M&A

LIST OF CONTRIBUTORS

Peter J. Buckley Leeds Business School, University of Leeds,UK

Steve Burt University of Stirling, Scotland

Susan Cartwright Manchester School of Management, UMIST,UK

John Child The University of Birmingham, UK

David Faulkner Said Business School, University of Oxford,UK

Pervez N. Ghauri Manchester School of Management, UMIST,UK

Marc Goergen Manchester School of Management, UMIST,UK

Robin Limmack University of Stirling, Scotland

Robert Pitkethly Said Business School, University of Oxford,UK

Fionnuala Price Manchester School of Management, UMIST,UK

Luc Renneboog Tilburg University, The Netherlands

David M. Schweiger University of South Carolina, USA

Phillippe Very EDHEC, France

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INTRODUCTION

In the first volume of this series we explained our view of the need for a forumto bring together the growing but disparate literature on mergers andacquisitions. We noted in particular the apparent gulf between the finance andmanagement literatures despite the fact that many papers in both camps weremotivated by a desire to explain the unsatisfactory outcomes that result frommany mergers.

Judged by the response to the first volume, the idea of bringing togetheracademics from different disciplines researching this topic has strucksomething of a chord, and we continue with this general theme in thisvolume.

We start with a number of papers that pursue the issues of integration andorganisational change. In the first paper, Schweiger and Very focus upon theimportance of integration in determining value creation, a matter which theyobserve has historically been rather neglected. They suggest issues that need tobe considered a priori as well as those that must be managed post completionof the deal. Related to this general theme, in the second paper Pitkethly,Faulkner and Child examine the issue of integration, using a study of theacquisition of U.K. targets by foreign acquirers. They find substantialdifferences in approach by acquirers of different nationalities.

Faulkner, Child and Pitkethly draw on the same dataset to examine theorganisational change mechanisms adopted to achieve this integration, and findthat whilst clear national differences to post acquisition change exist, there isno clear best practice that emerges for improving performance, although theyidentify “self confidence” on the part of the acquirer as perhaps the mostimportant factor.

On a related theme, Cartwright and Price examine the attitudinal preferencesof management towards foreign M&A partners, and investigates whether thesehave changed in the presence of growing internationalisation. They find thatattitudes have changed little and that managers still prefer to merge with or beacquired by companies from countries that are perceived to be culturallysimilar.

Our next two papers examine acquisition success or failure from twodifferent financial perspectives. Goergen and Renneboorg examine the issue of

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value creation in large European M&As, using announcement period (shortrun) returns of both acquirers and targets. They then go on to investigate thecharacteristics of the bid that determine share price reactions. The authors findevidence consistent with synergies being the prime motivation for bids in firmsthat generate positive total wealth gains. However, outside this group they notethat there is evidence that managerial hubris leads to poor decision making intakeovers.

Adopting a different approach to financial performance in acquisitions, Burtand Limmack look at the operating cash flow performance of acquirers andtargets rather than their equity returns. Their study is of takeovers in the retailindustry, and they find that there is an improvement in operating performancethat appears to be associated with improved asset utilisation. They note that thisfinding of improved performance is not incompatible with the findings fromlong run “event” studies as the benefits of such improved performance couldhave been passed on to the target firms’ shareholders.

Our final two chapters are review papers. Limmack provides a compre-hensive literature review on the wider issue of corporate diversification,including the more recent literature which offers a more subtle interpretation ofthe so-called “diversification discount”. Guari and Buckley offer a wideranging review of M&As from a number of perspectives and seeks to analysethe recent boom in M&A activity together with examining theoretical andsocietal impacts of M&A.

We would like to conclude by thanking our long-suffering editorial assistant,Maureen Costelloe, for her excellent efforts in assisting us with this series.Without her administrative skills the editors would doubtless still be wonderingabout organising the first edition rather than looking forward to the third.

NOTE FOR CONTRIBUTORS

We welcome papers on all aspects of mergers and acquisitions and in futureeditions intend to continue with the theme of bringing together contributionsfrom a range of disciplines spanning management, accounting, finance andeconomics. In the first instance, please send manuscripts (either in Word orPDF format) to Margaret Cannon at the University of Manchester Institute ofScience and Technology, e-mail: [email protected]

Cary Cooper and Alan GregoryEditors

x INTRODUCTION

CREATING VALUE THROUGH MERGERAND ACQUISITION INTEGRATION

David M. Schweiger and Philippe Very

INTRODUCTION

Successfully integrating mergers and acquisitions (M&As) has become anincreasingly important topic both in the academic and practitioner literatureduring the past decade (Cartwright & Cooper, 1996; Hubbard, 1999; Galpin &Herndon, 2000; Habeck, Kroger & Tram, 2000; Marks & Mirvis, 1998;Feldman & Spratt, 1999; Schweiger, 2002; Haspeslagh & Jemison, 1991;Schweiger & Goulet, 2000; Hitt, Harrison & Ireland, 2001). Almost everyonewriting on this topic acknowledges that integration is a critical part of M&Avalue creation. In spite of these acknowledgements, the literature has notdirectly demonstrated a clear linkage between value creation and theintegration process. It is the primary purpose of this chapter to do so.

VALUE CREATION AND INTEGRATION DEFINED

Before demonstrating any linkages it is critical that we first define what wemean by value creation and integration.

Value Creation

Most companies transacting M&As rely on discounted cash flow (DCF)models to value a target company (Brunner, Eades, Harris & Higgins, 1998).

Advances in Mergers and Acquisitions, Volume 2, pages 1–26.© 2003 Published by Elsevier Science Ltd.ISBN: 0-7623-1003-0

1

A DCF model provides an acquiring firm with reasonable estimates of what atarget may be worth to it. Based on this model, economic value is created whenthe return on capital employed in an acquisition exceeds a target’s weightedaverage cost of capital (Copeland, Koller & Murrin, 1995).

To develop a DCF model an acquirer typically forecasts cash flows oversome period of time (e.g. five years) and a terminal value for a target, anddiscounts those values at the weighted average cost of capital. The finalvaluation depends on the weighted average cost of capital chosen, cash flowsforecasted (e.g. revenue, cost, net working capital, and investment forecasts),and terminal value.1 Often, multiple estimates based, on different assumptionsand scenarios, are developed.

Based on the DCF methodology, it is apparent that an acquirer’s ability toaccurately forecast is critical to value creation. Perhaps, the ability to realizethese forecasts after a deal is closed is more important to value creation.(Csiszar & Schweiger, 1994).2 This is based on the premise that prior to closingvaluation is only a hypothetical exercise, although stock prices may movebased on the announcement of a deal.

If realization of cash flows is critical to value creation then we mustunderstand the important elements that influence “realization.” It is the majorpremise of this chapter that cash flows are realized as a result of the success ofthe integration process. As such, the remainder of this paper attempts todemonstrate the linkage between the nature and management of the integrationprocess and cash flow realization and value creation.

Value Creation and Pricing

Although DCF is a major tool employed in valuation, companies often rely onmarket-based measures to determine what to pay for a particular target. Marketbased measures of valuation establish what other comparable companies areworth or what recent comparable acquisition transactions have traded for.Essentially, these values establish a base of what companies have sold for in themarket. However, they may not accurately reflect what a particular target isworth to a specific acquirer. For example, the market price may exceed thevalue established by a DCF model. This may be due to an active marketwhereby there are multiple bidders who drive up the price (but not necessarilythe value) of a target (Hitt et al., 2001).

At any moment a target has an intrinsic value that is based on what a firmis worth as a stand-alone entity. This value is based on the stream of cash flowsit can produce as a going concern. If an acquirer pays more than this value

2 DAVID M. SCHWEIGER AND PHILIPPE VERY

based on market prices, value is likely to be destroyed. Unless, a buyer canutilize the acquisition to improve the cash flows of either the target, itself, orboth value cannot be created. In common language, this has come to be knownas the concept of “synergy.” The relationship between price, synergy and valueis illustrated in Fig. 1.

The figure illustrates that value can be created when the price paid for atarget (Price 1) is below its stand-alone value. In this case, an acquirer mustensure that value does not leak from the target. When the price (Price 2)exceeds the stand-alone value, synergies must be captured for value to berealized. In this case, changes must be made in either the target, the acquirer,or in both firms for cash flows to be improved and value to be realized. Whenthe price (Price 3) exceeds all synergies, there is no chance that value can becreated.

Recent research (Sirower, 1997) has found that when premiums are paid foracquisitions, the likelihood of value creation decreases significantly. Sirowerargues that often synergies are either not present, are exaggerated by a buyer,or cannot be effectively realized through integration. In this chapter we focuson one factor, the extent to which buyers can effectively integrate targets. In thenext section we will define sources of synergy that have the potential toimprove cash flows (Schweiger, 2002).

Fig. 1. Pricing, Synergy and Value Creation.

From: D. M. Schweiger (2002) M&A Integration: A Framework for Executives andManagers, New York: McGraw-Hill.

3Creating Value Through Merger and Acquisition Integration

Sources of Synergy 3

There are four basic sources of synergy: cost, revenue, market power, andintangibles. Cost synergies are often the easiest to document and capture in amerger or an acquisition. Revenue, market power and intangibles on the otherhand are increasingly more difficult to achieve. Each is described below.

Cost SynergiesReducing costs is one clear way to increase cash flows. Historically, it has beenthe most common form of synergy and often the easiest type to capture. Thereare two types of cost synergies:

(1) Fixed cost reduction;(2) Variable cost reduction.

Fixed cost reduction is often associated with economies of scope and scale andproductivity. It is also associated with reducing general, administrative andsales expenses through headquarters and support function consolidation,gaining economies of scale in operations, sales force and distributionoptimization and reduction of transaction costs in the supply chain. Variablecost reduction is associated with increased purchasing power and productivity.Both forms of cost reduction often come with the physical consolidation ofactivities between the combining companies. The synergies that can be accruedhere depend very much on the nature of the cost structure of the business modelbeing employed by an acquirer. This source of synergy is likely to be presentin almost every M&A.

Revenue SynergiesRevenue synergies are often hoped for but rarely realized in M&As. Typically,revenue synergies are associated with cross-selling products or servicesthrough complementary (i.e. non-overlapping) sales organizations or distribu-tion channels that serve different geographic regions, customer groups ortechnologies. A key assumption underlying this source is that complementarymarkets desire the same products and services.

In addition, revenue synergies can be derived from broadening a company’sproducts and services to provide needed bundling or a more complete offering.Critical to this synergy is to leverage complementary capabilities withoutadditional costs. This includes:

(1) Increased sales productivity by selling more volume with the same numberof or fewer sales people (this may also create cost synergies).

(2) Cross-selling products through complementary sales organizations anddistribution channels.


(3) Reducing fixed new product development costs by utilizing com-plementary products; (i.e. reducing the per unit cost of each product orservice through increased volume).

Market Power SynergiesThis type of synergy results from the elimination of competitors and capacityfrom a market. This synergy has been a critical element in many mature marketconsolidations where there is over capacity. It allows an acquirer to maintain orincrease prices in the market thereby improving margins and cash flows.

Intangible SynergiesThis type is the most difficult to achieve. It does not easily lend itself toquantification. Intangibles include brand name extensions and the sharing ofknowledge and know how. Rarely do they accrue through the physicalconsolidation of activities. They rely on the ability to transfer the intangiblecapabilities of one organization to the other (Haspeslagh & Jemison, 1991).

Negative Synergy

The synergies described above focus on the creation of value. However, it isimportant to note that M&As are interventions in organizations that can createdisruptions that can destroy the intrinsic value of a firm. We call this valueleakage or negative synergy. Although it is critical to manage for positivesynergies, it is also important to manage against negative synergies.

Rarely in a merger or an acquisition is only one form of synergy present orsought. In a large merger clearly multiple synergies are present. In a smallacquisition, only one source of synergy (e.g. pre-commercial technology) maybe sought. Depending on the particular deal the number and importance ofsynergies possible varies. Moreover, the realization of each form of synergycannot be assumed. The integration process must be managed with theachievement of each type in mind.

Synergy and Integration

Whether and how much synergy exists in a particular acquisition is likely to bea function of the strategic objectives driving a deal. It is a major premise of thischapter that different objectives create different opportunities for potentialsynergies. Further, the realization of synergies depends on different types andlevels of integration. In the next section we define integration and show howdifferent forms intersect to create different integration issues.


Integration DefinedThe integration literature recognizes that there are a variety of ways in whichpeople and assets can be combined and has developed frameworks to explainthem (Bastien & Van de Ven, 1986; Haspeslagh & Farquar, 1987; Schweiger &Ivancevich, 1987; Shrivastava, 1986; Shanley, 1988; Buono & Bowditch, 1989;Napier, 1989; Lubatkin, Calori, Very & Veiga, 1998). For the most part, theframeworks are quite similar. Thus we rely on an approach proposed bySchweiger (2002). This approach specifically recognizes that within aparticular merger or acquisition different approaches can be used based ongeographical areas, product lines and functions. Schweiger defines fourprimary approaches to integration.

Consolidation. The extent to which the separate functions and activities ofboth an acquirer and a target firms are physically consolidated into one.

Standardization. The extent to which the separate functions and activities ofboth firms are standardized and formalized, but not physically consolidated(e.g. separate operations may be maintained, but the operations are madeidentical). This is typical when acquirers formally transfer best practices acrossfirms.

Coordination. The extent to which functions and activities of both firms arecoordinated (e.g. one firm’s products are sold through the other firm’sdistribution channels).

Intervention. The extent to which interventions are made in an acquired firmto turnaround poor cash operating profits, regardless of any inherent sources ofsynergy (e.g. change management team, drop unprofitable products).

STRATEGIC OBJECTIVES, SYNERGIES ANDINTEGRATION: PUTTING IT TOGETHER4

Based on the discussion above it is important to understand how the strategicobjectives driving a merger or an acquisition are related to the achievement ofsynergies and thus the different approaches to integration. Simply put, differentstrategies result in different sets of potential synergies with different integrationchallenges. Failure to manage these challenges diminishes the realization ofneeded cash flows and thus value creation. Below is a series of strategicobjectives and the synergies underlying them. Also discussed are some of theintegration challenges associated with achieving these synergies. It is importantto note that an acquirer may be seeking multiple strategies and synergies in aparticular merger or acquisition. More will be said about this later.


Consolidate Market Within Geographic Area

When this objective is employed, the basic goal is to acquire competitors in thesame geographic market. Depending upon the nature of the market it mayinclude a region within a country, a country itself, a continent, or the globe.

The potential sources of synergy in this strategy thus include:

• Lower variable costs of raw materials through increased purchasing power.• Lower fixed costs through elimination of redundant functions; e.g. corporate

staff, information technology, sales staff.• Lower fixed costs through better utilization of fixed assets; i.e. economies of

scale.• Higher prices through elimination of capacity from the market place.

• Economies of scope in the sales organization through sharing of products andservices developed by each organization.

Market consolidation requires high levels of organizational consolidation,standardization and coordination. This means that:

• Most, if not all, organizational functions and activities are consolidated andstandardized.

• High levels of redundancy of management and employees exist and reductionin force is likely to take place at all organizational levels. Retention of keypeople in non-consolidated areas, or highly competent people in general, isimportant.

• Differences in organizational culture, identity and management practicesbetween the acquirer and the target have to be resolved.

• Differences in strategy, policies, operations, brand names, etc. have to beresolved.

Extend or Add Products, Services or Technologies

Typically, opportunities exist to increase competitive capabilities in themarketplace by acquiring new products and services, skills and technology, andaccess to complementary distribution (if products/services utilize differentdistribution channels).


• Lower variable costs through increased purchasing power, where acquiredproducts and services utilize the same basic raw materials.

• Lower fixed costs through elimination of redundant functions; e.g. corporatestaff, human resources and information technology.


• Lower fixed costs through better utilization of fixed assets (i.e. economies ofscale) where products share basic platforms.

• Lower fixed costs through better utilization of fixed investments such asadvertising and brand development; i.e. economies of scope.

• Increased revenue through sharing of products and services developed byeach organization.

• Increased market share (i.e. volume and revenue) by providing a morecompetitive lineup of products and services.

• Increased capabilities through acquiring new technologies.

Extension requires moderate levels of organizational consolidation andstandardization and high levels of coordination. This means that:

• Some functions and activities, especially with respect to general andadministrative overhead (e.g. MIS, accounting, human resources and sales),may be consolidated and standardized. Operations may be consolidated andstandardized depending upon the extent to which new products/services canbe provided within the existing operating infrastructure.

• Redundancy of management and employees and reduction in force are likelyto take place in those areas being consolidated. Retention of key people inconsolidated as well as non-consolidated areas, or highly competent peoplein general, are important. This may especially be the case where the value ofthe target is largely tied up in intangible assets such as people: for examplewhen acquiring R&D skills.

• High levels of coordination are required across organizations/sales forces ifcross selling is required.

• Differences in organizational culture, identity, and management practicesbetween the acquirer and the target have to be resolved.

• Differences in strategy, policies, operations, and brand names, may have tobe resolved.

Enter a New Geographic Market

In this case, the objective is to extend the business into geographic areas wherea firm has had no presence. Typically, this objective is employed by firms whoare rolling up a fragmented industry and by firms who are taking advantage ofmarket deregulation and liberalization.

In roll ups the market is highly fragmented and characterized by numeroussmall firms with very small market shares. Usually, one or several firms seean opportunity to grow revenues and profitability. Often roll-ups beginby consolidation within a geographic area (i.e. consolidation) and then by


geographic extension. Market deregulation and liberalization have influencednumerous industries. Essentially they have opened previously closed markets.


• Lower variable costs through increased purchasing power, where acquiredproducts and services utilize the same basic raw materials. This is nowaccomplished on a larger geographic scope than before.

• Lower fixed costs through elimination of redundant functions; e.g. corporatestaff, human resources and information technology.

• Lower fixed costs through better utilization of fixed investments such asadvertising and brand development over a broader geographic scope.

• Increased revenue through sharing of products and services developed byeach organization.

• Increased sales volume through geographic expansion.• Increased competitiveness by being better able to serve customers with needs

for broader geographic coverage.

Market entry requires low levels of organizational consolidation where there islittle geographic overlap, but may require high levels of standardization andcoordination. This, however, is dependent upon the extent to which the firmscan take advantage of doing things the same way across geographic markets. Ifeach market is relatively independent due to strong pressures for localization,there may be few if any opportunities for synergies. If markets areinterconnected in some fashion, synergistic opportunities increase dramatically.Certainly standard products across markets would lead to significant effi-ciencies in new product development and operations, as well as developing astandard for a best practice.

This means that:

• Very few functions and activities are consolidated. Some aspects of generaland administrative overhead (e.g. MIS, accounting, human resources, sales)are consolidated and standardized.

• Operations may not be consolidated, depending upon the economics of thebusiness. They may, however, be standardized to the extent that one basicapproach (e.g. best practice) for providing the product/service across allmarkets makes sense.

• High levels of consolidation and standardization within new markets (e.g. asin market consolidation) may take place if geographic entry is the first stepin a regional market concentration strategy.

• Redundancy of management and employees and reduction in force is likelyto take place in those areas being consolidated. Retention of key people innon-consolidated areas, or highly competent people in general, is important.


In geographic expansion retention of people is important in non-redundantareas since acquirers neither have the internal people available to staff thenew operation nor have “deep knowledge” of the local area.

• High levels of coordination are required across organizations/sales forces ifcross-selling is required.

• Differences in organizational culture, identity, and management practicesbetween the acquirer and the target have to be resolved, unless eachgeographic area is different.

• Differences in strategy, policies, operations, brand names, etc. have to beresolved, depending upon the degree of standardization.

Vertically Integrate

In this case, the objective is to enter into either sources of supply ordistribution. Such moves are made to increase value added into the business orgain control over more aspects of the business. Vertical integration requiresvery low levels of organizational consolidation, standardization but high levelsof coordination.


• Lower variable costs of raw materials through control over raw materials andvalue added retained within the new company. Accounting for the costsdepends on the transfer pricing agreements established within the newcompany.

• Lower overall costs through improved product development and manufactur-ing interfaces.

• Lower fixed costs through elimination of redundant functions; e.g. corporatestaff, information technology, sales staff. Costs associated with managing thenew vertical relationship internally replace costs of managing the externalrelationship (e.g. purchasing function).

This means that:• No functions and activities are consolidated with the exception of cash

management, treasury functions, and financial statements. Moreover, thesenior management of the target is likely to report into the acquirer’sstructure.

• Operations are neither consolidated nor standardized.• Key interrelationships are established, as the new acquisition supports

existing parts of the business.• Redundancy of management and employees and reduction in force is not

likely, although some key people in the target may leave or be replaced.Retention of key people is important.


• Differences in organizational culture and identity and management practicesbetween the acquirer and the target are not an issue, unless there are certainaspects of the acquired firm the acquirer cannot live with.

• Differences in strategy and brand names have to be resolved.

Enter a New Line of Business

In this case, the objective is to enter businesses where the acquirer has little orno previous experience. Typically, opportunities exist to grow revenues, adddistribution, and add new products/services, acquire new technologies, acquirenew management talent with different perspectives.


• Lower fixed costs through elimination of few redundant functions; e.g.corporate staff, information technology, sales staff.

• Lower cost of capital for combined firm by reducing firm risk throughdiversification.

• Intangibles such as broader pool of available management talent and businessknow-how.

This means that:

• No functions and activities are consolidated with the exception of cashmanagement, treasury functions, and financial statements. Typically, theacquired company operates either as a:(a) division of the acquirer, whereby the senior management of the target

reports into the acquirer’s structure, or(b) wholly-owned subsidiary whereby the acquirer controls the target

through board representation.• Operations are neither consolidated nor standardized because there are no

sources of operational synergy (e.g. operational cost reductions or cross-selling opportunities).

• High levels of consolidation and standardization may take place insubsequent acquisitions in the new line of business if the initial acquisitionis a platform for further market concentration.

• Redundancy of management and employees and reduction in force is notlikely, although some key people in the target may be leave or be replaceddue to historical performance. Retention of key people is important since theacquirer rarely has its own people to transfer to the target.

• Differences in organizational culture, identity, and management practicesbetween the acquirer and the target are an issue, unless there are certain


aspects of the acquired firm the acquirer cannot live with. Differencesbetween the senior management teams may be an issue.

• Differences in strategy and brand names have to be resolved.

Table 1 summarizes the five types of strategic objectives and the synergiespossible within each type. In each box is presented the level of synergisticbenefits present in each strategic objective.

STRATEGIC OBJECTIVES AND MAJORINTEGRATION ISSUES

As we noted earlier, effective integration is critical for cash flows to be realizedand value to be created. However, researchers suggest that integration is verychallenging and have identified numerous problems that acquirers face whenintegrating (Cartwright & Cooper, 1996; Hubbard, 1999; Galpin & Herndon,2000; Habeck, Kroger & Tram, 2000; Marks & Mirvis, 1998; Feldman &Spratt, 1999; Schweiger, 2002; Marks & Mirvis, 1998; Haspeslagh & Jemison,1991; Schweiger & Goulet, 2000; Schweiger & Walsh, 1990). For example,many researchers have argued that cultural differences are a major impedimentto integration. When examining culture, however, researchers have failed toexamine the strategic objectives or synergies being sought. In other words, theyhave assumed that cultural differences are always an issue in M&As. We arguethat this may not be the case, or at least the magnitude of the issue may varyby strategic objective. In this section of the chapter, we identify five issues

Table 1. Linking Strategic Objectives and Synergies.

Strategic Objective

Consolidatewithin a

geographicarea

Extend oradd newproducts,

services, ortechnologies

Enter anew market

Verticallyintegrate

Enter anew line

of business

Type of Synergy

Cost High Low Low Moderate LowRevenue Low High High Low NoneMarket power High Moderate Low High NoneIntangible Moderate Moderate Moderate Low Low


gleaned from the literature that may facilitate or hinder the realization ofsynergies. Then we discuss contingencies created by the strategic objectives.

Five Major Integration Issues

Numerous issues may be faced when integrating a target. For example,designing a common information system often raises technical difficulties suchas compatibility of computer hardware, general architecture, and softwarelanguages. Although these difficulties can threaten the integration or createadditional costs, we focus on the emerging research that has identified thehuman side of M&As as a critical causal factor in integration success.

The literature on integration is rather eclectic. In their review of the humanside of M&As, Schweiger and Walsh (1990) identified numerous themes,research methods and selected variables examined by researchers. In order toisolate issues, we primarily relied on three reviews of past research: Buono andBowditch (1989), Schweiger and Walsh (1990) and Schweiger and Goulet(2000). The first two reviews focused on human issues, while the last one dealtmore broadly with integration issues. Based on these reviews we identified fivemajor issues faced when integrating. These are presented below. Each issuedescribed hereafter has been identified at least by two of these researchreviews.

Individual Uncertainty and AmbiguityAs Haspeslagh and Jemison (1991, p. 187) stated, “the immediate post-acquisition is pregnant with expectations, questions, and reservations, amongthe personnel and the managers of both the acquired and acquiringorganizations.” During this period some employees perceive threats whileothers perceive opportunities. Risberg (1999) and Larsson and Risberg (1998)make a distinction between two kinds of issues: uncertainty and ambiguity.Uncertainty occurs when employees feel a lack of information. An uncertainsituation can be clarified by gathering more information. Ambiguity ischaracterized by the inconsistency of the information provided to theemployees. More communication is itself not sufficient for resolvingambiguous situations; what prevails is the consistency and clarity of the futurecommunication flows (Feldman, 1991). Uncertainty and ambiguity explainwhy employees react to a merger announcement and to the inherent changes.They are concerned about their future in the combining organization. As such,these issues contribute to the fact that, on average, acquisitions arecharacterized by a loss of productivity; defection of competent executives,managers and employees; absenteeism; poor morale; safety problems; and


resistance to change during the first months of the post-acquisition period(Pritchett, 1985; Schweiger & DeNisi, 1991; Cartwright & Cooper, 1997;Marks & Mirvis, 1998; Hubbard, 1999). These in turn contribute to valueleakage and an inability to realize projected cash flows and synergies.

Organizational PoliticsM&As often lead to a change in ownership for acquired firms, which oftenleads to changes in their organization and management practices. Power basesare also likely to shift as authority structures change and sources of power (e.g.expertise) needed in the organization change. As these happen instability iscreated, as employees perceive threats or opportunities; i.e. some people willperceive that they have “gained” whereas others will perceive that they have“lost.”

These conditions are ideal antecedents to organization politics – that is to say“those activities taken within organizations to acquire, develop, and use powerand other resources to obtain one’s preferred outcomes” (Pfeffer, 1980, p. 7).Consequently, M&As can create an excellent context for political tactics likescapegoating, controlling information, networking or manipulating people. AsPfeffer and Salancik (1977) argued, the greater the organizational politics thegreater the sub-optimization within organizations; thus, if too many peoplejockey for their own interests, the overall firm’s performance is likely todecline.

Power and politics have rarely been the direct focus of M&A research, withtwo exceptions. The first is Schweiger et al. (1987) who studied executiveactions for managing human resources before and after a merger. They foundthat one of the greatest challenges for executives was to minimize warfareamong employees and to avoid “playing favorites,” especially in staffingdecisions. In other words, effective managers were perceived as those whoavoided or minimized political behavior.

The second is research on the “theory of relative standing” which has beenused to explain target top-management behaviors (e.g. Hambrick & Cannella,1993). This theory asserts that the status an employee feels for himself in asocial setting is based on how he compares his status to others in a proximatesocial setting. According to Hambrick and Cannella (1993, p. 736), “acquiredexecutives are placed in a new social setting in which comparisons to acquiringexecutives as well as comparisons to their prior situation are inevitable andsalient.” This line of research suggests that the loss of standing, and resultingloss of power and stature, can lead to the turnover of executives. When thishappens there may be a loss of leadership talent needed to drive the changesrequired to realize synergies and cash flows.


Finally, political behavior during a merger can foster so much internalorganizational competition that executives, managers and employees fail toattend to external competition and other important market and business issues(Haspeslagh & Jemison, 1991). Again, the net result can be unrealizedsynergies and cash flows as customers defect to aggressive competitors.

In conclusion, political behavior can lead to the loss of key people, the de-motivation of others needed to implement changes to realize synergies and cashflows.

Voluntary Departure of Key PeopleKey people are those who are necessary for value preservation (e.g.relationships with key customers) or synergy realization (e.g. importanttechnology knowledge). Therefore their retention becomes critical to thesuccess of a merger or an acquisition.

