4….5….6….7

Very high

b) The number of bidders (competition in the M&A process)

1….2….3….4….5….6….7

c) Resistance of the target company’s top management

1….2….3….4….5….6….7

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4.2.3.3 Due diligence

Based on research by Rappaport and Sirower (1999) and expert interviews, due diligence was measured as the sum of the following items on a 7-point Likert-type scale, ranging from “very low” (1) to “very high” (7):

Table 4.12: Due diligence

Please estimate the following items

Very low

a) From the current perspective, how were your targeted future profit expectations?

1….2….3….4….5….6….7

Very high

b) How accurate were the valuation assumptions

1….2….3….4….5….6….7

c) Became the target price higher or lower during the Due Diligence

1….2….3….4….5….6….7

d) Impact of due diligence results on target price

1….2….3….4….5….6….7

e) To what extent did you use sophisticated analytical techniques to quantify the potential future benefits (e.g. valuation techniques)?

1….2….3….4….5….6….7

4.2.4 M&A performance factors The literature presents multiple ways to measure post-acquisition performance. Each performance measure has its distinct logic. Johansson and Yip (1994), for example, stated that performance is a more conceptual than perceptual construct. For instance, Japanese firms are often regarded as better performers than income generators. M&A performance is therefore best viewed as reflected by different measures. In the present study, three alternative but normal ways to measure postM&A performance were used: Synergy realization, absolute performance and relative performance. The self-report measure Despite the fact that self-report measures have a few methodological limitations, such as performance overestimation and respondent bias (Dillman 1991; Rossi et al. 118

1983), a self-report, and thus perceptual, method was utilized in this research, as there are difficulties related to the employment of “objective” methods to evaluate post-acquisition performance (Kitching 1967; Porter 1987). In respect of performance’s time frame, the focus in the present research was on M&As’ long-term effect on performance. In contrast to a long-term perspective, event studies capture the capital market’s forecast of the magnitude, nature, and viability of consolidation procedures. In respect of the type of information used to measure performance, accounting-based measures are generally accessible in aggregate form; consequently, it is a complicated process to separate the M&A’s performance after the performance of additional units and the influence of exogenous occurrences have been measured. A realistic option is to utilize managerial judgment, which offers an exclusive opportunity to not only collect information on an M&A performance’s various aspects, but also to separate the impact of the M&A itself on performance from other exogenous variables (Datta 1991). In keeping with the literature (Datta 1991; Hunt 1990), the M&A long-term performance in this study is based on selfreported measures for each item or construct. In keeping with Capron (1999) and Veiga et al. (2000), the author furthermore used self-reported performance measures because secondary data on acquired businesses are rarely available. Furthermore, there is evidence that supports the general reliability of self-reported performance measures, particularly when reported by a firm’s top managers (Venkatraman and Ramanujam 1986, and Nayyar 1992).

4.2.4.1 Synergy realization

Based on a study by Larsson and Finkelstein (1999), performance was measured in respect of “synergy realization” as the sum of the following items on a 7-point Likerttype scale, ranging from “very low” (1) to “very high” (7):

119

Table 4.13: Synergy realization

Please estimate the degree to which the M&A realized the following

Very low

Very high

benefits: a) The consolidation of input purchases to reduce the purchase price/cost per unit (e.g., through volume discounts).

1….2….3….4….5….6….7

b) The consolidation of production to reduce production cost per unit (e.g., through the utilization of excess capacity).

1….2….3….4….5….6….7

c) The consolidation of marketing to reduce marketing cost per unit (e.g., through an integrated sales force with fewer employee).

1….2….3….4….5….6….7

d) The consolidation of competitors to increase market power by reducing the competition, thereby being able to command higher prices (without losing a corresponding volume).

1….2….3….4….5….6….7

e) The consolidation of administration to reduce administrative overheads per unit (e.g., through the elimination of duplicated head offices).

1….2….3….4….5….6….7

f)

1….2….3….4….5….6….7

The consolidation of possible suppliers or consumers to reduce transaction costs per unit (e.g., through the elimination of intermediate storage, marketing, and purchasing).

g) Access to new geographic market(s) through the other firm’s established local sales organization to increase joint sales.

1….2….3….4….5….6….7

h) The cross-selling of complementary products to joint customers to increase joint sales.

1….2….3….4….5….6….7

i)

Transfer of current know-how (e.g. R&D) from one firm to the other for the latter firm to manage its operations more effectively.

1….2….3….4….5….6….7

j)

Creation of new know-how from the interaction between the unified firms, which one of the firms can use to manage its operations more effectively.

1….2….3….4….5….6….7

k) Other explicit sources of synergy in the firm that contribute significantly to the estimated total realization of synergy culminating from all these various synergy sources (e.g., financial synergy).

1….2….3….4….5….6….7

4.2.4.2 Relative performance

Veiga et al. (2000) noted that most examinations of merger performance measure it by means of corporate-level data drawn from the buying company. Although these data are usually obtainable, they provide little insight into explaining changes in the 120

acquired business’s ability to compete in its own product/market arena as a result of being acquired. Consequently, it is not surprising that in order to advance the field, theory (Gupta and Govindarajan 1991) and research (D’Aveni and Ravenscraft 1994) suggest the importance of investigating strategic phenomena at the business level, as the current study does, rather than at the corporate level. An additional “relative” performance measure was therefore used in the present study in order to comply with the structure-conduct-performance (SCP) approach and the business level. The same items and the same item scaling were used as those used for the absolute performance measurement construct. Based on the study by Veiga et al. (2000) and Capron (1999), post-merger performance was assessed by asking the managers to report their perceptions concerning their company’s performance compared to that of the largest competitor since the M&A. Five performance appraisal items were used: earnings, sales, market share, Accounting Return on Assets (ROA), and Return on Equity (ROE) (Veiga et al. 2000; Kusewitt 1985; Haleblian and Finkelstein 1999, Capron 1999, Vermeulen and Barkema 2001). The set of items was constructed to elicit responses on a seven-point scale, ranging from “very deteriorated” (1) to “very improved” (7).

Table 4.14: Relative performance

Estimate the relative development of the following items since the

Very

Very

M&A when compared to that of your largest competitor:

deteriorated

improved

a) Earnings growth

1….2….3….4….5….6….7

b) Sales growth

1….2….3….4….5….6….7

c) Market share

1….2….3….4….5….6….7

d) ROE

1….2….3….4….5….6….7

e) Accounting ROA

1….2….3….4….5….6….7

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4.2.4.3 Absolute performance

As already mentioned earlier in respect of “absolute” performance, the same items were used to measure post-merger performance as those used for the “relative” performance measurement and were likewise based on the study by Veiga et al. (2000) and Capron (1999). The managers were asked to report their perceptions regarding their company’s performance since the M&A. Five performance appraisal items were used: earnings, sales, market share, Accounting Return on Assets (ROA), and Return on Equity (ROE) (Veiga et al. 2000; Kusewitt 1985; Haleblian and Finkelstein 1999, Capron 1999, and Vermeulen and Barkema 2001).

Table 4.15: Absolute performance

Please estimate the absolute development of the following items

Very

Very

since the M&A:

deteriorated

improved

a) Earnings

1….2….3….4….5….6….7

b) Sales

1….2….3….4….5….6….7

c) Market Share

1….2….3….4….5….6….7

d) ROE

1….2….3….4….5….6….7

e) Accounting ROA

1….2….3….4….5….6….7

4.2.5 Informant competence The following questions were utilized to estimate the respondent’s competence to answer the questionnaire and to evaluate the collected information’s quality:

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Table 4.16: Informant competence

B

Personal information (confidential, for classification purpose only)

What is your current position? ____________________________________________ How long have you worked for this company? __________________________(Years) Please encircle the most appropriate:

Not At All

How involved are you in strategic activities of your company?

1….2….3….4….5….6….7

Very much

How involved are you in organizational activities of your company?

1….2….3….4….5….6….7

How involved are you in financial activities of your company?

1….2….3….4….5….6….7

Please encircle the most appropriate:

Not At All

How clear was this questionnaire?

1….2….3….4….5….6….7

Very much

4.3 Survey implementation Internet surveys’ advantages include larger audience reach, design flexibility as well as anonymity, despite being offset by such disadvantages as bias resulting from multiple and/or inappropriate responses and some issues of generalizability (Seehan and Hoy 1999). Generalizability has a problem on two levels (Smith and Barclay 1997): 1) Only Internet users are likely to respond to an outline survey 2) The difficulty of determining the response rate. The second problem can be avoided by only using a specifically identified email list, rather than posting invitations to participate on discussion boards and Usenet groups. It was therefore decided to use the Internet survey method of collecting data. Once the pre-test and resulting corrections to the instrument had been completed, an email was sent to each company’s contact person with an introductory message and a link to the survey. The email survey was conducted between May and July 2005. The key 123

informants were chosen from the Thomson One banker database, each representing a single M&A deal. The following search criteria were used:

Table 4.17: Sample Search Criteria

Request

Operator

Description

Database

Include

All Mergers & Acquisitions

Acquirer Nation (Code)

Include

France, the eastern part of Germany, Switzerland, United Kingdom, the western part of Germany United States of America

Acquisition Techniques (Code)

Include

Deal Value ($ Mil) Deal Status (Code) Deal Type (Code) Deal Date

Between Include Include Include

Merger of EqualsTender/MergerTender Offer 200 to HI Completed Disclosed Value M&A 2003 – 1998

The surveys were applied to the selected area sample of 1034 key informants (mainly the Chief Financial Officer or Head of M&A), each representing a single M&A deal. Their email address was either available on the database, on the company’s website, or determined via phone. The mailings to all the target countries were completed within a short time. A total of 54 were returned as either undeliverable, out of office replies, or were blocked by spam/firewall filters. A total of 67 responses were received during this phase of the data collection. After 14 days, a reminder was sent to all the key informants. This phase generated another 42 responses. Some of the informants wrote to explain why they did not wish to participate. The main reasons supplied for not participating in the study were a lack of time and corporate policies opposed to participating in surveys. The initial emailing as well as the reminder generated a few indignant responses. Several contacts objected to the data collection procedure (by email), maintaining that it amounted to spam. Others were upset at receiving a reminder (e.g., “If I didn’t answer the first time, it means I am not interested”). 124

The online data were stored in a Microsoft Access database from which they were exported to Excel and then to SPSS 13.0 or PLS graph software. Previous research has revealed that due to a massive claim on their time, senior managers are less likely to respond to surveys (Huber and Power 1985). Consequently, a number of recommended techniques were used to minimize this effect: a) The email featured the logo of the University of Geneva. The academic nature of the research was stressed. b) The benefits of the study for the key informants were emphasized and they were promised a detailed summary of the results. The value of the informants’ specific involvement regarding the success and quality of the research was recognized. c) Strict confidentiality and anonymity were ensured. d) The time it would take to complete the questionnaire (ca. 10 minutes) was specified. Response rate: In total, 109 questionnaires were received. The questionnaire was designed so that there would be no missing values and unanswered questions. Seven questionnaires were excluded from the analysis due to their incomplete data, or because of insufficient competence as indicated by the informant. The number of questionnaires finally included in the analysis thus amounts to 102. The response rate of this study was calculated as follows (Churchill 1999): Response rate = Total Surveys Returned / (Survey Sent Out – Surveys Returned Unopened) x 100. The response rate thus amounted to 11.03% (102 / (1034 – 109) x 100). Response rates of comparably complex surveys vary between 4% and 30%. The sample size of 102 respondents is particularly significant if one considers that according to the search criteria mentioned above; this represents 11.02% of the full M&A population represented by the sample. Furthermore, the sample size of 102 informants is relatively high compared to other empirical studies in the research field.

