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

Margaret Cording Petra Christmann L. J. Bourgeois, III Darden School University of Virginia

To be presented at Academy of Management, August 12, 2002

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A Focus on Resources in M&A Success: A Literature Review and Research Agenda to Resolve Two Paradoxes
This paper reviews the empirical literature on mergers and acquisitions with an eye towards identifying research questions that have not yet been addressed and that may help resolve two paradoxes that emerge from the literature review. Despite the empirical evidence that, on average, mergers fail to create value for the acquiring firm’s shareholders, corporations continue to employ this strategy at ever-increasing rates (the “success paradox”.) The

diversification theory claim that related acquisitions should outperform unrelated ones has not withstood the empirical test (the “synergy paradox”.) We suggest that the resource-based view of the firm can be leveraged to illuminate the nature and characteristics of resources that present difficulties in both the target valuation and integration processes, helping to resolve these two paradoxes. Specifically, we argue that certain qualities of resource bundles are more challenging when valuing target resources and resource combinations, as well as presenting ex post uncertainties about acquired resources. Other resource characteristics, such as embeddedness,

tacit value creating routines, and human qualities, present an enigmatic integration process. It is hypothesized that failures to understand these characteristics lead to a tendency to overvalue targets and the possibility of destroying during the integration process the very value purchased. By being consciously aware of these resource characteristics, and the difficulties encountered when valuing and integrating target firms, firms may be better able to preserve and leverage the value creating mechanisms of the acquired firm. Research propositions are proposed to test these hypotheses.

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Words such as “Herculean”, “heroic”, “ultimate change management” and the like are often used to describe the requirements for a successful merger or acquisition. Empirical evidence has shown that creating value for the acquiring firm’s shareholders is a 50/50 bet at best. Despite this dismal record, mergers and acquisitions continue to set records. In 1989, 3,407 m&a deals were completed with a total value of $230 billion (Mergers and Acquisitions, 1990); by 2000, the number of deals grew to 8,505, valued at over $1.7 trillion (Sikora, 2001.) Moreover, the average purchase price of transactions has grown dramatically; the bets are getting bigger. For more than thirty years, scholars have researched mergers and acquisitions. Early empirical work sought to identify the characteristics of successful mergers, especially as it relates to diversification theory. Results were mixed, but most agree that, on average, mergers and acquisitions fail to generate above normal returns for the acquiring firms’ shareholders. Why, then, do corporate CEOs continue to employ this strategy? And what can they do to improve the odds of success? Attention has also focused on understanding the variables that managers can manipulate to bolster a given transaction’s probability of success: ways to improve the quantity and quality of information gathered during due diligence, and potential impediments to the integration of two firms. This paper explores the literature with an eye towards identifying research questions that have not yet been addressed and that may help resolve two paradoxes that emerge from the literature review: the m&a success paradox and the synergy paradox. The literature is segmented into three separate, but related, critiques: the measurement of success of a merger; empirical evidence with respect to strategic diversification theory; and, empirical testing of integration factors that may drive a transaction’s success. We then argue that a resource-based view of the

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resource bundle that an acquiring firm purchases and integrates can better illuminate the sources of valuation and integration problems than the traditional approaches. We conclude with a suggested research agenda that seeks to further develop and operationalize the resource-based view of the firm in the context of mergers and acquisitions. MEASURING M&A SUCCESS It is widely agreed that the “success” of a merger or acquisition may be defined as the creation of synergy: the value of the combined firm is greater than that of the two firms operating separately. This reflects the simple observation that the price paid for a strategic asset must be lower than its expected value if it is to add economic value to the acquiring organization. Because the efficacy of a corporate combination is, at least in part, a function of how its outcome is calculated, this section reviews the empirical literature with respect to measuring success in mergers and acquisitions. Four principle methodologies have been employed: event study, accounting-based measures, survey data and case studies. -----------------Insert Table 1 about here -----------------Traditionally, the capital asset pricing model (CAPM) has been the primary measurement tool for determining the degree to which mergers and acquisitions create economic value. Utilizing the “event study methodology” (Fama, 1968), the stock prices of both acquiring and acquired firms are examined shortly after the merger announcement. The “cumulative abnormal returns” are calculated (the increase in stock price over and above that which CAPM would predict absent the merger), and the results assessed. The central underlying assumption is that investors are capable of accurately predicting the combined firm’s future cash flows. The event study methodology has several attractive features. First, the data is publicly available, permitting empirical studies on large data samples. Second, it relies upon the well-

enabling a broad cross-section of firms to be studied. hypothesized that the ability of top management teams to work effectively together would drive m&a success. 1992. Seth.) Over the past fifteen years. Datta. 1987.) Indeed. Singh & Montgomery. see Sirower. Third. measured by . may be due to its reliance on the assumption that investors can accurately predict the combined firm’s future cash flows. 1987. Krishman. 1990a. 1997. 1990b.5 respected efficient market hypothesis.) Later studies examined the distribution of this new wealth. and concluded that the stockholders of acquired firms capture most of the gains (Chatterjee. and survey responses. Seth. The definition of “success” began to take on a longer-term perspective: perhaps it took three to five years to fully reap the benefits of the combined firm. 1997. Sirower. scholarly attention shifted to exploring different dependent variables. Abandoning this assumption represents a direct challenge to the efficient market hypothesis (Shleifer & Vishny. This assumption embodies the attractive feature of ensuring that non-m&a related factors are not influencing the incremental stock behavior. the stock price performance of acquiring firms raises serious concerns: only about 35% of acquirers report positive stock market gains on the announcement date (for a useful review of these analyses. and regressed these against various factors hypothesized to drive financial performance. Miller and Judge (1997). Studies began using accounting-based measures of performance. These studies have provided support for the view that mergers and acquisitions create economic value (Jensen & Ruback. but rather with the event study methodology’s assumptions regarding success. Singh & Montgomery. 1991. because “abnormal” returns are calculated. however. Pinches & Narayanan. market share data. 1983.) These event study results. Perhaps the issue was not one with m&a “success”. 1986. the data is not subject to industry sensitivity. for example.