Employee or top-management voluntary turnover is seen as a consequenceof what Buono and Bowditch called “dysfunctional combination-relatedbehaviors” (1989, p. 245), citing the example of a merger where engineers andscientists left during the integration phase. Jemison and Sitkin (1986)suggested that such turnover could potentially come from acquirer arrogance.Haspeslagh and Jemison (1991) and Very (1999) underlined that those wholeave are often the most talented. The reason is that they can easily find a newjob.

Most of the research dealing with voluntary departure focuses on target top-managers. For example, Walsh (1988) found that acquisitions cause increasedtop management turnover in comparison with ordinary conditions. In moststudies, researchers do not make clear the distinction between voluntary andinvoluntary turnover in their empirical work, although they build theirframework and interpret their results from a voluntary perspective. Reviewingpast research on that theme, Risberg (1999) concluded that results do notclearly help us understand why managers leave a company. But she agreed thattop management voluntary turnover is a problem many acquirers face and haveto overcome in order to keep valuable skills and knowledge. Therefore,departure of valuable employees is likely to threaten the intrinsic value of theintegrating firms and prevents the realization of synergies and cash flows.

Loss of CustomersMany stakeholders are affected by an acquisition: customers, bankers,suppliers, and competitors (Csiszar & Schweiger, 1994; Schweiger, 2002).However, research on issues related to stakeholders is very poor. The limitedresearch tends to focus on customers. Many researchers cite loss of clients as


a major threat characterizing acquisitions, but most of them only positrelationships, interpretations or explanations for customer defection.

Hax and Majluf (1996) used the Merck-Medco merger to explain howvertical integration changed a customer-supplier relationship into competitiverivalry. Such a change in the rules of the game may benefit a merging firm’sinitial competitors. Customers may also leave when they perceive, likeemployees, uncertainty or ambiguity about the future; or when they areconcerned about whether existing contracts and agreements will be honoredafter a deal is closed (Csiszar & Schweiger, 1994); when the merger leads toa too much concentration of their suppliers (Very, 1999); or when they haveto deal with new procedures and policies (Buono & Bowditch, 1989). Whateverthe motivation for exiting, retaining and satisfying the most importantcustomers of both firms remains necessary to sustain the firm’s historicalrevenues, and thus avoid value leakage. Moreover, loss of customers can alsoaffect expected synergies like cross-selling that is aimed at enhancing revenuesand thus cash flows.

Cultural Resistance

Schweiger and Goulet (2000), in their review of the literature, conclude thatculture is a complex issue. Organizational cultural differences and clashes areidentified by most researchers and practitioners as primary cause of M&Afailure, both in domestic and cross-border deals. However, recent researchcomparing domestic and cross-border deals, suggests alternative findings (e.g.Larsson & Finkelstein, 1999; Morosini et al., 1998; Very et al., 1997; Weber etal., 1996). This research tends to show that the existence of cultural distancemight not be directly associated with poor performance. Conclusions indicatethat the relationship with performance is more complex than initially assumed.For example Very et al. (1997) found that the level of autonomy given to anacquired firm influences the culture-performance linkage. Some researchersintroduced a cultural process, called acculturation, to explain performance (e.g.Nahavandi & Malekzadeh, 1988; Larsson, 1993; Very, Lubatkin & Calori,1996). These researchers contend that the success of integration may dependmore upon how cultural integration is managed than upon initial culturalsimilarities (Schweiger, 2002).

Using this process perspective, Larsson (1993) connects acculturation to thereduction of conflict. In brief, questions remain about the conditions underwhich cultural problems and their interplay with other dimensions occur andhow they influence performance. The integration process at least seems tomoderate the relationship. Despite these unanswered questions, research has


shown that when cultural incompatibility exists, employee resistance emerges.As a consequence, target top management turnover is likely to increase andacquirers can face strong barriers for implementing their integration plan (e.g.Schweiger & Goulet, 2000). In other words, cultural resistance may have anegative impact on synergy realization and cash flows if cooperation betweencombining firms is not achieved.

Characteristics of Integration Issues

The five issues discussed above are clearly not independent, For example,uncertainty and ambiguity can lead to the departure of key people, but suchdeparture can also emanate from unfavorable organizational politics or arecruitment opportunity offered by a competitor. Relationships among theissues would be of interest if we were studying interventions for solving thoseproblems. Since each dimension can be either independent or linked, weconsidered each one separately so as to isolate the specific challenge theycreate.

Each issue is likely to have a negative effect on value preservation and/orsynergy realization, and thus cash flows. For example, individual uncertaintyand ambiguity decrease the productivity of employees, diminishing the firm’scash flows (value preservation). Moreover, when such a loss of productivityhappens, the realization of synergies can be threatened: employees will noteasily share their competencies as long as they are concerned about whetherthey will be retained. The same analysis can be made for the four other issues.

However, as we will see below, the importance of a particular issue dependsupon the strategy behind the acquisition.

LINKING ISSUES TO STRATEGIC OBJECTIVES

Research on acquisitions has neglected incorporating integration issues into acontingency framework, with some notable exceptions (e.g. Bower, 2001;Hunt, 1990; Haspeslagh & Jemison, 1991). For example, most researchers viewcultural issues as being pervasive across all types of deals. Therefore, they havegenerally been studied on populations of deals with little regard to the natureof those deals. In the following paragraphs, we will analyze the conditionsunder which the five issues described above affect integration are mostsalient5.

The five issues focus primarily on people’s reactions to change. From theperspective of an acquired firm, the arrival of a new owner can be perceived astroublesome, depending on the nature and size of the organizational changes


that are required. For Ansoff (1989) citing Macchiavelli, resistance to changeis proportional to the degree of discontinuity in the culture and power structureintroduced by the change. Resistance comprises cultural and social aspects, atboth the individual and collective level. Tichy (1982) characterizes strategicchange as a period favoring the redistribution of power. Consequently, theimportance of issues such as organizational politics, cultural resistance andloss of customers is likely to depend upon the nature and size of changes. Theintegration approaches described earlier differ according to the level of changesthat they induce. While coordination suggests slight changes in an organization,standardization suggests the use of common procedures and practices, andconsolidation suggests physical changes due to the combining or sharing ofcommon resources. We could deduce that, the more that integrationmechanisms are based on consolidation, the greater the cultural resistance,organizational politics and loss of customers.

Facing a change in ownership, people need assurances about their future.6

Argyris (1990), Pondy, Boland and Thomas (1988) have noted that anystrategic shift is unavoidably accompanied by individual fears. Consequently,whatever the acquisition strategy, individual uncertainties and ambiguitiesshould always be considered important issues.

The fifth issue, departure of key-employees, is also a consequence of change:the greater the change, the greater the probability of voluntary departure. But,regardless of the nature and depth of the implemented changes, retention of keyemployees often remains a major issue. Key employees possess skills neededto realize synergies and cash flows. The acquisition strategy helps identify keyemployees needed for value to be created. For instance, when entering a newline of business, an acquirer has generally little knowledge of how to managethis new field. Therefore, an acquisition provides a way to learn from sometarget top-managers who constitute inimitable resources for the acquirer. Whenconsolidating a market within a geographical area, the acquirer often seeks toincrease its market share, eliminate capacity, thanks to consolidation andstandardization of best practices. Consequently, those target employees thatmaster best practices (if any at the acquired firm) need to be retained. In sum,there are generally some people that need to be retained, those who possessvaluable competences according to the acquisition strategy.

Consolidating a market within a geographical area requires high levels ofconsolidation, standardization and coordination. Therefore, organizationalpolitics and cultural resistance are likely to emerge and slow the integrationprocess. Changes can also threaten customers, if their relationship with a firmis modified. The adoption of best practices suggests that target employees whopossess the required skills must be retained.


When extending products, services or technologies, synergies should beachieved primarily through coordination and moderately through standardiza-tion and consolidation. Therefore, changes in power structure and cultureshould essentially affect consolidated sub-units in both organizations. As theobjective of an acquisition is often to extend the scope of products or servicesoffered to customers, they should positively perceive the acquirer’s strategy.Departure of key-people is problematic if the acquirer has not successfullysecured and integrated knowledge about the target products and technologies.

When entering a new geographic market, the extent of synergies and theintegration choices depend upon the pressures for developing a locallydedicated strategy. When entry corresponds to the implementation of ageographic concentration strategy, an acquirer could face difficulties similar tothose pertaining to consolidating market within geographic area. When anacquisition is a first step in a very different market, the adaptation of thestrategy, the low levels of synergy and the logical choice of coordinationmechanisms militate for slight changes in the target. Consequently, as theorganization remains quasi unchanged, internally and in its relation with itsclients, few integration issues are likely to emerge. One main challengeremains, however: the retention of skilled top-managers from the target, sincethe acquirer has little or no knowledge of the new country.

When vertically integrating, an acquirer looks to efficiently coordinate bothfirms’ activities. Therefore, there is a low risk of organizational politics andcultural resistance. When vertically integrating downstream, an acquirerinstantly modifies its relationships with its customers. Customer, however,could indeed become competitors. In such cases, customers are likely to feeluncomfortable with the strategic move and could choose to change theirprocurement source.7 As vertical integration can be equated to entry into a newbusiness, an acquirer needs to learn about this new field as well. Thus, theretention of key managers, again, appears to be important.

When entering a new line of business, the unrelatedness with existingbusinesses restricts synergies to intangible ones (e.g. managerial knowledge).Therefore, few changes are likely be made to the power structure and cultureof the organizations. Customers may even be different. However, as an acquirerhas no previous knowledge about a new business, retention of target top-manager is likely to be important.

Table 2 summarizes our propositions by delineating the integration changes,strategic objectives and issues that need to be managed.

Our approach is not deterministic. The propositions essentially underline thelinkages between strategic objectives, synergies, integration approaches andintegration issues. Variables other than strategic objectives can influence the


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design of integration plans and the type of issues faced. The friendliness orhostility of a transaction, the price premium paid, the relative size of the targetcompany, and the prior performance of the target could certainly influenceintegration choices and employee reactions.

Also, the industry might influence the type of issues faced by the acquirer.When the value of a firm resides in its people, such as in investment banking,retention of key employees is of particular importance, regardless of thestrategic objectives.

A limit to our framework is that we have restricted it to five issues. There are,however, other potentially salient issues such as the loss of suppliers, thereaction of competitors, and the emergence of a collective political orideological resistance at the target that are important. Consequently, ourframework is intended to be illustrative, not exhaustive.

CONCLUSION AND IMPLICATIONS

That M&As, on average have not lived up to the financial expectations of thosetransacting them has become a common theme in both the academic andpractitioner literatures. Many reasons have been advanced for this, rangingfrom lack of strategic fit of acquisition or merger partners to poor due diligence.In this chapter we demonstrated how one historically neglected element of theM&A process, integration, impacts the success of M&As. Specifically, weillustrated the complex relationship between valuation, pricing, strategicobjectives, synergies and integration. We also presented a framework thatdemonstrated the contingent relationships among different strategic objectives,synergies and the integration issues that ensue.

The ideas presented in this chapter were not only intended to help youunderstand the integrations issues that must be managed after a deal closes (i.e.during the integration phase of a merger or an acquisition), but were alsointended to provide important insights into the issues that need to be considereda priori during the transaction and transition phases (see Schweiger, 2002). Itis a major premise of this chapter that integration issues must be consideredduring all phases of the M&A process to ensure that valuation and pricingdecisions are realistic and financial results are realized. Three issues clearlyillustrate this.

First, before the closing of a deal, dealmakers must factor integration issuesinto their valuations (e.g. DCFs). Specifically, they should examine howdifferent issues impact the success of changes needed in the acquirer, the target,or both firms and the impact they have on subsequent cash flows and earnings.


To the extent that changes lead to positive synergies value is created.Conversely, to the extent that they lead to value leakage (i.e. negative synergy)value is lost. Therefore, different integration scenarios should be developed,leading to a series of more realistic M&A valuations and prices.

Second, before or after the closing of a deal, an acquirer can intervene (thefourth integration mechanism of Schweiger’s, 2002 framework) to prepare andimplement actions aimed at dissipating or avoiding the emergence of potentialthreatening issues. For example, when an acquirer fears strong culturalresistances from a target it can engage interventions such as discussions,intercultural mirroring workshops, gathering employees from both companies,organizing reciprocal visits at worksites, work on future common values thatwill characterize the new group to mitigate the resistance.

Third, many acquirers seek to learn from their past experiences. Identifyingissues early in the M&A process can subsequently help identify any context-similar deals an acquirer has faced in the past. According to Zack (1999)context is important since the knowledge gained from dissimilar types of dealsmay not generalize very well. The contingency framework presented in thischapter defines one such context that may be helpful. An acquirer may thenlook at how it managed issues in the past and whether it did so successfully ornot and why. The insights gained from context may help an acquirer developmore realistic integration plans and even choose managers who havesuccessfully handled these issues before. These managers could then lead ortake significant roles in subsequent integrations.

Based on these reasons it is apparent that an acquirer could greatly benefitfrom associating probabilities to the occurrence of future integration issues andfrom measuring the potential impact these issues have on the future realizationof synergies. The framework that we presented in this chapter could be helpful,even though it identified only five challenges.

In terms of research, future investigations on integration should clearlydifferentiate acquisitions with regard to their financial and strategic objectiveswhen trying to explain integration outcomes and performance. It is importantthat research differentiate among types of M&As so that similarities anddifferences in integration issues among deals are clearly understood whenexamined. We believe that this will lead to a much richer set of findings withsignificant practical value. Working on one type should be valuable foridentifying the specific challenges and actions that need to be managed. Suchan approach based on a typology would avoid the growing confusion that hascharacterized past research – for example under what strategic objectives iscultural resistances likely to occur.


Future research should also examine the complex relationship betweenintegration and financial outcomes. For example, one could examine valuationmodels that were employed to price a deal and the results that weresubsequently realized. Gaps could then be examined to determine why theyoccurred. For example, where revenue synergies (e.g. cross selling) wereprojected, research could determine whether they were realized and why orwhy not. Clearly, this would require in depth analysis with a high degree ofaccess to an acquirer. But, without such research it may be very difficult toacquire a detailed understanding of these issues.

It was the intent of this chapter to provoke thinking and to stimulateadditional research in the area of M&A integration. It was also the intent to linka number of important variables that have heretofore been treated somewhatindependently. Although the chapter has some limitations (e.g. the breadth ofchallenges considered) we hope that we have stimulated you to participate inand help extend this area of inquiry. Clearly, M&A integration research is in itsinfancy with additional research needed to help us understand how it impactsvalue creation.

NOTES

1. Although beyond the scope of this paper it is important to note that there is muchdebate concerning the use of terminal values and which approach is best. As, such thevalue of a firm can vary greatly depending upon which approach (e.g. P/E multiple,perpetuity value) is chosen. Further the weighted average cost of capital can also greatlyaffect valuation and can vary depending upon the percentage of debt and equity used tofinance the acquisition.

2. This argument presumes that the market (in the case of publicly traded companies)recognizes the importance of return on capital and cost of capital in its trading activity.

3. Much of this section of the chapter is drawn from David M. Schweiger, “M&AIntegration: A Framework for Executives and Managers,” New York: McGraw-Hill,2002.

4. Much of this section of the chapter is drawn from David M. Schweiger, “M&AIntegration: A Framework for Executives and Managers,” 2002, McGraw-Hill.

5. A salient issue is one that could threaten the value creation process.6. We do not mean that everybody in both organizations will feel uncomfortable with

the future. We mean that, in any deal, a substantial proportion of individuals will feelperiods of uncertainty and ambiguity. Some people could see career opportunities as themost important direct consequence of the acquisition. These opportunities will guidetheir behaviors.

7. It should be noticed that the suppliers of an acquirer could react the same waywhen the deal corresponds to an upstream vertical integration. We focused on loss ofcustomers because this is the one most often identified in the literature.


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INTEGRATING ACQUISITIONS

Robert Pitkethly, David Faulkner and John Child

INTRODUCTION

During the 1990s there was significant direct investment into the U.K. byforeign firms (Child et al., 1998). Between 1986 and 1995 companies from theUSA, Japan, Germany and France were the largest sources of foreigninvestment, accounting for between 70.8% and 80.9% of the total. In 1996,foreign acquisitions of U.K. firms exceeded the total value for all otherEuropean Union countries combined, and the U.K. was topped world-wide asa take-over target only by the USA (KPMG, 1997). An extensive search usingnumerous sources covering the period 1985 and 1994, identified 1,422 U.K.activities comprising new acquisitions, joint venture formations, collaborationsor consortia involving foreign investment, but excluding greenfield develop-ments or expansions of existing facilities. It found that 79% of these activitiesinvolved acquisitions.1

This chapter concentrates on the key issue of integrating acquisitions usinga study of acquisitions of U.K. companies by companies from the USA, Japan,Germany and France. Four major areas are involved. These are overall level ofintegration, the control and communication methods adopted, and the strategicphilosophy pursued by the new parent company in relation to the subsidiary.

CATEGORIES OF CHANGE

Acquisition provides a potentially powerful lever for the direct application offoreign management practice insofar as 100% ownership legitimates foreignowners’ authority. Moreover, the greater investment demands of outright

Advances in Mergers and Acquisitions, Volume 2, pages 27–57.Copyright © 2003 by Elsevier Science Ltd.All rights of reproduction in any form reserved.ISBN: 0-7623-1003-0

27

acquisition encourage acquirers to devote greater attention to their newsubsidiaries. Acquisitions also weaken the ability of local management to resistthe introduction of new practices more than do joint ventures or collaborations.Greenfield sites might offer even less resistance, but do not offer such a clearcomparison of practices prevailing before and after FDI.

Many factors may bear upon changes in management practice in subsidiariesfollowing acquisition. Firstly, there may be “background changes” whichwould have occurred anyway even in the absence of an acquisition. Thesechanges in management practice may come from general conditions affectingU.K. industry during the period of study, be they the influence of newmanagement ideas or the economic cycle of boom and recession. Secondly,however there may be various “acquisition effects” which only occur followingacquisition. Amongst these are changes which would have occurred anywayeventually and which may, following an acquisition, be catalysed by it andproceed faster or more effectively. New investment may be made in plant andinformation technology, providing opportunities for new practices to beintroduced. The rationale for many acquisitions is to exploit perceivedopportunities for securing a greater return from assets, and this may bring abouta further impetus for change in management practice within the subsidiary.There is also likely to be a general “new broom sweeps clean” effect and somechanges implemented which would never have occurred in the absence ofacquisition. The acquisition effect is however characteristic of acquisitions perse, rather than reflecting any particular foreign approach to management andorganisation. It comprises both changes which would have occurred anywaybut which are catalysed by the acquisition, as well as changes which occurdirectly as a result of the acquisition but which do not differ by nationality ofthe acquirer. Thirdly, there is change that is specific to the nationality of thenew owner, which may be called the “transfer of foreign practice effect”. Thiscomprises the transfer of foreign management practice to domestic companiesfollowing foreign acquisition. It can also proceed by emulation within domesticcompanies, whether acquired or not, as Oliver and Wilkinson (1992) noted inthe case of Japanese-type production methods.

These considerations prompt the questions “what is being transferred” fromforeign investing companies, and “what are we comparing?” (Morris &Wilkinson, 1996, p. 727.) The first concerns the characteristics of managementpractices that are transferred directly or through emulation. What differences inthis respect might one find between companies from each of the “big four”countries investing in the U.K.? The second question concerns the differencethat FDI, as opposed to acquisition by U.K. companies, makes to themanagement practices introduced into U.K. subsidiaries. This chapter

28 ROBERT PITKETHLY, DAVID FAULKNER AND JOHN CHILD

addresses the first of these questions, and in particular the extent to which whatis transferred is affected by the overall integration, control, communication andstrategic philosophy exhibited by the new parent company.

Until the 1980s many students of management assumed that there weregeneral principles that might be applied to situations, irrespective of the cultureof the companies being studied. The dominant view was that the appropriateapproach to management and organisation should be determined in the light ofprevailing contingencies, particularly those established by the market, technol-ogy and scale of operation. Culture was either thought to be of limitedrelevance (e.g. Hickson et al., 1974) or just one of several contingencies to beconsidered (cf. Child, 1981).

In the last two decades, however, the pendulum has swung strongly in theopposite direction. Company and national culture are now seen as criticallyimportant in selecting management methods, strategies and structures (cf.Hampden-Turner & Trompenaars, 1993). A growing body of research onnational management systems, and relevant national cultural differences, hasled to the expectation that companies of different nationalities will introducedistinctive management practices. At the same time, markets and corporationshave been globalising rapidly, and many more companies now face two distinctcultures, their own, and that of a foreign partner or parent. Work on acquisitionsand their performance (Haspeslagh & Jemison, 1991; Norburn & Schoenberg,1994) as well as on the effects of differing national management cultures on theperformance of acquisitions (Very et al., 1996; Morosini & Singh, 1994) hasalso lead to interest in the wider implications of national and managerial culturefor acquisitions and their performance. Very et al. (1996) studied differences inacculturative stress and Calori et al. (1994) differences in control mechanismsin acquisitions by U.S., French or U.K. companies of French and British firms.However, the literature which studies post acquisition integration generallyavoids looking at national differences altogether or looks more at nationaldifferences between the acquired and acquiring company rather than betweendifferent nationalities of acquiring company. Thus while differences in nationalmanagement are much studied, differences in national approaches to acquisi-tion integration which this chapter addresses have been relatively neglected.

MAJOR ISSUES

This chapter focuses on the effects of acquisitions in four major areas. Firstly,the level of integration of the subsidiary into the parent. Secondly, the methodsand systems adopted by the parent to control its new acquisition. Thirdly, themethod of communication used. And fourthly, the strategy and philosophy

29Integrating Acquisitions

the new parent adopts in relation to the subsidiary. The second, third and fourthof these factors depend crucially on the overall attitude the parent takes tointegrating the new company into its overall corporate structure.

Integration

The importance of the extent to which an acquired company is integrated intoits parent organisation rapidly becomes apparent once one talks to acquiredcompanies. There have been a number of writers who have touched on the issueof integration. Norburn and Schoenberg (1994) identify the need for “relativelyspecialised integration skills different from those required within an intra-U.K.context” and identify three needs. These are integration by facilitating atransfer from owner-management to professional management, the proactivetransfer of skills to overcome a lack of integration, and the need to overcomepotentially conflicting national cultures. Morosini and Singh (1994), whileconcentrating on implementing a “national culture-compatible strategy” as ameans to improving the performance of acquisitions, draw attention to thedifficulties of integrating resources across both acquiring and acquiredcompanies, something seen as detrimental to the performance of theacquisition. Datta (1991) also highlights the importance of integration andthe finding that procedural integration problems are less detrimental toperformance of the acquisition than cultural integration problems associatedwith some but not all differing management styles. Shrivastava (1985)identifies three types of integration : procedural, physical and managerial/socio-cultural, the last of which is found by Datta to encompass the potentiallyimportant cultural differences in management style. Gall (1991) identifiesintegration as a key organisational issue faced by management of a newacquisition and emphasises the role of employee communication in building apositive post-acquisition climate.

The overall degree of integration achieved following an acquisition, and thedegree of control and communication involved in that integration process, aretherefore issues of great interest. This is because an inappropriate level ofintegration may be detrimental to performance. Thus a tendency to over orunder integrate as a result of cultural factors hindering integration or pressuringmoves towards it may result in sub-optimal solutions. Haspeslagh and Jemison(1991) have proposed a set of “metaphors” to classify acquisitions into fourtypes depending on whether their needs for organisational autonomy and forstrategic interdependence are high or low. In their typology a “Holding”acquisition involves a low need for both organisational autonomy and strategic


interdependence. “Absorption” acquisitions involve a low need for organisa-tional autonomy but a high need for strategic interdependence. “Preservation”acquisitions have a high need for organisational autonomy but a low need forstrategic interdependence. “Symbiosis” involves a high need for bothorganisational autonomy and strategic interdependence. However, while thiscategorises acquisitions, it is clear that:

The usefulness of choosing an overall metaphor for an acquisition integration does notchange the fact that acquisitions bring with them many positions and capabilities, theintegration of which, seen in more detailed perspective, might be best served by a differentapproach (Haspeslagh & Jemison, 1991, p. 146).

It is thus possible in considering acquisitions to anticipate both cases whereeither the overall picture or one detail of it suggests one of the typesof acquisition Haspeslagh and Jemison describe (Holding, Preservation,Symbiosis or Absorption) and yet also to see that in most cases there is asubtlety in the approaches adopted by some managers and a multitude of detailincluding the many resources, capabilities and other factors to be considered.Furthermore, it is difficult in practice sometimes to distinguish clearly betweenHaspeslagh and Jemison’s Holding and Preservation categories. Angwin (1998)however, gives increased focus to the two categories by distinguishing betweena holding category where the acquirer tries to effect a turnaround but withoutany degree of integration as opposed to a preservation approach where theacquired company is also left unintegrated but in order to continue makinggood profits. Another way to distinguish them is to say that holdingacquisitions are not concerned with preserving capabilities but with remainingas uninvolved as possible.

Whichever way one looks at acquisitions, there appears to be a potentialcontinuum in the degree of integration, or what might be called a spectrum ofintegration. This is illustrated in Fig. 1 below, which illustrates the acquisitionby company A of company B with varying degrees of integration. Thisspectrum of integration ranges from acquisitions with little integration (1–2 onthe scale, corresponding to Preservation and Holding) and where the parent andsubsidiary remain distinguishable and their functions largely unintegrated, tothose where the integration is almost total (6–7 on the scale, corresponding toAbsorption) and all functions and departments of B absorbed into A. Symbioticacquisitions could be arranged at intermediate points on this continuumcorresponding to partial integration where some but not all functions anddepartments of B are integrated into A. While this view simplifies integrationinto one continuum it does of course comprise or summarise a multitude ofdifferent components.


Figure 1 also suggests the way in which the integration of the new subsidiarymay vary. With a low level of integration (1–2), regular financial and otheroperating figures will be required for the parent to monitor the performance ofthe subsidiary. Some top level personnel changes may be initiated and somerestrictions are likely to be imposed on capital spending. However thesubsidiary will continue to operate and present itself to the market much asbefore acquisition.

With higher levels of integration (3–5), the new parent is likely to take overand run centrally whole areas of activity. This is likely to cover strategy, andmay involve finance, personnel policy and systems, procurement, productdevelopment, IT systems and possibly the whole area of branding andmanagement of the company image. Depending on how strongly the newparent regards the reputation of the subsidiary’s name and trade marks it mayor may not decide to continue using them. At these partial levels of integrationthe parent is likely to have recognised that it has something to learn from theacquired company. However, it will only centralise functions if it believes thisis to the advantage of the corporation as a whole.

The highest integration levels (6–7) correspond to total absorption into theparent’s organisation. Brand names may be retained if they are strong but,particularly in service organisations, may be discontinued after a transitionalperiod.

Control

When one company acquires another it needs to exercise some control over thecompany that is now acting in its name and using its resources. Control is inmany ways the antithesis of trust since the greater the level of trust between thecompanies the less the perceived need for tight control systems (Faulkner,1998). However, control can take many forms.

Control systems may be limited to control over budgets and capitalexpenditure. They may involve appointing staff to key positions in thesubsidiary company, carrying out certain important functions like planning andpersonnel in the parent company, or imposing ‘need for approval’ requirementson identified decisions (Geringer & Hebert, 1989). The control system selectedillustrates the degree to which the parent is willing to grant a level of autonomyto the newly acquired subsidiary, and may be crucial in terms of influencing thelevel of motivation of the acquired company personnel. While not discussingnational culture, Goold and Campbell (1988) draw attention to three mainapproaches to managing subsidiaries depending on the degree of control andplanning by the centre that is involved.


Fig

.1.

Spec

trum

of

Inte

grat

ion.