125

4.4 Sample demographics Sample traits were determined by an analysis of the demographic questions at the beginning and end of the survey. These included the response distribution per country, per year of the M&A completion, the non-response bias and key informant competence. Response distribution per country The distribution of the responses across countries in respect of both acquirers and acquirees was largely in line with the overall population. Although the main focus was on the acquirers, the acquirees’ countries are important, too. Switzerland was a slightly overrepresented, whereas France was somewhat underrepresented. This can be due to the University of Geneva being very recognizable in Switzerland and the degree to which English is understood in the respective countries, as the questionnaire was in English. Nevertheless, the following section makes it clear that overrepresentation did not bias the overall results of the study.

Figure 4.2: Response Distribution per Country Acquirers Others 14%

Australia France 2% 11% Germany 11%

Acquirees Others 5% UK 18%

Switzerland 3% USA 39%

Germany 15% Switzerland 14%

UK 20%

USA 44%

126

France 4%

Distribution per year of M&A completion Another area of concern was the year the M&A was legally completed. Because the integration’s success, and thus also M&A performance, are highly dependent on the post-M&A period, the data quality is highly dependent on the period between the M&A’s completion and the date of the analysis.

Figure 4.3: Response Distribution per Year of M&A Completion 2003 14%

1997 and before 15%

2002 14%

2001 14%

1998 15%

2000 14%

1999 14%

The distribution of the responses across the years was also largely in line with the targeted overall population. Only 15% of M&As were legally completed before 1997. Non-response bias A major fear in email or mail survey studies is the possible presence of non-response bias. This occurs if important differences are discovered between respondents and non-respondents. If this happens, the results of the research are sample specific and do not permit generalization of the overall population (Churchill 1999). According to the steps for testing non-response bias as described by Armstrong and Overton (1977), the sample was subdivided into first wave (ca. 60%) and second wave respondents (ca. 40%). In both cases, the distributions of the respondents were similar. However, to ensure that there were no significant differences among the respondents, a MANOVA test was undertaken. This test on the different variables’ means revealed no significant differences between the two groups. An additional chi127

square test of the different variables’ covariance matrices indicated no significant differences between the two waves. The tests thus led us conclude that the present research has no significant non-response bias. Key informant competence A further domain of interest is the competence of the key informants who were identified for the survey. As the data on each M&A were obtained from a single respondent, the data quality was highly dependent on this informant’s competence. In the survey, the key informant competence was tested by means of a number of questions. First of all, the respondents were asked to specify their current position. Almost all the participants are part of their company’s management. More than 80% are either members of the board of directors or C-level, heads of M&A, or managers. In keeping with their status, the informants are highly competent to respond to the survey. All the participants were also asked to state the length of their tenure within the company. Tenure has been recommended as a proxy with which to determine the extent of someone’s knowledge of a specific company (Seidler 1974). The fact that 70% of the respondents have worked for their current company for more than six years provides additional confirmation of the participants’ competence.

Figure 4.4: Informant Competence Position

Tenure

Head of Mergers and Acquisitio 30%

16 and more

Years

Others 19%

Manager 41%

Member of the board of Directors / C-level 10%

21%

11-15

19%

6-10

30%

1-5

30% 0

10

20

30

40

Num ber of key inform ants

Finally, the respondents were asked to rate on a seven-point scale (whereas 1 = “not at all”, and 7 = “very much”) the extent of their involvement in strategic activities, in 128

organizational activities, and in their companies’ financial activities as well as the confidence they felt in respect of responding to the questionnaire. The average involvement in strategic activities was rated 5.8, the average involvement in organizational activities 5.0, and the average involvement in financial activities 5.2. The comprehensibility of the survey was 5.3. These results are unexpectedly high for a questionnaire of similar intricacy35.

4.5 Analysis of data This section is structured in three parts: (a) reliability, (b) validity and (c) statistical methods. The following section analyzes the reliability and validity of the different constructs in this research. In addition, the statistical methods used in the study to examine the hypothesis are summarized.

4.5.1 Reliability According to Byrne (2001), behavioral science researchers are frequently keen to examine theoretical constructs that cannot be observed directly. These abstract phenomena are called latent variables, or factors. Typical examples of such latent variables are market similarity, market power or synergy realization. As latent variables are not directly observable, they cannot be measured directly either. The researcher must therefore define the specific latent variable operationally in the sense of behavior believed to represent it. The unobservable variable is connected to one that is observable and through which measurements are made possible. These measured scores (i.e. measurements) are called observed or manifest variables. They are used as indicators of the underlying construct that they are presumed to represent. In this study, eighteen exogenous constructs and one endogenous construct were examined. Of these, fourteen were measured using multiple-item scales. The nature 35

No questionnaire had to be excluded from the survey due to unclear informant competence, although 23 responses were received that mentioned that the sender was unable to respond to the entire questionnaire.

129

of these multiple-item scales is quite doubtful (Brosius 2002), hence, it is suggested that the reliability of these constructs should be assessed together with the validity. The analysis of reliability has been operationalized to test the quality of the scales and to select the most appropriate items to be retained. Reliability is a measure of a scale’s internal consistency. It refers to the accuracy, i.e. the precision of what is observed. It is concerned with the extent to which a variable’s obtained value differs from the true value as a result of random error. This means that reliability is the relative absence of error variance in a measurement instrument. According to Churchill (1999), the most common test for reliability in social science is Cronbach’s Coefficient Alpha. This measure shows how well indicators measure each of the constructs. The results were tested for Cronbach’s Alpha values by means of SPSS 13.0. According to Nunnally (1978), Alpha values greater that 0.7 are considered indicators of sufficient reliability. Values above 0.8 are indicators of strong reliability. The specific results for each construct are found in the following table:

Table 4.18: Reliability Analysis Construct

Market Similarity

Market Complementarity

Item

Scale Variance if Item Deleted

Corrected

Cronbach's

Item-Total

Alpha if Item

Correlation

Deleted

MarketSim1

16.78

.393

.702

MarketSim2

13.05

.666

.521

MarketSim3

14.94

.459

.669

MarketSim4

18.21

.493

.655

MarCom2

8.946

.527

.867

MarCom4

7.832

.705

.689

MarCom3

7.243

.754

.633

Production

ProOpSi2

8.893

.807

.747

Operation

ProOpSi3

9.195

.734

.817

Similarity

ProOpSi4

10.132

.688

.856

Production

ProOpCo2

9.098

.709

.919

Operation

ProOpCo3

7.719

.850

.799

Complementarity

ProOpCo4

7.574

.828

.819

MaPower1

7.583

.578

.625

MaPower3

9.137

.557

.653

MaPower4

8.429

.545

.662

PurchPower1

9.34

.601

.555

PurchPower2

10.23

.474

.637

PurchPower3

10.98

.482

.636

PurchPower4

10.33

.389

.701

Market Power

Purchasing Power

130

Cronbach's Alpha .706

.809

.864

.895

.734

.701

Acquisition

AcqExp2

17.906

.834

.861

Experience

AcqExp3

18.261

.739

.891

AcqExp4

16.975

.774

.879

AcqExp5

15.883

.805

.870

CultrualDiffA1

49.25

.625

.809

CulturalDiffA2

51.23

.444

.839

CulturalDiffA3

48.07

.588

.815

CulturalDiffA4

49.71

.525

.825

CulturalDiffA5

48.82

.682

.802

CulturalDiffA6

48.99

.700

.800

CulturalDiffA7

49.16

.596

.814

Premium1

6.36

.423

.871

Premium2

6.20

.694

.561

Premium3

5.74

.671

.567

BiddingProc1

5.24

.709

.570

BiddingProc2

7.25

.564

.741

BiddingProc3

6.50

.565

.739

DueDilligence2

6.921

.500

.805

DueDilligence3

6.422

.950

.611

DueDilligence4

7.495

.512

.791

DueDilligence5

6.325

.580

.768

SynergyReal1

94.86

.210

.750

SynergyReal2

78.24

.641

.687

SynergyReal3

82.38

.533

.705

SynergyReal4

87.20

.391

.727

SynergyReal5

82.50

.580

.700

SynergyReal6

89.35

.428

.722

SynergyReal7

92.56

.214

.754

SynergyReal8

88.26

.400

.725

SynergyReal9

95.44

.238

.745

SynergyReal10

95.47

.253

.742

SynergyReal11

91.47

.440

.723

RelatPerform1

15.68

.835

.878

RelatPerform2

16.71

.800

.887

RelatPerform3

17.88

.613

.922

RelatPerform4

14.95

.884

.867

RelatPerform5

15.79

.751

.897

AbsolPerform1

23.14

.892

.921

AbsolPerform2

26.27

.800

.938

AbsolPerform3

26.77

.773

.942

AbsolPerform4

23.84

.906

.918

AbsolPerform5

23.98

.865

.926

Cultural Differences

Acquisition Premium

Bidding Process

Due Diligence

Synergy Realization

Relative Performance

Absolute Performance

All six constructs regarding complementarity,

production

.904

.837

.753

.772

.797

.745

.911

.943

strategic logic, i.e. market similarity, market operation

similarity,

production

operation

complementarity, market power, and purchasing power, had Cronbach’s Alphas ranging from 0.701 to 0.895 and, thus, sufficient reliability. A single item was 131

removed from each of the following constructs in order to improve the overall reliability: market complementarity, production operation similarity, production operation complementarity, and market power. In relation to organizational behavior, acquisition experience and cultural differences had very high Cronbach Alphas of 0.904 and 0.837 and, thus, strong reliability. One item was removed from acquisition experience so that the overall reliability was improved. Relative size was measured directly, no construct was therefore needed. The financial constructs, i.e. premium, bidding process, and due diligence, were sufficiently reliable since the Cronbach Alpha values ranged from 0.753 to 0797. One item from the construct due diligence was removed to increase the overall reliability. In respect of the constructs of M&A performance, i.e. synergy realization, relative performance, and absolute performance, the Cronbach Alphas ranged from 0.745 to 0.943. Cronbach Alphas for the constructs relative performance and absolute performance were remarkably high. No item had to be removed. Finally, the item-to-total correlations greater than 0.2 and Cronbach Alphas greater than 0.7 were retained for all constructs in the research. All constructs were sufficiently or strongly reliable.