they reduce some of the noise that may accompany publicly available information.6 return on assets. Because every merger and acquisition is a unique event. a merger or acquisition should be deemed a “success” if the objectives identified during the due diligence process are met. return on assets was used to measure performance over a three-year period. Capron. Marks & Mirvis. 1986. 1993. Shanley & Correa. Chatterjee. . the key question may be. 1992.) While it is not possible to generalize to other specific situations. 1992. 1999: 993.) While these approaches rely on self-reported perceptions of long-term performance. Again. 1999. But accounting measures are subject to one of the same limitations as are long-term stock price measurements: factors other than the merger or acquisition may be driving the numbers. occurring in a unique environment that is subject to innumerable influences. In other words. Some academics have opted to use survey measures to elicit the management team's views on whether or not the merger was a success (Cannella & Hambrick. regardless of other exogenous or endogenous factors simultaneously at work?” Capron’s recent survey-based work claims: “…traditionally available financial data are too gross to permit differentiation between the types of fine-grained value-creating mechanisms…” (Capron. Lubatkin & Weber. Ramaswamy (1997) explored the impact of strategic similarity in mergers occurring in the banking industry.) Nor do they reflect changes in the firm’s risk profile. 1991. 1998. the case study This analytic device methodology does enable one to generalize to theoretical constructs. case studies have also provided a rich stream of research (Haspeslagh & Jemison. In addition. accounting measures reflect the past.) In theory. rather than present financial performance expectations (Montgomery & Wilson. “Did we accomplish what we set out to accomplish.

gives rise to the “m&a success paradox. an increase in the size of the firm.) The newly combined entity is left with the task of creating value in excess of the premium paid. combined with the observation of continued growth in merger and acquisition activity. (Chatterjee. TESTING DIVERSIFICATION THEORY IN M&A While the event study literature demonstrates that the acquired firm’s shareholders reap above-normal returns (due to the payment of a premium for the firm). 1974. or internal funding of the target’s investment projects at a cost lower than that available in the capital markets. not value creation (Seth. which has not been observed. Collusive synergies – sometimes called “market power” – enable the firm to either extract a higher price for its products or services or pay suppliers a reduced price. the higher . While different terminology is used. First. and that corporate governance structures serve as a check and balance on poorly conceived strategic actions. three broad classes of synergy are the usual focus of researchers. 1990a.” If we assume that managers are rational. These results. Financial synergies are driven by reductions in the cost of capital due to a reduction in bankruptcy risk.7 enables the analysis of processes of value creation. To date. 1986. 1978. rather than simply events seeking to create value. this represents value capture.) Diversification theory claims that related acquisitions should have greater potential for synergy creation than unrelated acquisitions (Rumelt. Strategy theory tells us that value is created in an m&a through the identification and exploitation of synergy. operating synergies arise when economies of scale or scope are captured across a variety of the firm’s activities. Salter & Weinhold. scholars have been unable to unravel the m&a success paradox.) This is because the greater the points of contact and overlap between two firms’ value chains. we would expect the level of m&a activity to taper off.

In a review of these empirical studies (all using the event study methodology). Federal Trade Commission’s Standard Industry Classification at either the two. The presence of a related skill. . a related merger. conflicting results have been achieved. Arguing that the type of synergies captured cannot be classified based on the type of merger due to the potential presence of multiple sources of synergies in. resource or purpose of two merging firms was the usual definition of relatedness employed (Rumelt.8 the potential for capturing operational synergy. market. with related mergers outperforming unrelated ones. While the above diversification theory is intuitively appealing.05 level. 1974. while the acquiring firm did not experience any statistically significant wealth gains. Singh and Montgomery (1987) hypothesize that because all three forms of synergy are theoretically available in related acquisitions. standardized on the value of acquired assets. while Elgers and Clark (1980) found that unrelated mergers outperformed related ones.or four-digit level. say.) Researchers operationalized this concept generally by using the U. Chatterjee (1986) attempted to empirically isolate the effects of various sources of synergy. For example. Attention therefore focused on measuring the results from related versus unrelated mergers. scholars sought to understand what types of mergers might lead to above normal shareholder value. target firms obtained the lion’s share of these gains. again using the event study methodology. However. Lubatkin (1987) found no statistically different results in related versus unrelated mergers. related acquisitions will create more value than unrelated ones.S. Singh and Montgomery (1987) found that total dollar gains. However. Given this model of value creation possibilities. and that because only financial synergies and administrative efficiencies are available in unrelated mergers. showed statistically significant differences between related mergers and unrelated ones at the . Lubatkin (1983) noted that the concept of “synergy” had never been tested.

Furthermore. 1990a: 112. In an analysis that controls for industry. conglomerate mergers.” (Seth. Interpreting the results of targets involved in a related acquisition. Chatterjee argued that the observation that two sources of synergy may be present in a related merger while only one in an unrelated merger does not logically lead to the expectation that the former type of merger will outperform the later. he found. Hopkins (1987) found that all firms pursuing an acquisitive strategy in fact lost market share. His hypothesis was that if horizontal mergers were excluded from the study. that firms acquired by non-related acquirers fared much better than their counterparts acquired by related firms. but operational synergies would only be available to a firm that acquired a related business. Financial synergies may be present in any type of merger. She found “overwhelming evidence” that mergers and acquisitions create value when the target and bidder firm are viewed together. Seth (1990a) built upon Chatterjee’s argument that there is no a priori theoretical reason to suppose that value creation is a function of the number of potential synergies.9 Chatterjee examined non-horizontal related mergers versus non-related. he could eliminate the impact of any collusive synergies and zero-in on operational and financial synergies. Seth concludes that. but only “limited evidence” that this value creation occurs to a greater extent in related acquisitions versus unrelated. “…the finding that related acquisitions do not unequivocally outperform unrelated acquisitions provides evidence that the sources of value creation associated with unrelated acquisitions provide similar magnitudes of synergy compared with the sources of value creation associated with related acquisitions. counter-intuitively. suggesting that improving a . Chatterjee suggests that operational synergies may prove very difficult to implement.) Methodologies other than event study have also been used to test diversification theory in mergers and acquisitions. Using event study methodology.