Control of new acquisitions is seen as a key issue by Calori, Lubatkin andVery (1994) who study the effect of culture on the process of integration. Caloriet al. rely in their analysis on the control strategy dimensions of centralisationand formalisation identified by Child (1972, 1973). Their research found thatFrench firms exercise higher formal control of the strategy and the operationsand lower informal control through teamwork than American companies whenthey buy firms in the U.K. American firms however were found to exercisehigher formal control through procedures than the British when they buy firmsin France. In fact Dunning writing about an earlier wave of FDI notes that “wemay perhaps say with some certainty that U.S. managerial and financial controlis more likely than not to be fairly rigid for the first five years or so [afterinvesting in a U.K. firm]” (Dunning, 1958, p. 112). Other research has shownthat French decision-making is concentrated towards the top of hierarchies(Horowitz, 1978; Hickson & Pugh, 1995). Research by Maurice et al. (1980),comparing French with West German and U.K. manufacturing firms, found thatin France there are usually more levels in the hierarchy. French hierarchies tendto be more top-heavy, with between 1.5 and twice as many supervisors andmanagers as in German firms. Calori and De Woot (1994) add to thishierarchical characterisation by noting that French companies have a far highernumber of organizational levels, and a lower level of participation than Germanor other northern European countries.

Culturally, the Germans emerge from surveys as tending to have high levelsof uncertainty avoidance (Hofstede, 1991). This is associated with attaching ahigh value to stability, and has been taken by commentators to be a main reasonwhy in German organisations there tends to be a strong orientation to the useand adherence to rules, and a heavy stress on control procedures (Hampden-Turner & Trompenaars, 1993). Relationships exhibit a high level of formalityand commitment to paper, and attention to detail is painstaking. As Hicksonand Pugh (1995, p. 97) have put it,

One of the most characteristic aspects of the German culture, which certainly strikes anoutsider, is their way of managing uncertainty through an emphasis on planning andorderliness.

This penchant for order is, according to some writers, manifest in attention toorganizational structure rather than to process (e.g. Stewart et al., 1994).Germans also tend to score highly on Hofstede’s measure of “power distance”and this cultural disposition manifests itself in the presence in most Germanorganisations of ordered hierarchies, at least of status hierarchies.


The issue of control is of course closely linked to that of autonomy andresearch by Datta and Grant (1990) suggests that autonomy should beproportional to the unrelatedness of the acquisition’s business. Abo (1994)describes the Japanese management system as very flexible with few rigid jobdemarcations. Workers, supervisors and managers collectively take part in thediscussion of managerial and operational functions. Assembly-line workers areresponsible for on-line inspection and quality. There is a use of “implicitcontrol” based on shared corporate norms and understanding. The importanceof control of acquisitions and the fact that a wide variety of approaches to itexist are thus widely acknowledged in the literature.

Communication

Communication is partly a matter of systems and style, but also a question ofthe communicator’s skill at getting his message across to his colleagues. Thisis an area where nationality is very important, since different cultures havedifferent attitudes towards communication, and language barriers inevitablymake communication difficult. What is undeniable is that differing nationalitieshave differing communication styles ranging from the indirect, often unspokenstyle and “implicit understanding” of Japanese culture, through the distantunderstatement and explicit comprehension of British culture, to the close buthighly direct communication style of U.S. culture. Relative to this continuumFrench and German communication styles might perhaps be tangential,differing on issues of logical necessity and formality respectively. For exampleFrench organisations have more non-managerial white collar specialists ineither commercial-cum-administrative or technical functions, which reflects theFrench tendency to separate technical, planning, administrative and supervisorytasks from execution and operational ones (Sorge, 1993). In order to make thissegmented and complex operation predictable and reliable, French organisa-tions tend to use written rules, instructions, and communications extensively.The formality of German organisations on the other hand has already beennoted (Stewart et al., 1994) and this formality can be seen to extend to methodsof communication too.

The methods and style of communication adopted by a parent company indealing with a foreign subsidiary are thus by the very differences which existbetween the parent and subsidiary’s natural communication style bound to playa critical role in the integration of any foreign subsidiary into its parentcompany’s organisation.


Strategic Philosophy

The parent company’s strategy or philosophy is clearly crucial to thesubsidiary’s future well-being. This comprises the parent company’s manage-ment style and culture as well as whether it adopts a primarily strategic orfinancial orientation. It also comprises the extent to which autonomy is grantedto the subsidiary, and the expectation or otherwise of immediate and short-termprofits. It establishes a framework within which the new subsidiary will have tolearn to work.

The short-termism of U.K. management has been frequently cited, both inacademic studies (Lane, 1995) and by those working in industry (Marsh, 1995).Acquisitions by French companies on the other hand tend to be strategic ratherthan based on short-term financial considerations. This strategic emphasis isoften phrased in a quasi-military language in which the contestants (for Francehas a large number of contested take-over bids) adopt, by analogy, the stanceof the great generals and marshals (Barsoux & Lawrence, 1990). In contrastU.S. management culture places a stronger emphasis on achieving short-termfinancial results (Jacobs, 1991) and many U.S. companies tend to be managedfor the short-term maximisation of profits and the satisfaction of shareholders(Calori & De Woot, 1994; Lawrence, 1996).

The strategic approach or philosophy adopted by a new parent company inrelation to a new foreign subsidiary is thus another critical component involvedin the integration of the subsidiary into the parent’s organisation.

SAMPLE AND METHOD

The data used in this chapter and chapter 3 were obtained primarily throughsemi-structured interviews with managing directors of acquired companies.The companies investigated are profiled by nationality of acquirer in Tables 1,2, 3 and 4 below.

The essential details of the company selection process for the interviewswere as follows. A list of potentially relevant examples of FDI was preparedusing data from the Central Statistical Office, Reuters, Predicasts, DTI, theJournal “Acquisitions Monthly” and other sources. This covered acquisitions ofU.K. companies by U.S., French, German and Japanese companies in theperiod 1985–1994. Interviews were held with companies selected from amongthose companies acquired by a U.S., French, German or Japanese company.Forty of 79 companies asked (50.6%) agreed to being interviewed with thecompanies being divided equally among the four nationalities. Interviewedcompanies were spread over the whole of the United Kingdom with the


exception of Wales and Northern Ireland. Seventy percent of companiesinterviewed were in the manufacturing sector and 30% in service industries.U.K. companies acquired by U.K. companies were excluded from the interviewprogram since the cross-cultural interactions occurring in the transfer processbetween companies, which it was intended to study, would obviously not bepresent in such cases.

The interview schedule covered a wide range of management practices.Background information on the story behind the acquisition was also gathered.

Table 1. USA Acquisitions.

Acquirer Acquiree Acquiree AcquireeIndustry Condition

USA 1 Major MNC (H)* Small family co Medical implants just profitableUSA 2 Large Nat’l retailer (L) Perfumier Cosmetics lossesUSA 3 Major transport co (H) 4 local transp’t cos Courier lossesUSA 4 Major MNC (H) Specialist manuf’r Automobiles lossesUSA 5 Major Int’l consult’y (H) Nat’l IT consult’y IT consult’y profitableUSA 6 Large Nat’l hi-tech co (L) Hi-tech defence co Electronics profitableUSA 7 Major MNC (H) National FM co Facilities Mgt profitableUSA 8 Major MNC (H) Small Mfg co Synthetic fibres just profitableUSA 9 Large Nat’l co (H) Specialist Start-Up Insurance profitableUSA 10 Large Int’l co (H) Small national co Engineering just profitable

* International experience: H = High, M = Medium, L = Low; Information gleaned from theinterviews.

Table 2. Japanese Acquisitions.

Acquirer Acquiree Industry Condition

J1 Major national co (L) Small family co Engineering lossesJ2 Major national co (L) Ex-sub’y of MNC Engineering lossesJ3 Major national co (L) Old branded co Household goods lossesJ4 Major MNC (M) Nat’l branded co Computers lossesJ5 Large domestic bank (L) City merchant bank Banking lossesJ6 MNC (H) Medium Eng co Engineering just profitableJ7 MNC (H) National branded co Mens clothing just profitableJ8 Major Int’l co (M) Ex Danish sub’y co Polymers lossesJ9 Major MNC (H) Old Manuf’g co Engineering just profitableJ10 Large Nat’l family co (L) Old ex-sub of U.S. Pharmaceuticals just profitable


Respondents were asked open ended questions about which changes they felthad been the greatest and had the most impact on the company. The interviewsinvolved questions under the following headings:

(1) General Background to the acquisition: Reasons and consequences.(2) Background to major changes and influences:

(a) Discussion of 2–3 Major Areas of Change;(b) Patterns of Influence;(c) Integration.

Table 3. French Acquisitions.


F1 Major MNC (M) 2 Small Private cos Defence lossesF2 Large MN bank (H) City firm Banking lossesF3 Small Parisian bank (L) City firm Banking just profitableF4 Major domestic co (L) Domestic co Engineering profitableF5 Major MNC (H) Small domestic co Marketing just profitableF6 MNC (H) IT consultancy co IT consultancy profitableF7 MNC (H) Brand name co Adhesives lossesF8 Major MNC (H) Regional co Water profitableF9 Family co (L) Ex-sub of U.K. plc Pharma profitableF10 Major MNC (H) 2 regional cos Water profitable

Table 4. German Acquisitions.


G1 Major MNC (H) Family co Pharmaceutical profitableG2 Large national co (L) Small regional co Engineering lossesG3 Major landesbank (H) City bank Banking just profitableG4 Major MNC (H) Specialist Manf’r Hi-tech medical just profitableG5 Major MNC (M) Truck agency Automobiles lossesG6 MNC (H) Small family co Fire security just profitableG7 Medium national co (L) Small local co Furniture lossesG8 Medium national co (L) Med. National Trailers profitableG9 Major MNC (H) Small family co Chemicals profitableG10 Domestic co (L) Small national co Construction profitable


(3) Impact of acquisition on Performance:(a) What have been the main benefits of the acquisition?(b) What have been the main disadvantages of the acquisition?(c) How has the acquisition contributed to profitability and growth?

In each case the interviews lasted for at least an hour and in all save one casewere conducted at the offices of the acquired company.

The interviewees were primarily (73%) CEOs, Managing Directors orGeneral Managers of the subsidiary company, most of whom had been with thesubsidiary company since before the acquisition and almost all of whom (95%)were board level directors of the subsidiary company, (cf. Table 5 above). Some(13%) had been appointed by the new parent company from among parentcompany staff. In order to avoid any bias that might still result from such a mix,the interviews focused on significant events and minimised more judgementaland qualitative questions. However, all interviewees were also asked to rate thedegree of integration achieved by the acquisition on the scale of 1 to 7described above. All interviews were tape recorded.

FINDINGS

Overall Findings

On the 1–7 scale of integration described above, the 40 companies interviewedhad an average integration level of 3.61. However within this overall figure

Table 5. Interviewees.

No. of Interviewees French German Japanese U.S. TOTAL Total

CEO/MD /General Manager 5 8 8 8 29 73%Chairman 2 1 0 1 4 10%Other Director 1 1 2 1 5 13%Non Board Level – Manager/Director 2 0 0 0 2 5%

TOTAL 10 10 10 10 40 100%

Subsidiary Board Level Directors 8 10 10 10 38 95%Appointed from Parent 0 3 0 2 5 13%Appointed from Subsidiary 10 7 10 8 35 88%Joined company before acquisition 8 7 8 7 30 75%Average no. of years since acquisition 7.4 5.6 7.2 5.5 6.4Average no. of subsidiary employees 983 212 922 1213 833


there were significant national differences in the level of integration. Americancompanies were the most committed to total integration of subsidiaries with anintegration level of 4.77, while Japanese and German companies tended to bethe least inclined to integrate with average integration scores of only 3.05 and2.95 respectively. French companies interviewed had an average integrationlevel of 3.65. An ANOVA test showed that the overall differences between theaverage integration scores for each country were significant at the 7% level( p = 0.072).

Overall, the interviews showed that the most common form of controlimposed was through financial means, i.e. approval and monitoring ofsubsidiary budgets, and control of capital expenditure. This form of control wasgenerally allied to the provision of a strategic framework within whichsubsidiary decision-making was to be confined. Differences between nationalapproaches in this area mirrored those found in levels of integration.

The parents were generally able to reassure their subsidiaries that theirinvestment was for the long-term. Communication was an area in which therewas a clear differentiation between individual national styles. From theinterviews it was apparent that American companies were professionalcommunicators relishing the use of first names, regular meetings at all levels,notice boards with mission and vision statements on them and companynewspapers. Communication between Japanese companies and their U.K.subsidiaries did not seem as easy or open in comparison. German companies onthe other hand appeared to veer between the stiffly formal and the self-consciously informal, while French companies seemed to suffer littleself-doubt, communicating well amongst themselves but informing subsidiarystaff only on a ‘need to know’ basis and adopting what one interviewee referredto as a generally ‘colonial attitude’. The four countries’ attitudes to the four keyareas concerned with are summarised in Table 6 below.

These four areas of overall integration, control, communication and overallstrategic philosophy will now be reviewed in more detail in respect of each ofthe four countries.

COMPARISON BY ACQUIRER NATIONALITY

American Companies

(a) IntegrationAmerican post-acquisition management tended primarily towards total absorp-tion even where this required some time for readjustment. In the case of adiversified U.S. manufacturer’s subsidiary USA32 the new U.S. manager said:


The people here seem to hate all things American, even the size of the note pads. Some ofthe personnel still have to adjust to the fact that they are now part of a very successfulAmerican-based multinational, not a little family company.

In this case the company was very much absorbed and other examples of totalintegration of U.K. companies by U.S. parents abounded. USA4 progressivelyabsorbed a U.K. subsidiary strengthening both control systems and financialreporting. The MD said the new subsidiary:

had been totally integrated. There was about a year of separateness, but for full integration5 years have been needed. We have a well organised account management structure whichdoesn’t tolerate weak performers.

In some cases the nature of the business made integration inevitable. Forexample, USA5 a U.S. freight company totally integrated a U.K. company intoits world-wide organisation reorganising its systems to match USA5’s globalsystems.

Of the ten USA acquisitions interviewed five had an integration level of 5 ormore, three were at the 3–4 level and only 2 at the non-integrated 1–2 level.With an average score of 4.77 the preference of U.S. parent companies was fora high level of integration.

(b) ControlAn emphasis on financial control and shorter financial time horizons wastypical of the U.S. subsidiaries interviewed. In many cases the change infinancial controls was sudden and related to a lack of the controls expectedin a U.S. financial environment with quarterly reporting requirements which

Table 6. National Contrasts in Parent-Subsidiary Relationships.

Integration Control CommunicationStrategic

Philosophy

USA Fully Integrated Targets/BudgetsStrict Financial

Control

Open but Formal Short TermFinancial

France PartiallyIntegrated

Strategic & FinancialControl

Need to Know/Top Down

Long Term“Imperial”

Japan Not Integrated Budgets/Systems“Advisers”

Need to Know/Implicit

Long TermStrategic

Germany Not Integrated Varied:Budgets/SystemsInformal Controls

Upward FormalityDownwardInformality

Long TermIndistinct


privately owned U.K. companies do not face. The MD of a small U.K.company USA6 acquired by a larger U.S. company said:

The Americans had to justify their investment. They put in financial reporting systemsmuch quicker and ones which were compatible with their own systems and what they havedone has improved the business. It needed a financial controller rather than a part timeaccountant.

The need for regular financial returns by U.S. companies facing quarterlyreporting constraints was common. According to the U.K. MD of USA7 this isalso linked with a pragmatic style of management depending on trust but witha heavy emphasis on performance:

The relationship with the U.S. CEO was one of trust. He asked ‘is this British Managementdelivering that which we require?’ . . . if it was he didn’t interfere . . . . He said to me ‘. . .you know what style of management we have? It’s the management of the Mafia – send usthe money and we leave you alone!’ . . . it worked very well.

A requirement for consistency with the corporate profile often accompanied thefinancial controls. This could be tempered by a realisation that there had to bea balance between integration involving instilling big company values andtrying to preserve the small company’s entrepreneurial spirit and flexibility.However, all ten U.S. acquired companies interviewed reported substantialtightening of control systems especially financial ones.

(c) CommunicationThe U.S. companies interviewed also tended to pursue informal communica-tions in a relatively formal way. That is not to say that U.S. parent companiesare always formal but as one MD of a U.S. multinational manufacturingcompany’s subsidiary USA8 said:

On the one hand there’s a very informal style. I was at the site when the take-over tookplace and the CEO of USA8 came over and said “Call me Hank”, well you wouldn’t callthe chairman of UK1 [the former parent Co.] “Hank”. He wouldn’t invite you to . . . . Buton the other hand there’s a very high degree of toughness and insistence on conformity . . .conform – or you’re dead. With UK1 . . . a signal from on high was a signal for wideranging debate – was this meaningful, useful and were we going to obey it! USA8 cannotcope with a stand-alone subsidiary. They have to integrate everything.

Companies acquired by U.S. parents, reported moves towards a shorterplanning time horizons and employment philosophy but the toughnessmentioned above also extended to employee relations as the MD of USA8 alsosaid:

I find American business culture pretty difficult. UK1 never talked about caring and valuingpeople but its actions showed that it did. USA8 talks a huge amount about caring andvaluing people but when the going gets tough . . . it doesn’t care at all.


(d) Strategic PhilosophyThe American philosophy of post-acquisition management appears to be verymuch a hands on approach. The MD of USA7 which had been German ownedbut which was bought by a U.S. company said:

They expect instant returns . . . . There’s no well, we wait for three years, make sure there’ssynergies and then look for a return – they want it now. ”The shock is not just financial, . . .the speed at which change is to be introduced is quite extraordinary. So no doubt about it,a much more interventionist type of policy, much more dynamic, much more forcible andmuch more demanding.

Despite a shortening of financial time horizons imposed by USA acquirers, thelarger size of many U.S. parent companies relative to their U.K. subsidiariesmeant that very significant investments were still made in the subsidiaries. TheMD of a small U.K. technology based company USA9 said that the mainbenefit of the acquisition of his company was that:

Our company was going down the tubes fast. USA9 has been very successful in turningaround the business and putting in huge sums of money. One must give them credit for thatwhich UK2 (our former owners) probably could not have done.

Another MD of the U.K. service company USA9 said:

Now we are preparing five year plans . . . before we never went further forward than 12months. But at the same time, there is pressure for quarterly results . . . . You get all kindsof absurd requests to make more profit or collect more debt each quarter . . . so we’venoticed both a lengthening and a shortening of the time horizons.

However, while experiencing the financial demands of U.S. ownership thesubsidiaries of some U.S. companies have tended to have more autonomy overcapital expenditure and changes in strategy. One MD of a U.S. company’ssubsidiary USA10 said that, with a fairly dynamic approach, it may be possibleto drive strategy which the parent company might not think of. In the case ofthe U.K. company concerned this was mainly apparent through marketing andliaison initiatives which it, not its U.S. parent, had initiated.

The U.S. acquirers tended to install a formal multi-year planning systems,and to adopt a global approach to business but demand good short-termfinancial results. The implication is that if the company does not perform in arelatively short timescale it or at the very least the MD will be divested.

Japanese Companies

(a) IntegrationJapanese companies’ attitude to integration contrasted strongly with theAmerican one, with any change achieved incrementally by slow adaptation tothe parent company’s norms.


One Japanese Bank, had acquired a U.K. financial services company in orderto establish a presence in the City of London but having done so made very fewchanges, assuming that the U.K. management understood the business better. Inanother case, a U.K. pharmaceutical company was acquired inadvertently by aJapanese Pharmaceutical firm when it acquired a U.S. owned group in order topreserve a Japanese licensing arrangement. Nevertheless, it provided the U.K.firm with substantial financial support and technical assistance despite havinglittle other involvement with the company.

The new Japanese owners of a U.K. consumer products company J1 gave itsteady financial support, and did not interfere in operational matters, leavingthe company essentially unintegrated. A hands-off attitude which surprised thedirector interviewed. In the case of an U.K. electronics company (J2) acquiredby a major Japanese company, which again remained unintegrated, the MDsaid:

Historically most of their sales organisations are totally controlled from Japan . . . but notwith us! We are quite an experiment . . . the numbers are not crucial so long as we are goingin the right direction.

In all acquisitions there is a balance between allowing the subsidiary freedomfrom interference by the parent and on the other hand seeking the benefits thatcloser integration could bring. There is thus a balance between independenceand intervention along the spectrum of integration. In the case of Japaneseacquisitions the balance is often one where supportive independence dom-inates.

Of the ten Japanese acquisitions interviewed none had been integrated at the5 or higher level, six were at the 3–4 level and four were left at the 1–2 non-integrated level, giving a low average of 3.05 overall.

(b) ControlJapanese companies not only use budgets and financial control systems tomonitor their acquisitions but also other methods of keeping informed.Japanese companies uniquely introduced “advisers” and they generallypermitted rather more decision-making autonomy to their new subsidiaries.The “advisers” were often managers sent abroad for two to four years to gaininternational experience prior to promotion back in Japan. In one subsidiary itwas said that:

There are no formal links, there have been some placements of Japanese personnel butthey’ve been in new staff roles . . . . The few that have done it have been perceived by J8to be up and coming managers and have come to learn about management internationallyrather than take part in day to day management.


However, in many cases these advisers had substantial expertise in somespecialist area. J7’s MD said that once he realised one Japanese manager wasa highly skilled engineer he was able to make very good use of his expertise inproduction management. The advantages of specialist technical support werealso available as the MD of J6 found:

We ran into a problem on a product. It required technology on adhesives which we hadn’tgot experience of and they quite easily said we’ll send our adhesives man in . . . . But thenthey had all these experts very, very, focused experts.

In general where decisions were required from Japanese parent companies theycould prove rather slow in arriving according to several interviewees. The MDof a U.K. retailing company J5 said that a problem with their Japanese parentwas:

Getting a clear answer, a clear ‘yes go ahead’. We keep battling away and sometimes they’llnever say no. If they said ‘no, go away’ we’d know where we stand but their culture doesn’tpermit them to say no.

Another MD of a Japanese subsidiary J6 said:

It was very frustrating, it would sometimes take weeks to get an answer. In reality youactually knew the answer to it. It was very annoying for the guys on the shop floor.

On the other hand where trust over a particular issue or range of issues hadbeen established considerable independence could be expected but the trust andrespect had to be earned. The MD of J7 said:

I learned very quickly . . . that because of the communication problems they are onlyinterested in figures not written words. It makes my life very much easier.” “My firstpresentation in Tokyo was to the effect that we needed 3–4 years to get things going. Wherewe stand today is where we predicted we would be . . . [4 years ago] . . . achieving whatyou promise is very, very important to a Japanese . . . so it’s a very happy relationship.

The ways in which Japanese acquirers stand out compared to the other nationalgroups support some but not all of the normal characterisations of Japanesemanagement practice. Their long-term and strategic orientation and collectiveorientation were clearly apparent. As the MD of a pharmaceutical company’ssubsidiary J9 said:

There is a feeling that we should know what we need to do and that we don’t need to goto [our parent] for counsel. But they know what is going on and have been verysupportive.

Overall Japanese companies attitude to control was to believe in budgets andforecasts and expect them to be met in detail, to give considerable operationallatitude but to take the big decisions in Japan, often agonisingly slowly.


(c) CommunicationThe area of communication can be a difficult one with a Japanese acquirer forboth linguistic and cultural reasons. For example in one interview with apreviously family owned engineering company J1 the MD said:

Because all Japanese companies’ managers speak good English, language is not a problemon a day-to-day basis. It does, however, pose a barrier in terms of control and information.Virtually all written communication to and from Japan is in Japanese and I cannotunderstand it. Nor is it translated for me. I therefore don’t know for certain exactly whatthey are saying.

Language problems can thus lead to communication barriers. However, inanother Japanese acquisition (J10) the interviewee said:

I think language is undoubtedly an issue at times but it’s never a significant problem. I thinkit can be at the more junior level . . . . When it’s just straightforward technical reports its noproblem but when they are trying to get over areas of subtlety it can be difficult.

Thus communication barriers due to language could be overcome more easilywhere technical terminology was involved, perhaps due to the preponderanceof imported foreign words or “gairaigo” in technical Japanese.

(d) Strategic PhilosophyThe Japanese companies’ strategic philosophy was consistently long-term,even if the strategic details could often appear to be rather fuzzy and ad hoc.The MD of a U.K. pharmaceutical company J3 acquired along with its U.S.parent by a Japanese company said:

I think we have benefited from the take-over from being able to address issues which priorto the take-over would have been difficult . . . through lack of funding or lack of strategicdirection. Sometimes the patience for the return amazes even me. They seem quite laidback about it . . . the return on these things will stretch way out into the future.

Another U.K. company, J4, which manufactured a specialist consumer productand was bought by a major Japanese firm said that:

The main benefit has to be the investment that was made. Our subsequent success hasstemmed from the fact that it gave us the breathing space to move forward . . . .

The same company J4 is also a good example of the “slingshot effect” in thatthe subsidiary was eventually sold due to the parent’s financial difficulties inJapan and left having received substantial technical and financial support. This,when put together with their own in-house development arguably put themahead of their former Japanese parents.

With the exception of a longer-term employment philosophy, we did not findsignificant differences between Japanese and other acquirers in personnel


policy changes. Virtually every company had introduced some or all of theoperational practices associated with Japanese companies. It appears thatJapanese acquiring companies adjust their HRM practices to suit the local U.K.context, while in the operations area most companies have gone a long waytowards adopting a Japanese approach, as Oliver and Wilkinson (1992)concluded.

All ten Japanese acquisitions interviewed described new owners whosemajor merit was their long-term philosophy, and willingness to back theirpurchase with financial resources. The logical incremental attitude commonlyascribed to Japanese companies meant that while detailed plans were often notin place or apparent, general objectives behind the acquisitions such asdeveloping closer customer relations, or becoming more international werediscernible.

German Companies

(a) IntegrationIn a similar way to Japanese companies, German acquirers tended to avoidclosely integrating their new acquisitions if at all possible. Of the tencompanies interviewed none had an integration score above 6; five were in the3–4 range and the other five were at the 1–2 non-integrated level, the averageGerman score being 2.95.

A major German safety equipment manufacturer acquired a small entrepre-neurial firm (G6) in the same line of business. Unusually the entrepreneurialMD has remained with the company with the German parent saying:

We don’t want you to change. Stay the way you are, because you have the ability to movein a market place more than we can.

Another U.K. company, in this case a very high tech instrument company (G4)acquired by a German competitor with a larger global presence, was also leftalone by its new parent. The MD said:

They have never sought to change any thing. They really have left us alone, I don’t thinkwe have learnt much from them, but they may have learnt something about the flexibilityof a small company, and what they need to do to become more flexible.

It is worth noting that where little change occurred it was often due to thesubsidiary’s management gaining the trust and acceptance of the new parent’smanagement and convincing them that it knew its business better than theydid.


(b) ControlThe German attitude to control revealed by the interviews is varied, rangingfrom Board representation and use of management accounts to putting in a MDwho then controls very directly. The subsidiary managers interviewed generallyfelt that their German parent companies exercised relatively little influenceover their acquisitions. Compared with the other firms, the German acquisitionswere less likely to have parent company managers as CEOs, or as marketingand R&D directors. One successful subsidiary (G4) of a German acquirercomments:

We report with management accounts on a monthly basis which we send direct to Germany. . . . Since we have never been wildly off budget, there is no major response to these.Anyway financially we outperform our parent as a whole.

Even less successful companies enjoyed a fair degree of freedom. One (G6)manager said:

We are visited from Hamburg once a quarter. They get involved in the thinking as well asthe numbers. But in general their aim is to keep a tight rein on the finances and not worrytoo much about how we achieve the results.

But there were also more muddled companies. One (G8) director said:

The German company has a combined board of five people all of whom came over in thefirst few months to see their new acquisition . . . to be totally honest all of their views totallydiffered. So we produced a five-year business plan and rang them up and they said ‘that’sgood, get on with it’ . . . . We did look to them for guidance in the early days, . . . but theirability to make decisions was somewhat strange to say the least.

Another German company (G9) started out very autocratically but showed thatpersonal relationships as well as success could influence the degree of freedoma subsidiary enjoyed. The MD of the subsidiary commented that:

. . . We would use G where we needed them but push them away where we didn’t . . . . wewere able to wave our results as justification for the UDI that we declared. It was a quirkof the changing times within G and our success that lead them to that method of control.It was also personal. I very quickly developed a relationship of 100% trust with thechairman in both directions and he left it to me.

(c) CommunicationThe issue of personal relationships also concerns communication. On the issueof formality two photographs belonging to the MD of a company (G10) whichhad been part of a U.S. led MBO subsequently sold to a German companyillustrate the point. One showed the U.S. led MBO team on a beach at 10amcelebrating the fact that they had just bought the company. The other showeda row of sober suited people in a wood panelled hotel reception room the day


the contract to sell the company to a German company was signed. This theU.K. MD felt graphically illustrated the difference in formality between thetwo companies.