4.5.2 Validity Validity proves whether an observed hypothetical construct has been accurately measured (Churchill 1999). The emphasis here is on what is being measured. A valid measurement instrument measures what it is supposed to measure (high validity means a high coefficient/factor loading between the latent variable and the indicator). In keeping with Gerbing and Anderson (1988), various fit indices as well as normalized residuals were checked. Three types of validity were considered: (a) content validity, (b) convergent validity, and (c) discriminant validity.

132

Content validity Content validity is a qualitative type of validity focused on the adequacy with which the construct’s field is captured by the measure (Churchill 1999). In other words, content validity deals with the items’ representativeness and comprehensiveness when creating the scale (Bohrenstedt 1970). They are estimated by examining the process through which scale items are generated (Straub 1989). In this research, content validity has been assured by means of a detailed review of the relevant literature as discussed in the previous chapters. The research field was conceptually defined prior to building the related constructs. All the scales utilized in the empirical research were also based on recommendation in the literature, and have either been utilized in other empirical research, or were subsequently adapted during the pre-test. Convergent validity Convergent validity verifies the extent to which measures and the underlying construct correspond. The verification is usually done by means of correlation measures (Bollen 1989). The convergent validity of the constructs in this study was assessed by the significance of the item’s loading on its underlying construct (tvalues > 2.00) and the standard error (> 0.2). The detailed results are found in the following table:

Table 4.19: Convergent Validity Analysis Construct

Market Similarity

Market Complementarity

Production Operation Similarity

Production Operation Complementarity

Item

Standard Error

T-Statistic

MarketSim1

0.0774

8.3377

MarketSim2

0.0307

27.4625

MarketSim3

0.0481

15.0237

MarketSim4

0.0454

15.8421

MarCom2

0.1003

7.5050

MarCom4

0.0183

49.6831

MarCom3

0.0250

35.4302

ProOpSi2

0.0176

52.4021

ProOpSi3

0.0240

36.7562

ProOpSi4

0.0438

19.5445

ProOpCo2

0.0350

24.5656

ProOpCo3

0.0161

58.3604

ProOpCo4

0.0184

50.3450

133

Market Power

Purchasing Power

Acquisition Experience

Cultural Differences

Acquisition Premium

Bidding Process

Due Diligence

Synergy Realization

Relative Performance

Absolute Performance

134

MaPower1

0.0358

22.9512

MaPower3

0.0375

21.4929

MaPower4

0.0398

20.0572

PurchPower1

0.0303

27.3703

PurchPower2

0.0567

13.2517

PurchPower3

0.0615

12.4792

PurchPower4

0.1042

6.1331

AcqExp2

0.0236

38.6247

AcqExp3

0.0336

25.3462

AcqExp4

0.0360

24.2628

AcqExp5

0.0241

37.2018

CultrualDiffA1

0.0464

16.0137

CulturalDiffA2

0.1119

5.1007

CulturalDiffA3

0.0593

12.0936

CulturalDiffA4

0.0785

8.1832

CulturalDiffA5

0.0296

26.8390

CulturalDiffA6

0.0310

26.1262

CulturalDiffA7

0.0637

11.4855

Premium1

0.1047

6.4020

Premium2

0.0249

36.2239

Premium3

0.0221

40.6061

BiddingProc1

0.0215

41.3236

BiddingProc2

0.0307

26.0297

BiddingProc3

0.0441

18.0556

DueDilligence2

0.0609

11.7558

DueDilligence3

0.0030

330.3975

DueDilligence4

0.0619

11.8033

DueDilligence5

0.0361

21.8697

SynergyReal1

0.1543

2.5061

SynergyReal2

0.0563

14.0651

SynergyReal3

0.0624

12.3200

SynergyReal4

0.1113

5.2148

SynergyReal5

0.0569

13.0775

SynergyReal6

0.0863

7.2947

SynergyReal7

0.1391

2.2886

SynergyReal8

0.1179

3.9657

SynergyReal11

0.1177

4.0437

RelatPerform1

0.0203

44.6106

RelatPerform2

0.0337

25.9985

RelatPerform3

0.0735

9.9952

RelatPerform4

0.0112

83.3856

RelatPerform5

0.0346

24.3939

AbsolPerform1

0.0137

68.0973

AbsolPerform2

0.0392

22.2007

AbsolPerform3

0.0332

25.5863

AbsolPerform4

0.0133

70.7674

AbsolPerform5

0.0178

51.3785

The

constructs

complementarity,

linked

to

production

strategic

logic,

operation

i.e.

market

similarity,

similarity,

production

market operation

complementarity, market power, and purchasing power, had T-values ranging from 6.1331 to 58.3604, thus higher than the acceptable minimum. With the exception of two items, the standard errors were below 0.1. In fact, all standard errors were below 0.2 and showed convergent validity. No item had to be removed from the construct. The constructs related to organizational behavior, i.e. acquisition experience and cultural differences had T-values between 5.1007 and 38.6247. All standard errors were below 0.2 and thus indicated insufficient convergent validity. These items had to be removed. The financial constructs premium, bidding process, and due diligence also indicated convergent validity, since the T-values ranged from 6.4020 to 330.3975. The standard errors were all below 0.1. No item had to be removed from the financial constructs. The T-values for the M&A performance constructs, i.e. synergy realization, relative performance, and absolute performance, ranged from 2.2886 to 83.3856. From the synergy realization construct, two items, synergyReal9 and synergyReal10, were below 0.2 and had to be removed in order to guarantee convergent validity. The standard errors were below 0.2 and hence showed convergent validity, too. Finally, T-values greater than 2.0 and standard errors lower than 0.2 were reserved for all items in the various constructs. All constructs thus indicated a high convergent validity. Discriminant validity Discriminant validity measures the degree to which a construct does not correlate with other constructs from which it needs to differ (Churchill 1999). According to Fornell and Larcker (1981), discriminant validity is tested by the average variance being extracted from a construct and comparing it to the squared correlation of this construct and other constructs in the research. In keeping with Saadé and Bouchaib 135

(2005), items from each of the three construct dimensions were averaged because PLS does not allow the modeling of second-order factors. Discriminant validity is confirmed if the average variance extracted from each construct is greater than the squared correlation of the constructs. As demonstrated in the following table, discriminant validity was applied to each of the multiple-item constructs utilized in this research.

Table 4.20: Discriminant Validity Analysis

MarSi Average Variance Extracted MarSi MarCom PropOpSi ProOpCo MaPower PuPower AcqExp RelSize CuDifA Premium BidProc DueDil SynRealI RelPerf AbsPerf

0.54 1.00 0.11 0.53 0.13 0.18 0.01 0.06 0.01 0.00 0.03 0.03 0.01 0.07 0.00 0.01

MarCom

PropOpSi

ProOpCo

MaPower

PuPower

AcqExp

0.72

0.79

0.82

0.65

0.56

0.78

1.00 0.11 0.41 0.04 0.00 0.01 0.00 0.07 0.02 0.08 0.03 0.03 0.00 0.00

1.00 0.12 0.05 0.03 0.11 0.00 0.02 0.08 0.03 0.02 0.09 0.02 0.01

1.00 0.11 0.00 0.03 0.00 0.00 0.00 0.01 0.01 0.08 0.00 0.00

1.00 0.14 0.00 0.00 0.01 0.01 0.00 0.00 0.32 0.04 0.10

1.00 0.00 0.00 0.00 0.00 0.01 0.00 0.16 0.01 0.03

1.00 0.01 0.01 0.00 0.07 0.08 0.00 0.02 0.01

RelSize

1.00 0.01 0.00 0.00 0.06 0.01 0.02 0.02

CuDifA

Premium

BidProc

0.51

0.69

0.69

1.00 0.01 0.00 0.00 0.01 0.01 0.01

1.00 0.08 0.01 0.04 0.00 0.06

1.00 0.00 0.01 0.00 0.04

DueDil

SynRealI

RelPerf

AbsPerf

0.66

0.36

0.74

0.81

1.00 0.10 0.08 0.06

1.00 0.10 0.14

1.00 0.65

1.00

In summary, all the multi-scale constructs utilized in this study indicate a high validity.

4.5.3 Statistical methods The best structural equation modeling (SEM) techniques are by far covariance-based methods as implemented by software such as LISREL, EQS, AMOS, SEPATH, and RAMONA as well as PLS (Partial Least Squares). In fact, many social science researchers regard the covariance-based procedure as tautologically synonymous with SEM. Usually, SEM-based approaches give the researcher flexibility to: (1) determine model relationships between multiple predictor and criterion variables, (2) construct unobservable latent variables, (3) model errors in measurements in respect of observed variables, and, finally, (4) statistically test a priori substantive/theoretical and measurement assumptions against empirical data (i.e., confirmatory analysis).

136

SEM-based procedures’ major benefit in respect of first-generation techniques, like principal components analysis, discriminant analysis, factor analysis, and multiple regression, is the greater flexibility that the researcher has to reciprocally play with or influence theory and data. However, if the theoretical knowledge is strong, the researcher can rely on a theory to a greater extent when analyzing data (Chin 1998). The covariance-based approach to SEM modeling can be traced to its original development by Jöreskog (1973), Keesling (1972) and Wiley (1973). Its widespread popularity is largely due to the LISREL III software developed by Jöreskog and Sörbom in the mid-1970s, and the subsequent updates (Jöreskog and Sörbom 1989). Alternative programs such as EQS, CALLIS; AMOS, and SPEATH have recently further increased this approach’s accessibility. Like covariance-based structural equation modeling techniques (e.g., LISREL, and EQS), PLS36 is a second-generation statistical technique that allows the testing of causal models with multiple intervening and dependent variables, in which a distinction is made between the structural, theoretical and measurement models. Differing from techniques such as LISREL and EQS, PLS explains variance and resembles ordinary least squares regression as regards output and assumptions (Barclay et al. 1995). As such, PLS permits smaller sample sizes than covariancebased models do, and neither indicates the direction of the model’s optimization, nor the fit of the model as a whole (see Chin 1998). Consequently, PLS overcomes some of the theoretical and estimation problems associated with the use of covariancebased models, although it requires its own set of assumptions (see, e.g., Hulland 1999 and World 1974). As far as the structural model is concerned, PLS results are analogous to ȕ-statistics from OLS regressions, and similar to principal component analysis in respect of the measurement model (Hartmann 2005). PLS has been utilized in other disciplines (e.g. Duxbury and Higgins 1991; Smith and Barclay 1997) as well as in the strategic management area to examine business strategy, market structure, risk-return relationships (Cool et al. 1989), cooperative ventures (Fornell et

36

The PLS approach has its origins in 1966 when Herman World presented two iterative procedures using least squares (LS) estimation for single- and multi-component models and for canonical correlation (World 1966).