the presence of both related physical and skill bases – and controlling for industry effects. Indeed. “Managers concerned with the position of their firms may want to consider internal growth as an alternative to growth through acquisitions.g.. market-to-book ratio. Supporting this view is Lubatkin’s (1983) observation that predicted synergistic benefits are highest for marketing concentric mergers.10 firm’s market position via acquisitions may be an unrealistic goal.. Hopkins hypothesizes that this is due to the relative attractiveness of industries that have high marketing related barriers to entry. similar engineering skills).” (Farjoun. and in conglomerates.e. when viewed together – i. Hence. the above researchers would often group the various FTC classification schemes differently.) Perhaps these conflicting conclusions speak more to measurement and classification problems than to the true economics underlying mergers and acquisitions. 1998: 614. firms with a strong marketing position (i. However. and Jensen’s alpha measure.) However.g. and how these factors of relatedness might be correlated with financial performance (operationalized as return on assets. brand loyalty) lost less market share than those with a particular strength in technology.” (Hopkins.e. Farjoun concludes that the joint effects of relatedness are synergistic in nature: “each base thus extends the other. a strong effect on performance emerged.. He states. Examining diversification activity in the manufacturing sector. the existence of neither physical asset relatedness nor skill relatedness was correlated with financial performance. production lines) and human skills (e. 1987: 544.. Farjoun (1998) argues that the above studies on related versus unrelated acquisitions suffer from too narrow a view of relatedness.) He found that when viewed separately. return on sales. Seeking to operationalize certain views of diversification that may be classified under the resource-based view of the firm. Farjoun explored degrees of relatedness with respect to physical assets (e. an .

say. These schools are: Overpayment. i.) There may in fact be no a priori reason to expect greater abnormal returns from a related acquisition than from an unrelated one (Zollo. Alternatively. The question then turns to what obstacles are faced in generating wealth for the acquiring firm’s shareholders. 1987). Diversification theory has not yet been empirically confirmed. Assertions that mergers and acquisitions are a useful and productive method for diversification and growth. the potential synergy gains available in related acquisitions may be priced out during negotiations (particularly to the extent that it is based on publicly available information) making value creation in horizontal mergers a particularly difficult task (Barney. what variables management should manipulate to improve the odds of success? This section reviews eight schools of thought that emerge from the literature regarding the key issues that must be tackled to make a strategic acquisition work in terms of financial performance. 1998. Agency Problems. the empirical evidence has been conflicting as to what type of diversification strategy can in fact create value for the acquiring firm’s shareholders. giving rise to the m&a synergy paradox. Difficult as they may be. building the business internally (Singh & Montgomery.11 underlying problem may be one the definition of related versus unrelated acquisitions.) To sum up so far. do not withstand the empirical test.e. 1988. and that synergies are more readily and easily captured in related acquisitions.. FACTORS INFLUENCING M&A OUTCOMES: EIGHT SCHOOLS OF THOUGHT While the above empirical work focused on the average distribution of various performance measures. scholars have also sought to isolate those variables that may drive superior performance. CEO . mergers are often viewed as a more favorable strategy than.

I call this the synergy limitation view of acquisition performance. Experience. the market for corporate control) and that prices are bid up to their “fair” value. Conflicting Cultures.) While the premium is known and paid up-front. 1985. Pointing out the risks involved in paying a premium. Some researchers warn executives to “walk away” if the price exceeds what they were originally prepared to pay (Haspeslagh & Jemison. and. 1997: 14. Sirower (1997) presents a direct challenge to this assumption: “The first step in understanding the acquisition game is to admit that price may have nothing at all to do with value. the synergy gains are uncertain. and difficult to obtain. derived in the future. The process of identifying a suitable acquisition candidate and negotiating its price is riddled with problems. either implicitly or explicitly. The analyses often occur in secrecy and under significant time constraints. reflecting the risk of actually generating the synergistic effects. Sirower (1997) urges executives to be clear about how synergy gains are to be extracted and the strategies for doing so. Kusewitt. Process. Haspeslagh and Jemison (1991) report that a majority of executives feel that .” (Sirower. Employee Distress. In this view. thus. Top Management Complementarity.12 Hubris. synergy has a low expected value and. emphasis in original. -----------------Insert Table 2 about here -----------------The School of Overpayment Most researchers assume. a relatively high discount rate should be used.) Sirower (1997) argues that the presumption of outcomes should be failure. When calculating the net present value of these future synergies.. 1991. Complete data is often not available.e. that acquisitions occur in a highly competitive market (i. Others have pondered why managers may overpay for an acquisition. the level of the acquisition premium predicts the level of losses in acquisitions.