However, while there may sometimes be a sober suited formality associatedwith German management there is also a sense, as the interviews revealed, inwhich German management style can be very informal. Various explanationswere offered for this apparent paradox. One MD in a German owned subsidiary(G2) held that it was a generational issue:

The Germans are quasi-formal and the first management team was very traditional andformal. The new management however is much younger and much less formal. We have‘casual days’, ‘funny tie days’ and ‘sandals days’ and this sort of thing!

Other managers saw increased informality as a reaction to the recession of theearly 1990s and a learning process whereby a more informal approach wouldpreserve some of the small company characteristics that large Germancompany might learn from in a recession. In the latter case this approach wascontrasted with an earlier approach which involved management quite literally“by the book” using a rigid set of procedures. A German manager managing aU.K. subsidiary (G7) said:

We Germans are still pretty formal, . . . I can use first names with the British but use titleswith my German colleagues.

Despite such cultural differences German managers were seen to be closer toU.K. culture than many other nationalities as a financial services company (G3)manager observed:

The culture is not that different. A bit more formal, but they are in my opinion far closerto us than any other European lot. You wouldn’t have any trouble having dinner withthem.

(d) Strategic PhilosophyGerman parent companies, as Japanese companies, had a long term view ofinvestment decisions. However, even this could have an apparent downside bybeing almost too good. The MD of a manufacturing subsidiary G10 said:

I think our financial director would almost have welcomed being pressed more to be self-sufficient. It was almost a failing of the Germans to be as supportive as they were. Quitefrankly I think it would have done us good if they had said “look there’s no more money– you’ve got to sort yourself out.

Looking at several other acquisitions it seems that for long term financialsupport to be a success the subsidiary has not only got to have the support butalso some idea about how to use that support and about the long term direction


of the company – whether that direction is self-generated or dictated by theparent. Just support or just direction is insufficient. This was reflected by theabove MD’s sense that the U.K. company under its German owners sufferedfrom a lack of strategic direction:

it failed to have a long term strategic objective. The business objectives were not known bythe board so how on earth could they be transmitted to the rest of the troops.

German management seems definitely influenced by the differing nature of thehome financial markets (compared to U.S. financial markets). For example themanager of a German company’s subsidiary (G3) said what might be difficultfor a U.S. company manager to say:

They are long-termist. They do not have making a profit itself as a prime matter. They arenot profit driven. They want to know about quarterly results but they are not dominated bythem.

The remarkable aspect of these findings is that while they confirm the long termnature of the German management approach they directly contradict one of theassumptions about German management practice found in the literature.Commentators tend to stress a high level of formality, rule-orientation,orderliness and formal provisions for participation as salient characteristics ofGerman management. These features did not distinguish the changes broughtabout by German investors in the U.K.; in fact quite the contrary. This mayreflect, to some extent, the observation made by Stewart et al. (1994) that aGerman penchant for order is manifest in organisational structure rather than inprocess, since several of the changes which were distinctively less formalamong German acquisitions concerned process rather than structure per se.Nevertheless, our findings raise questions regarding the validity of the typicalGerman management stereotype, even if it represents an over-simplified viewwhich is in any event subject to change. However it can be challenged both ongrounds of the present contradictory findings and also in view of the fact thatconfirmation of other elements in the stereotype presented by the literature wasabsent from our comparative data.

French Companies

(a) IntegrationThe French acquirers interviewed were in the middle of the integrationspectrum at an average level of 3.65. Less determined to integrate acquiredcompanies than American parent companies but more than Japanese andGerman companies. Four of the ten companies interviewed were at a 5 + levelof integration, a further four at 3–4 and two at a non-integrated 1–2 level. The


level of integration varies from total integration of a previously British ITconsultancy company to form a French based transnational to water companiesthat have been largely left alone to operate substantially as before, at least inpart due to regulatory restrictions. A manager in a French owned U.K. publicutility company said:

the general philosophy is “Local Management” although they are interested in this high upview they really leave the rest of it to local management. . . . Because we are a regulatedbusiness there’s a limit to what they can do.

(b) ControlNational characteristics reveal themselves much more in French companies’way of exercising control. In general they operate very hierarchically anddetermine major decisions between French managers, regarding acquiredcompany personnel with a ‘colonial’ attitude. Another example of thecolonialist attitude to acquisitions is noted by Empson (1998). An executivefrom a French acquired aerospace company (F1) states:

Things are decided informally amongst Frenchmen to the exclusion of British middlemanagement. If contacts were plotted, pretty well all the informal links would be betweenthe French.

The British part-time chairman of a French-acquired financial servicescompany (F2) said:

They have difficulty in understanding the British concept of a Board. So far as they areconcerned a Board is a kind of registration. It is like a levee, not a discussion and decisiontaking body.

French companies seem to place great emphasis on the distinction betweenstrategic decisions (to be made by French managers at HQ) and operationaldecisions (to be made by local managers on the spot) though financial controlsremain important. As an executive from a French-acquired water company(F10) said:

They appointed a French Financial Controller . . . that is one post they try and keep forthemselves. On the operational side it’s all-local.

(c) CommunicationCommunication tends to be very hierarchical and top-down with littleinvolvement of British managers in the decision-making hierarchy. The head ofa financial services company (F3) acquired by a French bank said:

Communications are largely on a need to know basis. I don’t get involved in the Parisbusiness at all although I try to network as much as I can. I don’t ferret around with thingsthat don’t concern London.


An executive of an engineering company (F4) added:

The French hierarchy is a ‘power’ hierarchy and it is the power that we find the mostdifficult to live with. I don’t think most of industry in the U.K., certainly a TQM-inspiredparticipative modern ethos, has the power element that the French have built in toeverything and they do have an arrogance and a dominance characteristic that one findsvery difficult to live with.

(d) Strategic PhilosophyFrench companies generally have a long-term strategic philosophy in relationto acquisitions. A manager in a major French electronics company’s subsidiary(F1) said:

A strategic rather than a financial orientation exists; it has to, since the company losesmoney. However, it is thought to be important to stay in the market.

The MD of a high-tech manufacturing firm (F9) acquired by a French companysaid:

The way in which the business is being approached is interesting ‘the centre and severalself-sufficient satellites’ but in my opinion it was never going to be a workable philosophybecause it weakens the whole thing rather than strengthens it . . . . It’s wonderful to managea subsidiary where one is totally empowered but on the other hand how is one going togrow the business without the help of the group?

Another interviewee (F5) said:

Decision-making is collective, but the French are very autocratic, but on big strategic issuesonly.

This suggests that the issue may depend on the size of the decision being made.A French financial services company, for example, was said to reserve largerdecisions for itself but to allow its British subsidiary (F7) a lot of localautonomy. Indeed one personnel director related an incident shortly after beingacquired when this became quite clear:

The FD spoke about the state of the business, you can imagine the air of gloom . . . thenanother (U.K.) director said “What do you want us to do?” and there was a pregnant silenceand the French director paused, looked straight down the table and said ‘Monsieur if wehave to tell you what to do we have the wrong people’. So I thought this is good newsbecause nobody is going to tell us what has to be done.

In other words the French management considered that it was not for them toinfluence the U.K. management so much as for the U.K. management to runtheir business. This apparently surprised the U.K. manager concerned who saidhe had always regarded French companies as bureaucratic and centralist. Thisalso shows that to a certain extent it is up to a subsidiary to manage its ownersas much as be managed by them.


CONCLUSION

This chapter has reported the findings of interviews with managers of a rangeof acquisitions of U.K. companies by foreign companies and has concentratedon four main issues. The level of integration of the subsidiary, the controlmethods and systems adopted by the parent, methods of communicationand lastly, the strategy and philosophy of the new parent concerning thenew subsidiary. All of these factors depend on and reflect the overall attitudea parent takes to integrating a company into its overall corporate structure.Past research (Calori et al., 1994) has looked at differences in controlmechanisms between nationalities but more general studies of post-acquisitionintegration (e.g. Haspeslagh & Jemison, 1991) have tended to discuss differ-ences between acquired and acquiring companies more than nationaldifferences between acquiring companies as in the present study.

Haspeslagh and Jemison (1991) characterised acquisitions in terms of theirneeds for strategic interdependence and organisational autonomy. At first sightthese two axes seem to be orthogonal. However with needs for autonomy andinterdependence, being in some sense opposites it would seem that replacingthem with a single measure, overall need for integration, would achieve thesame power of distinguishing types of acquisitions more economically. This isreinforced by the fact that H&J found no instances of their holding category ofacquisitions (those with a low need for both autonomy and strategicinterdependence). The present research confirms though that both a need fororganisational autonomy and a need for strategic interdependence are critical.As outlined above, there were several German acquired companies where thenew parents wished to keep their subsidiary intact precisely in order to preserveand learn from their unique managerial character. There were also companiessuch as the U.S. acquired freight company where absorption was total leavingalmost no trace of the subsidiary’s former independent existence.

A number of factors affect the degree of integration to be pursued.Haspeslagh and Jemison (1991) single out both acquired company quality andacquisition size. The present investigation has also identified as other importantfactors the control methods and systems adopted by the parent, the methods ofcommunication and the strategy and philosophy of the new parent concerningmanagement of subsidiaries, as well as the focal variable of this study:nationality. Organisationally embedded capabilities that require organisationalboundaries for their preservation are no less strategic capabilities than othersthat require the boundaryless conditions of absorption to maximise theirbenefits. It seems therefore that the overall choice to be made and thus thekey dimension involved is one of the degree of integration to be adopted. The


key factor to be assessed with respect to any capability is whether thatcapability’s benefits following acquisition will increase or decrease with thedegree of integration of the two companies.

Paradoxically therefore the complexity of the issues involved in acquisitionsand revealed by the present research has suggested a simplified categorisationof acquisitions using the degree of integration of subsidiaries. WhileHaspeslagh and Jemison (1991) characterised acquisitions in terms of theirneed for strategic interdependence and organisational autonomy, the new scalesimply ranges from not integrated, through partially integrated to fullyintegrated where the subsidiary organisation is no longer distinguishable withinthe parent company. This does not ignore the fact that many componentscontribute to deciding a company’s position on the scale of integrationfollowing acquisition but neither does it concentrate on particular componentsto the exclusion of others. In presenting such a scale one must thereforeemphasise the multi-dimensional nature of post-acquisition integration.

The research showed that U.S. subsidiaries tended to be more integrated thanother nationalities and German and Japanese subsidiaries less integratedthan others with French subsidiaries somewhere in between. The interviewsalso showed that, while the degree of integration differed, the means of controlused were common, albeit not applied to the same degree. Key examples werefinancial controls related to investment but common cost controls were alsoinvolved as well. The use of advisers and or informal controls in Japanese andGerman subsidiaries contrasted with the stricter financial controls of U.S.companies. The way in which parents communicated with their subsidiariesalso showed distinct differences between the four nationalities studied with themain parameters being the degree of formality/informality, the degree ofopenness or more limited ‘need to know’ communication, and the directness ofcommunication. As expected, Japanese companies operated more on a need toknow and implicit communication style, U.S. companies were open but formalwhile French companies tended to a more autocratic top-down style. Germancompanies who might be expected to be unduly formal were found to beupwardly formal in dealing with their parent but downwardly very informal incommunicating with their subsidiary.

These findings reflected the overall strategic philosophy adopted by the fournationalities of acquiring company. U.S. companies tended towards a shortterm financial approach to the three key issues while the other three countrieswere predominantly long-term in their approach. However they differed in thatwhile Japanese companies had a strategic approach generally involvingsubstantial financial support, French companies had a more “imperial”


approach and German companies a range of indistinct though generally longterm approaches.

The lessons to be learned from the research findings are several. Firstly thatwhile there are many similarities between acquisitions in general there aresubstantial differences in approach by acquiring companies of differentnationalities. Secondly, communication is critical in building links betweenparents and subsidiaries but words must be backed by consistent actions ifcredibility is to be maintained. Linguistic and cultural problems withcommunication need more attention than they usually receive. Thirdly, a rangeof control styles is possible, ranging from the very strict financial controlsfavoured by many U.S. parents to the much more “laissez faire” attitude ofJapanese parent companies and even some French companies.

One might compare these findings with those of Goold and Campbell (1988)who drew attention to three main approaches to managing subsidiaries(Strategic Planning, Strategic Control and Financial Control) depending on thedegree of control and planning by the centre that is involved. The presentresearch shows that strategic and financial control and planning are importantelements of managing an acquisition. However, it also shows that many otherelements are involved and equally important to the success of the acquisition,not least the issues of the differing cultures of the acquiring and acquiredcompanies and communication between them, as well as the overall level ofintegration. This again emphasises the multi-dimensional nature of post-acquisition integration.

The research also suggests several areas for further investigation. Investigat-ing potential links between integration and performance is one area. Forexample does subsidiary profitability at the time of acquisition affectapproaches to integration? This paper does not report results concerning post-acquisition performance. However it is worth noting that despite the distinctnational approaches to managing the control and integration of subsidiaries, noone country’s acquisitions were significantly more successful than any other.This all leads to the overall impression that it is not so much whethercompanies, control, communicate with or integrate new subsidiaries but theparticular ways of doing so that they adopt in any given situation. Norburn andSchoenberg (1994) suggest that with an international acquisition there is a needfor “relatively specialised integration skills different from those required withinan intra-U.K. context” but, as this research has shown, such skills and theapproaches adopted will differ from nationality to nationality. The multi-dimensional nature of acquisition management and the issues of integration,control and communication are therefore shown to be open to different national


approaches but none the less important for that. They remain of continuinginterest as important factors in managing the acquisition process.

NOTES

1. These sources are unlikely to be comprehensive. In particular, smaller deals maygo unnoticed by the British press and unrecorded by the DTI and CSO. The actual levelof activity will therefore certainly be higher than that captured by the above sources.However, it is believed that the relative size of the number of activities by type,nationality and industry will reflect the overall picture, and these are the only datareadily accessible to researchers.

2. All companies for reasons of confidentiality are referred to by numbered codesdenoting the parent company nationality: USA for U.S., J for Japanese, G for Germanand F for French parent companies where n = 1 to 10. Former U.K. parent companiesare denoted by U.K.

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ORGANISATIONAL CHANGEPROCESSES IN INTERNATIONALACQUISITIONS

David Faulkner, John Child and Robert Pitkethly

INTRODUCTION

Following the previous chapter’s discussion of how acquiring companies forthe USA, Japan, Germany and France integrated their U.K. acquisitions withregard to the overall level of integration attempted and achieved, control,communication and strategic philosophy, this chapter discusses the organisa-tional change mechanisms adopted in order to achieve this integration. Theprevious chapter gives details on the methodology adopted for the research andthe criteria for the choice of sample. The codes for the companies (e.g. US04)follow those laid out in Tables 1–4 (pp. 37–38).

A LITERATURE REVIEW

Corporate and national culture are now seen by many researchers as criticallyimportant in the determination of management methods, strategies andstructures (cf. Hofstede, 1991; Hampden-Turner & Trompenaars, 1993). Thisview can be traced back to Roberts (1970) in her evaluation of the influence ofculture on organisation. To Sorge (1982), culture was the dominant force to beconsidered in evaluating international performance. Boisot (1995) takes asimilar view when analysing information theory across national boundaries.Loveridge (1998) implicitly accepts the importance of underlying culture in


59

influencing management methods in flagging up the contention that completeconvergence to a globalised best-practice may never come about. Child (1981)proposes a comparative examination of national differences in organisationalpractices between nations whose economic conditions are similar, in order toassess the importance of culture in determining management practices.Redding (1994) argues along similar lines. Boisot (1986) using two dimensionsnamely codification and diffusion of information, notes the different prefer-ences of different cultures for information along these dimensions which hedesignates culture space. He claims that it explains the Anglo-Saxon preferencefor market transactions, and the Chinese preference for network capitalism(Boisot & Child, 1988, 1996). This form of theory can also be applied to theway in which different cultures record information and transform it from tacitto explicit (Nonaka & Takeuchi, 1995) leading to different organisational formsand practices for different cultures. Similarly Liu (1986) shows how thefactorial analysis orientation of the West contrasts with the synthetic-holisticorientation of the East leading to different forms of preferred decision-making.

A country’s institutions are shaped by its social and cultural history as wellas by the logic of expediency, and they in turn shape a country’s managementpractices (Biggart & Guillen, 1999). The varying institutional factors ofdifferent nations are therefore also important in cross-cultural research intomanagement practices. Mokhiber and Weissman (1999) point out that it canalso work in the other direction as the management power of large multi-nationals can influence the evolution of a country’s institutions. The interactionof national culture and management practice is therefore by no meansnecessarily uni-directional, and more research is needed to develop a fully-fledged theory of the respective interactive roles of culture and organisation.Even in the absence of such a theory however, many researchers would concurthat different nations with different cultures do manage companies differently,and would hypothesise that not all such differences are due to environmentalcontingencies.

Calori, Lubatkin and Very (1994) in their research conclude that the Frenchexercise higher formal control of strategy and operations, and lower informalcontrol through teamwork in U.K. acquisitions, than do the Americans. Theyalso conclude that the Americans exercise higher procedurally-based controlthan do the British in French acquisitions.

being conscious of the influence of national administrative heritage should help reduceanticipated cultural problems in the integration process following international acquisitions. . . Firms are prone to carry their home practice with them as they move into foreignmarkets (Calori, Lubatkin & Very, 1994).

60 DAVID FAULKNER, JOHN CHILD AND ROBERT PITKETHLY

Perlmutter (1969) had long ago warned of the risk of ethnocentricity where thebuyer does not make any adaptation to local practice, and carries on as thoughin its domestic market. Gates and Egelhoff (1986) concentrate on theimportance of the country of origin of MNCs in their choice of controlmechanisms over new acquisitions. Whitley (1992) addresses the issue fromthe viewpoint of the local company, and stresses the importance of localinstitutional and infrastructural circumstances in influencing effective con-solidation of acquisitions across borders.

A growing body of research on national management systems and relevantnational cultural differences has led to the expectation that companies ofdifferent nationalities will introduce distinctive management practices. At thesame time, markets and corporations have been globalising rapidly, and manymore companies now face two distinct cultures, their own, and that of a foreignpartner or parent. Work on acquisitions and their performance (Haspeslagh &Jemison, 1991; Norburn & Schoenberg, 1994) as well as on the effects ofdiffering national management cultures on the performance of acquisitions(Very et al., 1996; Morosini & Singh, 1994) has also led to interest in the widerimplications of national and managerial culture for acquisitions.

There is considerable interest in the impact that the integration of the newsubsidiary may have on its post-acquisition performance. Nahavandi andMalekzadeh (1988) find that the success of implementation is highly dependentupon the attitudes to the mode of acculturation held by both the acquirer andthe acquired company. They see the four possible modes as integration,assimilation, separation and deculturation. Sales and Mirves (1984) seeconflict, and hence probable failure of the acquisition, as most likely whenfirms with radically different corporate cultures come together. Kogut andSingh (1988) find that the greater the cultural distance between the twocountries involved, and the higher the level of uncertainty avoidance in thepotential market-entering firm, the less likely it is to adopt acquisition as amethod of market entry, preferring greenfield development or joint venture.

The impact of the acquirer’s national management practice on the post-acquisition behaviour and performance of the acquired company is also anissue of concern. The implication of the globalisation of markets and themultiple management cultures faced by U.K. management, is that inward FDI,through the control and influence it gives to foreign management, will stimulatethe adoption of management practices which contrast with past practices of theacquired U.K. firm. As Shrivastava (1986) points out there are several areas inwhich management practice influence might come about; e.g. in accountingand budgeting systems, in physical assets, product lines, production systemsand technologies; and most importantly at a managerial and socio-cultural

61Organisational Change Processes in International Acquisitions

level. Integration or at least influence are not always needed or in fact achievedat all these levels. It might be suggested that the managerial and socio-culturallevel is the most important one, since Buono and Bowdich (1985) find in theirresearch that where cultures collide and cause a merger to fail, the predominantobserved factor is the discontent felt by the non-dominant partner based onsubjective, i.e. cultural, rather than objective features.

The importance of the national origin of the acquiring company in cross-border acquisitions is thus by now a well established and much studiedphenomenon. However past study of the balance between direct application offoreign management practice and its adaptation to local conditions, leaves openthe question of how far and in what manner FDI induces domestic changes inthe management practices of acquired companies. Once the waves of foreigninvestment have swept over U.K. Industry, what is their effect on U.K.management practice and how are the changes involved achieved?

CHANGES PROCESSES INVOLVED IN INWARD FDI

The integration process involved in ‘digesting’ the acquisitions can be depictedas in Fig. 1 below.

Distinctly different approaches were taken to the task of bringing aboutchange and improving performance in newly acquired companies. It isappreciated that other factors than the national identity of the acquirer are likelyto influence post-acquisition behaviour, including the performance of thesubsidiary at the time of acquisition, the prior international experience ofthe acquirer, the relative size of the partners, and perhaps the industry involved.It is impossible to formally control for all possible factors in a qualitative study.However, a varied range of companies in a wide range of industries was chosen

Fig. 1. Post-Acquisition Change Processes.


for interview in order to seek to avoid bias in any particular direction regardingthese other possible influencing factors.

OVERALL FINDINGS

The following is the general cross-nationality picture of the acquisition process.As shown in Table 1 below, of the forty companies interviewed 30% wereacceptably profitable at the time of purchase, a further 30% were at break-even,and 40% were making losses. By the time the interviews were carried out, theprofitable companies had increased to 55%, the break-even ones reduced to23%, and the remaining loss makers were only 22%. So with 78% companiesin profit after acquisition compared with 60% prior to acquisition, a qualifiedapproval could be given to the take-over process.

An important issue is which of two parties initiates any post-acquisitionchange. In the companies interviewed the initiator was by no means dominantlythe acquirer, as shown in Table 2 below. In 14 cases the acquirer led and in afurther four acted as catalyst, but in 13 cases the subsidiary claimed to have

Table 1. Profitability of Interviewed Companies.

Companies USA Japan Germany France Total

Acceptably: before 4 0 4 4 12Profitable: after 8 4 4 6 22Just: before 3 4 3 2 12Profitable: after 0 3 3 3 9

Loss: before 3 6 3 4 16Making :after 2 3 3 1 9

Table 2. Initiators of Change.

Change Initiator USA Japan Germany France Total

Acquirer 6 2 3 3 14Acquirer as catalyst 1 2 0 1 4Subsidiary 2 5 3 3 13Both 0 1 1 1 3Little change 1 0 3 2 6


initiated the changes. In three companies changes were attributed to the jointefforts of the parent and subsidiary, and in the remaining six acquisitions, littlechange was said to have taken place. It is thus as likely that change will beinitiated by the subsidiary as by the parent company following an acquisition,though as can be seen in Table 2 initiation by the parent is more frequent whereU.S. parent companies are involved.

As regards the method of post acquisition change, in 12 cases the subsidiarywas absorbed into the parent or had a Managing Director appointed by theparent imposed upon it as shown in Table 3 below. However in sevencompanies the change was effected by the parent and subsidiary companiesworking together.

In the rest of the companies interviewed, the parent company either adopteda “hands off” management style (five companies) more or less leaving thesubsidiary to manage itself, or (in eight companies) allowed the subsidiary toeffect changes for which the subsidiary’s management team had obtained priorapproval. The degree of independence possessed by subsidiaries thus variedconsiderably, and subsidiaries were by no means confined in all cases to closemanagement by their new parent companies.

All acquirers provided finance, even if only in the sense of making thepurchase. However, there was a wide variety in their attitude to dividends, someleaving the money in and some taking it out. As shown in Table 4, somepositively improved the credit rating of the subsidiary by providing creditsupport for local loans. Only 18, just under half of those interviewed, providedstrong technical and other support activities to bring the subsidiary up to thestandard of the parent. The numbers exceed forty, since some parentscontributed resources under more than one heading.

In terms of monitoring progress in bringing about change 27% of thecompanies appointed a new MD to the subsidiary and sometimes other senior

Table 3. Method of Change.

Change Method USA Japan Germany France Total

Absorption 5 0 0 0 5MD appointed 1 1 3 2 7Joint action 1 4 0 2 7Hands-off 2 2 1 0 5Action by sub 0 3 2 3 8Decisions by HQ 0 0 1 1 2Little change 1 0 3 2 6


executives, a further 15% made senior appointments but left the existing MDin place, 17% made junior appointments, often ostensibly just for trainingpurposes, but presumably also to monitor events in the subsidiary. Anastonishingly high 42% made no appointments to the subsidiary at all, butmerely tied it into a parent company appointed board resident in the parentcompany’s country (see Table 5).

DIFFERING NATIONAL APPROACHES TO CHANGE

U.S. Companies

The U.S. acquirers were the most internationally experienced of the fournationalities surveyed as shown in Table 6. Although international experience

Table 4. Resources Introduced.

Resources introduced USA Japan Germany France Total

Finance 10 10 10 10 40Technology 6 4 4 4 18Systems & IT support 1 0 0 0 1Mediocre products 1 1 0 0 2Asset investments 0 0 2 0 2Credit support 0 2 2 0 4

Table 5. Parent Company Appointments.

MD Senior Advisors Junior None Total& others Appointments Appointments

USA 4 0 0 0 6 4Japan 1 4 2 4 1 11Germany 3 2 0 2 4 7France 3 0 0 1 6 4Total 11 6 2 7 17% of Co.s 27% 15% 5% 17% 42%

NB some rows and columns add up to more then the total of 40 cases or 10 per country as somecases involved appointments in more than one category.


is often important in achieving high international performance, this is only thecase where the experience has led to increased know-how, and this is notalways the case (Simonin, 1997). The U.S. acquirers were also the most likelyto buy an already profitable company.

The change process in U.S. acquisitions tends to be characterised by threemain features. Change is initiated by the new parent company, it is ofteneffected by absorption into the parent company in the manner described byHaspeslagh and Jemison (1991), and strong backing is usually given to newsubsidiaries, not just in the form of finance, but also in support activities andtechnology. As the MD of a U.K. firm acquired by a major U.S. MNC (US5)said:

After the take-over in 1990 they progressively absorbed us, and we are now totallyintegrated into US5 (U.K.). There were huge negatives at first. ‘The yanks are coming; theyhave no sense of irony.’ This took three years to settle down.

However, companies usually experienced an increase in performance followingU.S. acquisition.

Five out of ten U.S. parent companies absorbed their new subsidiary into theAmerican parent’s organisation and systems in such a way that the subsidiary

Table 6. USA Acquisitions.

Acquiree AcquireeAcquirer Acquiree Acquiree Industry Condition

USA 1 Major MNC (H)* Small family company Medical implants Just profitableUSA 2 Large National Perfumier Cosmetics Losses

retailer (L)USA 3 Major transport 4 local transport Courier Losses

company (H) companiesUSA 4 Major MNC (H) Specialist manufacturer Automobiles LossesUSA 5 Major International National IT consultancy IT consultancy Profitable

consultancy (H)USA 6 Large National Hi-tech defence Electronics Profitable

hi-tech company (L) companyUSA 7 Major MNC (H) National FM company Facilities Mgt. ProfitableUSA 8 Major MNC (H) Small Mfg company Synthetic fibres Just profitableUSA 9 Large National Specialist Start-Up Insurance Profitable

company (H)USA 10 Large International Small national company Engineering Just profitable

company (H)

* International experience: H = High, M = Medium, L = Low; Information gleaned from theinterviews.


could no longer be clearly distinguished from the parent. This involvedadoption of the parent’s logo, brands and company culture and left little traceof the original company’s former independent identity. This was very muchacquisition by absorption in the form identified by Haspeslagh and Jemison(1991). An example of such an absorption is that described by the generalmanager of US1.

We are now a professionally organised part of the Health Care Division of USA1 and fullyintegrated into its organisation structure. I formally report to the EBC (European BusinessCentre) for manufacturing and to North America for business applications and R&D. Thereis no one person, but an integrated multi-point approach When stand alone businesses areacquired for example their R&D is not closed down but linked in to the world-widenetwork.

Only U.S. companies applied a total absorption approach to their acquisitionsin any of the situations researched. They either absorb the subsidiary entirely,or leave it nominally independent but subject to substantial intervention by theparent. Thus U.S. parents are the main source of change in acquisitions by U.S.companies (cf. Table 2).