137

al. 1990), global strategy (Johansson and Yip 1994), and determinants of global integration (Birkinshaw et al. 1995).37 According to Chin (1998), PLS might be a solid method of analysis due to its minimal demands on measurement scales, sample size, and residual distributions (World 1985). Due to these advantages, PLS is therefore considered an adequate and suitable statistical method for theory confirmation and is used in the present study. All latent variable paths models in PLS consist of three sets of relations: (1) the inner model (also called the inner relations, structural model, or substantive theory), which specifies the relationships between latent variables; (2) the outer model (also referred to as the outer relations, submodel or measurement model), which specifies the relationships between the latent variables and/or their associated observed or manifest variables; and (3) the weight relations, according to which case values for latent variables are estimated. Without loss of generality, it can be assumed that latent variables and manifest variables are scaled to zero means and unit variances, so that localization parameters can be eliminated in the following equations (Chin 1998). In the present study, the inner model explains whether the dependent latent variable performance is influenced or determined by independent latent variables such as strategic logic, organizational behavior or finance, as the following figure illustrates:

37

138

For an outstanding introduction to the use of PLS in practical applications, see Barclay et al. (1995).

Figure 4.5: Research Model (first order model)

Level 1 e e e e e e e e e e e e

Level 2

Level 3

Integrated Model (1st order Model)

MarSi1 …

MarSi

MarSi4

MarCom1 …

MarCom

MarCom4

ProOpSi1 …

ProOpSi

ProOpSi4 ProOpCom1 …

Strategy ProOpCom

ProOpCom4 MaPower1 …

MaPower

MaPower4 PuPower1 …

PuPower

PuPower4

SynReal

e

AcqExp1

e

AcqExp5

e

RelSize

…

e e

CuDifA1 …

AcqExp

RelSize

Organizational Behavior

M&A performance

RelPerf

CuDiff AbsPerf

CuDifA7

SynReal1 …

e

RelPerf1 …

e

RelPerf5

e

AbsPerf1 … AbsPerf5

e e e e e e

Premium1 …

e

SynReal9

e e

Premium

Premium3 BidProc1 …

BidProc

Finance

BidProc3 DueDil1 …

DueDil

DueDil5

139

4.6 Conclusion In this chapter, the methodology was reviewed to validate the proposed theory-based models. The consistency of the research findings was found to be proven. The thorough foundation of the target sample, the meticulous selection and identification of qualified target informants, and the careful questionnaire development and testing contributed to the reliability of the obtained data. The response rate of more than 11% of the full M&A population as represented by the sample was extremely satisfyingly in the light of the difficulties experienced to obtain this kind of data. The distribution of the responses per country, the distribution per year of the M&As’ completion, the non-response and bias tests as well as the key informants’ high competence are all indicative of the positive results. The participants revealed

exceptionally

high

competence

and

demonstrated

very

good

comprehension of the questionnaire. Sufficient or strong reliability was indicated in respect of all the research constructs. In addition, the high validity proved that the observed hypothetical multi-scale constructs were accurately measured. Finally, the statistical methods used in chapter 5 were described. In summary, chapter four developed a solid basis with which to test the developed hypotheses in chapter 5.

140

5 Research Findings The objective of this chapter is to present and discuss the results of the hypothesis testing. The chapter is composed of four sections. The first three sections: (1) determinant analysis, (2) outer model analysis, and (3) model analysis represent three sequential analyses. Finally, in the last section, the (4) implications of the most relevant of the empirical study’s results are discussed. To generate clear as well as structured results, the different analysis sections are divided into subsections. The main hypothesis of the thesis claims that M&A performance is influenced by three distinct areas: Strategic logic, organizational behavior, and financial aspects. On another - subordinate - level, several hypotheses have been built on the significant effect on M&A performance of distinct determinants based on different theoretical perspectives. Different methods of analysis were used in the present work: Simple regression analysis was used to test for the independent effect; multiple regression and structural model on outer and inner level were used to test for marginal effects. The use of partial regression also helps to be able to better compare the results of the present study with those of previous research in the field utilizing mainly the more classical statistical methods. Furthermore it increases the statistical information and should help to be able to better interpret the data. The partial least squares (PLS) approach to multiple indicators and structural equation analysis was used to assess both the measurement and structural models. Partial least squares’ confirmatory analysis was applied using PLS Graph38 software. According to Vandenbosch (1996), confirmatory approaches have numerous advantages over exploratory approaches in that they incorporate prior knowledge, the removal of rotational indeterminacy, and utilization of a wide variety of measurement tools to estimate the reliability and validity of model results. As we use a pure confirmatory approach in this thesis and thus incorporate prior knowledge, a factor analysis was not used. 38

W. Chin, PLS-Graph Software 1995, Version 3.

141

The path coefficients were calculated by means of the PLS bootstrap procedure (Chin 1998). According to Chin, the bootstrap procedure represents a nonparametric procedure for estimating the exactness of the PLS estimates. N sample sets are formed in order to obtain n estimates for each parameter in the PLS model. Every sample is achieved by sampling with replacements from the original data set (in a normal way until the number of cases is identical to the original sample set). A variety of approaches has been developed to estimate confidence intervals (see Efron and Tibshirani 1993). The bootstrap procedure is regarded as more efficient than the alternative method, called the jackknife method (Efron & Tibshirani 1993)39. According to Chin (1998), both the jackknife and the bootstrap methods’ standard errors should converge. Bootstrap was used in the present work to define confidence intervals for the parameters of the model and to test for significance. The fact that each model is different in itself, although using the same information for M&A performance, explains why the loadings of the M&A performance construct (synergy realization, relative- and absolute performance) change over the different models. LISREL and other covariance structure analyses’ modeling approaches to goodnessof-model-fit involve parameter estimation procedures that seek to reproduce the observed covariance matrix as closely as possible. In contrast, the PLS method’s primary objective is the minimization of error (or, equivalently, the maximization of variance explained) in all endogenous constructs. The degree to which any particular PLS model accomplishes this objective can be determined by examining the R2 values of the dependent (endogenous) constructs. One consequence of this difference in the LISREL and PLS objectives is that there is no proper overall goodness-of-fit measures for models estimated by the latter. Although existing PLS algorithms report goodness-of-fit statistics, such as the Bentler-Bonett normed fit index (Bentler and Bonett 1980), these statistics are meaningless. They are based on the assumption that the estimated model parameters have been chosen to minimize the difference between the observed and reproduced covariance matrices (with the latter having been assessed by means of the estimated parameter values) – an 39

142

Further explanations of the detailed functioning of the bootstrap and the software would be beyond the scope of the present work. For more information on this topic, see e.g. Bentler and Bonett (1980) or Chin (1998).

unwarranted assumption in respect of PLS. Thus, in the present study, the R2 values of the dependent (endogenous) constructs are included. According to Saadé and Bouchaib (2005), the largest construct’s number of items has to be multiplied by ten to get the required sample size. The largest construct of the independent perspectives in this study had seven items (cultural differences), which made a required PLS sample of 70 observations (7x10). The sample consisted of 102 observations. In the present study, the standardized coefficients, the t-value (>1.96*; >2.58**; >3.29***)40 as well as the standard error were analyzed to test the validity of a construct or model. The estimated coefficients or path coefficients were tested to indicate the relationship among the latent variables.

5.1 Determinant analysis The first step to test the comprehensive model’s research propositions concerned the analysis of the identified determinants’ direct effect on performance. The purpose was to ascertain the first evidence of the hypothesized significant relationships between the different determinants and M&A performance. Two analyses were conducted for hypothesis testing. The hypotheses were first of all tested in a series of simple regression equations. Then they were tested in multiple regressions at an outer model level (e.g., the entire group of determinants related to strategic logic).

5.1.1 Simple regression analysis Prior to the evaluation of the findings, it is crucial to mention that simple regression analysis only evaluates each determinant’s direct effect on M&A performance. The direct effect is the impact of one variable on another that is unmediated by any other 40

The following three categories of significance were analyzed: *p 0.5) is not significant and much weaker. Nevertheless, cultural differences are positively related to M&A performance. Surprisingly, significance allocation differs from the finding in the simple regression analysis. Acquisition experience as well as relative size is stronger while cultural differences is weaker. The standard errors load is satisfactory (from 0.09 to 0.11). The percentage of the variance explained (R2) in respect of M&A performance is 19%. Financial factors The financial perspective also has three variables (acquisition premium, bidding process, and due diligence) that are assumed to be significantly related to performance. Figure 5.15 illustrates the conceptual model. The detailed findings can be viewed in table 5.16, which displays the respective loadings.

Figure 5.15: Multiple Regression Analysis – Financial Factors (structural diagram)

R2 = 0.21

d Premium 0.23 Bidding Process

0.07

0.57 M&A performance

Due Diligence

0.39***

Synergy d Realization

0.68

0.90

Relative Performance

0.19

0.92

Absolute Performance

0.16

163

Table 5.16: Multiple Regression Analysis – Financial Factors (model loadings) Variables

Original

Mean of

Standard

subsamples

error

0.2310

0.2218

0.1219

1.8944

Bidding Process

0.0650

0.0784

0.1054

0.6166

Due Diligence

0.3930

0.3844

0.0856

4.5901

sample estimate

Acquisition Premium

T-statistic

Significance

;;;

At it first seems that the findings of the financial perspective are rather surprising. Only due diligence shows a highly significant and positive relationship with M&A performance (original sample estimate = 0.39, standard error = 0.09 and p < 0.001). While acquisition premium and bidding process have no significant impact, they do have a positive one on M&A performance (original sample estimates = 0.23 and 0.07, p > 0.05). The standard errors load satisfactorily (from 0.09 to 0.12). The percentage of the variance explained (R2) in respect of M&A performance is 21%. The causes of this effect can be traced to the correlations between the three variables. They furthermore seem to share a common core, as they seem to jointly share a large part of the variance that they cause in the dependent variable. This shared part of the explained variance is attributed to the variable with the strongest overall effect. Once the strongest variable is removed (in this case, due diligence), the next variable in line (in this case, acquisition premium) takes over. Consequently, it does not make sense to analyze single variables independently. All three variables reflect a common underlying construct and should therefore be modeled appropriately. Table 5.17 summarizes the multiple regression analysis’s results.