Lubatkin. 1963. 1991. et al. (Kesner. Schmidt & Fowler. it is difficult for any one person to develop a broad. 1990. The building of momentum to complete the transaction further exacerbates this danger zone. One aspect of the problem is the occurrence of “fragmented perspectives”. due to the complexity and speed required.) The School of Agency Problems Researchers began to query the role of agents in the acquisition process. the opportunity to misjudge qualities in this due diligence environment is quite high. managers may harm the long-term health of their firms rather than securing the best possible value. but detailed. (Haspeslagh & Jemison. 1983. Kroll. 1986. Kesner. Shapiro and Sharma (1994) investigated how investment bankers’ influence the size of the premium.) There thus seems to be an incentive for CEOs to increase firm size rather than firm profitability. and the influence of outside advisors. Toombs and Leavell (1997) investigated the nature of acquisition decisions from the perspective of corporate ownership and control. Because compensation paid to these bankers is positively related to the purchase price. They categorized firms along . Wright.13 a breakdown in the due diligence process led to a poor purchase decision. (Lubatkin. the environment of secrecy and intensity.) Focusing on a possible agency problem between the interests of the chief executive officer and shareholders in mergers and acquisitions. Momentum builds in an unpredictable way. regardless of firm performance. several studies have found that CEO compensation increases with the size of the firm.) Given the bounded rationality (Cyert & March. view of the acquisition opportunity (Jemison & Sitkin. 1994. 1983). especially those involved in negotiating the transaction’s price. reflecting increased personal commitment on the part of the due diligence participants.

Shanley and Correa (1992) queried whether agreement between top management teams improves expectations for post-acquisition performance. Owner-controlled firms had at least one shareholder with a 5% or greater stake. 1997.) If CEOs believe that they can defy all odds and efficiently extract above normal returns from an acquisition. Owner-manager-controlled firms were those firms where at least one senior manager owned 5% or more of the company. may lead to otherwise unsound decisions. Kroll. using the event study methodology. these transactions generated positive returns. The School of CEO Hubris Another stream of research attempting to explain the dismal track record of acquisitions has focused on hubris of chief executive officers (Roll. Clearly. The School of Top Management Complementarity Some scholars have investigated the influence of two distinct top management teams’ ability work together after a corporate combination. et al (1997). For owner-manager-controlled and ownercontrolled firms. 1986. the role of the board of directors should serve as a check on this behavior. Following Bourgeois (1980). and when the CEO is also the board’s chairman. or exaggerated selfconfidence.) Hubris. no single shareholder owned more than 5% of the firm.14 three dimensions. found that acquisitions purchased by manager-controlled firms generated significant negative returns. Premiums paid represent a significant signal of the amount of value that the acquiring firm believes it can create via the acquisition (Hayward & Hambrick. Manager-controlled firms are those firms with diffused external shareholder ownership. Hayward and Hambrick (1997) found that the relationship between CEO hubris and the size of premiums paid is particularly striking. the researchers hypothesized that if the two top . then those CEO are likely to overpay. but when the board has a significant number of insiders on it.

“…executives from acquired firms are an intrinsic component of the acquired firm’s resource base. The resource-based view of the firm (Barney.15 management teams perceived agreement and actually agreed on the strategic objectives of the acquisition. Losing a majority of the combined firms’ top management team may represent a hurdle so high that it is difficult to overcome. Walsh (1988) investigated whether the conflict among top management teams involved in an acquisition leads to a higher turnover rate than in firms that have not gone through a merger.” (Cannella & Hambrick. In an analysis of 96 large acquisitions. the type of acquisition – related versus unrelated – did not mitigate this relationship. Kogut & Zander. 1993: 137. that post-acquisition performance would improve through healthy cooperation. Closely related to culture-based studies (see discussion below). 1984) claims that knowledge specific to a firm is often tacit. then conflict may arise that could thwart the achievement of objectives. and that their retention is an important determinant of post-acquisition performance. 1986. Miller and Judge (1997) explored the relationship between post-merger performance and the complementarity of top management teams. the authors conclude that. This conclusion was reinforced by the work of Cannella and Hambrick (1993). where complementarity was defined as differences in functional backgrounds. et al (1997) found that a complementary management . and not easily replaced. Datta (1991) also found that differences in top management styles had a negative influence on merger performance. Krishnan. He found a significantly higher rate of turnover within five years of a merger. Alternatively. 1992. if perceived and actual agreement were low. Wernerfelt. Shanley and Correa’s (1992) results confirm these hypotheses. In addition.) In addition. Krishnan. top management retention was important in related acquisitions as well as unrelated ones.

“…it appears that organizational learning. In this study. managers develop the ability to discriminate when appropriate. The School of Experience It seems natural to assume that the greater the experience with acquisitions.) Singh and Zollo’s (1998) study of the U. and negatively related to the acquired firm’s top management team turnover. while the past determinants of behavior are termed “consequences”. et al. et al conclude that. Haleblian and Finkelstein (1999) argue that the experience curve associated with mergers and acquisitions is U-shaped. 1997: 371. discrimination should occur. During the first acquisition. resulting in the U-shaped distribution. When an antecedent is similar to past situations. appears to be most enhanced by acquiring firms that are run by complementary top management teams and then by limiting the turnover with the two teams after the acquisition. managers have no prior experience and will therefore interpret events as unique. It was also found that firms who acquired firms similar to those it had acquired in the past were better performers.16 team was positively related to post-acquisition performance. When an antecedent is dissimilar to past experience. failing to appropriately discriminate the current situation from previous ones. generalization of past behavior should be observed.S. Krishnan. and this learning occurred more readily and easily when the top management teams were blended. banking industry also concluded that high levels of replacement of acquired firm’s executives had a negative impact on performance. . however. Organizational learning led to a successful acquisition process. “antecedents” refer to present conditions. managers may assume that past situations are at play. As experience builds.” (Krishnan. and hence synergy. according to the authors. Once experience with this failed generalization is assimilated. the lesser the risk that potential value will not be captured.