One interesting aspect of the integrationist approach favoured by severalU.S. companies was that it did not necessarily involve imposing U.S. appointedMDs on to the new subsidiaries. In four cases the U.S. parent did appoint a newMD, and took over the running of the new subsidiary. However, in six cases theparent company made no new appointments and worked through the existingmanagement team. There was also no use of advisors, senior sub-MDappointments or junior trainee appointments i.e. they had slim and directmanagement lines from subsidiary to parent.

The interventionist approach could, however, lead to problems as the generalmanager of the acquired subsidiary of US3 commented:

The U.S. expats expected to put in an exact blueprint of US3 in the new country and weresurprised when it didn’t work. Cultures are different. It took the Americans three or fouryears, a lot of money and some quite painful decisions to realise this.

One positive aspect of this interventionist approach was that such companieswere also the most likely to supplement the finance provided with whateverother managerial and technological support services were needed to bring thenew subsidiary up to the required standard. As the MD of the subsidiary of US4put it:

Quality was improved dramatically. US4 provided people for product design, training andmanagement services . . . They brought money, armies of bureaucrats, and internationalprofessionalism.

However traumatic an acquisition by an American company might be to a smallnew subsidiary frightened of losing its identity and autonomy as it disappears


into the maw of the corporate monster, the result was in most cases asubstantial improvement in its economic performance. Of the ten companiesacquired, only two were not acceptably profitable at the time of interview,whereas six had been so at the time of acquisition.

The distinctiveness of U.S. company attitudes to acquisition was noted bythe MD of a U.K. company acquired by a U.S. (US10) company, who had alsoworked previously in a subsidiary of a German company:

So if I was to say what is the lesser of the two evils – is it the benign neglect of the Germansand the avuncular style of management and the helter skelter dynamics of the Americans– I would go for the American style quite frankly . . .

Even if individual preferences for particular styles of management must also beallowed for in the comment, this does illustrate the difference in approach ofcompanies from the two countries. However, the Americans are not alwaysteachers rather than learners. As the MD of a U.K. company put it:

The strategic planning group came to talk over the take-over. They’re not daft and theyrecognise that there’s been some learning on both sides which will help them in future tointegrate smaller companies in a way which will not destroy the flexibility and culture andentrepreneurial attitude but gives them what they need in terms of embracing core US8values, so they look at this as some form of role model for the future.

This suggests that, while U.S. companies can and do add value to theiracquisitions, they may, at least sometimes, take care not to stifle the advantageswhich are part of being a smaller company.

Japanese Companies

The Japanese acquirers were the least internationally experienced of the fourcountries (see Table 7). Most were large domestic companies seeking tobecome more international. In their selections of acquisitions, they boughtmore loss-makers than did the other nationalities (see Table 1). Despite this,their track record at improving performance was good. However, theircompany attitudes towards acquisitions, and to the implementation of changefollowing them, differed quite markedly from those of the other nationalitiesinvestigated. This is characterised by several distinctive features. The manner inwhich change was effected was much more by co-operative or indirect meansthan other countries.

Consistent with this low-key approach to managing subsidiaries, most ofthe initiatives for change among the companies interviewed came from thesubsidiaries themselves, rather than their Japanese parent companies. However,the support provided by the Japanese parent companies, particularly finance,


played a large role in making implementation of such subsidiary initiativespossible.

The economic condition of the companies acquired seems to have been of farless concern to Japanese companies than to companies of the othernationalities. Six out of the ten Japanese – owned companies interviewed weremaking losses at the time of purchase, and the other four were only close tobreak-even. This suggests that Japanese companies made their purchases morefor strategic reasons than short-term financial ones. A further factor may stemfrom the difference between U.K./European accounting practice and Japaneseaccounting practice in that there is less pressure on Japanese parent companiesto consolidate the accounts of their poorly performing foreign subsidiaries withtheir home accounts than for U.K./European companies, with the result thatJapanese companies have another reason to take a more relaxed and longerterm view of making their subsidiaries’ operations profitable (Tomohide,1998).

However despite these differences, Japanese companies do not seem to havebeen less successful in rendering previously unprofitable businesses profitable.Of the ten companies interviewed four had been helped into an acceptable level

Table 7. Japanese Acquisitions.


J1 Major national Small family company Engineering Lossescompany (L)

J2 Major national Ex-subsidiary of MNC Engineering Lossescompany (L)

J3 Major national Old branded company Household goods Lossescompany (L)

J4 Major MNC (M) National branded company Computers LossesJ5 Large domestic City merchant bank Banking Losses

bank (L)J6 MNC (H) Medium engineering Engineering Just profitable

companyJ7 MNC (H) National branded company Mens clothing Just profitableJ8 Major international Ex Danish subsidiary Polymers Losses

company (M) companyJ9 Major MNC (H) Old manufacturing company Engineering Just profitableJ10 Large national Old ex-subsidiary of US Pharmaceuticals Just profitable

family company (L)


of profit, three were just profitable and only three remained as loss-makersfollowing acquisition (see Table 1).

The critical difference was how that change was effected. Japanesecompanies intervened less and imposed their culture and systems on theirsubsidiaries far less than other nationalities. The MD of a U.K. companyacquired by a Japanese firm (J10) said of his firm’s acquisition:

When the acquisition took place J10 said ‘Well we know nothing about trading in theinternational market so therefore we’re not going to tamper with the organisation. You carryon with what you’ve been doing over the past 100 years’ . . . . It might have been better ifthere had been more integration, at least at an earlier stage. To this day there has been nointegration. It’s almost as if the companies are associates.

So far as initiation of change was concerned the subsidiary was frequently themain source of change (see Table 2) In only one case was a ‘changemaker’executive from Japan (J1) installed with the remit to shake up the newsubsidiary in the manner of a troubleshooting U.S. executive, and this seems tohave been a noticeably unsuccessful experiment. Generally, the method ofbringing about change was either by leaving it to the local team, with theJapanese parent company merely encouraging or setting an example, or bythe Japanese parent and subsidiary working closely in a joint team (seeTable 3).

The Japanese acquisitions also illustrated a point seen in the U.S. cases,which is that in any acquisition there is a balance to be struck between allowinga company the freedom to pursue it’s aims without interference from theparent, while also allowing it to benefit from the parent’s resources, such asfinance, technology and R&D, that it could take advantage of as a moreintegrated part of a larger group. In the case of the Japanese companies though,this balance sometimes erred towards a lack of integration. The MD of thecompany acquired by J2 said:

The Japanese financial director tells me what I need to know and I tell him what he needsto know and there is tremendous trust between us. If we had not been part of J2 we wouldnot be here today, but they had absolutely no international experience and so said whenthey arrived ‘we’re not going to change anything. Everything will remain the same.’

Of all the resources put into their subsidiaries by Japanese parents, financialassistance was the most significant. There were several examples of this, andthe help took several forms usually being in the form of guarantees or financefor investment. One was described by the MD of the U.K. subsidiary of a largeJapanese company (J08):

. . . the activities, when they were taken over by the Japanese were loss making and weneeded secure guarantees. We needed time and our credit rating wasn’t very good and


we got letters of comfort from our parent company which were accepted by the banks here,and because of our parent company’s massive involvement with Japanese banks we also gotfunding through these banks in London.

Japanese parent companies used their domestic financial muscle to improve thesubsidiary’s credit rating. As the MD of a Japanese owned U.K. merchant bank(J05) said:

The only resource they put in was money. Two major defensive injections. To give you anidea how bad it was the bank had capital of £30 million. Loan losses were £120 million.It lost all its capital four times over! But our Japanese parent bank have a Comfort Letterto the Bank of England as do all foreign owned financial institutions, which is a hugeadvantage to us, as we as a small bank have a higher credit rating than Rothschilds,Hambros and so forth, because we have a big brother shareholder. But the Japaneseproduce no actual business for us.

In many cases the amount of financial support and relaxed attitude to short-term performance surprised the U.K. managers as the MD of J6 said:

I’ve had a lot of dealings with companies like TI who measure cash-flow sometimes daily;yearly would be an innovation for J6, but that’s from one extreme to the other. Over theyears they have had a very, very long-term view.

Japanese parent companies provided substantial support services in only a fewcases. They were generally much less involved and more inclined to help wherepossible only from afar (cf. Table 4).

In terms of monitoring or change-making appointments Japanese companieshad a varied approach. They were the only nationality to make use ofmonitoring ‘advisors’ located in the subsidiary (see Table 5). Although theyonly appointed one MD outright, they frequently made senior appointmentwhile leaving the U.K. MD in position. They also often made junior trainingtype appointments, which also had some monitoring effect. However, the onlyoverall trend discernible in the appointments made was a reluctance to take thehelm, and take direct responsibility for the performance of the new subsidiary.The concept of a team approach was much more in the ascendant, and althoughit might take longer, was no less successful than more direct methods ofintervention.

German Companies

The German acquirers were very mixed in international experience, includingmajor German based MNCs and other large German companies with little suchexperience, but seeking to increase their international reach (see Table 8). Theywere equally mixed in the economic condition of their acquisitions at thetime of purchase (Table 1). However they consistently failed to turn around


their loss-maker. At the time of interview, the profitable companies werestill profitable, the break-even one still breaking even, and the loss-makers stillmaking losses.

It became apparent that German acquirers sometimes lacked the confidencethat their proven domestic management methods would translate effectivelyonto an international stage. Their actions tended therefore to be far from clear-cut and purposeful. The U.K. Chief executive of the German engineering parent(G02) of a Tyneside company said:

G2 are very long-term orientated, and that has been reflected in the culture. It is almost anadverse reflection as there is a casualness in attitude to losses. They don’t seem to view thisas seriously as we do in the U.K. where a loss is a serious matter. They are very traditional,isolated in terms of the world market place. The German market is different from the worldmarket. They are willing to let people find their feet. But they don’t bring a flow of benefits.They haven’t really tried to impose any particular industrial concepts or ways of workingon us.

There was little consistency in the area of the initiation of change. Among the10 cases investigated, the German company rarely took the lead (see Table 2).It might be possible to ascribe some of this apparent indecisiveness of Germanparent companies to their senior management and board structures, with theirtwo-tier governance system and/or collegiate philosophy (Lane, 1989). Thebenign neglect G10s subsidiary suffered was also an opportunity fordevelopment with the German company’s support. However, that support could

Table 8. German Acquisitions.


G1 Major MNC (M) Family company Pharmaceutical ProfitableG2 Large national Small regional company Engineering Losses

company (L)G3 Major Landesbank (H) City bank Banking Just profitableG4 Major MNC (H) Specialist manufacturer Hi-tech medical Just profitableG5 Major MNC (M) Truck agency Automobiles LossesG6 MNC (H) Small family company Fire security Just profitableG7 Medium national Small local company Furniture Losses

company (L)G8 Medium national Medium national Trailers Profitable

company (L)G9 Major MNC (H) Small family company Chemicals ProfitableG10 Domestic company (L) Small national company Construction Profitable


lead to complacency about the availability of support to bail the company outof any mistakes. As the MD noted:

It was a feeling that nobody actually cared much about us actually. I think our financialdirector would almost have welcomed being pressed more to be self- sufficient. It wasalmost a failing of the Germans to be as supportive as they were. . . . So it was a lack ofleadership from the top and thus of strategic planning.

Obviously if the U.K. subsidiary looked up to a German board for guidance itcould sometimes receive mixed advice as the MD of one U.K. firm found(G8):

We did look to them for guidance in the early day bearing in mind that they were theowners but their ability to make decisions was somewhat strange to say the least . . . . TheGerman company is just owned by three people all of whom are active in the business witha combined board of five people all of whom came over in the first few months to see theirnew acquisition. . . . to be totally honest all of their views totally differed.

However, whatever factors one might ascribe the indecisiveness to, whatperhaps distinguished companies which overcame such confusion was whetherthey treated it as a disadvantage to be endured or as an opportunity. The sameU.K. Managing Director for example having encountered a hydra-like Germanmanagement style decided to propose and pursue his own plans:

. . . So we sat down and said all right we know where we’ve been, we know what the U.K.market is, we know what to do. So we produced a five year business plan and rang themup and said look here.. would you like to see what we’ve got to say? [And they said] ‘that’sgood get on with it’ and that’s exactly what we did.

Just as in the case of Japanese companies, German companies foundindependence and integration both to have benefits requiring a balance to bestruck. As the U.K. MD of an engineering subsidiary (G06) said:

The number of changes have been pretty minimal and have happened through theirdecisions but after consultation. Numbers employed have actually gone down slightly. Thecompany’s position hasn’t changed much since the acquisition in either profits or sales.

A subsidiary often needs direction, and if this is not provided by the parentcompany, it has to be provided by the subsidiary management.

In common with most other nationalities and especially Japanese parentcompanies, German parents could be a particularly useful and generous sourcesof funds for their subsidiaries, often supporting them to such an extent thatwithout them the company would have ceased to exist (see Table 4).

However, when comparing all the companies studied in this investigation, itappears that for any acquired subsidiary to be a success it not only requiresfinancial support from its parent company, but also some idea about how that


support is going to be used, and about the longer term direction of the company.Just one or the other is insufficient. Moreover, while the ideas about how todirect the long-term future of the company can come from either the parent orthe subsidiary, if they come from neither, the acquisition will merely drift. Thisseems to be precisely what happened in the case of several of the Germanacquisitions studied. The acquisitions by German companies can thereforeperhaps be characterised by their generous financial but indecisive strategicsupport, and this is shown by the methods used to implement change.

In three of the companies interviewed, a ‘changemaker’ in the form of aGerman Managing Director for the new subsidiary was appointed. In one casechange came from Germany, where it was decided behind closed doors, butonly after consultation with the local management team. In the remainingcases, the subsidiary took advantage of the new stability that came from beingpart of a financially powerful group to carry out the necessary changesthemselves, often under the watchful eye of monitoring parent companyexecutives. However, in three companies very little change had occurred at all(see Table 3).

German companies were very varied in their response to new acquisitions interms of new staff appointments. In three cases they appointed a new MD, intwo cases they satisfied themselves merely with some senior appointments, andin two cases with some junior appointments. In four cases they made noappointments at all to the new subsidiary (see Table 5). This of course left thesuccess of the new subsidiary very much at the mercy of the incumbentmanagement, who could either use the opportunity to move on to greater thingsor drift in the state they were acquired in, kept afloat by the German parents’financial support. A final comment from the U.K. MD of case G4:

G4 put in some key personnel but left us well alone otherwise, as we are probably moresophisticated than G4 are. I don’t think we have learnt much from them, but they may havelearnt something about the flexibility of a small company, and what they need to do tobecome more flexible themselves.

French Companies

Most of the French acquirers in the sample were pretty experiencedinternationally (see Table 9) and had therefore developed a distinct style ofinternational management. They tended to buy already profitable companies, orstrategically important ones (see Table 1) which they were generally successfulat bringing into profit. From the interviews it appeared that French companieswere very self-confident in their approach to their new acquisitions. Indeedthey were liable to display a very ‘colonial’ attitude in a number of cases,


discussing proposed courses of action only with fellow Frenchmen. As the MDof the subsidiary of F4 put it:

The French hierarchy is a ‘power’ hierarchy, and it is the power that we find the mostdifficult to live with. They do have an arrogance and a dominance characteristic that onefinds very difficult . . .

There was little consistency in how the French acquirers handled their newsubsidiaries (see Table 2). Sometimes they initiated change unilaterally, and inone case they acted as the catalyst for change. However, in other cases thesubsidiary initiated the change process itself. In one case the process wasinitiated by both sides and in two cases there was little change to report at all.French initiators tended to discuss matters with other Frenchmen, and thenissue orders. But more often there was either a joint task force working onchange, or one composed of only local management. Perhaps the best way ofcharacterising the greater certainty regarding French companies’ attitude totheir subsidiaries is that they were more adamant that, either the subsidiary wasthere to represent the parent’s business, and had to deliver the performancerequired, or else that the direction was a matter which required closeinvolvement of French managers, seconded or appointed from the parentcompany. An example of the former attitude occurred in a French owned U.K.plastics company (F7) soon after the acquisition:

Table 9. French Acquisitions.


F1 Major MNC (M) 2 Small private companies Defence LossesF2 Large MN bank (H) City firm Banking LossesF3 Small Parisian City firm Banking Just profitable

bank (L)F4 Major domestic Domestic company Engineering Profitable

company (L)F5 Major MNC (H) Small domestic company Marketing Just profitableF6 MNC (H) IT consultancy company IT consultancy ProfitableF7 MNC (H) Brand name company Adhesives LossesF8 Major MNC (H) Regional company Water ProfitableF9 Family company (L) Ex-subsidiary of UK plc Pharmaceuticals ProfitableF10 Major MNC (H) 2 regional companies Water Profitable


The Technical director got up and . . . part way through his presentation . . . said to the table‘What do you want us to do?’ and there was a pregnant silence and the (French Co.)director paused, looked straight down the table and said ‘Monsieur if we have to tell youwhat to do we have the wrong people’ . . . . Certainly the French have questioned ourstrategies, but they have expected us to identify them and make them happen.

In effect the director was saying that it’s not for the parent company toinfluence the subsidiary, so much as for the subsidiary to run its part of theparent’s business, albeit with some monitoring.

The other attitude combined a more centralist but also independentapproach. It was favoured by a French pharmaceutical company (F9), andsummarised by the U.K. MD as:

The philosophy of my boss was to see the company as a standalone company, the wordingis affiliate rather than a subsidiary. That was a good initial aim but to be a bit critical, itdidn’t give us the leverage of being part of a bigger group.

This again brings us back to the independence-integration dilemma facingparent companies in dealing with their subsidiaries. The same MD recognisedthis as a problem inherent in an approach involving independence: “The way inwhich the business is being approached is interesting ‘the centre and severalself-sufficient satellites’ ”.

As with the other nationalities, French companies provided the stability offinance, credit support and sometimes some actual managerial and technicalsupport activities (see Table 4).

Apart from the view of French managers as centralist bureaucrats lookingdown on local managers, the picture of French companies’ attitude tointegrating their acquisitions is somewhat variable, and depends strongly onindividual company culture and specific circumstances. The attitude of Frenchcompanies to monitoring or bringing about change was also mixed. In threecases, they moved in by appointing a new MD and senior staff, but in six casesthey made no new appointments and in one appointed only juniors (see Table5). Thus while there is a noticeable tendency towards some elevated centralistapproach, this may not be incompatible with allowing subsidiaries a fair degreeof independence. As the MD of the U.K. subsidiary of F5 put it: “The Frenchare very autocratic. My boss feels he is the boss and he decides, yet at the sametime he doesn’t interfere with me.”

However, along with this centralist and combined attitude to independenceand integration the attitudes toward longer-term strategic investments provideda contrast with the American short-term profit expectations. As the U.K.Chairman of F2’s subsidiary put it:


The French are strategic to a fault. They were too tolerant of loss, much more than theBritish would have been. With this went a tendency to centralisation and bureaucracy and tofitting things into strategy.

CONCLUSIONS

As Hampden-Turner and Trompenaars (1994) show, the forms of capitalismand hence management practice vary substantially by nationality of acquirer,and national paradigms are evident. There is therefore likely to be a variety ofdifferent methods, at least partially nationality influenced, of integrating newacquisitions. It is even possible, as this research suggests, that there is no singlebest-practice way of treating a newly acquired company and getting goodperformance out of it.

The way in which individual acquirers behaved also depended in part not juston nationality, but also on the condition of the acquisition company at the timeof purchase, and the acquirer’s company culture and hence preferredmanagement methods. Thus, where an acquired company was in crisis, a moreinterventionist approach was adopted than in a company making acceptableprofits. Furthermore acquirers with little international experience tended to bemore tentative in their actions than major MNC acquirers.

However, there were discernible differences between approaches bycompanies of different nationalities, irrespective of the international experienceof the acquirer or the economic condition of the subsidiary.

The American acquirers made the most effort to ensure that their acquisitionswere profitable at the time of purchase. They then tended to absorb them intothe parent company systems and to demand rapid high performance. One wayor the other the U.S. absorptive management style usually achieved it, as at thetime of interview only two U.S. acquisitions were still making losses.

Japanese companies were less concerned to buy existing profitablecompanies, as their aims were more long-term than those of Americancompanies. They tended to be gentler in their treatment of their acquisitions,often acting primarily as a catalyst, rather than as an owner. They were the onlynationality to appoint ‘advisors’ to monitor events in the new subsidiary. Theirresults were no worse than those of American companies however. This wasremarkable given their relative international inexperience. Considering thebetter initial condition of the U.S. acquisitions, this co-operative and catalyticpost acquisition change style was generally very successful.

The French style tended to be ‘centralist’. They either appointed a newFrench MD and took decisions after discussions in France, or they left the localteam in day to day charge of operations but determined high level strategy at


headquarters. This contrasts somewhat with Calori, Lubatkin and Very’s (1994)experience that the French tended to exercise high formal control of bothstrategy and operations. The French approach was generally effective.

German companies were less successful or certain in their methods. Therewas no discernible German method of change-making, as their actions variedfrom appointing an MD and giving orders to leaving well alone and hoping forthe best. This eclectic, perhaps unfocussed and largely non-interventionistapproach achieved no turnarounds in their troubled acquisitions, but main-tained profit in their profitable ones. In line with Whitley’s (1992) thesis,institutional factors may have played a role in inhibiting leadership, particularlythe dual board system, but this does not seem an adequate explanation for theirpoor performance.

In a qualitative study conducted through interviews with British managers, itis possible to do no more that identify some hypotheses for future research. Inour view, some of the most interesting hypotheses that might usefully besubjected to further testing are the following:

(1) The national origin of the acquirer has significant impact on themanagement methods adopted in integrating a newly acquired company.

(2) No one method of treating a new subsidiary is consistently more effectivethan another in achieving superior performance, but the confidence of theacquirer in adopting a particular method consistently is an importantsuccess factor.

(3) The U.S. are typically ‘absorbers’, the Japanese ‘preservers’ or, symbiosi-sists’, the French ‘colonialists’ while the Germans lack a clear integrationstyle.

(4) U.S. acquirers seek short-term profits and hence tend to buy alreadyprofitable companies.

(5) The Japanese, French and Germans take a longer-term strategic outlook,and are thus less concerned with their acquisition’s current profitability.

The overall conclusion from the study is that clear national differences inapproach to post-acquisition change do exist. Furthermore, it appears from ourobservations that there is no clear best practice for improving performancefrom an acquired company, but that self-confidence (otherwise described as’Leadership’ cf. Olie, 1994) on the part of the acquirer in its preferred methodof integration is perhaps the most important factor, as this transfers to thesubsidiary a belief that it is in the hands of a ‘winner’ and leads to consequentlyenhanced motivation and ultimately performance.


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MANAGERIAL PREFERENCES ININTERNATIONAL MERGER ANDACQUISITION PARTNERS REVISITED:HOW ARE THEY INFLUENCED?

Susan Cartwright and Fionnuala Price

ABSTRACT

Cross border mergers and acquisitions (M&As) are an integral part ofinternational business. Although M&A activity is predominantly driven bya rational-economic model, cultural attitudes are likely to play a role ininfluencing selection decisions and management integration practices.This Chapter reports on a study to establish whether different nationalmanagerial groups (n = 480) have similar/dissimilar attitudinal prefer-ences towards M&As with foreign partners. Comparisons are made withan earlier study.

INTRODUCTION

The dollar value of completed mergers, acquisitions and divestitures worldwidein 2000 increased by almost 25% to more than $1.7 trillion, and set a record forthe sixth consecutive year. A significant trend in the recent pattern of mergerand acquisition (M&A) activity has been the increase in foreign acquisitions.

Whilst the USA continues to be a major acquirer of overseas companies, thevalue of these deals during the period 1991–2000 was significantly less than


81

the level of investment flowing into the U.S. in terms of foreign acquisitions ofU.S. companies. In 2000 alone, over a thousand U.S. companies were acquiredby overseas buyers at a value of $340 billion. In contrast, a little over 2,000U.S. companies were bought by foreign acquirers in a ten year period between1978–1988.

The U.K. has similarly seen an increase in inward foreign direct investment,mainly from the USA, Japan, Germany and France (Child et al., 2000). In1996, foreign acquisitions of U.K. companies exceeded the combined totalvalue of all other European Union countries (KPMG, 1997). It would seem thatlike their U.S. counterparts, U.K. companies are both highly acquisitive and atthe same time, extremely attractive acquisition targets.

The global trend in M&A activity is further supported by the increasingnumber and value of cross border deals in Europe (see Table 1 below).

Cross border deals represent a significant and growing aspect of globalM&A activity far exceeding domestic deals in terms of average value andrepresenting an increasing proportion of the total value of all deals done acrossthe world – 41% in 2002; compared to 24% in 1996 (KPMG, 2000).

The underperformance of M&As continues to be the focal point of muchdebate and attention. Estimates of M&A failure range from 80% (Marks, 1988)to 50% (Hunt, 1988; Weber, 1996; Cartwright & Cooper, 1997) thusemphasising the notion that M&As invariably do not deliver what is expectedin terms of increased profitability or economies of scale. Whilst overall somesectors, e.g. banking and insurance, tend to record higher success rates thanothers in terms of enhanced shareholder value, the success of a few top

Table 1. Cross Border Deals in Europe 1991–2000.

Year No. of Deals Value ($ billion)

1991 1,097 24.01992 1,030 36.21993 875 28.91994 1,096 38.91995 1,372 52.91996 1,294 50.61997 1,422 87.81998 1,602 146.21999 2,236 312.42000 2,422 526.7

Source: Mergers and Acquisitions, 2001.

82 SUSAN CARTWRIGHT AND FIONNUALA PRICE

performers often masks the failure of the majority (Financial Times, August2000). According to a recent report (KPMG, 2000), 83% of recent deals failedto deliver shareholder value and an alarming 53% actually destroyed value. Thereport concludes that underperformance is the outcome of excessive focus on“closing the deal” at the expense of focusing on factors that will ensure itssuccess.

Hussey (1998) also cautions organisations to explore in detail the widerimpact of strategies before committing to any strategic decision to acquire.According to Hussey, acquisition failure can be the outcome of any one or moreof three failures of analysis: a misconceived action, failure to think through andimplement actions that will enable the acquisition to deliver the intendedbenefits or financial over-extension. In the context of both domestic andinternational M&As, strategic fit is obviously an important consideration intarget identification. However, the recognition of synergistic potential, it wouldseem is no guarantee that it will be realised, particularly if there is a lack ofcultural fit.

When Daimler and Chrysler merged in January 1999, the event was heraldedas the biggest ever auto merger and the year’s smartest deal (Fortune, January1999). As the partners’ markets scarcely overlapped the strategic fit wasperfect. Yet, despite the synergistic potential, within two years the combinedcompany was worth less than Daimler Benz was before the merger and thehostile relationships between the U.S. and German management groups werewidely reported in the business press (The Economist, 13 December 2000).Clearly, the challenges of marrying the entrepreneurial style of a U.S. businesswith the conservatism of a German company proved more difficult than wasexpected (Schoenberg, 2000). Experiences such as this serve to emphasise theimportance of partner or target selection based on additional and differentcriteria from traditional practice (Jemison & Sitkin, 1986), particularly thepotential problems of cultural integration.

As the level of international M&A activity has increased there has been aparallel growth in the management literature on the influence of nationalculture on M&A integration and outcomes, and to a lesser extent on the issueof partner/target selection.

In a recent review of the literature on cross border acquisitions, Schoenberg(2000) observes that research studies confirm theoretical reasoning that therelative national cultures influence the eventual outcome of an internationalacquisition. Although the interaction of organisational cultures cannot beignored (Larsson & Risberg, 1998), it has been argued that cross bordercombinations between organisations with similar corporate cultures may not besufficient if the national cultures conflict. Consequently, it has been proposed

83Managerial Preferences in International Merger

that the challenge for leadership in cross border M&As is to successfullyaccommodate and integrate both national and organisational cultures – i.e. toaddress what has been termed the “double-layered acculturation process”(Nahavandi & Malekzadeh, 1998).

In the context of international business more generally, Zarkada-Fraser(2001) draws attention to the potential influence of national stereotypes oninternational relationships and decision-making. Many studies (Diamantopou-los et al., 1995; Tse et al., 1996; Zang, 1996) have demonstrated the extent towhich consumer purchase decisions are influenced by country-of-origin (COO)or product country image (PCI) effects. The evaluative nature of stereotypingis considered to be a significant barrier to international understanding and co-operation (Klineberg, 1964). Importantly, as a frame of reference, theemotional nature of stereotypes can often override logic and lead to irrationaldecisions.