164

Table 5.17: Multiple Regression Analysis - Summary Variables

Original

Mean of

Standard

subsamples

error

0.0490

0.0253

0.1312

0.3736

-0.0450

-0.0318

0.1041

0.4323

0.3150

0.3160

0.1243

2.5348

;;

0.4440

0.4029

0.1239

3.5849

;;;

0.2300

0.2359

0.0997

2.3073

;

0.2230

0.2125

0.1065

2.0946

;

0.3020

0.3210

0.1038

2.9096

;;

0.3270

0.3214

0.1071

3.0520

;;

0.1500

0.1590

0.0963

1.5577

0.2310

0.2218

0.1219

1.8944

Bidding Process

0.0650

0.0784

0.1054

0.6166

Due Diligence

0.3930

0.3844

0.0856

4.5901

sample estimate

T-statistic

Significance

Strategic factors Market Similarity Market Complementarity Production Operation Similarity Production Operation Complementarity Market Power Purchasing Power

Organizational Behavior Factors Acquisition Experience Relative Size Cultural Differences Financial Factors Acquisition Premium ;;;

165

Conclusion In sum, multiple regression analysis at an outer model level confirms the prior findings from the simple regression analysis. The six strategic variables all show significant results, although at a weaker level than in the simple regression analysis where all of them were highly significant.42 The original sample estimates are much lower, the standard errors higher, and the T-values in general lower. The three organizational behavior variables were all significant and even in sum stronger than in the simple regression analysis. The three financial factors are al significant, too, but together they represent a lower significance that in the simple regression analysis. Nevertheless, it is difficult to deconstruct the overall effect to single factors, due to the correlations between the distinct variables of the same outer model. The development of comprehensive models for each perspective will therefore be continued. The “outer models” (or “submodels”) treat the single variables as part of one underlying construct with a common influence of M&A performance.

5.2 Outer model analysis The objective of this section is to establish comprehensive PLS outer models for all three perspectives. Strategy outer model In the following, the discussion of the strategy outer model’s research results is continued. The outer model of strategy suggests that strategic logic has a significant effect (reflected by the manifest indicators: market similarity, market complementarity, production operation similarity, production operation complementarity, market power, and purchasing power) on M&A performance (reflected by synergy realization, relative performance, and absolute performance). Figure 5.16 shows the path diagram, while the detailed outer model loadings are revealed in table 5.18. 42

166

The six strategic variables explain almost 65% of the variance in M&A performance (R2 =0.65); significantly, more than any of the variables on their own.

Figure 5.16: Outer Model Analysis – Strategic Logic (structural diagram)

0.45

Markets Sim.

0.60

Markets Com.

R2 = 0.63 0.74*** 0.63***

Prod. Op. Sim.

0.48

Prod. Op. Com.

0.51 0.61

Market Power

0.70***

Synergy d Realization

0.10

0.51

Relative Performance

0.74

0.56

Absolute Performance

0.68

0.95

0.71*** Strategic Logic

M&A

0.79***

performance

0.62*** 0.41***

Purchasing d Power

0.83

Table 5.18: Outer Model Loadings: Strategic Logic Variables

Original

Mean of

Standard

subsamples

error

0.7940

0.8001

0.7399

sample

T-statistic

Significance

0.0409

19.4299

;;;

0.7462

0.0437

16.9356

;;;

0.6331

0.6244

0.0805

7.8650

;;;

0.7190

0.7247

0.0520

13.8227

;;;

0.7026

0.7072

0.0612

11.4787

;;;

0.6246

0.6261

0.0806

7.7528

;;;

0.4086

0.3762

0.1128

3.6214

;;;

estimate Strategic Logic Market Similarity Market Complementarity Production Operation Similarity Production Operation Complementarity Market Power Purchasing Power

The strategy model indicates that all six manifest indicators reflect the underlying construct, strategic logic, very well (original sample estimates > 0.4; standard errors < 167

0.11; p < 0.001). The results match our prior findings: all six variables are highly significant and have very strong factor loadings. The factor loading of the latent variable strategic logic (path = 0.79, p < 0.001) is also particularly strong and has a highly significant positive impact on M&A performance. The standard error of strategic logic loads extremely satisfactorily (0.04). The percentage of the variance explained (R2) in respect of M&A performance is 63%, which is also a very impressive outcome. It can be concluded that strategic logic has a highly significant effect on M&A performance. Furthermore, the construct is well reflected by the variables market similarity, market complementarity, production operation similarity, production operation complementarity, market power, and purchasing power. The findings are consistent with the prior findings, and even better. Organization behavior outer model The organizational behavior outer model suggests that organizational behavior has a significant effect (reflected by the manifest indicators: acquisition experience, relative size as well as cultural differences) on M&A performance (reflected by the manifest indicators: synergy realization, relative performance, and absolute performance). Figure 5.17 shows the path diagram, while the findings are summarized in table 5.19.

168

Figure 5.17: Outer Model Analysis – Organizational Behavior (structural diagram)

R2 = 0.19

Acquisition Exp.

0.62

Organizational 0.70

Relative Size

0.55

0.85

Cultural Differences

0.39

Synergy d Realization

0.29

0.69

Relative Performance

0.52

0.73

Absolute Performance

0.46

0.85

0.62*

Behavior

0.44*

M&A performance

Table 5.19: Outer Model Loadings: Organizational Behavior Variables

Original

Mean of

Standard

subsamples

error

0.4370

0.4341

0.6198

sample

T-statistic

Significance

0.1807

2.4179

;

0.5068

0.3216

1.9574

;

0.5457

0.5076

0.3479

1.5685

0.3925

0.3194

0.3267

1.2015

estimate Organizational Behavior Acquisition Experience Relative Size Cultural Differences

First of all, organizational behavior shows a significant positive effect on M&A performance (standardized coefficient =0.44, p < 0.05). Organizational behavior’s standard error still loads satisfactorily (0.18). The percentage of the variance explained (R2) in respect of M&A performance is 19%, which is also a good outcome. Furthermore, the manifest variables, acquisition experience, relative size, and cultural differences, reflect their underlying latent variable positively, but do not all have a significant influence. Acquisition experience reveals a significant and highly positive impact (original sample estimate = 0.62, p < 0.05), but while relative size and cultural 169

differences are both highly positive, they are not significantly related to M&A performance (original sample estimates = 0.55 and 0.39, p > 0.05). The standard errors of the variables are relatively high (from 0.32 to 0.35). The findings regarding the manifest variables therefore differ from those obtained in the simple regression analysis and those obtained in the multiple regression analysis where relative size was significantly related to M&A performance. Based on the findings, it can be summarized that the latent variable organizational behavior has a highly positive effect on M&A performance. However, two of the outer model’s manifest variables are not significant. Still, they do have very high positive factor loadings. Furthermore, the T-value of relative size is almost significant. Finance outer model The finance outer model suggests that finance has a significant effect (reflected by the manifest variables: acquisition premium, bidding process, and due diligence) on M&A performance (reflected by the manifest variables: synergy realization, relative performance, and absolute performance). Figure 5.18 shows the path diagram and the findings are summarized in table 5.20.

Figure 5.18: Outer Model Analysis – Financial Aspects (structural diagram)

R2 = 0.20

0.72

d Premium

0.71

Bidding Process

0.46

Due Diligence

170

0.56

Synergy d Realization

0.90

Relative Performance

0.19

Absolute Performance

0.14

0.70

0.53** M&A 0.53 0.74*

Financial Aspects

0.45***

performance

0.93

Table 5.20: Outer Model Loadings: Financial Aspects Variables

Original

Mean of

Standard

subsamples

error

0.4470

0.4628

0.5270

Bidding Process Due Diligence

sample

T-statistic

Significance

0.1219

3.6667

;;;

0.4204

0.3111

1.6940

0.5343

0.4911

0.1870

2.8580

;;

0.7361

0.6948

0.2877

2.5769

;;

estimate Financial Aspects Acquisition Premium

To begin with, the latent variable financial aspects indicates a strong and highly positive effect on M&A performance (standardized coefficient = 0.45, p < 0.001). The standard error of the financial aspects loads satisfactorily (0.12). The percentage of the variance explained (R2) in respect of M&A performance is 20%, which is also an excellent result. Moreover, the manifest variables of the outer model, acquisition experience, bidding process, and due diligence, reflect their underlying latent variable and all have a highly positive impact on it. Bidding process and due diligence reveal a highly significant impact (original sample estimates = 0.53 and 0.74, p < 0.01), But their standard errors are rather high (0.19 and 0.29). Acquisition premium has no significant relationship, but still has a very good T-value as well as a very high original sample estimate (0.53). The findings regarding the manifest variables are therefore quite similar to those obtained in the simple regression analysis. The only exception is that acquisition premium is now not significant. Thanks to the relatively high T-value, it can be said that acquisition premium also has a strong and nearly significant impact on the latent variable. Still, the standard errors from acquisition premium (=0.31) as well as due diligence (=0.29) are relatively high. This indicates that the model is largely reliable. Based on the findings, it can be concluded that the latent variable finance has a very strongly positive influence on M&A performance and that the manifest variables of 171

the outer model also have very high positive factor loadings. The model itself, however, can be considered relatively weak because of the high standard errors and acquisition premium’s low T-value. Conclusion At this point, it can be confirmed that the three constructs, strategic logic, organizational behavior and finance, show a positive and significant effect on M&A performance. Strategic logic as a whole exhibits the highest effect on M&A performance, followed by finance and then organizational behavior, both of which had nearly similar standardized coefficients. Table 5.21 summarizes the results of the multiple regression analysis.

172

Table 5.21: Outer Model Loadings - Summary Variables

Original

Mean of

Standard

subsamples

error

0.7940

0.8001

0.7399

sample

T-statistic

Significance

0.0409

19.4299

;;;

0.7462

0.0437

16.9356

;;;

0.6331

0.6244

0.0805

7.8650

;;;

0.7190

0.7247

0.0520

13.8227

;;;

0.7026

0.7072

0.0612

11.4787

;;;

0.6246

0.6261

0.0806

7.7528

;;;

0.4086

0.3762

0.1128

3.6214

;;;

0.4370

0.4341

0.1807

2.4179

;

0.6198

0.5068

0.3216

1.9574

;

0.5457

0.5076

0.3479

1.5685

0.3925

0.3194

0.3267

1.2015

0.4470

0.4628

0.1219

3.6667

0.5270

0.4204

0.3111

1.6940

Bidding Process

0.5343

0.4911

0.1870

2.8580

;;

Due Diligence

0.7361

0.6948

0.2877

2.5769

;;

estimate Strategic Logic Market Similarity Market Complementarity Production Operation Similarity Production Operation Complementarity Market Power Purchasing Power Organizational Behavior Acquisition Experience Relative Size Cultural Differences Financial

;;;

Aspects Acquisition Premium

At the indicator level, a number of variables have been repeatedly confirmed as relevant and significant. The original sample estimates are very strong throughout the 173

different models and therefore reveal the variables’ strong positive influence on their respective latent variables (e.g. strategic logic). Most of the variables are significant and those that are not still show relatively high T-values (from 1.20 to 1.69). Also on this level, strategic variables are again the strongest and best outer model. All six variables, market similarity, market complementarity, production operation similarity, production operation complementarity, market power, and purchasing power, are highly significant with low standard errors as well as very high T-values. Organizational behavior and finance have somewhat high standard errors and somewhat low T-values, but all the variables from the two outer models nevertheless indicate highly positive loadings. On the basis of these results, bringing the various perspectives (outer models) together in an overall model (inner model) is continued.