Because mergers and acquisitions precipitate major life changes for organizational members. Buono and Bowditch (1989) hypothesized that: Some mergers do fail because of financial and economic reasons. and specific efforts aimed at postcombination integration. However.” (Singh & Zollo. and Bowditch. they argue that attention to the human side of mergers is imperative. because of the myriad questions about merger and acquisition success.17 Singh and Zollo (1998) demonstrate that for firms in the banking industry. the tacit knowledge acquired from previous acquisitions positively impacts performance provided that the two integration experiences are homogenous. 1998: 30. most of the problems that adversely affect the performance of a merged firm are suggested to be internally generated by the acquirers and by dynamics in the new entity. In fact. and because it is these same members that can harm or enhance the outcome of the merger. caution is warranted.) Buono. When the type of acquisition or integration process is substantially different. “Learning curve effects in the context of highly infrequent and heterogeneous events…are heavily taxed…. an industrial and organizational psychologist.and acquisition-related difficulties are simply self-inflicted. the cultural ramifications of merger activity. attention has begun to shift toward human resource concerns. and on the impact mergers have on employees. They argue that. 1989: 10. .) The School of Employee Distress Researchers also began to focus on the process of merger integration. management of the overall combination process. trained as an organizational sociologist. The reality may be that many merger. Their focus is on the individual experience. provide a much different perspective from the scholars referred to above. (Buono & Bowditch. and how the organization can either help or hinder that experience.

Also informing this “corporate” culture.18 Basic human responses such as lowered commitment. First is how the organization accomplishes its objectives. They argue that an atmosphere that stimulates peoples’ willingness to work together is critical. The process of acculturation follows a three-stage process: contact. As it relates to m&a research. Buono and Bowditch (1989) argue that these costs.” (Nahavandi & Malekzadeh. is national culture. of organizational culture. play in determining the financial success of the merger. and the values and beliefs that underlie these routines. The issue.. becomes not just culture awareness. Nahavandi and Malekzadeh (1988) provide a broad definition of culture: “…the beliefs and assumptions shared by members of an organization. office politicking. corporate or business unit cultures of the two organizations are incompatible. however. The challenges encountered when merging two different cultures is that either one or the other (or both) needs to change.e. and fear of the unknown. reward system changes. however. and loss of key organizational members. In addition. and the closely related acculturation process after a merger or acquisition. organizational power struggles. If managed well (i. but culture change management during the integration period. honest and participative way). can be minimized. while not eliminated. conflict and . process changes.) There are two broad layers. an organization may have multiple cultures within it. in an open. then. represent hidden costs to a merger. Haspeslagh and Jemison (1991) also focus on the employee side of the m&a integration process. 1988: 80. The School of Conflicting Cultures Another school of thought centers on the role that the two cultures. and that the barriers to cooperation in an m&a context that ought to be managed include fears about job security. drops in productivity. or sources. The above human problems get exacerbated when the underlying national. a loss of power and resources.

Nahavandi and Malekzadeh (1988) generate several hypotheses about how the integration process will proceed for each possible pair of processes. but rather that the two companies can work together. Indeed.” (Nahavandi & Malekzadeh. in which it will seek to avoid the acquirer’s culture. If the . minimal acculturative stress will result and the mode of acculturation … will facilitate the implementation of the merger. For instance. and its perception of the attractiveness of the acquirer. the lower the risks of unproductive conflicts. Nahavandi and Malekzadeh (1988) argue that the process of acculturation is a function of the preferred approach for both the acquired and acquiring firm. unified culture. “If there is congruence between the two companies regarding the preferred mode of acculturation.) Clearly. the acquired firm highly values its culture and does not rate the acquirer as highly attractive. the fewer the integration and acculturation problems that will be encountered. They conclude that it is not cultural differences that matter per se. for instance. One stream of research presupposes that the more similar the cultures of the target and bidding firms. in turn. and the degree of relatedness between the merging firms. This. the more quickly one can achieve adaptation. 1983. If. From the perspective of the acquirer. 1988: 87. the desired process is driven by the degree to which it values its own culture and seeks to preserve it. Chatterjee et al (1992) found a strong negative correlation between the perceived cultural differences between the two top management teams and stock market gains to the buying firm.19 adaptation (Berry. From the perspective of the acquired firm. the two dimensions driving the acculturation process are the degree of tolerance for multiculturalism versus seeking one.) Cartwright and Cooper (1992) performed empirical analyses of firms involved in horizontal mergers that required a significant degree of integration. then its acculturation is likely to be "separation”. is driven by the extent to which employee individual freedom is affected.

In an effort to assess each firm’s cultural preferences before agreeing to merge. value creation will be seriously limited.20 two cultures are distinctly different. while unsuccessful ones did not. the authors believe that even if the profitability targets are well conceived. Value destruction is the flip side of . While all acquisitions wrestled with these problems. Arguing that the process by which cultural acculturation occurs determines the success of the merger.) In discussing the challenges involved in effectively combining two firms. Haspeslagh and Jemison (1991) identified three types of problems that stand in the way of capability transfer. “. if the process of resource or capability transfer is flawed.. the authors note that. as is typically done currently. the successful ones actively managed the underlying dynamics.the integration strategy should be made dependent on such cultural differences.) The key to success lies in creating an atmosphere in which this transfer can occur. 1998: 58. the easier the acculturation process. Forstmann (1998) developed a “cultural analysis” to be performed during the merger negotiations.” (Forstmann. Flexibility in acquisition integration is therefore important. Implicitly. Cartwright and Cooper (1992) assert that problems will likely arise. rather than only portfolio goals.) The School of Process Perhaps the most comprehensive research on post-merger integration is the work done by Haspeslagh and Jemison (1991. he recommends. They acknowledge that the closer the two cultures are to each other. “Integration is an interactive and gradual process in which individuals from two organizations learn to work together and cooperate in the transfer of strategic capabilities” (Haspeslagh & Jemison.. and individual freedom declines. 1991: 106. “Determinism” occurs when management is unable to adjust its integration strategy in light of new information.