By their very nature, cultural stereotypes are a condensation of reality in thatthey simplify and over-generalise the characteristics of a societal group. In theabsence of detailed knowledge and direct experience of a potential mergerpartner or acquisition target, stereotypes offer a means of reducing thecognitive complexity of a decision. It has been suggested (Cooper & Kirkcaldy,1995) that the selection of suitable international partners or collaborators isinfluenced, in part, by cultural stereotypes. This chapter reports on recentresearch conducted amongst senior-middle managers to investigate whetherdifferent national managerial groups have similar/dissimilar attitudinal prefer-ences toward foreign M&A partners. In replicating an earlier study based ondata collected in 1994 (Cartwright, Cooper & Jordan, 1995) it examines theextent to which attitudes may have changed in light of the continued growth ininternationalisation.

ACCULTURATION AT THE NATIONAL LEVEL:DISTANCE AND ATTRACTIVENESS

National or societal culture is a pervasive influence on the attitudes andbehaviour of its members. The national culture in which an organisationoperates will to a greater or lesser extent influence the values, strategy,behaviours and style of work organisation that companies will adopt (Hofstede,1980). Ethnocentrism is identified by many studies as a barrier to internationalmanagement (Cartwright & Cooper, 1996; Hodjetts & Luthans, 1994) and isdefined as a belief that one’s way of doing things is superior to that of others.This perspective invokes cultural stereotyping and presents potential obstacles


to the effective integration of diverse national cultures in an internationalbusiness context, particularly when the goal of many M&As is to assimilatethe acquired or smaller partner into the dominant culture. Stereotypingcan influence the way in which we interpret and classify behaviour wehave observed and how subsequently we recall that behaviour, i.e. it candetermine what we select to notice in the first place and hence what we laterremember. Stereotypical attitudes are enduring and difficult to displace becauseof our tendency to focus on information and behaviours which reinforce ourstereotype and discount, as exceptional, that which is inconsistent.

Many years ago, Dunning (1958), in a study of U.S. investment into Britishmanufacturing companies identified the tendency of foreign parents to imposetheir management principles and practices on their acquisitions – what istermed the “foreign practice effect”. Traditionally, the U.S. has preferredoutright acquisition to merger or joint venturing. Jaeger (1983) also found anational culture pattern in ways in which organisations manage their crossborder acquisitions. More recent evidence (Child et al., 2000) supports thisforeign practice effect. In a study of over 200 U.K. acquisitions by U.S.,Japanese, German, French and U.K. companies, it was found that the veryprocess of being acquired led to significant changes in management practices,particularly towards more performance-related rewards. However, foreignacquired companies tended to experience a wider range of changes thandomestically acquired firms. Interestingly, U.S. and French acquirers exertedmore influence than Japanese or German acquirers. Furthermore, the Frenchand German management approach did not conform to the accepted view ofnational management practice.

In terms of selecting a compatible foreign merger partner or acquisitiontarget, Larsson and Risberg (1998) note that organisations tend to prefer toinvest in neighbouring territories or those with which they have the closesteconomic, linguistic and cultural ties. Schoenberg (2000) suggests thatattractiveness in international M&As can be viewed in terms of culturaldifferences as well as cultural similarities. Whilst differences can lead togreater acculturation stress and integration difficulties, cultural differences donot necessarily result in negative outcomes. In a study of 129 European crossborder acquisitions Schoenberg and Norburn (1998) found that only differencesin cultural attitudes towards risk negatively impacted on acquisition perform-ance. In contradiction to Child et al. (2000), other researchers (Larsson &Risberg, 1998) have argued that cultural differences at the national level do nothave such a negative impact as differences at the organisational level indomestic M&As, because there is a greater awareness and appreciation of


national culture differences and a greater tolerance for multi-culturalism. Inparticular, a number of studies (Very et al., 1997; Calori, Lubatkin & Very,1994; Cartwright & Cooper, 1993) have found irrespective of nationality if thebuyer’s culture is perceived as being relatively less controlling then it is morelikely to be perceived as being more attractive.

The issue of compatibility of national cultures is frequently discussed andstudied within the framework of Hofstede’s (1980) and Trompenaars’ (1993)classifications. The country indices for Power Distance, Uncertainty Avoid-ance, Individualism and Masculinity developed by Hofstede have provided ameans of representing cultural distance between collaborating companies.Most research studies on M&As have tended to focus on the dimensions ofPower Distance and Uncertainty Avoidance with equivocal results (Schoen-berg, 2000).

Very, Lubatkin and Calori (1998) incorporated all four dimensions into theirstudy of the performance of U.K. and French mergers and found that Frenchcompanies acquired by the British performed significantly poorer thandomestic acquisitions. However, overall the results were not straightforward,making it difficult to generalise.

The results of the survey conducted in 1994 (Cartwright, Cooper & Jordan,1995) on which the following study is based, found that the mainly NorthernEuropean sample of managers showed stronger preferences for merging withother Northern European and American organisations. In addition, they rankedJapan, Italy and Spain amongst their least preferred partners. In terms ofHofstede’s (1980) classification, Northern European countries and the USAtend to cluster in terms of their orientation towards “individualism” as opposedto “collectivism” which is highly characteristic of both Japan and Spain.Furthermore, the preferences expressed were found to map the pattern of actualM&A activity during the previous year.

Individualism pertains to societies in which ties between individuals areloose and where an individual is expected to look after his or herself and theirown immediate family. Typically, the concept of “I” and short-term individualself-interest dominates over the wider and longer term implications of “we”. Incontrast, collectivism pertains to societies in which individuals from birthonwards are integrated into strong cohesive groups, which throughout theirlives, continue to protect them in exchange for loyalty.

In a business context, this translates into very different employer-employeecontracts and attitudes towards organisational relationships. In highlyindividualistic cultures like the USA and the U.K., this contractual relationshipbetween employer-employee is based on supposed mutual advantage and


reciprocal exchange. Similarly, partnerships between organisations arepredominantly founded on the opportunity to capitalise on a situation ofimmediate strategic advantage irrespective of the quality of the interpersonalrelationship between the partners. In collectivist cultures like Japan, the rela-tionship between employer-employee is more familial and developmental witha heavier moral foundation and more linear approach to career progression.Decisions about interorganisational collaborations are carefully and extensivelyconsidered with the focus as much on the trust and ongoing quality of therelationship between the parties as the potential strategic advantage.

As individualism is strongly linked to the capitalist system, M&A activity isvery “individualistic” in cultural orientation.

This apparent tendency of managers to prefer national cultures which are tobe perceived to be “more like us” suggests that M&A selection decisions maybe influenced by an underlying desire to reduce cultural differences and avoidcultural distance. However, increased globalisation and an expansion ininternational management education may lead to a greater acceptance andappreciation of the potential value of cultural differences.

METHODOLOGY

The questionnaire which formed the basis of this study was adapted from the1994 survey and consisted of three parts:

(i) Biographical/organisational information: items relating to nationality ofrespondent, nationality of parent company, organisational activity, sizeand experience of M&A.

(ii) Attitudinal preference – this section invited respondents to place in rankorder (1–3) their preferred/least preferred choice of foreign merger partneror acquirer and the rationale for their choice.

(iii) Compatibility – this section required respondents to indicate whichforeign country they considered was most/least compatible in terms ofmanagerial style. In addition, data was collected on managerial expecta-tions concerning their organisation’s future involvement in M&A activityover the next three years.

Following negotiation with airport authorities at a major international U.K.airport, access was granted to the Executive lounges over a two week periodduring summer 2001. During this period questionnaires were distributed and


collected from business passengers awaiting flights. A total of 480 ques-tionnaires were collected and analysed using SPSS for Windows.

RESULTS

Biographical and Organisational Information

Completed questionnaires were returned by 22 different nationalities. Themajority of respondents were Northern European. Not surprisingly, given thatthe data were collected at a U.K. airport, 45% of the sample was British(n = 217). Swedish managers comprised 11% (n = 54) of the sample as didDutch managers (n = 51), with U.S. managers (n = 24) and Irish managers(n = 24) both accounting for 5% of the sample.

The majority of the sample worked for British (25%) or Americanorganisations (24%). As the majority of the sample (66%) worked fororganisations whose nationality was different from their own, the sample couldbe satisfactorily described as being international.

Almost three-quarters (72%) worked for very large organisations with over1,000 employees and in the main described their responsibilities as being in thearea of strategy (34%) or operations (48%). Their organisations represented abroad spectrum of industries including manufacturing, pharmaceuticals,telecoms, healthcares, energy and financial services.

As Table 2 illustrates, the respondents were representative of organisationsthat were highly active in M&As and were particularly acquisitive. Over halfhad acquired another organisation and one-third had merged during the last fiveyears.

Furthermore, 62% indicated that it was likely/extremely likely that theywould make further acquisitions within the next three years. In the same period

Table 2. Type of Activity in Which Organisation Had Been Involved Duringthe Last 5 Years (1996–2001).

No. %

Merged 153 32Acquired another organisation 276 58Been taken over 69 14Target of an unsuccessful bid 33 7Party to a joint venture 145 30Entered some other form of strategic alliance 159 33


86% indicated that they expected to become involved in joint ventures/strategicalliances, while 20% expected to merge. Compared with 1994 data, the patternindicates a further significant increase in M&A activity.

Attitudinal PreferencesTable 3 shows the overall and highest ranking ‘preference dimension’ choicesfor each of the analysed nationalities. This analysis was restricted to nationalgroups which contained at least 10 respondents.

It is notable that the total sample selected the U.S. as the most popular (28%)1st preference, with the U.K. being a close second (25%). Forty-seven percentof German respondents chose their own nationality, a similar percentage ofU.S. respondents (46%) also chose their own nationality; with 40% of U.K.respondents choosing their own nationality. All these respondents werecurrently working for organisations of different national parentage to theirown.

In 69% of cases the reasons given for their choices was perceived culturalcompatibility, which was cited as being at least four times as important asmarket potential or management approach.

Finally, an analysis was conducted to investigate the combined frequency ofthe 1st, 2nd and 3rd ranking. The results found that the U.S. remains the mostpreferred merger choice for the total sample (18%) with the U.K. again a closesecond (16%). However, the France (4%), German (10%) and Switzerland(5%) also entered the rankings.

Table 4 shows the least preferred choices of merger partner or acquirer forthe overall sample and the subset of national groups. While Japan emerged asthe least preferred choice for the overall sample and the nationality subsets, itis interesting to consider the second preferences which tend to mirror the 1994survey data.

Table 3. Most Preferred Merger Partner or Acquirer.

No. of Cases 1st Preference

Total Sample 480 U.S.USA 24 U.S.U.K. 217 U.S.Danish 19 U.S.Dutch 51 U.S.German 15 GermanIrish 24 U.S.Swedish 54 U.K.


A range of issues relating to incompatible culture and differences in workingpractices, e.g. lack of directness, slow decision-making, dominate the reasonsgiven by respondents in choosing Japan.

Further analysis was conducted to investigate the combined frequency of the1st, 2nd and 3rd rankings. The results found that Japan remained the leastpreferred partner followed closely by France and Italy.

Finally, the results were examined using the country indices for the fourdimensions developed by Hofstede (1980). Table 5 relates to the PowerDistance dimension.

The data shows a uniform clustering of nationalities choosing either theirown nationality (hence an identical power distance rating) or nationalities withvery similar positions on the Power Distance Index. It is notable that Danishmanagers expressed a preference for merging or being acquired by a national

Table 4. Least Preferred Merger Partner or Acquirer.

No. ofCases

LeastPreferred

2nd LeastPreferred

Total Sample 480 Japan FranceUSA 24 Japan FranceU.K. 217 Japan FranceDanish 19 Japan FranceDutch 51 Japan Italy/FranceGerman 15 Japan FranceIrish 24 Japan IrelandSwedish 54 Japan Italy/USA

Table 5. Power Distance.

SubsetNationality

PowerDistance

1stPreference

PowerDistance

U.S. 40 U.S. 40U.K. 35 U.K. 35Danish 18 U.S. 40Dutch 38 U.S. 40German 35 German 35Irish 28 U.S. 40Swedish 31 U.K. 35


culture which is associated with rather more formality and greater powerdistance. However, Danish culture scores very low on this dimensioncomparative to most other countries. It is notable that the Power Distance Indexfor Japan, the least preferred nationality, is 54 which is very much higher thanthe nationalities sampled.

Table 6 presents the results in terms of the Individualism/Collectivismdimension.

In the context of partner preference the results support the notion that thereis a cultural attraction amongst countries which are high on individualism andan avoidance of highly collectivist cultures such as Japan which has a score of46 on this index.

Table 7 compares the results in terms of the Masculinity/Femininitydimension.

Table 6. Individualism/Collectivism.

SubsetNationality

Individualism/Collectivism Index

1stPreference

IndexScore


Table 7. Masculinity/Femininity.

SubsetNationality

Masculine/Feminine Index

1stPreference

IndexScore



The countries represented in the sample differ significantly in theirorientation on this dimension. Denmark, The Netherlands and Sweden are allregarded as feminine cultures which place a high value on relationships, caringand the quality of life. In contrast, the USA, U.K. and Germany are consideredto be high on masculinity, although Japan is the most “macho” culture with ascore of 95.

Table 8 relates to the Uncertainty Avoidance dimension. Low scores areindicative of a greater propensity to tolerate uncertainty and to take risk. Withthe exception of Germany, all the countries represented in the sample areconsidered to be relatively high risk takers. In contrast, Japan has an extremelyhigh Uncertainty Avoidance index of 92 and is risk averse preferring to plancarefully and take a longer-term perspective.

SUMMARY AND CONCLUSIONS

Over the last decade, considerable effort has been expended in increasing theawareness of both researchers and practitioners to the importance of humanfactors in M&As. Certainly the potential importance of culture is increasinglyrecognised as a factor which influences M&A integration and subsequentoutcomes. However, the complex interplay between national and organisationalculture and its level and direction of influence is still perplexing in light of thecurrent and still limited research evidence. Rather than focussing on theinherent characteristics of different national cultures, it may also be fruitful tofocus more on their inherent attitudes and strategies towards M&A activity andtheir level of cultural tolerance. For example, it is feasible to hypothesise thatsome cultures may be more inclusive and less ethnocentric than others.

It has been argued that better M&A outcomes could be achieved if moreattention was paid to culture at the selection stage. In the context of

Table 8. Uncertainty Avoidance.

SubsetNationality

Uncertainty/Avoidance Index

1stPreference

IndexScore



international M&As, culture may already influence partner selection decisions.The results of this study show that, given a choice, managers would choose tomerge or be acquired by a foreign national culture which they perceive to besimilar and hence compatible with their own, and are highly avoidant ofcultural distance.

The evidence of this study suggests that managerial attitudes have changedlittle over the last 7 years or so. The highly individualistic cultures of the USA,U.K. and Northern Europe tend to prefer to enter M&As with each other ratherthan with Southern European or Japanese partners. Perhaps because as highlyindividualistic cultures, they are perceived more likely to recognise and acceptthe instrumentality of a merger or acquisition and are more familiar, so tospeak, with the “rules of the game”. This study is based on a limited sample ofEuropean nationalities. It would be interesting to conduct a similar study witha sample drawn predominantly from more collectivist cultures.

It is impossible to determine to what extent the decisions made by themanagers in this study were influenced by cultural stereotypes, managementeducation (e.g. exposure to Hofstede’s theories) or direct experience. Withoutdoubt, management educators and researchers have a role to play in influencinginternational management practice. Consequently, there is a pressing need forfurther research in this area. Existing studies have heavily relied upon theHofstede (1980) model of national culture despite its acknowledged limitations(Very et al., 1998). Although not a direct replication, the later work ofTrompenaars (1993) suggests that the relative position of some countries,particularly the developing economies, in respect of certain dimensions mayhave shifted over time. Therefore, it may be an appropriate time to conduct alarge-scale study to review and possibly revise the index scores. Alternatively,it may be helpful to develop new cultural measures specifically tailored for usein M&A research.

REFERENCES

Calori, R., Lubatkin, M., & Very, P. (1994). Control mechanisms in cross border acquisitions: Aninternational comparison. Organisation Studies, 15, 361–379.

Cartwright, S., & Cooper, C. L. (1997). Managing mergers, acquisitions and strategic alliances:interpreting people and cultures. Oxford: Butterworth Heinemann.

Cartwright, S., Cooper, C. L., & Jordan, J. (1995). Managerial preferences in international mergerand acquisition partners. Journal of Strategic Change, 4, 263–269.

Child, J., Faulkner, D., & Pitkethly, R. (2000). Foreign direct investment in the U.K. 1985–1994:The impact on domestic management practice. Journal of Management Studies, 37(1),141–167.


Cooper, C. L., & Kirkcaldy, B. D.(1995). Executive stereotyping between cultures: The British vs.German manager. Journal of Managerial Psychology, 10(1), 3–6.

Diamantopoulos, A., Schlegelmilch, B. B., & Preez, J. P. (1995). Lessons from pan-Europeanmarketing? The role of consumer preferences in fine-tuning the product-market fit.International Marketing Review, 12(2), 38–52.

Dunning, J. H. (1958). American investment in British manufacturing industry. London: Allen &Unwin.

Hodgetts, R. D., & Luthans, F. (1994). International management (2nd ed.). New York: McGraw-Hill.

Hunt, J. (1988). Managing the successful acquisition: A people question. London Business SchoolJournal, (Summer), 2–15.

Hofstede, G. (1980). Cultures consequences: International differences in work-related values.Beverly Hill CA: Sage.

Hussey, D. (1998). Strategic management: Past experiences and future directions. In: D. Hussey(Ed.), The Strategic Decision Challenge. Chichester: John Wiley & Sons Ltd.

Jemison, D. B., & Sitkin, S. B. (1986). Acquisitions: The process can be a problem. HarvardBusiness Review, 60(6), 109–121.

Klineberg, O. (1964). The human dimension in international relations. New York: Holt, Rinehart& Winston.

KPMG (1997). Mergers and acquisitions A global research report – unlocking shareholder value:the keys to success. Amsterdam: KPMG.

KPMG (2000). Dealwatch. Amsterdam: KPMG.Larsson, R., & Risberg, A. (1998). Cultural awareness and national vs. corporate barriers to

acculturation. In: M. C. Gertsen, A-M. Søderberg & J. E. Torp (Eds), Cultural Dimensionsof International Mergers and Acquisitions. Berlin: Walter de Gruyter.

Marks, M. L. (1988). The merger syndrome: The human side of corporate combinations. Journalof Buyouts and Acquisitions, (Jan/Feb), 18–23.

Nahavandi, A., & Malekzadeh, A. R. (1998). Leadership and cultural transnational strategicalliances. In: M. C. Gertsen, A-M. Søderberg & J. E. Torp (Eds), Cultural Dimensions ofInternational Mergers and Acquisitions. Berlin: Walter de Gruyter.

Schoenberg, R., & Norburn, D. (1998). Leadership compatibility and cross border acquisitionoutcome. Paper presented to 18th Annual Strategic Management Society. InternationalConference, Orlando.

Schoenberg, R. (2000). The influence of cultural compatibility within cross-border acquisitions: Areview. In: C. L. Cooper & A. Gregory (2000). Advances in Mergers and Acquisitions(Vol. 1). New York: JA1.

Trompenaars, F. (1993). Riding the waves of culture. London: Economist Books.Tse, A., Kwan, C., Yee, C., Wah, K., & Ming, L. (1996). The impact of country-of-origin on the

behaviour of Hong Kong consumers. Journal of International Marketing and MarketingResearch, 21(1), 29–44.

Very, P., Lubatkin, M., Calori, R., & Veiga, J. (1997). Relative standing and the performance ofrecently acquired European firms. Strategic Management Journal, 18, 593–614.

Very, P., Lubatkin, M., & Calori, R. (1998). A cross-national assessment of acculturative stress inrecent European mergers. In: M. C. Gertsen, A-M. Søderberg & J. E. Torp (Eds), CulturalDimensions of International Mergers and Acquisitions. Berlin: Walter de Gruyter.

Weber, Y. (1996). Corporate culture fit and performance in mergers and acquisitions. HumanRelations, 49(9). 1181–1202.


Zang, Y. (1996). Chinese consumers’ evaluation of foreign products: The influence of culture,product types and product presentation format. European Journal of Marketing, 30(12),50–68.

Zarkada-Fraser, A. (2001). Stereotyping in international business. In: C. L. Cooper, S. Cartwright& P. C. Early (Eds), The International Handbook of Organizational Culture and Climate.Chichester: John Wiley & Sons.


VALUE CREATION IN LARGEEUROPEAN MERGERS ANDACQUISITIONS

Marc Goergen and Luc Renneboog

ABSTRACT

In this paper, we analyse the short-term wealth effects of large(intra)European takeover bids. We find large announcement effects of 9%for target firms, but the cumulative abnormal return that includes the pricerun-up over the two-week period prior to the event rises to 20%. The shareprice of the bidding firms reacts positively with a statistically significantannouncement effect of only 0.7%. We also show that the type of takeoverbid has a large impact on the short term-wealth effects of target andbidder shareholders with hostile takeovers triggering substantially largerprice reactions than friendly mergers and acquisitions. When a U.K. targetor bidder is involved, the abnormal returns outperform those ofContinental European bids. We also find strong evidence that the meansof payment in an offer has a large impact on the share price reactions. Ahigh market-to-book ratio of the target leads to a higher bid premium buttriggers a negative price reaction for the bidding firm. Bidding firmsshould not further diversify by acquiring target firms that do not match thebidder’s core business. We also investigate whether the predominantreason for takeovers is synergies, agency problems or managerial hubris.We find a significant positive correlation between target shareholder gainsand total gains for the merged entity as well as between target gains and


97

bidder gains. This suggests that synergies are the prime motivation forbids and that targets and bidders tend to share the resulting wealthgains.

1. INTRODUCTION

The clustering of mergers and acquisitions through time is a strikingphenomenon. The first European merger wave started approximately in 1880and ended in 1904. It was fuelled by the industrialisation started by thediscovery of the steam engine. The prime incentive for these mostly horizontalmergers was the creation of monopolies. The introduction of anti-trustlegislation played an important role in the second merger wave which startedin 1919 and continued throughout the 1920s. The old monopolies were brokenup and mergers and acquisitions were used to achieve vertical integration. Thethird merger wave started in the 1950s, but reached its peak only in the mid-1960s. The focus turned towards diversification and the development of largeconglomerates to face global markets. The development of new financialinstruments and markets (e.g. the junk bond market) facilitated the financing ofacquisitions and led to the fourth wave (1983–1989) which was fuelled bytechnological progress in biochemistry and electronics. The fifth M&A waveemerged in the 1990s (1993–2000) and went hand in hand with a longeconomic boom period, stock exchange development and the growth in theinternet- and telecommunications industries. In 2001, the collapse of consumerconfidence in these industries as well as the overcapacity in the traditionalsectors caused an abrupt reduction in merger activity.

Over 1993, the total dollar value paid for target firms in the U.S. and Europedoubled after 4 consecutive years of reduction in M&A activity. A sharp risecould be observed as of 1996: the total value of U.S. and European acquisitionsrose to USD 1,117 million (with Europe accounting for 37%). In the followingyears the M&A wave gained even more strength with a value of USD 1,574million in 1997 (35% of which was realised in Europe), USD 2,634 million in1998 (33% in Europe), USD 3,319 million in 1999 (47% in Europe), USD3,451 million in 2000 (43% in Europe). The year 1999 was not only aremarkable year, because the European M&A market was now almost as largeas the U.S. market or because 12% of the total value was accounted for by dealsin excess of USD 100 billion, but also because an exceptionally high numberof hostile takeovers took place in Europe. There were 369 hostile bids inEurope in 1999 compared to only 14 in 1996, 7 in 1997, 5 in 1998 and 35 in2000.1

98 MARC GOERGEN AND LUC RENNEBOOG

In this paper, we aim at investigating the wealth effects within the majormergers and acquisitions wave of the 1990s. We have chosen 1993 as thestarting year for the following two reasons. First, it is the first year with asubstantial increase in M&A activity since 1989. Second, the Maastricht Treatyof 1992 cleared the way for a European Monetary Union culminating in theintroduction of a single currency in 1999. As most of the M&A researchconcentrates on the U.S. and U.K. markets and most studies concentrate onM&As in one single country, we believe that a European study will yieldinteresting results. The paper is organized as follows: Section 2 summarises themain findings of previous studies on mergers and acquisitions. Section 3describes the data sources, variables and methodology. Section 4 investigatesthe short-term wealth effects for target and bidder firms of mergers, friendlyacquisitions and hostile takeovers. A correlation analysis in Section 5 shedssome light on the type of takeover motives. Section 6 then analyses thedeterminants of the market price reactions to M&A announcements andSection 7 concludes.

2. THE DETERMINANTS OF BIDDER AND TARGETRETURNS IN THE LITERATURE

The literature on the wealth effect of M&A announcements for targetshareholders is unanimous: these shareholders receive an average premiumwithin the 20 to 30% range over and above the pre-announcement share price.For the 1960s to 1980s, Jarrell and Poulsen (1989), Servaes (1991), Kaplan andWeisbach (1992), for instance, report average U.S. target share price returns of29% for 1963–1986, 24% for 1972–1987 and 27% for 1971–1982, respec-tively. In the 1990s, the U.S. abnormal announcement returns remained at asimilar level of 21% (Mulherin & Boone, 2000). In contrast, there is littleconsensus about the announcement wealth effects for the bidding firms. Abouthalf of the studies report small negative returns for the acquirers (see e.g.Walker, 2000; Mitchell & Stafford, 2000; Sirrower, 1994; Healy, Palepu &Ruback, 1992) whereas the other half finds zero or small positive abnormalreturns (see e.g. Eckbo & Thorburn, 2000; Maquiera et al., 1998; Schwert,1996; Loderer, 1990). Considering that the average target is much smaller thanthe average acquirer, the combined net economic gain at the announcement ispositive, albeit very small.

The M&A literature has discovered a variety of profitability drivers. First,the announcement of tender offers and hostile takeovers generates higher targetas well as bidder returns than the announcement of friendly mergers oracquisitions (see e.g. Gregory, 1998; Loughran & Vijh, 1997; Lang et al.,

99Value Creation in Large European Mergers and Acquisitions

1989). Second, when the bidding management owns large equity stakes,bidding firms obtain higher returns (see e.g. Healy et al., 1997; Agarwal &Mandelker, 1987). This suggests that managers are more likely to undertakevalue-destroying mergers, if they do not own equity in their firm. Third, all-cash bids generate higher target and bidder returns than stock-for-stockacquisitions (see e.g. Yook, 2000; Franks & Harris, 1989; Franks et al., 1988;Huang & Walking, 1989). The announcement that the takeover will be paidwith equity may signal to the market that the bidding managers believe thattheir firm’s shares are overpriced. This is in line with the fact that managerstime the issues of shares to occur at the high point of the stock market cycle.Fourth, acquiring firms with excess liquidities destroy value by overbidding.Several papers show evidence that free cash flow (Jensen, 1986) is frequentlyused for managerial empire-building purposes (see e.g. Servaes, 1991; Lang etal., 1991). Fifth, corporate diversification strategies destroy value (Maquiera etal., 1998; Berger & Ofek, 1995). This confirms that companies should notattempt to do what investors can do better themselves, i.e. creating a diversifiedportfolio. Sixth, the acquisition of value-companies leads to higher bidder andtarget returns. Rau and Vermaelen (1998) show that the acquisition of firmswith low market-to-book firms generates high returns (of about 12% onaverage) to the shareholders of the bidding firm whereas the acquisition ofglamour firms (with high market-to-book ratios) leads to substantial negativereturns.2

The main motive for mergers and acquisitions is the value creation resultingfrom synergies. These synergies are called operating synergies, if there areeconomies of scale or scope, and are called informational synergies, if thecombined value of the assets of the two firms is higher than the value the stockmarket attributes to the assets. For example, informational synergies consist ofthe creation of an internal capital market: slack-rich firms with poor investmentpossibilities acquire slack-poor firms with outstanding growth opportunities.3

Informational synergies can also consist in minimising transaction costs orbankruptcy costs. However, Warner (1977) shows that the reduction in directbankruptcy costs (due to less than perfectly correlated earnings of the bidderfirm and the target firm) is small. In Anglo-American markets, the role ofhostile takeovers as a disciplinary force to remove poorly performingmanagement is also often emphasized. This market for corporate control seemsto be more active in the U.S. (Morck et al., 1988; Bhide, 1989; Martin &McConnell, 1991) than in the U.K. (Franks, Mayer & Renneboog, 2001).