5.3 Inner model analysis The inner model (overall model) unites the various perspectives (outer models) on M&A performance. The main intention of this section is consequently to demonstrate both the merits and the limitations of the inner model. The inner model has three exogenous latent constructs (strategic logic, organizational performance, and finance) that are presumed to exert a significant effect on a single endogenous latent variable (M&A performance). All four latent constructs are reflected by a number of manifest underlying indicator variables. Figure 5.19 shows the path diagram and the findings are summarized in table 5.22.

174

Figure 5.19: Inner Model Analysis (structural diagram)

0.45

Market Sim.

0.61

Market Com.

0.74*** 0.62***

0.48

Prod. Op. Sim.

0.52

Prod. Op. Com.

0.59

Market Power

0.83

Purchasing d Power

0.62

Acquisition Exp.

0.62**

Relative Size

0.53**

0.72*** 0.69***

Strategic Logic

0.64*** 0.42***

0.68***

0.82

Cultural Differences

Synergy d Realization

0.23

0.65**

Relative Performance

0.57

0.70**

Absolute Performance

0.52

0.88*** Organizational

0.72

R2 = 0.75

0.31***

M&A performance

Behavior

0.42

0.29*

0.88

d Premium

0.80

Bidding Process

0.26

Due Diligence

0.34 0.44

Financial Aspects

0.86***

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Table 5.22: Outer Model Loadings: Inner Model Variables

Original

Mean of

Standard

sample

subsamples

error

T-statistic

Significance

estimate Strategic Logic

0.6770

0.6820

0.0797

8.4956

;;;

Market

0.7432

0.7330

0.0544

13.6685

;;;

0.6217

0.6273

0.0705

8.8197

;;;

0.7174

0.7083

0.0616

11.6504

;;;

0.6919

0.7116

0.0567

12.2079

;;;

0.6370

0.6305

0.0753

8.4591

;;;

0.4181

0.3843

0.1036

4.0345

;;;

0.3130

0.3101

0.0669

4.6757

;;;

0.6188

0.4567

0.3374

1.8339

0.5297

0.5741

0.2432

2.1779

0.4205

0.3540

0.2711

1.5508

0.2920

0.2719

0.1257

2.3227

0.3423

0.2814

0.3852

0.8887

0.4436

0.4035

0.2774

1.5992

0.8590

0.7872

0.1964

4.3743

Similarity Market Complementarity Production Operation Similarity Production Operation Complementarity Market Power Purchasing Power Organizational Behavior Acquisition Experience Relative Size Cultural Differences Financial

;

;

Aspects Acquisition Premium Bidding Process Due Diligence

176

;;;

The findings involve two essential sets of findings that reflect the inherent strength and weaknesses of the inner model. Let us consider the strength of the model first. As can be seen in figure 5.19 and table 5.22, all three perspectives (strategic logic, organizational behavior as well as finance) reveal very strong and significant effects on M&A performance (standardized coefficients from 0.29 to 0.68, T-values from p < 0.05 to p < 0.001). Moreover, all manifest indicators load highly positive on the assumed underlying latent outer model. With the exception of the findings in the multiple regression analysis, the original sample estimates as well as the T-values for strategy are in line with the previous results, and show highly significant loadings (original sample estimate from 0.42 to 0.74, p < 0.001). The original sample estimates and the T-values for organizational behavior (original sample estimates from 0.42 to 0.62, T-values from 1.55 to 2.18) are not in line with the previous results from the outer model analysis, and, in total, are worse than in the simple or the multiple regression analysis. However, they indicate a strong impact on their outer model. The financial indicators (original sample estimates from 0.34 to 0.86, T-values from 0.89 to 4.37) are worse than in the simple regression and the outer model analysis, but pretty much the same as in the multiple regression analysis. Apart from strategic logic, the standard errors are relatively high and therefore weak. All six strategic manifest variables (from 0.05 to 0.10) indicate more than satisfactory results. The findings are therefore in line with previous results. The three manifest variables from the organizational behavior outer model (from 0.24 to 0.34) are all much weaker than those from the previous outer model. They are in line with the results from the outer model analysis, but higher, and therefore worse than the findings in the simple or multiple regression analysis. The findings in respect of the manifest financial variables (from 0.20 to 0.39) also illustrate high standard errors and thus weak results. The percentage of the variance explained (R2) in respect of M&A performance is 75%, which is an excellent result. These findings are mainly in line with the prior results. The outcomes strongly support the first lead hypothesis that insights from multiple perspectives (strategic logic, 177

organizational behavior, and finance) are jointly required to explain M&A performance. Moreover, the identified determinants’ three fields have been confirmed as highly relevant in explaining M&A performance.

5.4 Implications The first purpose of this chapter was to recognize the determinants that play an essential role in explaining M&A performance. After twelve distinct variables had been taken from the literature on M&A performance, hypotheses were developed regarding their effect on M&A performance. Thereafter, four different kinds of statistical analyses were used to test evidence for these hypotheses. All four tests largely led to similar outcomes. Table 5.23 summarizes the outcomes of the hypotheses regarding the latent variables.

Table 5.23: Hypothesis testing for latent variables: Conclusion

Variables

Strategic logic Organizational Behavior Finance

Outer Model Analysis

Inner Model Analysis

;;;

;;;

(0.79)

(0.68)

;

;;;

(0.44)

(0.31)

;;;

;

(0.45)

(0.29)

In addition to the detailed estimation of single determinants’ role in explaining M&A performance, the purpose of this section was to verify the need for a comprehensive perspective. The main hypothesis of the comprehensive model was that M&A performance is best explained by a model that captures the most important determinants arising from various research streams on M&A performance. The analysis of the comprehensive model confirmed the three perspectives’ important role in explaining M&A performance. Strategic logic, organizational behavior, and

178

finance all had a significant effect on M&A performance, thus confirming the comprehensive model. Overall, table 5.24 summarizes the outcomes related to the hypotheses.

179

Table 5.24: Hypothesis testing for determinants: Conclusion Variables

Simple

Multiple

Regression

Regression

Analysis

Analysis

Outer Model

Inner Model

Analysis

Analysis

;;;

;;;

Strategic perspective Market

;;;

Similarity

(0.51)

Market Complementarity Production Operation Similarity Production Operation Complementarity

(0.74)

(0.74)

;;;

;;;

(-0.05)

(0.63)

(0.62)

;;;

;;

;;;

;;;

(0.58)

(0.32)

(0.72)

(0.72)

;;;

;;;

;;;

;;;

(0.66)

(0.44)

(0.71)

(0.69) ;;;

(0.05)

;; (0.48)

Market

;;;

;

;;;

Power

(0.48)

(0.23)

(0.62)

(0.63)

Purchasing

;;;

;

;;;

;;;

Power

(0.39)

(0.22)

(0.41)

(0.42)

Organizational Behavior Perspective Acquisition

;;

;

Experience

(0.26)

(0.30)

(0.62)

(0.62)

;;

;;

(0.25)

(0.33)

(0.55)

(0.53)

(0.15)

(0.39)

(0.42)

(0.23)

(0.53)

(0.34)

Relative Size Cultural Differences

;

; (0.28)

Financial Perspective Acquisition

;

Premium

(0.27)

Bidding

;

;;

Process

(0.22)

(0.07)

(0.53)

(0.44)

Due

;;;

;;;

;;

;;;

Diligence

(0.39)

(0.39)

(0.74)

(0.86)

All six strategy indicators (market similarity, market complementarity, production operation similarity, production operation complementarity, market power, and 180

purchasing power) confirmed their positive and highly significant impact on M&A performance. In the different kinds of analyses, large differences were only found between the multiple regression analysis and the other analyses (simple regression, outer and inner model analysis). The three organizational behavior variables (acquisition experience, relative size, and cultural differences) had a very positive direct impact on M&A performance. On average, relative size is the most significant variable, showing significance in three of the four analyses. Although the significance varies among the different analyses, the loadings are relatively high. Finally, the three financial variables (acquisition premium, bidding process, and due diligence) also showed a very positive and direct effect on M&A performance. Due diligence is by far the most favorable variable, showing a highly significant impact in all the four analyses. As with the organizational behavior variables, significance varies between the various analyses, but largely it is still quite strong. On average, the results in the simple regression showed better loadings that those from the more complex analysis. This reveals that the strong direct effect on performance could be biased through correlations between the various variables.

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6 Conclusions The final chapter presents a summary of the study’s results together with their contributions. In a first step, the different findings are summarized and discussed. Thereafter the intrinsic limitations of the present research are discussed. Directions for future research will also be presented, followed by concluding comments.

6.1 Discussions of the major findings The overall objective of this research was to develop and empirically confirm a comprehensive research framework that bridges rival perspectives and promotes a modern understanding of factors underlying M&A performance. The first important step towards this objective was the development of a common frame of reference that spans conflicting theoretical assumptions from different perspectives. On this basis, a framework was proposed with which to understand the origins of M&A performance better and address the problem of fragmentation by integrating the most important competing perspectives in respect of studies on M&A performance. Once the comprehensive framework was established, the proposed model was empirically tested. The definition of the research setting, the data collection method, the sample frame, the unit of analysis and the target informants were used to describe the research design and, finally, the credibility of the data. Based on a cross-sectional sample survey, a descriptive method was chosen. The survey sample across different industries and countries was also defined well. An e-mail survey was sent out to an area sample of 1034 key informants, each representing a single M&A deal. The number of questionnaires finally included in the study amounted to 102, which was extremely satisfyingly in the light of the difficulty experienced with obtaining this kind of data. According to the sample, this represents 11.2% of the full population of M&As. There was no significant non-response bias to be found in the present research. 183

Further reliability was supplemented by precise questionnaire development, which included a pre-test. The distribution of the responses per country (USA, UK, D, CH, and A), the distribution per year of the M&A’s completion (mainly between 1997 and 2003), the non-response bias-tests (MANOVA and chi-square test of covariance matrices), as well as the key informants’ high competence (mainly the heads of M&A, managers, or members of the board) revealed more positive results. The participants exhibited exceptionally high competence (70% have worked for their current company for more than 5 years) and demonstrated good comprehension of the questionnaire (5.3 out of 7). Moreover, when the reliability of the research’s constructs was tested, sufficient or strong reliability in respect of all constructs was indicated. Item to total correlations greater than 0.2 and Cronbach Alphas greater 0.7 were preserved for all constructs in the research. In addition, high validity proved that the observed hypothetical multiscale constructs had been accurately measured. Content validity was guaranteed by a detailed review of the relevant literature. Convergent validity was assessed by means of the significance of the item’s loading on its underlying construct related to its T-value and standard error. Discriminant validity was confirmed if the average variance extracted from every construct surpassed the squared correlation between the constructs. Simple and multiple regression analysis, as well as structural equation modeling based on PLS Graph Software43 was then utilized to test the established hypothesis in respect of the model. The central hypothesis of the comprehensive model stated that a combination of different perspectives is necessary to explain M&A performance. On a more concrete level, hypotheses were formulated regarding the significant effect of a number of individual

determinants

(derived

from

the

different

perspectives)

on

M&A

performance. Consequently, four statistical methods (simple regression, multiple

43

184

W. Chin, PLS Graph Software 1995, Version 3.0.

regression, outer model analysis, and inner model analysis) were utilized to test these hypotheses. In general, the various methods showed partially differing results.