THE ROLE OF RESOURCES The “best practices” that emerge from the literature indeed represent a Herculean task. the third integration problem is a “leadership vacuum”. unless both institutional and interpersonal leadership were provided. develop experience and competence in valuation and integration. Underlying each of these best practices is the role of resources. therefore. Simultaneously – and while running an existing business – managers are advised to not overpay. The authors report that in situations in which (employee) value was destroyed. manage employee and other stakeholder emotions. is when to accommodate peoples’ needs and concerns and when to press ahead. and so on. check over-confidence. Perhaps a clearer idea of the cause of the difficulties encountered could better inform management practice. Managing the people process then becomes critical. In the process of creating value for shareholders. One central decision.21 the value creation coin. employees may be asked (or perceive to be asked) to destroy value for themselves. ensure management complementarity. focus on the integration process. beware of self-interest. the possibilities for creating the atmosphere necessary for capability transfer were limited. individuals’ commitment to the firm or to making the acquisition work declined because they perceived a qualitative change in the nature of their relationship with the firm. Finally. acquire a similar culture. How much should a firm pay for another firm’s bundle of resources? How can the board of directors ensure that the resource of the chief executive officer and other top managers and advisors are acting in the best interest of the firm? What can managers do when certain human resources begin acting contrary to what “rational” behavior would dictate? How can the firm adequately evaluate the target’s organizational culture? How can managers ensure that they do not destroy the very value they have purchased during the integration process? .

information. We narrow our focus to horizontal acquisitions in which the acquiring firm must integrate the resources and activities of the target. 1986. value. 1991).” (Barney. acquiring firms fail in their merger or acquisitions due to one or two (or both) errors. controlled by a firm that enable the firm to conceive of and implement strategies that improve its efficiency and effectiveness. In the resource-based view tradition. firm attributes. knowledge. With its emphasis on resource rarity. heterogeneity and inimitability (Barney. We hypothesize that the resource-based view of the firm can productively inform the problems of mergers and acquisitions from both a valuation and integration perspective. sustainable competitive advantage is achieved when a firm is able to identify and leverage imperfections in factor markets when acquiring and combining resources (Barney. organizational processes. Following Barney (1991). First. 1991: 101.. etc.22 This section explores the attributes of specific resources through the lens of valuation and post-merger integration. capabilities. the acquirer either overvalues the target – in which the hoped for synergies simply cannot be attained – or it ineffectively integrates the target into its operation – in which synergies that were theoretically available are not realized.) A necessary (but not sufficient) condition for achieving this competitive advantage is the ability to acquire private and uniquely or inimitable . we define resources as “…all assets.) Those resource characteristics that make valuation and/or integration particularly treacherous are summarized in Table 3. -----------------Insert Table 3 about here -----------------Broadly speaking. 1988. the RBV has the potential to facilitate understanding of the valuation and integration issues that arise in a merger or acquisition.

should we not expect the price of existing firms (i. As Penrose (1959) observed. 1986. Each of these qualities. the potential uniqueness and inimitability of particular resource bundles embedded in the target firm. When valuing a target firm. 1993. that is to say. in the absence of special individual circumstances. and that cannot be purchased in a competitive market (Barney. If the value of a target is a function of the synergy created for the combined firm. In an extensive survey.e. she concluded that “…there is a significant risk of damaging acquisition performance in the process of divesting and redeploying the target’s assets and resources. 1999: 988. and. Peteraf. the potential acquirer needs a wealth of information about the target’s resources and their value creating capability. ex post uncertainties about certain acquired resources. their value to themselves) to be. Dierickx & Cool. when present. the decision propensity should lean towards caution rather than optimism. makes the identification and quantification of synergy elusive.” (Capron.) Valuing resource bundles can prove difficult in three broad ways: lack of information necessary to accurately value the target firm. “In the general case. if anything. 1989. exploring how post-acquisition resource redeployment and asset divestiture influence acquisition performance. Valuation As Penrose (1959) asked.) We hypothesize that this result reflects a lack of thorough understanding on the part of the acquirer as to the value creating mechanisms employed by the target. the absence of strategic factor .. However. above their value to other firms?” (Penrose.) Capron (1999) examined horizontal acquisitions from a resource-based perspective. The following discussion considers each characteristic in turn.23 cash flows that are more valuable to it than to other firms. then the presence of these broad characteristics makes that valuation highly difficult. 1959: 157.

and relying on managerial discretion without the ability to objectively check that judgment. If.24 markets for many resource bundles (Barney. however. 1997. information asymmetry and even tacit knowledge are weaknesses that are (relatively) easily overcome. Tacit knowledge (Nelson & Winter. 1986) means that there is no competitive market against which to check valuation.) . Avisnash. 1988) – leads to the necessity of making uninformed assumptions. 1982) – in which value creation capability is a function of complex interactions with other resources of the target and/or acquirer – makes the valuation process a function not only of a particular resource. Combined with the second factor – information asymmetry between seller and potential buyers (Barney. As Sirower (1997) points out. the performance of other resources. Resource embeddedness (Nelson & Winter. 1982) also presents difficulty in valuing target resources. Lubatkin. We also hypothesize that synergy associated with the creation of new capabilities is more difficult to estimate than that arising from the addition and/or consolidation of existing capabilities (O’Shaughnessy & Flanagan. Other resource bundles. and contribution to. Schulze & Cotterill. 1998. The degree of difficulty presented by these factors is a function of the characteristics of certain resource bundles. are more challenging to value. the preponderance of evidence requires the assumption of failure that anticipated synergies will not be realized. 1998.) In addition. for example. during the valuation process. the acquirer is purchasing a bundle of physical assets in which the productive capacity can be (relatively) easily measured. but also of its reliance on. synergies arising from cost-reduction actions are considered more easily captured than those related to revenue increases (Anand & Singh. then the absence of a strategic factor market.