In this paper, we investigate the short-term returns in large Europeantakeovers. We also analyse whether the type of offer has an important impacton the premium paid for the target’s shares. Furthermore, we distinguish among


different means of payment of the bid: all-cash offers, all-equity offers or bidscombining cash, equity and loan notes. Given that the level of stock marketdevelopment and the corporate governance regulation differs substantiallybetween the U.K. and Continental Europe, we investigate whether theabnormal returns for target and bidder firms are significantly different. Industryeffects and year-of-bid effects are also analysed. We examine the announce-ment effect of unsuccessful bids in order to see whether the market alreadyaccounts for this ex post effect at the moment of the first announcement.

3. DATA AND METHODOLOGY

3.1. Sample Selection and Data Sources

Data on European acquisitions – involving both a European bidder and target– were collected from the ‘Foreign deals’ section of the monthly publicationMergers & Acquisitions Report for the period 1993–2000. This report gives thenames of the firms involved in the acquisition, the value of the transaction (inUSD and local currency) and the type of deal (merger, acquisition, acquisitionof majority/minority control, or divestiture). Additional information, such asthe means of payment in the offer, the status of the bid (hostile or friendly) andmultiple bidder involvement is also frequently reported. To be included in oursample, either the bidder or the target (or both) must be listed on a Europeanstock exchange, and the announcement date must be available. We restrictedthe sample to large acquisitions only, with a deal value of at least USD 100million (equivalent to about 100 million at the current exchange rate). Wealso used information from the Financial Times (FT) to check the data qualityfrom the Mergers & Acquisitions Report (hereafter the Report), and to collectmissing announcement dates or other missing information. We also requiredthat at least two articles about the mergers and acquisitions were published inthe Financial Times so as to exclude non-recurring rumours. The resultingsample consists of 228 merger or acquisition announcements. We also includethe cases where a bid is made for part of a firm (a divestiture). In these cases,the target share price reaction is that of the divesting firm.

We adopt the distinction between mergers and acquisitions made by the FTand the Report. Both sources describe a merger as a transaction between twoparties of roughly equal size, whereas in an acquisition the larger party takesover the smaller one. A takeover (attempt) is classified as hostile, if thepotential target rejects the offer for whatever reason. Hostility may, amongothers, result from a bargaining strategy to extract a higher premium for thetarget shareholders (Schwert, 2000) or from the target’s directors’ viewpoint


that the proposed plan is incompatible with the target’s strategy. We alsoclassify an acquisition with multiple bidders as hostile and report these casesseparately. Lack of share price and/or accounting information reduced thesample to 185 offer announcements. For these cases, 139 bidders and 129targets are listed. The final sample consists of 55 mergers, 40 (friendly)acquisition bids, 40 hostile takeover bids and 21 hostile takeovers with multiplebidders. In addition, 29 of the 185 announcements refer to divestitures.

Information on share prices and market indices, on the risk-free rate bycountry (3-month Treasury Bill rates), on risk measures and accountinginformation was collected from Datastream. For both target and bidder, wecollected the following additional information using Datastream and theFinancial Times. Industry (SIC) codes indicate the degree of corporatediversification. The market capitalization of target and bidder (MV), the marketto book-value (MVBV) representing the growth potential of the target,dividend yield (DY), interest coverage (IC) representing potential financialdistress, the amount of liquid assets (NC) (cash and short term loans, depositsand investments) divided by total market value, the price to cash flow (PCf),assets per share (APS; measured as net tangible assets (fixed assets lessdepreciation, plus longer-term investments and current assets, less current anddeferred liabilities) divided by the number of shares at year-end), and the returnon equity (ROE) were also collated. We calculated relative target to bidder sizeusing the market capitalisation at least 6 months prior to the announcement.Finally, we also recorded the country in which the targets and bidders arelocated: our sample embraces firms from 18 European countries.

3.2. Methodology

We measure the short-term wealth effects for bidding and target firms bycalculating cumulative abnormal returns in an event study. The event windowstarts 6 months prior to the announcement date to capture the effects ofrumours or insider trading. There is little consensus on when to start measuringannouncement period returns, as evidenced by the great variety of practice inpublished work. The precision when using a short measurement period isdoubtful, if there is a leakage of information before the first mention in thefinancial press. On the other hand there is evidence that bids follow positivemovements in the acquirer’s stock price, with the danger that starting themeasurement period too early will lead to an overstatement of the takeoverreturns.


To calculate the expected returns and verify the robustness of the returns, weuse 6 different measures of beta. First, we estimate the beta by running themarket model over a 9-month period (195 trading days) ending 6 months priorto the event date. Second, as the beta from the first method is calculated overa period well before the event date, we estimate the beta over the 9-monthperiod ending 1 month prior to the event date. This second method may moreaccurately incorporate recent changes in systematic risk, but in turn may beinfluenced by the event. Third, we use the Datastream beta which is correctedfor mean-reversion. Fourth, we also adjust betas for mean-reversion using theMerrill Lynch method based on Blume (1979), in the following way:�i

a = 0.34 + �*i 0.67 where �ia is the beta adjusted for mean-reversion and �i is the

beta estimated using the market model over a 9-month period ending 6 monthsprior to the event. Fifth, the betas from method 1 are corrected for regressionto the mean according to Vasicek’s technique using Baysian updating (Vasicek,1973). The degree of adjustment towards the mean depends on the samplingerror of beta: �i

v = [�2�i /(�

2�*1 + �2

�i1] · �*1 + [�2�*1 /(�2

�*1 + �2�i1)] · �i1, where �i

v is theVasicek-beta for security i, �*1 is the average beta across the sample of sharesestimated over a 9-month period ending 6 months prior to the event date(period 1), �i1 is the beta from the market model over period 1, �2

�i1 is thevariance of the estimate of beta for security i measured over period 1, and �2

�*1

is the variance of the average beta measured over period 1 (Elton & Gruber,1995). Sixth, we calculate Dimson-betas to control for inaccurate beta-estimation resulting from thin trading which biases beta downwards (Dimson,1979; Marsh & Dimson, 1983). These betas are the sum of 5 parameterestimates of the market model in which the current level of the daily marketreturn, as well as its first three lags and one lead are included. The model isestimated over a 9-month period ending 6 months prior to the event date.4 Forall 6 estimation methods, the betas are trimmed at the 5%–95% distributionrange. As none of the main results of this study are significantly influenced bythe choice of beta estimation technique, we only report results based on theDimson-betas corrected for thin trading.

The abnormal returns are calculated as the difference between the actualdaily returns and the expected returns obtained from the CAPM. Thecumulative average abnormal returns (CAAR) are then calculated over theevent period. The standard significance tests we apply are the ones from e.g.Kothari and Warner (1997). The one-day test statistic is:

AR�(AR)


where

�(AR) =� 1199 �t=�41

t=�240

(ARt � AR )2

The test statistic for CAAR is

CAAR

�(AR)�T

where T is the number of time observations. The total gain for each pair oftarget firm and acquiring firm is measured by:

CAARTotal =CAARTarget * MVTarget + CAARAcquirer * MVAcquirer

MVTarget + MVAcquirer

where MV denotes the market value of the target’s or acquirer’s stock before thebeginning of the event window (Cybo-Ottone & Murgia, 2000).

4. SHORT TERM SHAREHOLDER WEALTH EFFECTS

4.1. Target Versus Bidding Firms

Figure 1a shows that the announcement of a takeover bid causes substantialpositive abnormal returns for the sample of European bids. On the event day,a return of 9% is realised. Strikingly, as the cumulative abnormal returns overan event window starting one month prior to and including the event dateamount to about 21% (panel A of Table 1), it seems that the takeover bid wasanticipated, probably as a result of rumours or of insider trading. On average,investors owning a target company for a period starting 3 months prior to theevent date (60 trading days) and selling at the end of the event day would earna return of 24%. After about 30 trading days, the average cumulative abnormalreturn decreases by about 3% as a result of the fact that some takeover bids areunsuccessful or the fact that a long period to finalise the offer raises doubtsabout the ultimate success of the negotiations.5

The effect of the takeover announcement on the wealth of the bidders’shareholders is very small (Fig. 1b): at the announcement, the share price onlyrises by 0.7% (significant at the 1% level) (panel B of Table 1). All otherabnormal returns in an event window of 6 months are not statisticallysignificant. The reason why the share prices of the 139 bidding firms hardlychange in this event window compared to the target firms is that the


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announcement effect is an amalgamation of positive and negative share pricereactions depending on the type of the bid (see next section).

The cumulative abnormal returns obtained by this study are close to the onesreported by Franks and Harris (1989) and Higson and Elliott (1998). Franksand Harris report CAARs of 21% for large U.K. targets and of 0% for U.K.bidders over the period 1955–1985 in the event month. Higson and Elliott findCAARs of 30% for the target shareholders in the largest bids and of 0% for thebidding shareholders over the period 1975–1990. Recent research on the wealth

Table 1. Cumulative Abnormal Returns for Target and Bidding Firms.

This table shows cumulative abnormal returns over several event windows for target firms andbidder firms. ***, ** and * stand for statistical significance at the 1%, 5% and 10% level,respectively. Source: own calculations.

Panel A: Target firms

Time Interval CAAR (%) t-valueEvent date[–1, 0] 9.01 29.53***[–2, + 2] 12.96 26.88***[–5, + 5] 15.92 22.25***Window prior to and at event[–10, 0] 19.13 19.35***[–20, 0] 21.58 18.62***[–60, 0] 24.12 17.56***Window around event[–30, + 30] 23.43 13.91***[–60, + 60] 21.78 9.18***[–90, + 90] 21.59 7.44***Observations 129

Panel B : Bidding firms

Time Interval CAAR (%) t-value

Event day[–1, 0] 0.70 2.98***[–2, + 2] 1.18 3.18***Window around event day[–30, + 30] 0.39 0.30[–60, + 60] –0.48 –0.26[–120, + 120] 0.41 0.16Observations 139


Fig

.1b.

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effects over longer time periods for cross-border acquisitions by U.K. firmsreveals that such operations do not generate any gain (nor loss) for the bidders’shareholders (Gregory & McCorriston, 2002; Conn et al., 2001)

4.2. Hostile Versus Friendly Takeover Bids

We also analyse the market reactions to the different types of takeover. For thetargets, we distinguish between mergers (40 cases), acquisitions (18 cases),hostile takeovers (28 cases) and hostile takeovers with multiple bidders (14cases). For all of these types of takeovers, Fig. 2a shows a strong positiveannouncement effect (significant at the 1% level). As expected, hostile takeoverbids trigger the largest share price reactions for the target ( + 13%) on theannouncement day. These reactions are significantly higher than the ones forthe other types, i.e. 9% for mergers and 6% for acquisitions (see panel A ofTable 2). When a hostile bid is made, the share price of the target immediatelyreflects the expectation that opposition to the bid will lead to upward revisionsof the offer price. Surprisingly, the announcement reaction to a takeover bidwith multiple bidders is low at 7%, but Fig. 2a depicts that a large upward pricemovement starts already 1.5 months prior to the announcement. Figure 2a alsodepicts that there are large differences in the price run-ups for the differenttypes of bids. Whereas the upward price reactions prior to the bidannouncement are limited to two weeks for hostile takeovers and for friendlyacquisitions, it seems that in the case of mergers, rumours or insider tradingoccur already 1.5 to 2 months prior to the announcement (compare thecumulative abnormal returns for the event windows [–10, + 1] and [–40, + 1]in panel A of Table 2). A hostile takeover announcement generates a CAAR ofmore than 25% over the 2 week-period preceding and including theannouncement day. At the event date and over the 2 months prior to the firstannouncement of the bid, the returns to the target shareholders for hostiletakeovers vastly outperform those of friendly mergers and acquisitions (panelB of Table 2). The difference in returns between merger and friendlyacquisition announcements is limited to the event date and to the 2-week periodprior to the announcement. For the longer symmetric event windows (6 monthsand longer) differences between the types of bids are no longer statisticallysignificant.

Figure 2b breaks down the CAAR for the bidder by type of bidding firm.Shareholders of bidding firms clearly react differently to announcements ofmergers, acquisitions and hostile takeovers. The instantaneous price reaction onthe event day is 2.2% and 2.43% for mergers and unopposed acquisitions,respectively (panel C of Table 2). However, on average, the bidder’s


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wn

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ulat

ions

.

Pan

el A

: C

AA

Rs

of t

arge

t fir

ms

by t

ype

of t

akeo

ver

bid

Tim

e In

terv

alM

erge

rt-

valu

eA

cqui

sitio

nt-

valu

eH

ostil

eTa

keov

ert-

valu

eM

ultip

leB

idde

rst-

valu

e

Eve

nt d

ay%

%%

%[–

1, 0

]8.

8019

.00*

**5.

966.

34**

*12

.60

22.8

1***

6.98

8.62

***

[–2,

+2]

12.6

217

.24*

**11

.33

7.62

***

17.9

520

.54*

**11

.28

8.82

***

Win

dow

pri

or to

and

at e

vent

[–10

, 0]

13.2

012

.54*

**20

.01

10.9

8***

25.6

410

.84*

**15

.05

4.23

***

[–40

, 0]

23.4

16.

04**

*20

.34

5.41

***

29.2

36.

79**

*23

.68

2.87

***

Win

dow

aro

und

even

t[–

30,

+30

]20

.76

8.12

***

23.4

94.

52**

*34

.69

11.3

7***

25.0

35.

60**

*[–

60,

+60

]23

.59

6.55

***

26.5

23.

62**

28.3

66.

60**

*20

.53

3.26

***

[–90

, +

90]

26.7

96.

08**

*23

.99

2.68

**28

.83

5.49

***

20.3

92.

65**

Obs

erva

tions

4018

2814

Pan

el B

: S

igni

fican

ce o

f di

ffer

ence

s in

tar

get

CA

AR

s ac

ross

typ

es o

f ta

keov

er b

ids

Hos

tile

take

over

s –

Mer

gers

t-va

lue

diff

eren

ceH

ostil

eta

keov

ers

–A

cqui

sitio

ns

t-va

lue

diff

eren

ceH

ostil

eta

keov

ers

–M

ultip

lebi

dder

s

t-va

lue

diff

eren

ceM

erge

rs –

Acq

uisi

tions

t-va

lue

diff

eren

ce

Eve

nt W

indo

w%

%%

%[–

1, 0

]3.

817.

59**

*6.

6410

.40*

**5.

638.

67**

*2.

835.

16**

*[–

2, +

2]5.

336.

72**

*6.

626.

56**

*6.

676.

49**

*1.

291.

48[–

10, 0

]12

.44

6.47

***

5.63

4.36

***

10.5

94.

25**

*–6

.81

–3.2

8***

[–40

, 0]

5.82

3.59

***

8.89

3.78

***

5.55

3.51

***

3.07

1.68

[–30

, +

30]

13.9

45.

03**

*11

.20

3.18

**9.

672.

70**

–2.7

30.

90[–

60,

+60

]4.

771.

221.

850.

377.

841.

55–2

.92

0.68

[–90

, +

90]

2.05

0.43

4.85

0.80

8.44

1.37

2.80

0.54


Tabl

e2.

Con

tinue

d.

Pan

el C

: C

AA

Rs

of b

iddi

ng fi

rms

by t

ype

of t

akeo

ver

Tim

e In

terv

alM

erge

rt-

valu

eA

cqui

sitio

nt-

valu

eH

ostil

eTa

keov

ert-

valu

eM

ultip

leB

idde

rst-

valu

e

Eve

nt d

ay%

%%

%[–

1, 0

]2.

205.

22**

*2.

435.

06**

*–2

.51

–5.6

1***

–0.0

8–0

.13

[–2,

+2]

4.35

6.55

***

1.94

2.56

***

–3.4

3–4

.85*

**0.

850.

81W

indo

w p

rior

to a

nd a

t eve

nt[–

10, 0

]3.

834.

20**

*1.

782.

02**

–3.3

3–1

0.84

***

–1.3

6–1

.59

[–40

, 0]

4.63

2.95

***

4.86

2.45

***

–2.5

1–1

.56

–1.0

4–0

.59

Win

dow

aro

und

even

t[–

30,

+30

]2.

761.

190.

720.

27–1

.62

–0.6

6–0

.96

–0.2

7[–

60,

+60

]3.

030.

93–1

.67

–0.4

5–0

.69

–0.2

0–2

.96

–0.5

8[–

90,

+90

]3.

090.

77–1

.66

–0.3

6–1

.15

–0.2

7–0

.54

–0.0

9O

bser

vatio

ns41

3832

17

Pan

el D

: S

igni

fican

ce o

f di

ffer

ence

s in

bid

der

CA

AR

acr

oss

type

s of

tak

eove

r bi

ds

Hos

tile

take

over

s –

Mer

gers

t-va

lue

diff

eren

ceH

ostil

eta

keov

ers

–A

cqui

sitio

ns

t-va

lue

diff

eren

ceH

ostil

eta

keov

ers

–M

ultip

lebi

dder

s

t-va

lue

diff

eren

ceM

erge

rs –

Acq

uisi

tions

t-va

lue

diff

eren

ce

Eve

nt W

indo

w%

%%

%

[–1,

0]

–4.7

1–1

0.89

***

–4.9

4–1

0.62

***

–2.4

3–4

.59*

**–0

.23

0.51

[–2,

+2]

–7.7

8–1

1.38

***

–5.3

7–7

.31*

**–4

.28

–5.1

1***

2.41

3.39

***

[–10

, 0]

–7.1

6–8

.69*

**–5

.11

–2.2

4***

–1.9

7–1

.50

2.05

2.23

***

[–40

, 0]

–7.1

4–5

.66*

**–7

.37

–3.1

4***

–1.4

7–1

.28

–0.2

3–0

.31

[–30

, +

30]

–4.3

9–1

.84*

–2.3

4–0

.91

–0.6

6–0

.23

2.04

0.82

[–60

, +

60]

–3.7

2–1

.10

–0.9

9–0

.27

2.28

0.55

4.70

1.35

[–90

, +

90]

–4.2

4–1

.03

–0.5

1–0

.11

–0.6

1–0

.12

4.75

1.11


Fig

.2b.

Cum

ulat

ive

Abn

orm

al R

etur

ns o

f B

iddi

ng F

irm

s by

Typ

e of

Bid

.


shareholders seem to disapprove of hostile takeovers. When the bid iscontested, the announcement abnormal return is –2.5%. These differences arestatistically significant at the 1% level as shown in panel D of Table 2.

4.3. Comparing U.K. Bids With Continental European Offers

As 85% of the companies listed on the London Stock Exchange are widelyheld, U.K. firms are continually auctioned and hence, an active market forcorporate control exists. In contrast, in Continental Europe the number of listedfirms is much lower and most listed firms (around 85%–90% for Germany andFrance) have concentrated ownership (for a detailed overview of ownership andcontrol in Europe, see Barca & Becht, 2001). Consequently, hostile takeoversare largely ruled out in Continental Europe as most firms have a controllingshareholder. Not surprisingly, more than half of the sample of listed target andbidding firms is from the U.K. (77 out of 129 targets and 76 out of 139 bidders)(see panel A of the table in the appendix). For the majority of the Europeanbids, the bidder and target are from the same country (65%). As there is a highdegree of disclosure in the U.K., a liquid and well-developed equity market(McCahery & Renneboog, 2002) and a higher degree of shareholder protection(La Porta et al., 1997), higher premiums in takeover offers are expected forU.K. firms. Figure 3a confirms this conjecture: the announcement effect issubstantially larger for U.K. target firms (12.3%) than for ContinentalEuropean firms (6%), as shown in Table 3 (panel A). There is not muchdifference in terms of the price run-up prior to the announcement: in bothContinental Europe and in the U.K., significant positive abnormal returns aregenerated 2 to 3 months prior to the announcement. U.K. target shareholderswho own equity as of 2 months prior to the announcement and sell on the dayof the announcement can earn (on average) a premium of more than 38%, morethan double the return earned by the Continental European target shareholders(15%) over the same period (panel A of Table 3). Figure 3a also depicts that,whereas the post-announcement cumulative abnormal returns are not statisti-cally different from zero, they are substantially negative for ContinentalEuropean target firms for the 1.5 to 3 months after the announcement day.Hence, in spite of the lower bid premiums in Continental Europe, it seems thatthe market price reactions to the announcements are overoptimistic and thatreturns are subsequently corrected.6

Figure 3b and panel B of Table 3 report the returns for the shareholders ofthe bidding firms. Bidding shareholders in the U.K. earn more than those inContinental Europe. Over a five-day window centred around the announcementdate, U.K. bidders obtain a cumulative abnormal return of 1.5% versus 0.9%


Fig

.3a.

Cum

ulat

ive

Abn

orm

al R

etur

ns o

f U

.K. a

nd C

ontin

enta

l Eur

opea

n Ta

rget

Fir

ms.


Table 3. Cumulative Abnormal Returns of Target and Bidding Firms: U.K.Versus Continental Europe.

This table shows cumulative abnormal returns over several event windows for target firms andbidder firms by location (U.K. versus Continental Europe). ***, ** and * stand for statisticalsignificance at the 1%, 5% and 10% level, respectively. Source: own calculations.

Panel A: CAARs of Target Firms: U.K. vs. Continental Europe

Time Interval U.K. t-value ContinentalEurope

t-value U.K. –Continental

t-valuedifferences

Event day % % %[–1, 0] 12.31 29.09*** 5.95 13.99*** 6.35 14.96***[–2, + 2] 17.42 26.03*** 8.85 13.15*** 8.56 12.75***Window prior to and at event[–10, 0] 20.25 15.79*** 10.05 8.89*** 10.20 8.94***[–40, 0] 38.30 14.66*** 14.95 7.56*** 23.35 5.64***[–60, 0] 38.14 10.05*** 17.98 3.61*** 20.16 4.25***Window around event[–30, + 30] 29.83 12.76*** 17.53 7.46*** 12.30 5.25***[–60, + 60] 29.32 8.91*** 14.82 4.48*** 14.49 4.39***[–90, + 90] 28.87 7.17*** 14.84 3.67*** 14.03 3.47***Observations 48 52

Panel B: CAARs of Bidding Firms: U.K. versus Continental Europe

Time Interval U.K. t-value ContinentalEurope

t-value U.K. –Continental

t-value ondifferences

Event window % % %[–1, 0] 1.04 3.41*** 0.40 1.19 0.64 1.98*[–2, + 2] 1.51 3.11*** 0.90 1.69* 0.60 1.17Window prior to and at event[–10, 0] 0.61 0.79 1.03 0.89 –0.42 –0.93[–40, 0] 1.19 0.92 0.35 0.22 0.84 0.68[–60, 0] –0.06 –0.08 2.31 1.03 –2.37 –1.26Window around event[–30, + 30] 0.19 0.11 0.91 0.49 –1.101 –0.62[–60, + 60] –1.65 –0.69 0.54 0.21 –2.193 –0.87[–90 + 90] –3.12 –1.07 0.68 0.21 –3.806 –1.24Observations 65 74


Fig

.3b.

Cum

ulat

ive

Abn

orm

al R

etur

ns o

f U

.K. v

ersu

s C

ontin

enta

l Eur

opea

n B

iddi

ng F

irm

s,


for Continental European bidders. Whereas there is evidence of trading onrumours in target shares or of insider trading, this is not the case for the biddingfirms.

4.4. Takeover Bids By Means of Payment

The average bid value of our sample is USD 5,469 million (see panel B of thetable in the appendix). The distribution of the bid value is highly skewed:the median offer is USD 575 million. The majority of bids (excluding thedivestitures: see Section 4.8) are cash offers (93 out of 156 cases or 60%).Twenty-four percent of the offers are all-equity offers and the remainderconsists of combinations of cash and equity (11%), of cash and loan notes(2%), of equity and loan notes (2%) and of cash, equity and loan notes (1%).Payment for smaller targets usually takes place in cash: the average value of all-cash offers amounts to USD 1,489 million while that of all equity-offers isUSD 14,255 million (with medians of USD 443 and 2,580 million,respectively). In 12 cases out of the 93 all-cash offers, the bidders also gave thetarget shareholders the opportunity to accept an all-equity offer or a combinedoffer (with a higher value than the cash offer).7

If managers of an acquiring firm know that their shares are worth more thanthe current market price, they should prefer to finance the acquisition with cash.Hence, future changes in the stock price will only benefit the shareholders ofthe bidding firm. Conversely, if the bidding management believes that its stockis overvalued, they should prefer paying for the acquisition with equity. Hence,asymmetric information on the bidder’s share value will have some bearing onthe choice between cash or equity payments.

We find strong evidence that the share price reaction of target firms issensitive to the means of payment for the target’s shares. Cash offers triggersubstantially higher abnormal returns (10% at announcement) than offersincluding the bidders’ equity (6.7%) and combined offers of cash and equity(5.6%) (Fig. 4a). Panel A of Table 4 shows that when the price run-up startingtwo weeks prior to the event day is included, cash offers trigger CAARs ofalmost 20% versus 14% and 12.5% for all-equity bids and combined bids,respectively. Panel B shows that, whatever the event window, the share priceperformance of cash-financed bids outperforms the one of other bids at the 1%significance level. Figure 4b shows an entirely different picture for biddingfirms. Over both short and longer term windows, the shareholders of theacquiring firms greet equity offers more favourably (1%) than cash offers(0.4%) (panel B of Table 4).8 This implies that the choice to make an all-equityoffer does not signal to the market that the bidder’s equity is overvalued. Within


Fig

.4a.

Cum

ulat

ive

Abn

orm

al R

etur

ns o

f Ta

rget

Fir

ms

by M

eans

of

Paym

ent.


Table 4. Cumulative Abnormal Returns of Target and Bidding Firms byMeans of Payment.

This table shows cumulative abnormal returns over several event windows for target firms andbidder firms by means of payment (all-cash, all-equity or a combination of cash, equity and/or loannotes). ***, ** and * stand for statistical significance at the 1%, 5% and 10% level, respectively.Source: own calculations.

Panel A: CAARs of target firms by means of payment

Time Interval Cash bid t-value Equity bid t-value Combinedbid

t-value

Event day % % %[–1, 0] 9.89 35.81*** 6.65 16.07*** 5.63 11.68***[–2, + 2] 13.56 21.95*** 11.38 12.30*** 13.24 12.28***[–10, 0] 19.87 21.69*** 14.13 10.30*** 12.41 7.76***[–40, 0] 27.49 15.54*** 12.23 4.62*** 16.81 5.44***Window around event[–30, + 30] 28.89 13.39*** 13.03 4.03*** 17.46 4.64***[–60, + 60] 28.75 9.46*** 12.89 2.83*** 5.66 1.07[–90, + 90] 28.64 7.71*** 14.93 2.68*** 0.91 0.14Observations 62 25 13

Panel B : Significance of differences in target CAARs across types of payment

Cash offers –Equityoffers

t-valuedifference

Cash offers –Combined

offers

t-valuedifference

Equity offers –Combined

offers

t-valuedifference

Event Window % % %[–1, 0] 3.24 36.10*** 4.26 30.81*** 1.01 0.20[–2, + 2] 2.18 10.84*** 0.32 1.02 –1.86 –0.24[–10, 0] 5.74 19.25*** 7.46 16.27*** 1.72 0.19[–40, 0] 15.26 26.52*** 10.68 12.07*** –4.58 –0.35[–30, + 30] 15.87 22.61*** 11.44 10.59*** –4.43 –0.31[–60, + 60] 15.86 16.04*** 23.09 15.19*** 7.23 0.43[–90, + 90] 13.72 11.34*** 27.73 14.91*** 14.02 0.75

Panel C: CAARs of bidding firms by means of payment

Time Interval Cash bid t-value Equity bid t-value Combinedbid

t-value

Event day % % %[–1, 0] 0.37 1.68* 0.98 3.01*** 0.13 0.35[–2, + 2] 0.90 1.83* 2.57 3.52*** 0.22 0.27Window prior to and at event[–10, 0] –0.16 –0.20 2.60 2.40** –0.71 –0.58[–40, 0] –1.18 –0.84 5.15 2.46** –0.20 –0.09Window around event[–30, + 30] –0.33 –0.19 3.50 1.37 –1.42 –0.49[–60, + 60] –1.44 –0.59 2.72 0.76 –1.39 –0.34[–90, + 90] –1.52 –0.51 2.13 0.48 –4.21 –0.85Observations 83 33 23


the sample of large take-over bids, the relatively smaller ones are all-cash bidswhereas the relatively larger ones involve equity. Consequently, it may be thatthe market realises that for large deals the choice of means of payment isrestricted.