6.1.1 Main hypothesis In summary, as far as the central hypothesis of this study is concerned, all three the dimensions (strategic logic, organizational behavior as well as financial factors) proved their highly significant importance in relation to M&A performance. The significant importance was proven in both the outer model analysis and the inner model analysis.

Table 6.1: Hypothesis testing: Strategic Logic, Organizational Behavior and Financial Aspects Hypothesis 0

Confirmed Strategic logic, organizational behavior and financial

;;;

aspects are positively related to post-M&A performance.

6.1.2 Strategic logic hypotheses Another major hypothesis was formulated to integrate the most relevant determinants of firm performance as derived from strategic management. All six strategic variables (market

similarity,

market

complementarity,

production

operation

similarity,

production operation complementarity, market power, and purchasing power) proved their importance, indicating a significant impact on M&A performance. Therefore, a strong and significant relationship was observed in respect of the following hypothesis. Table 6.2: Hypothesis testing: Strategic Logic Hypothesis 1

Confirmed The first research objective is to integrate into a single model the most relevant determinants of M&A performance that have been derived from strategic management into a

;;;

single model.

185

Consequently, because each strategic variable was found to be highly significant, the following hypotheses could be confirmed.

Table 6.3: Hypothesis testing: Strategic Logic Determinants Hypothesis 1.1

Confirmed The

greater

the

market

similarity,

the

better

the

performance. 1.2

The greater the market complementarity, the better the performance.

1.3

The greater the production operations similarity, the better the performance.

1.4

The greater the production operations complementarity, the better the performance.

1.5

The greater the market power, the better the performance.

1.6

The greater the purchasing power, the better the performance.

;;; ;;; ;;; ;;; ;;; ;;;

6.1.3 Organizational behavior hypotheses An additional central hypothesis was formulated to integrate the most relevant factors of M&A performance as derived from organizational behavior (acquisition experience, relative size, and cultural differences). The results in respect of this hypothesis varied in the four different statistical methods used for hypothesis testing. In general, in can be said that all three variables had a very positive and, in some cases, even significant impact on M&A performance. On average, relative size showed the best results. The organizational behavior indicators were never all significant in a single statistical method. Nevertheless, each variable was significant at least once and in general revealed superior but not significant T-values. The original sample estimates were relatively high throughout the various statistical methods and proved the positive relationship in respect of M&A performance.

186

Table 6.4: Hypothesis testing: Organizational Behavior Hypothesis 2

Confirmed The second research objective is to integrate the most relevant determinants of M&A performance that have been

;

derived from the organizational behavior (integration) into a single model.

Consequently, as each of the strategic variables had a positive and sometimes even significant effect on M&A performance, the following hypotheses could be confirmed.

Table 6.5: Hypothesis testing: Organizational Behavior Determinants Hypothesis 2.1

Confirmed Prior acquisition experience is positively associated with the performance.

2.2

The greater the target’s relative size is in relation to the acquirer’s, the better the performance.

2.3

;

;

Cultural compatibility is positively related to post-M&A performance.

;

6.1.4 Financial aspects hypotheses Finally, a third essential hypothesis was formulated to integrate the most relevant determinants of M&A performance from the financial field (acquisition premium, bidding process, and due diligence). In contrast to the previous construct, organizational behavior, the results regarding the hypothesis varied less in the four different statistical methods used for the testing. In sum, the variables indicated a very positive and, in some cases, even significant to highly significant effect on M&A performance. Due diligence was by far the best indicator and proved highly significance in all four statistical methods. In the simple regression analysis, all three indicators were significant. On average, each variable

187

had superior but not significant T-values. The original sample estimates were relatively high in all the statistical methods and proved the positive relationship in respect of M&A performance.

Table 6.6: Hypothesis testing: Financial Aspects Hypothesis 3

Confirmed The third research objective is to integrate the most relevant determinants of M&A performance in the financial

;

field (especially regarding price) into a single model.

Consequently, because each of the strategic variables had a positive and sometimes even significant effect on M&A performance, the following hypotheses could be confirmed.

Table 6.7: Hypothesis testing: Financial Aspects Determinants Hypothesis 3.1

Confirmed Acquisition premium and goodwill are negatively related to post-M&A performance.

3.2

The bidding process is negatively related to post-M&A performance.

3.3

Due

diligence

is

positively

related

performance.

to

post-M&A

; ; ;

6.1.5 Conclusion and research Implications In sum, the findings provide strong support for the overall research framework and the underlying assumptions. The main hypothesis was confirmed and it was proven that all three dimensions (strategic logic, organizational behavior, and financial aspects) had a positive and even significant impact on M&A performance. As this positive linkage between the three dimensions reveals, firms with a good strategic logic in respect of an M&A project do better. Factors related to organizational behavior are also important for the

188

companies in the sample, as they lead to better M&A outcomes. Finally, all financial aspects regarding the price of an M&A do matter and have been crucial for post-M&A performance. In other words, according to the sample, the results lead to the assumption that the reasons for past M&A activities’ failure are due to the fact that the acquiring firm could have selected the wrong target (strategic logic), the target firm could have been poorly integrated (organizational behavior) and the acquiring firm could have paid too much (financial aspects). Furthermore, the hypotheses in relation to the different dimension were also confirmed. All six strategic variables (market similarity, market complementarity, production operation similarity, production operation complementarity, market power, and purchasing power) proved their importance by revealing a significant impact on M&A performance. All the organizational behavior variables had a very positive and, in some cases, even significant impact on M&A performance. Moreover, the financial variables also indicated a very positive and, in some cases, even significant to highly significant effect on M&A performance. However, the statistical results in respect of the organizational behavior and financial aspects varied in the different statistical methods used in the study. The results indicated strong support for a comprehensive perspective. It can therefore be stated that variables from different perspective are important and matter to obtain a full picture of a problem. In addition, it was clear that besides the simple regression analysis, the more complex analyses, like multiple regression, or outer and inner model analysis, revealed that there are relationships between the different factors. This can be explained by the fact that they often have a common impact on M&A performance. Future research should overcome the present fragmentation of the determinants of post-M&A performance. Various perspectives have to be considered due to the multidisciplinary nature of M&A. The center of attention should thus be on a superior comprehension of the effects essential to M&A performance.

189

6.2 Limitations of the research The findings of this study must be considered in the light of its limitations. The inherent theoretical as well as methodological limitations of the present research are discussed in the following sections.

6.2.1 Theoretical limitations There is a clear likelihood that this author failed to include all variables that might affect M&A performance in the comprehensive model. According to Raisch (2004), complexity theory as well as population ecology has claimed that a fully comprehensive model cannot be achieved at all. It would therefore definitely be helpful to choose and analyze more variables and dimensions. The selection of variables and dimensions arose from a broad consensus on the determining factors that are mainly relevant in this literature. Despite the fact that the author of this thesis is convinced that he has included the most essential determinant factors, he has obviously not succeed in including all of them. In respect of the model as it was used in this study, which revealed different constructs and underlying manifest variables that are important in explaining M&A performance, the comprehensive model fails to capture reality in its full complexity. In reality, there could be interactions among the various perspectives, for example, between strategic logic and financial aspects. Moreover, feed-back effects could also appear, such as, for example, M&A performance’s possible retroactions on single determining factors. The author of the present work did not take all effects into account due, in part, to the limited literature and prior empirical research on the subject. The possibility of an empirical validation of such models decreases quickly with increasing complexity. In order to have a testable model, this author therefore only included the above-mentioned interactions. Furthermore, some of the factors used in the literature to measure M&A performance cannot be easily assigned to one or the other theory or cluster, and are simultaneously utilized in more than one research field, for instance in strategic 190

management and in organizational behavior. As shown in this study, the phenomenon of M&A performance is clearly an interdisciplinary one, and it therefore makes sense to split the construct according to the specific research field. Consequently, to avoid any misunderstandings in that sense, this author tried not to include such “intersecting factors” in this study.

6.2.2 Methodological limitations To limit the scope of the study, limitations were applied44, such as limitations in relation to the countries included in the study, the size of the M&As, the extent of the database and the timeframe. Generalizing to other contexts should therefore be undertaken with care. Moreover, single key informants were utilized for the collection of data. Each of these limitations could influence the validity of the outcomes. Nevertheless, all effort was made to ensure that the outcomes’ data quality was satisfactory. More than 80% of the study’s respondents are either members of the board of directors, managers or heads of M&A. Additionally, 70% of the respondents have worked for their current company for more than six years and are highly involved in their respective companies’ strategic, organizational as well as financial activities. The Thomson One banker database is also one of the biggest and most reliable databases in the world and is therefore often used in the literature on M&A. There could also be bias intrinsic to self-reported and perceptual responses. This could be particularly strong in respect of measuring M&A performance. However, various studies (e.g. Dess and Robinson 1984, and Venkatraman and Ramanujam 1986; 1987) have confirmed evidence supporting the broad reliability of self-reported performance measures. In addition, self-reports of performance and other measures have been used in a number of studies on strategic management (e.g. Samiee and Roth 1992, Johansson and Yip 1994).

44

See chapter 4.1.