the risk of those resources exiting the combined organization increases. the greater the probability that the acquirer will overpay for the target. resources acquired that have no role in the newly combined firm must be jettisoned. and the importance of tacit routines. and the objective of revenue increases. the absence of strategic factor markets for the target’s resources bundles. The greater the presence of these attributes. the greater the risk that the potential acquirer will overvalue the target (leading to overpayment.. Proposition 1-B: In horizontal mergers and acquisitions. or the direct destruction of shareholder value) or undervalue it (which. the greater the degree to which valuation is a function of embedded resources. Proposition 1-A: In horizontal mergers and acquisitions. but often there is a significant amount of uncertainty surrounding their disposal value.g. The presence of one or more of these characteristics makes valuing a target’s resources particularly enigmatic. also hindering the ability of the potential acquirer to accurately value the resource bundle. When a significant degree of value is created with highly mobile assets (e. if the target will not sell. managerial attention should be focused on the types of resource characteristics embodied in the target firm during the due diligence process. . In addition. jeopardizing the probability of the acquisition’s success. leads to an opportunity cost incurred by the potential acquirer from not purchasing the target. the ability to create new capabilities. the greater the probability that the acquirer will overpay for the target.25 The ability of a firm to retain the resources it purchases is a function of the mobility of those resources.) To minimize these risks. the greater the degree of information asymmetry. human capital).

the greater the degree of resource mobility and the greater the necessity to dispose of some of the target’s resources. so too does the complexity of the integration process (Jemison & Sitkin. the greater the probability that the acquirer will overpay for the target. value creation typically occurs through resource combination. value creation may be considered through the lens of consolidation. attending to the nature of those resources can help identify . however.. Integration Once a purchase decision has been made and agreed to.26 Proposition 1-C: In horizontal mergers and acquisitions. value is often a function of cost reductions. product line) require relatively less integration versus resources employed at the same point in the value chain (e. “Overall. Kitching. making the integration process simpler.) When acquiring complementary resources. the acquirer is better skilled at rationalizing its own resources than rationalizing and using the target’s assets and resources. therefore.) Capron (1999) showed that. the resource-based view also enables a focus on the required degree of integration as a function of the nature of the two firm’s resource relationships. product development teams with complementary capabilities) requiring higher level of integration. as excess resources are eliminated and economies of scale and scope are secured. suggests that even cost-based synergies are more difficult to achieve than previously thought. 1986.” (Capron. In general. seeking to enhance revenues and/or reduce costs..g. 1967.g. as the degree of required integration increases. however. 1999: 1010. 1994. Here. This category can be segmented into two sub-parts: sequential resources (e. sales force.) When purchasing a bundle of resources that require a high level of integration. When merging similar resource bundles. Pablo. This focus on the degree of integration required reflects the hypothesis that certain types of resources are more difficult to integrate than others. (A recent study by Capron (1999).

where the risk of destroying the value purchased during the integration process is relatively greater. 1991). Tacit routines are. . Due to their embeddedness. 1991). Acquired resources based on human interactions and/or human capabilities tend to exhibit these characteristics. early planning (Haspeslagh & Jemison. and which exhibit embeddedness. and careful management of conflicts (Buono & Bowditch. Embedded tacit routines (Nelson & Winter. and thereby actually destroy value during the integration process rather than simply failing to secure the intended value. “How should these resources be integrated to avoid destroying their value creating capabilities?” include a high degree of resource embeddedness and tacit value creating mechanisms. flexibility (Haspeslagh & Jemison. We hypothesize that firms sometimes fail to understand the nuances of these resource characteristics. 1982) employed by employees and other stakeholders are particularly at risk for value destruction during the integration process. When engaging in a merger that requires a significant level of resource integration for value realization.27 potential problems. developing a thorough understanding of those mechanisms in the target. attention should be focused on the avoidance of destroying the value creating mechanisms. Characteristics that raise the question. creating a substantial risk of misunderstanding the very value creating mechanisms that the firm sought to acquire. risk reduction.) Capron (1999) supports this hypothesis through demonstrating that the divestiture of the target’s resources does not reduce costs and damages capabilities. inexpressible (Nelson & Winter. 1982). they present the risk of a high level of mobility and potential exit. 1989. tacit value creating routines. by definition. In addition. and a reliance on human interactions and capabilities. value creation can be harmed through failing to understand and preserve the linkages across resources.

the greater the risk that the acquirer will fail to secure the anticipated synergy gains. Proposition 2-A: In horizontal mergers and acquisitions involving the integration of complementary resource bundles. tacit and human routines play in the inability of the acquirer to secure the value it purchased? The concepts outlined herein can be empirically tested. We suggest . what role did a failure to understand and accommodate the embedded. scholars have not yet studied the link between pre-merger routines. Perhaps the synergy paradox could be clarified by this focus on resources. firms may be able to better preserve and leverage the value creating mechanisms of the acquired firm. Proposition 2-B: In horizontal mergers and acquisitions involving the integration of complementary resource bundles. tacit value creating mechanisms in the target. the greater the degree of embedded. CONCLUSION Empirical tests have not yet examined the driver of horizontal merger failures: Are they typically driven by overpayment or by integration problems? An analysis of those transactions in which the failure is in the valuation process should examine the prevalence of particular resource characteristics to determine if some types of resource bundles lead to overvaluation more often than others. When a fair value was paid for the target firm.28 By being consciously aware of these resource characteristics. value creation and the preservation or disruption of those routines in a merger or acquisition. the greater the degree of reliance on human interactions and/or human capabilities for value creation. the greater the risk that the acquirer will fail to secure the anticipated synergy gains. While other factors may lead to integration problems as reviewed above. although operationalization of some of the variables may prove challenging. and the difficulties encountered when integrating them.

Finally.e. -----------------Insert Figure 1 about here ------------------ . Characteristics that present difficulties in the integration process should be managed with caution.29 that an emphasis on the degree of the resource characteristic – rather than on its presence – could prove useful. valuation and integration are relatively easy) should gain comfort that the transaction’s probability of success is relatively high. An emphasis on due diligence should be employed when the target resources are difficult to value. targets that embody difficulties in both valuation and integration should be avoided. Depending on the empirical results. possible management prescriptions include: Acquirers who are targeting firms that exhibit a relatively low degree of enigmatic resource characteristics in both valuation and integration (i..

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possible researcher bias The due diligence process. factors other than the m&a may be driving the numbers Case Study In-depth analysis of a few acquisitive firms to determine if merger objectives were met Survey Based Managers involved in M&A are asked to rate the success of the merger Basic Approach Strengths A more robust and finegrained understanding of the drivers of m&a success or failure Recognizes the complexity and multi-dimensional nature of measuring m&a success Weaknesses Small sample size. price paid and management of integration all must be deftly managed to ensure m&a success Be prepared to “walk away”. extraneous factors eliminated. unbiased rational expectations of future cash flows. data publicly available Reflects the past. return on assets over a multi-year period used to measure improvements in financial performance Permits a multi-year perspective reflecting belief that it may take years before merger benefits are realized. be clear on sources of synergy.36 TABLE 1 Methodologies for Measuring M&A Success Dimension Event Study Capital Asset Pricing Model used to calculate “abnormal returns” shortly after merger announcement Efficient market hypothesis. inability to generalize to other situations. unrelated performance. regardless of whether it is a related or conglomerate merger . m&a theory not empirically supported Accounting Measurements Return on equity. no adjustment for changing risk profiles. manage the integration process Self-reporting biases Conclusions Same as “Event Study” Recommendations Beware of overpaying Retain top management team of the acquired firm. data publicly available Assumption that market participants are able to quickly and accurately calculate cash flow impact of the merger At best a 50/50 bet for acquiring firm shareholders. mixed results on related vs. return on sales. not the future.

presume failure Be highly aware of the potential pitfalls. Hayward & Hambrick (1997) Shanley & Correa (1992) Walsh (1988).37 TABLE 2 Schools of M&A Success School Key Authors Sirower (1997) Overpayment Haspeslagh & Jemison (1991) Kesner & Shapiro (1994) Lubatkin (1984).e. the market for corporate control is not efficient). retention of top management of the acquired firm is critical to the m&a success. Kusewitt (1985) Central Propositions Price does not equal value (i. CEOs may engage in m&a to increase their own compensation Firms managed by substantial owners will generate positive returns from m&a. even in unrelated mergers Experience with acquisitions improves management’s ability to productively integrate two firms Recommendations Use a high discount rate when valuing future synergies to reflect risk of capture. probable loss is equal to the amount of premium paid Escalating commitment and complexity. then post-acquisition performance will improve via healthy cooperation Top management turnover will be higher in firms that have merged than in firms that have not. Shareholders of acquiring firms should be highly concerned with the degree of board vigilance when making acquisition decisions Pay attention to the dynamics of the top management teams during due diligence and during integration Hubris Top Management Complementarity Carefully manage these relationships to minimize any conflict and flight Experience Learn from your experience . Think. speed and secrecy of due diligence process can lead to overpayment Acquiring firm’s investment bankers have an incentive to negotiate the highest possible price Because CEO compensation tends to increase with the size of the firm. and in fact do agree. those managed by nonowners will experience negative returns Hubris. Schmidt & Fowler (1990) Kroll. may lead to poor purchase decisions If top management of both the acquiring and acquired firms perceives agreement vis-à-vis merger goals. et al (1998) Roll (1986). Cannella & Hambrick (1993) Haleblian & Finkelstein (1999). or exaggerated self-confidence in one’s management capability and/or ability to generate and capture synergies. Restructure typical contract so that bankers’ fees are not a function of the size of the deal The board should seriously consider if this motive is driving the m&a recommendation Agency Problems Boards of firms managed by non-owners should beware.

push causeeffect understanding of benefits down to the middle management level. Cartwright & Cooper (1992). manage them effectively Employee Distress Haspeslagh & Jemison (1991) Nahavandi & Malekzadeh (1988). focus on the employee distress level to achieve a healthy and strong new entity Recognize that these human emotions are at play.38 TABLE 2 (Continued) Schools of M&A Success School Key Authors Buono & Bowditch (1989) Central Proposition Employees have the power to make the merger more or less successful. but must overcome barriers such as fears about job security. and hence the achievement of merger goals Asses cultural fit before agreeing to merge if possible. Forstmann (1998) Chatterjee et al (1992) Haspeslagh & Jemison (1991) Conflicting Cultures Cultural differences between acquired and acquiring firms have the potential to thwart the effective integration of the two firms. if handled poorly from the employee perspective. base the integration plan on an understanding of cultural differences Ensure reciprocal organizational learning. clearly identify the resources and capabilities to be transferred. loss of power and resources. actively manage the process of acculturation. fear of the unknown Recommendations Manage the merger process in an open. honest and participative way. be highly sensitive to how cultural differences may affect the achievement of merger goals. develop cooperation and trust Process The key to merger success is to create an atmosphere in which the transfer of strategic capabilities can occur . changes in reward systems. because a merger represents a major life event for employees. hidden costs may go up Merger success can be heightened in a cooperative environment.

Tacitness Difficulties valuing resource combinations: .New capability creation .g.Disposal value of undesired resources Integration Uncertainties regarding integration process: . stakeholder relationships) .39 TABLE 3 Enigmatic Resource Characteristics Valuation Difficulties valuing target resources: .Resource mobility .High level of mobility and risk of exit ..No strategic factor market .Information asymmetry .Embeddedness .Difficulties in transferring resources (e.Embeddedness .Tacit value creating mechanisms Resource value based on human interactions and/or human capabilities: .New revenue creation Ex post uncertainties about acquired resources: .

40 FIGURE 1 The Role of Resources in Valuation and Integration Ease of Valuation High Low High Buy it! Extreme focus on due diligence Ease of Integration Proceed with caution Low Walk away! .