191

6.3 Suggestions for Future Research In terms of further research, it is tantalizing to note that strategic logic, organizational behavior, and financial aspects seem to lead to improved performance. This would seem to go counter to the contingency theory and be in line with theories that maintain that a company has to fit certain circumstances. It could, of course, be a purely empirical accident, with the 102 M&As merely happening to following a specific pattern. Although there is some plausible theory explanation, more theoretical explanation is also required, e.g., could a certain strategic logic serve as a stimulus in respect of an M&A and thus improve M&A outcomes? As it was mentioned before, the comprehensive model possibly still fails to capture reality in its entire complexity, and there might be interactions between the various variables and perspectives. However, the developed comprehensive model could form a sound foundation for further analysis of the more complex interactions in this model, e.g. interrelations or feed-back effects. In addition, future research could lead to additional variables being revealed or even new perspectives, and establish their importance regarding M&A performance. As the present model is quite flexible, these variables could easily be included or added. Furthermore, because the comprehensive framework separates variables and perspectives, it is possible to replace them and insert new ones. Curiosity could be aroused for further research by enlarging the model to include more qualitative aspects. These insights would lead to a better and deeper comprehension of M&A performance. Alternatively, the results could encourage further research into the following two directions: One would be towards a larger sample study, and, if possible, an even more detailed one. That would allow a more complex analysis, contributing to more confidence in the findings, thus avoiding some of the discussed limitations in this study’s methodology. The other direction would be to add smaller M&As as, given their more local focus, they are likely to have different patterns.

192

6.4 Concluding Remarks In the present research, the author stressed the need for a more comprehensive perspective of M&A performance to help solve the “puzzle” and the mixed results found in the literature (see chapter 1). A major intent of this study was to overcome the traditional lack of uni-dimensional frameworks and to show how individual explanations fail to explain the whole picture. The study’s frame of reference as well as the empirically validated research framework provides a foundation for a better comprehension of the origins of M&A success. The author hopes that the present research study will contribute to further acceptance of more comprehensive approaches towards the theory of the origins of M&A success.

193

7 Annex Annex 1: Questionnaire University of Geneva, HEC Institut of Business Admnistration Thomas Straub Bd du Pont-d’Arve 40 CH-1211 Geneva 4 Switzerland Or Fax: 0041- 22 379 8104

Determinants of Success and Failure in Mergers and Acquisitions A COMPREHENSIVE ANALYSIS OF DETERMINANTS OF M&A PERFORMANCE

This study is designed to produce a better understanding of how M&A performance is impacted by strategic decisions, organizational behavior and financial conditions. The findings are intended to support companies in their future strategic decisions. To fill out the survey should not take more than 10-15 minutes. ALL INFORMATION WILL BE TREATED IN STRICTEST CONFIDENCE. DATA WILL BE ANALYZED ON THE INDUSTRY LEVEL ONLY. If you are interested in a summary of the findings, please feel free to contact us, or provide your name and email address here: ________________________________________________________________________ THANK YOU VERY MUCH FOR TAKING THE TIME TO COMPLETE THIS SURVEY! ________________________________________________________________________ Conditions: Please answer this questionnaire in respect of a specific strategic Merger or Acquisition project, where your company took a major stake (>50%) of the other business and which has been legally completed at least 3 years ago. - Please indicate the country of residence of: a) The acquirer

____________________

b) The acquiree

____________________

- Please indicate the year when the M&A was legally completed

_________ (Year)

- Please indicate the current size of your company in terms of sales ________________ (Sales)

195

1/4 The purpose of this section is to obtain an overview of the strategic potential resulting from the combination of the two companies. Market similarity and/or complementarity:

How similar and complementary were the markets between the combined firms, as primarily based on: a) Their geographic markets?

Very low

Similarity Very high

Complementarity Very low Very high

1….2….3….4….5….6….7

1….2….3….4….5….6….7

b) Their customer groups?

1….2….3….4….5….6….7

1….2….3….4….5….6….7

c) Their product segments?

1….2….3….4….5….6….7

1….2….3….4….5….6….7

d) The overall complementarity of the markets?

1….2….3….4….5….6….7

1….2….3….4….5….6….7

Prosuction similarity and/or complementarity:

How similar and complementary were the production operations between the combined firms, as primarily based on: a) Their required resources (raw material, man power, know how…)?

Very low

Similarity Very high

Complementarity Very low Very high

1….2….3….4….5….6….7

1….2….3….4….5….6….7

b) Their production process?

1….2….3….4….5….6….7

1….2….3….4….5….6….7

c) Their product range?

1….2….3….4….5….6….7

1….2….3….4….5….6….7

d) The overall complementarity of the production operations?

1….2….3….4….5….6….7

1….2….3….4….5….6….7

Market and Purachsing Power

How extensive do you think were the changes in the combined firms’ market and purchasing power, as primarily based on: a) Competition due to the changes in the number of competitors?

Market Power

Purchasing Power

Very low Very high 1….2….3….4….5….6….7

Very low Very high 1….2….3….4….5….6….7

b) The decrease in purchasing costs?

1….2….3….4….5….6….7

1….2….3….4….5….6….7

c) The increase in selling prices?

1….2….3….4….5….6….7

1….2….3….4….5….6….7

d) The access to new and/or larger customers?

1….2….3….4….5….6….7

1….2….3….4….5….6….7

2/4

The purpose of this section is to obtain an overview of the combined companies’ integration.

Acquisition experience: Please estimate your companies’ acquisition experience compared to that of your companies’ largest competitor in terms of: a) The number of other major M&As made by the acquiring firm in the 4-year period preceding the M&A

Much Much lower higher 1….2….3….4….5….6….7

b) The proven tools in respect of due diligence.

1….2….3….4….5….6….7

c) The existence of procedures in use for the target company’s integration

1….2….3….4….5….6….7

d) Your company’s reputation as a successful acquirer

1….2….3….4….5….6….7

e) The existence of a proven M&A process in use?

1….2….3….4….5….6….7

Relative size: Please estimate the relative size of the acquired firm’s revenue (or, alternatively, its assets or employees) as a ratio of that of the acquiring firm’s revenue (or, alternatively, its assets or employees) at the point that it legally united with the acquirer.

196

Size of Acquired firm: ---------------------------- X 100 = _______% Size of Acquiring firm:

Degree of cultural differences: Please indicate the most appropriate answer for each item: “1” means very similar, while “7” means very different. At the time How similar were the two joining firms’ cultures in terms of of the M&A? a) Information sharing and communication within the firm? b) Managers’ risk taking? c) The measures with which to judge managerial performance? d) Managers’ autonomy in decision making e) Managers’ transparency in conflict solving? f)

The procedures in decision making?

g) The clear communication of each manager’s responsibility? 3/4

The purpose of this section is to obtain an overview of some financial aspects with regard to the target price.

Premium and goodwill: Please estimate the following items a) Evaluation of the goodwill in comparison to the enterprise value

Very low Very high 1….2….3….4….5….6….7

b) EBIT multiple paid in comparison to industry EBIT multiple average

1….2….3….4….5….6….7

c) Evaluation of acquisition premium

1….2….3….4….5….6….7

Bidding process: Please estimate the following items a) The increase of the final target price compared to the first non binding bid (generally before due diligence).

Very low Very high 1….2….3….4….5….6….7

b) The number of bidders (competition in the M&A process)

1….2….3….4….5….6….7

c) Resistance of the target company’s top management

1….2….3….4….5….6….7

Due Diligence: Please estimate the following items a) From the current perspective, how were your targeted future profit expectations? b) How accurate were the valuation assumptions

Very low Very high 1….2….3….4….5….6….7 1….2….3….4….5….6….7

c) Became the target price higher or lower during the Due Diligence

1….2….3….4….5….6….7

d) Impact of due diligence results on target price

1….2….3….4….5….6….7

e) To what extent did you use sophisticated analytical techniques to quantify the potential future benefits (e.g. valuation techniques)?

1….2….3….4….5….6….7

197

4/4 The last section covers questions on the M&A’s performance aspects and on your personal background. The information is anonymous and will be kept strictly confidential. A. M&A Performance Synergy realization: Please estimate the degree to which the M&A realized the following benefits: a) The consolidation of input purchases to reduce the purchase price/cost per unit (e.g., through volume discounts).

Very low

Very high

1….2….3….4….5….6….7

b) The consolidation of production to reduce production cost per unit (e.g., through the utilization of excess capacity).

1….2….3….4….5….6….7

c) The consolidation of marketing to reduce marketing cost per unit (e.g., through an integrated sales force with fewer employee).

1….2….3….4….5….6….7

d) The consolidation of competitors to increase market power by reducing the competition, thereby being able to command higher prices (without losing a corresponding volume).

1….2….3….4….5….6….7

e) The consolidation of administration to reduce administrative overheads per unit (e.g., through the elimination of duplicated head offices).

1….2….3….4….5….6….7

f)

1….2….3….4….5….6….7

The consolidation of possible suppliers or consumers to reduce transaction costs per unit (e.g., through the elimination of intermediate storage, marketing, and purchasing).

g) Access to new geographic market(s) through the other firm’s established local sales organization to increase joint sales.

1….2….3….4….5….6….7

h) The cross-selling of complementary products to joint customers to increase joint sales.

1….2….3….4….5….6….7

i)

Transfer of current know-how (e.g. R&D) from one firm to the other for the latter firm to manage its operations more effectively.

1….2….3….4….5….6….7

j)

Creation of new know-how from the interaction between the unified firms, which one of the firms can use to manage its operations more effectively.

1….2….3….4….5….6….7

k) Other explicit sources of synergy in the firm that contribute significantly to the estimated total realization of synergy culminating from all these various synergy sources (e.g., financial synergy).

1….2….3….4….5….6….7

Relative performance: Estimate the relative development of the following items since the M&A when compared to that of your largest competitor: a) Earnings growth

Very Very deteriorated improved 1….2….3….4….5….6….7

b) Sales growth

1….2….3….4….5….6….7

c) Market share

1….2….3….4….5….6….7

d) ROE

1….2….3….4….5….6….7

e) Accounting ROA

1….2….3….4….5….6….7

198

Absolute performance: Please estimate the absolute development of the following items since the M&A: a) Earnings

Very Very deteriorated improved 1….2….3….4….5….6….7

b) Sales

1….2….3….4….5….6….7

c) Market Share

1….2….3….4….5….6….7

d) ROE

1….2….3….4….5….6….7

e) Accounting ROA

1….2….3….4….5….6….7

B

Personal information (confidential, for classification purpose only)

What is your current position? ____________________________________________ How long have you worked for this company? __________________________(Years) Please encircle the most appropriate: How involved are you in strategic activities of your company? How involved are you in organizational activities of your company? How involved are you in financial activities of your company?

Not At All Very much 1….2….3….4….5….6….7 1….2….3….4….5….6….7 1….2….3….4….5….6….7

Please encircle the most appropriate: How clear was this questionnaire?

Not At All Very much 1….2….3….4….5….6….7

Thanks a lot for your contribution!! Please return the completed questionnaire to the address which is mentioned on the cover page. If you are interested in the results of the survey please do mention that you would like to have a feed back. Your participation in this study will be greatly appreciated. Sincerely, Prof. Dr. G.J.B. Probst , Institute of Organization & Management, University of Geneva (HEC) Prof. Dr. J.-C. Jarillo, Institute of Corporate Strategy, University of Geneva (HEC) Thomas Straub, Project Lead & Doctoral Student, University of Geneva (HEC)

199

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