4.5. Takeover Bids By Industry

In this sub-section, we analyse whether our results are driven by particularindustries. We created the following 5 industry groups based on the SICclassification:

(i) energy, natural resources, waste development and utilities (7 firms);(ii) production and manufacturing (45 firms);

(iii) services (21 firms);(iv) retailers, stores, pubs, hotels (11 firms); and(v) banking and insurance (16 firms).

Panel A of Table 5 shows that, on the announcement day, bids targeting retailand manufacturing firms trigger the strongest positive price reactions, 14.4%and 10.9%, respectively. For longer time intervals of e.g. two months thereare no substantial differences between the industries. Our results for banks areconsistent with the findings of Cybo-Ottone and Murgia (2000), who found asignificant and positive 15.3% announcement effect for European target banks.The strong decline in the prices of financial and energy target firms in the post-announcement period reflects the fact that a few of the bids were ultimatelyunsuccessful (Fig. 5a).

However, the picture for bidding firms by industry looks different (Fig. 5b).Some industries show positive CAARs (manufacturing, retailing) whereas

Table 4. Continued.

Panel D : Significance of differences in bidder CAAR across types of payment

Cash offers–Equity offers

t-valuedifference

Cash offers –Combined

offers

t-valuedifference

Equity offers –Combined

offers

t-valuedifference

Event Window % % %[–1, 0] –0.61 –9.95*** 0.24 2.97*** 0.85 8.93***[–2, + 2] –1.67 –12.08*** 0.68 3.79*** 2.35 11.00***[–10, 0] –2.76 –13.36*** 0.55 2.05** 3.31 10.43***[–40, 0] –6.33 –16.01*** –0.98 –1.89* 5.36 8.75***[–30, + 30] –3.83 –7.94*** 1.09 1.74* 4.93 6.59***[–60, + 60] –4.16 –6.11*** –0.05 –0.05 4.11 3.91***[–90, + 90] –3.65 –4.39*** 2.70 2.49** 6.34 4.93***


Fig

.4b.

Cum

ulat

ive

Abn

orm

al R

etur

ns o

f B

iddi

ng F

irm

s by

Mea

ns o

f Pa

ymen

t.


Tabl

e5.

Cum

ulat

ive

Abn

orm

al R

etur

ns o

f Ta

rget

and

Bid

ding

Fir

ms

by I

ndus

try.

Thi

s ta

ble

show

s cu

mul

ativ

e ab

norm

al r

etur

ns o

ver

seve

ral

even

t w

indo

ws

for

targ

et fi

rms

and

bidd

er fi

rms

by i

ndus

try.

***

, **

and

* st

and

for

stat

istic

al s

igni

fican

ce a

t the

1%

, 5%

and

10%

leve

l, re

spec

tivel

y. S

ourc

e: o

wn

calc

ulat

ions

.

Pan

el A

: C

umul

ativ

e A

bnor

mal

Ret

urns

of

Targ

et F

irm

s by

Ind

ustr

y

Tim

e In

terv

alE

nerg

yt-

valu

eM

anuf

ac·

t-va

lue

Serv

ices

t-va

lue

Ret

aile

rt-

valu

eB

ank

t-va

lue

Eve

nt d

ay%

%%

%%

[–1,

0]

5.06

4.57

***

10.8

725

.77*

**7.

3410

.48*

**14

.35

17.9

9***

4.03

5.48

***

[–2,

+2]

6.83

3.90

***

15.1

622

.73*

**10

.50

9.48

***

16.8

713

.38*

**10

.06

8.63

***

Win

dow

aro

und

even

t[–

30,

+30

]17

.31

2.83

**24

.14

10.3

6***

26.9

06.

96**

*21

.26

4.83

***

21.1

25.

19**

*[–

60,

+60

]21

.30

2.78

**24

.86

7.58

***

27.1

04.

98**

*18

.22

2.94

**8.

831.

54[–

90,

+90

]21

.11

2.01

*26

.82

6.69

***

26.8

84.

04**

*17

.88

2.36

**2.

770.

40O

bser

vatio

ns7

4521

1116

Pan

el B

: C

umul

ativ

e A

bnor

mal

Ret

urns

of

Bid

ding

Fir

ms

by I

ndus

try

Tim

e In

terv

alE

nerg

yt-

valu

eM

anuf

ac·

t-va

lue

Serv

ices

t-va

lue

Ret

aile

rst-

valu

eB

ank

t-va

lue

Eve

nt d

ay%

%%

%%

[–1,

0]

–1.9

1–1

.98*

1.89

5.00

***

–2.3

5–4

.43*

**2.

073.

94**

*0.

440.

75[–

2, +

2]–0

.83

–0.5

42.

924.

88**

*–2

.19

–2.6

1**

2.19

2.64

**–0

.15

–0.1

6[–

5, +

5]–1

.07

–0.4

73.

243.

65**

*–3

.73

–3.0

0***

2.66

2.16

**–1

.28

–0.9

3W

indo

w a

roun

d ev

ent

[–30

, +

30]

0.70

0.13

–0.0

01–0

.00

0.47

0.16

4.13

1.43

–2.0

3–0

.63

[–60

, +

60]

7.64

1.02

–1.6

6–0

.56

2.90

0.70

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[–90

, +

90]

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670.

135.

921.

19–9

.83

–1.7

6*O

bser

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Fig

.5a.

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ulat

ive

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etur

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f Ta

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ndus

try.


Fig

.5b.

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ustr

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other industries have negative announcement effects (energy, services). Thelatter difference is largely due to the fact that the energy and services industriescount more hostile takeovers (see Section 4.2). Financial firms (banks,insurance) realise positive (but not significant) returns and negative (sig-nificant) CAARs over longer time periods (Table 5). These findings areconsistent with those from Cybo-Ottone and Murgia (2000) for Europe andFrame and Lastrapes (1990) for the U.S.

4.6. Failed Versus Successful Bids

In this sub-section, we address the question as to whether the markets areable to anticipate the ultimate success or failure of the merger negotiations. Themerger or acquisition negotiations are assumed to be ultimately successful ifthe Financial Times reports acceptance of the bid by the target’s shareholders.Conversely, the takeover attempt is considered to be a failure if the bidderabandons negotiations within a 6-month period subsequent to the announce-ment. Out of the 185 announcements 37 failed. When focussing on the 100announcements involving listed target firms (excluding divestitures), 27 wereunsuccessful. Out of these 27 target firms, only 16 were categorised as hostilebids due to resistance by the target’s management or due to the fact thatmultiple firms were attempting to acquire the target. Hence, there were also 11cases of unsuccessful mergers and (friendly) acquisitions. For both the(ultimately) failed and successful bids, we find a significant positiveannouncement effect for the target firms (Fig. 6a). The event day effect issignificantly larger (by 5%) for the successful bids than for the failures.However, for the two-week window prior to and including the event day, thereis no difference in the CAARs between failed and successful bids (panel A ofTable 6). When the price run-up over a 3-month period is included, the failedbids significantly outperform the successful bids by 30% versus 23%. Whereasthe abnormal returns for the targets in the successful bids are not significantlydifferent from zero subsequent to the announcement of the bid, the abnormalreturns for the failed bids nose-dive (by 7.5%) between 2 and 3 monthssubsequent to the event. This is a result of the collapse of the (friendly) mergernegotiations or of the successful hostile opposition by the target’s management.However, it should be noticed that the cumulative abnormal return for thecompanies on which a failed bid was launched does not revert to the level priorto the announcement. This implies that the stock prices of these targets stillcontain a merger premium reflecting the possibility of another potentialtakeover bid in the (near) future.


Fig

.6a.

Cum

ulat

ive

Abn

orm

al R

etur

ns o

f Ta

rget

Fir

ms

by (

Ex

Post

) Su

cces

sful

ver

sus

Faile

d B

ids.


Table 6. Cumulative Abnormal Returns of Target and Bidding Firms by(Ex Post) Successful and Failed Bids.

This table shows cumulative abnormal returns over several event windows for target firms andbidder firms by outcome of the negotiations (failure versus success). ***, ** and * stand forstatistical significance at the 1%, 5% and 10% level, respectively. Source: own calculations.

Panel A : CAARs of Target Firms by Ex Post Success or Failure of the Bid

Time Interval Failures t-value Successes t-value Failed offers –Successful offers

t-valuedifference

Event date % % %[–1, 0] 5.51 8.49*** 10.30 27.84*** –4.79 –10.36***[–2, + 2] 10.83 10.55*** 13.75 23.51*** –2.92 –3.99***Window prior to and at event[–10, 0] 16.42 9.59*** 16.30 16.74*** 0.12 0.24[–20, 0] 24.61 7.23*** 19.74 14.58*** 4.87 4.69***[–60, 0] 29.87 4.31*** 22.41 7.31*** 7.46 4.43***Window subsequent to event[ + 1, + 40] –1.89 –0.45 –0.10 –0.14 –1.79 –0.40[ + 1, + 60] –7.53 –14.78*** –2.20 –1.54 –5.33 –4.53***Window around event[–30, + 30] 28.69 8.00*** 21.49 10.51*** 7.20 2.82***[–60, + 60] 25.02 4.95*** 20.58 7.15*** 4.44 1.23[–90, + 90] 27.03 4.38*** 19.58 5.56*** 7.46 1.69*Observations 27 73

Panel B : CAARs of Bidding Firms by Ex Post Success or Failure of the Bid

Time Interval Failures t-value Successes t-value Failed offers –Successful offers

t-valuedifference

Event date % % %[–1, 0] –0.73 –1.45 1.08 4.05*** –1.81 –5.48***[–2, + 2] –0.97 –1.22 1.75 4.16*** –2.72 –5.21***Window prior to and at event[–10, 0] –0.12 –0.66 1.00 2.21*** –1.12 –2.68***[–20, 0] –0.18 –0.68 0.91 1.70* –1.09 –1.97**Window subsequent to event[ + 1, + 40] –0.09 –0.44 –1.21 –1.39 1.02 1.50[ + 1, + 60] –0.92 –1.24 2.30 1.68** –3.22 –2.42***Window around event[–30, + 30] 0.55 0.20 0.36 0.24 0.19 0.11[–60, + 60] 1.96 0.50 –1.13 –0.54 3.09 1.20[–90, + 90] –1.61 –0.34 –0.96 –0.38 –0.66 –0.21Observations 29 109


The announcement effect for unsuccessful bidding firms is negative, but notstatistically significant from zero (Table 6; Fig. 6b). This negative effect can beexplained by the fact that two thirds of the subsample of failed bids consist ofhostile takeovers (see Section 4.2).

4.7. Bids Made Prior and Subsequent to January 1st 1999

M&A activity during the 1990s is characterised by continuous increases involume, in average bid value and hence in total bid value. European M&Aactivity grew by more than 280% over the period of 1996–1999. The year 1999was not only remarkable in terms of the total bid value, but also in terms of thenumber of hostile takeovers: there were a staggering 369 hostile offers. Shelton(2000) reports evidence that bidder gains fall during merger peaks, suggestingthat bidders are more aggressive, display greater tendencies to over-pay fortarget firms or assume more risk in pursuing takeover projects. Hence, we splitthe bids into two categories based on the year in which they were made: bidsbefore 1999 and those in 1999–2000. About half of the bids were made in1999–2000.9 Part of the difference in wealth effects between the two periodsmay be the result of the introduction of the Euro. However, panel A of Table7 shows that, on the announcement day, there is little difference in terms of theprice reaction for bids that took place prior to 1999 and those in 1999/2000: forboth samples the abnormal return is around 9%. Still, Fig. 7a suggests that theprice run-up for pre-1999 offers only started one month prior to theannouncement whereas that of the bids in 1999–2000 was generated for aperiod starting as long as 3 months prior to the announcement. Over longwindows, for instance over a 6-month symmetrical event window, the recentbids yield higher CAARs (almost 25%) than the pre-1999 ones (19%). We alsoinvestigate the difference in announcement reactions for firms bidding prior toand after 1 January 1999, but do not find any difference in abnormal returns(panel B of Table 7).

4.8. Divesting Firms

The 185 announcements include 29 bids for a divestiture of a division from alisted firm. In all 29 cases the initial bid is a friendly attempt, but one caseinvolved multiple bidders and was therefore considered to be a hostile bid. Inhalf of the cases, bidder and target are located in the same European countryand in more than one third of the cases bidder and target are U.K.-based.Ninety percent of the bids are cash financed; two offers were financed by bothcash and loan notes and in one case a combination of equity and loan notes was


Fig

.6b.

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etur

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f bi

ddin

g fir

ms

by E

x Po

st S

ucce

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l and

Fai

led

Bid

s.


offered. The market value of the divestitures is smaller than that of the averagebid for an independent firm and averages USD 480 million (median of USD415) (see the table in the appendix). Table 8 and Fig. 8 show that the

Table 7. Cumulative Abnormal Returns by Year of Bid.

This table shows cumulative abnormal returns over several event windows for target firms andbidder firms by year of bid (prior to 1999 and 1999/2000). ***, ** and * stand for statisticalsignificance at the 1%, 5% and 10% level, respectively. Source: own calculations.

Panel A : CAARs of Target Firms by Year of Bid

Time Interval pre-1999offers

t-value 1999/2000offers

t-value 1999/2000offers – pre-1999 offers

t-valuedifferences

Event day % % %[–1, 0] 08.80 23.30*** 09.20 18.90*** 0.40 0.92[–2, + 2] 14.02 23.48*** 11.99 15.58*** –2.03 –2.93***Window prior to and at event[–10, 0] 19.82 17.02*** 17.56 11.13*** –2.26 –1.99**[–40, 0] 21.78 8.52*** 24.15 9.34*** 2.37 1.31Window around event[–30, + 30] 22.71 10.89*** 24.10 8.96*** 1.39 0.57[–60, + 60] 18.47 6.29*** 24.83 6.56*** 6.36 1.87*[–90, + 90] 18.98 5.28*** 24.00 5.18*** 5.02 1.21Observations 48 52

Panel B : CAARs of Bidding Firms by Year of Bid

Time Interval pre-1999offers

t-value 1999–2000offers

t-value 1999–2000offers – pre-1999 offers

t-valuedifferences

Event day % % %[–1, 0] 0.55 2.13** 0.87 2.17** 0.32 0.96[–2, + 2] 1.22 2.98*** 1.14 1.80* –0.08 –0.16Window prior to and at event[–10, 0] 0.16 0.36 0.03 0.11 –0.13 0.29[–40, 0] 1.72 1.59 0.07 0.10 –1.65 1.60Window around event[–30, + 30] 0.39 0.27 0.41 0.18 0.02 0.01[–60, + 60] –0.10 –0.05 –0.91 –0.29 –0.81 –0.31[–90, + 90] –0.47 –0.19 –1.81 –0.47 –1.33 –0.42Observations 74 65


Fig

.7a.

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ive

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orm

al R

etur

ns o

f Ta

rget

s Fi

rms:

Bid

s M

ade

Pre-

and

Pos

t-Ja

nuar

y 1s

t 199

9.


Fig

.7b.

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ids

Mad

e Pr

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nd P

ost-

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ary

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announcement of the divestitures is greeted by the market as positive news forthe divesting firm as the CAAR of a 5-day window around the event day is3.5% (significant at the 1% level). The reasons that are reported for thedivesture in the announcement press statements include: return to core business(69%) and the generation of cash to pursue a focus strategy (21%).

Hanson and Song (2000) find that buyers and sellers on average receivesignificant positive percentage returns, although significant returns only occurin the 1990–1995 period. Other recent U.S. divestiture research by Mulherinand Boone (2000) for the period 1990–1999 concludes that the combined targetand bidder return at the announcement averages 3.5%, while the announcementreturn for corporate divestitures averages 3%. The results are consistent withthe views that divestitures create value by moving assets to the buyer’s moreefficient operating environment and that divestitures resolve agency problems.

5. TAKEOVER MOTIVES: SYNERGIES,AGENCY OR HUBRIS?

Although most bidding firms make statements about the potential synergiesfrom mergers and acquisitions, frequently the forecasted benefits are notobtained. This may be the result of poor synergy forecasts by the biddingmanagement or the fact that the takeover was initiated for entirely differentreasons such as managerial hubris or other agency problems. We will attemptto distinguish between these three different takeover motives by performing acorrelation analysis of the target, bidder and total announcement gains.

Table 8. Cumulative Abnormal Returns of Divesting Firms.

This table shows cumulative abnormal returns over several event windows for divesting firms. ***,** and * stand for statistical significance at the 1%, 5% and 10% level, respectively. Source: owncalculations.

Time Interval CAAR t-value

Event day %[–1, 0] 0.31 0.51[–2, + 2] 3.46 3.60***Window around event[–30, + 30] 0.81 0.24[–60, + 60] 1.03 0.22[–120, + 120] –10.06 –1.50Observations 29


Fig

.8.

Cum

ulat

ive

Abn

orm

al R

etur

ns o

f D

ives

ting

Firm

s.


If synergies are the main motive for the merger, we assume that themanagement of both the target and acquirer intend to maximise shareholdervalue. Hence, the wealth effects of the takeover for both target and acquirershareholders should be positive and the division of the value created shoulddepend on the relative bargaining power of target and bidder. In addition, thewealth gains for the target shareholders should be positively correlated to thoseof the bidder shareholders and the total wealth effect.

A second motive for a takeover may be agency related: in this case, the self-interest of the bidder’s management is the prime reason for the offer. Managersmay prefer to stimulate corporate growth rather than corporate value as theirprivate benefits tend to be more substantial in the larger firms. For example,Conyon and Murphy (2002) show that for the U.K., corporate size (and notcorporate performance) is the main determinant of the level of managerialsalaries, bonuses as well as of the allotment of stock options. Hence, managersmay be tempted to use free cash flow for ‘empire building’ (Jensen, 1986).Similarly, Shleifer and Vishny (1989) suggest that managers may makeacquisitions such that the combined entity will depend even more on theirpersonal expertise. Hence, they may exploit this dependency and extract valuefrom the acquirer: both the total value of the combined entity as well as thewealth of the bidder’s shareholders will be lower. As a result, the correlationsbetween the target’s value and the bidder’s value and between the target’s valueand the total value will be negative.

A third takeover motive may be the bidding management’s hubris, whichhinges on the assumption that the management makes mistakes in evaluatingpotential targets (Roll, 1986). If there is an equal probability that managers areover- and underestimating the synergies of potential takeovers, and managersmake a bid after having overestimated synergy values, they may mostly pay toomuch for the target. As a result, the higher the target’s gain, the lower thebidder’s gain, such that there is a wealth transfer from the bidder to the targetwith the total gain being zero (Berkovitch & Narayanan, 1993). Hence, thecorrelation between the target’s and bidder’s wealth changes is negativewhereas the one between the target’s and total wealth change is zero. Panel Aof Table 9 summarizes the expected signs of the correlations.

In order to test these hypotheses, we select the 68 takeovers for which bothtarget and bidder are listed. The average total gain is calculated on the eventday (panel B of Table 9) and over the time window [–10, + 1] (panel C), usingthe market capitalizations of bidder and target as weights. Total wealth gainsover these periods amount to 4% and 6%, respectively, of the combined entity.Fifty-eight percent of takeovers in this sample have positive total wealth gains.For the whole sample, we find that the correlations between the target and total


gain in panel B are significantly positive. When we measure the wealth gainover a longer event window, the correlation between the target and the biddergains is also significantly positive. This suggests that, on average, the largeEuropean takeover bids in the 1990s were motivated by synergies. However, asthe motives for individual firms may still be different, we also analyse thecorrelations for the subsamples of takeovers with positive vs. negative totalwealth effects. We find that the synergy hypothesis for the firms with positivewealth effects is corroborated (see panel C). In contrast, for the companies withnegative gains, we find no correlation between target and total gain and a

Table 9. Correlations Between Target, Bidder and Total Wealth Gain.

This table tests whether or not takeover bids were made for reasons of synergy, agency or hubris.Source: own calculations.

Panel A : Expected sign of correlation

Expected signCorrelation Target

and Total Gain

Expected signCorrelation Targetand Bidder Gain

Synergy Positive PositiveAgency Negative NegativeHubris Zero Negative

Panel B : Correlations between target, bidder and total event day gain

Correlation Targetand Total

Gain

Correlation Targetand Bidder

Gain

Total sample (64 observations) 0.4545** 0.0617Positive total gain sub-sample (42) 0.2474* –0.1990Negative total gain sub-sample (22) 0.2359 –0.1267

Panel C: Correlations between target, bidder and total gain over period [–10, 0]

Correlation Targetand Total

Gain

Correlation Targetand Bidder

Gain

Total sample (64) 0.6330*** 0.4155**Positive total gain sub-sample (42) 0.5541** 0.1763*Negative total gain sub-sample (22) 0.1393 –0.1640*


negative correlation – only statistically significant for longer term wealtheffects – between target and bidder gains. This suggests that in about a third ofthe firms, managerial hubris may, to a large extent, be responsible for poordecision making about takeover bids. The findings from this study are in linewith those of Gupta et al. (1997) and Berkovitch and Narayanan (1993) whoboth find strong evidence that synergy is the prime motive for takeovers. Thelatter study also finds evidence that agency problems and hubris are a motivefor acquisitions.

6. DETERMINANTS OF SHORT-RUN WEALTHEFFECTS FOR TARGET AND BIDDING FIRMS

We regress the cumulative abnormal returns of target and bidding firms (inseparate regressions) over several windows ([–1, 0] and [–10, + 1]) on variablescapturing:

(i) the type of takeover (merger, acquisition, hostile takeover),(ii) the means of payment (all-cash offer, all-equity offer or a combination of

cash, equity or loan notes),(iii) the takeover characteristics (relative size: target/bidder),(iv) the target and bidder characteristics (net cash held by target over market

value of equity, performance of target, interest coverage of target, growthpotential of target (MV/BV), degree of diversification of bidder, industryof target and bidder,

(v) corporate governance characteristics (U.K. target, U.K. bidder).

We correct both target and bidder regressions for industry effects. The samplesize is 100 for the target firms and 139 for the bidder firms.

Table 10 shows that the type of takeover bid is an important determinant ofthe short-term wealth effects (on the event day and for the period including theprice-run up) for both target and bidder firms. In comparison to merger offers,hostile bids trigger large positive abnormal returns for the target shareholdersbut significant, negative returns for the bidder. This follows from the fact thatbidder shareholders are fearful that the management’s motives for the bid areagency problems or hubris. In contrast, target shareholders expect thatopposition against the offer will lead to upward bid revisions. When the offeris cash financed, the target’s share price will increase more than when the bidconsists of an all-equity offer or a combination of equity, cash and loan notes.An all-cash offer signals that the bidder’s equity is undervalued. It may alsosignal the bidder’s confidence in the value of the synergies as the bidder doesnot want to share future value creation with the target shareholders. However,


Tabl

e10

.D

eter

min

ants

of

Shor

t Ter

m W

ealth

Eff

ects

for

Tar

get a

nd B

iddi

ng F

irm

s.

Thi

s ta

ble

show

s O

LS

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essi

ons

of c

umul

ativ

e ab

norm

al r

etur

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ver

diff

eren

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nt w

indo

ws

for

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et a

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idde

r fir

ms.

Targ

et fi

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der

firm

s

Dep

var

iabl

eC

AA

R [

–1, 0

]C

AA

R [

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0]

CA

AR

[–1

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[–1

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oeff ·

p-va

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ff ·p-

valu

eC

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ff ·p-

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e

Inte

rcep

t0.

0643

2.26

9**

0.08

482.

673*

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0553

2.15

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0.82

42.

428*

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id c

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cter

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tion

0.02

532.

141*

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2.36

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502

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22**

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640.

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740.

537

cash

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590*

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tics

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1.65

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0.26

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over

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001

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0.00

040.

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0.00

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50.

315

0.57

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arge

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1.92

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0561

1.78

2*0.

0463

2.01

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0.03

821.

856*

U.K

. bid

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0.01

891.

846*

0.03

251.

699*

0.04

111.

911*

0.04

451.

874*

Indu

stri

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nerg

y–0

.056

4–0

.467

–0.0

724

–0.8

97–0

.023

2–0

.565

–0.0

633

–0.7

44Se

rvic

es–0

.046

3–0

.409

6–0

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6–0

.402

–0.0

217

–0.6

88–0

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2–0

.148

Ret

ail

–0.0

717

–0.3

616

–0.0

738

–0.5

660.

0495

1.58

50.

0315

1.04

1Fi

nanc

ial

–0.0

337

–0.7

758

–0.0

443

–1.3

130.

1052

0.75

40.

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0.25

1O

bser

vatio

ns10

010

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295

0.35

20.

303

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1A

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ted

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215

0.22

30.

246

Sign

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60.

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0.00

1


for the very large takeover targets it may be difficult to raise large amounts ofcash such that the bidder has to resort to an equity or combined offer. The shareprice reaction for bidding firms to a cash offer is (weakly) negative. This mayresult from the concern that management may bid too high a premium whereaswhen the target shareholders accept an equity offer, they share some of the riskfrom the acquisition.

The impact of the following target and bidder firm characteristics is alsoinvestigated: the relative size of the target compared to the bidder, the cashreserves held by the target firm, the target’s market-to-book ratio, the target’sreturn on equity and interest coverage, the degree of the bidder’s diversifica-tion, the fact whether or not bidder and target are in the same industry and thecountry the bidder and target are located in. Table 10 shows that the relativesize is not significant, which may be explained by the fact that this study onlyconcentrates on large European bids. The amount of cash reserves held by thetarget company may have an impact on the bid and hence on the share pricereaction at the announcement, because a target firm with substantial cashreserves may finance its own takeover. Table 10 shows that this is not the casein our sample. For a target firm with growth opportunities (as reflected in a highmarket-to-book ratio), the market expects a premium whereas Table 10suggests that the market is anxious that the bidder will overpay for growthoptions. Neither the target’s performance (return on equity) nor the financialdistress measure (interest coverage) has any bearing on the abnormal returns ofthe sample targets and bidders. In addition, the fact that the takeover is withinthe same industry does not influence the announcement effect of a takeover. Incontrast, we find some weak evidence (at the 10% level) that the bidder’s shareprice reacts negatively to a takeover bid when the bidder is already diversified.The regressions also analyse whether the location of the bidder and target –U.K. versus Continental Europe – influences the announcement effect. We findstrong evidence of significantly positive abnormal returns when the target firmand the bidding firm are U.K. based. This is because the U.K. has an activemarket for corporate control which is largely inexistent in ContinentalEurope.

7. CONCLUSIONS

The 1990s were characterised by a large increase in European M&A activity.In 1999, the total deal volume, the average deal value and the number of hostiletakeovers almost reached U.S. levels. In this study we analyse the marketreactions to takeover bids in large M&A deals (185) with a value of at leastUSD 100 million. Our sample comprises 55 mergers, 40 friendly acquisition,


40 hostile takeovers, 21 hostile takeovers involving multiple bidders and 29divestitures.

The short-term wealth effects are remarkably similar to those of U.S. andU.K. studies. We find large announcement effects of 9% for target firms, but thecumulative abnormal return that includes the price run-up over the two-weekperiod prior to the event rises to 20%. The share price of the bidding firmsreacts positively with a statistically significant announcement effect of only0.7%. We also show that the type of takeover bid has a large impact on the shortterm-wealth effects of target and bidder shareholders. For hostile takeovers, theannouncement effect for target firms is substantially higher (12.6% on day 0and almost 30% including the price run-up) than the one for mergers andfriendly acquisitions (8% on day 0 and 22% including the price run-up). Hence,the market seems to expect that opposition against a bid will lead to a revisionof the offer and ultimately to a higher bid premium. This is confirmed by theshare price reaction of bidding firms: a hostile takeover triggers a negative pricereaction of 2.5% whereas the announcement of a merger or friendly acquisitiongenerates a positive announcement abnormal return of 2.5%. The location ofbidder and target firms also seems to have an important impact on short-termwealth effects: both U.K. bidders and targets generate significantly higherreturns than their Continental European counterparts. This can be partiallyexplained by the higher incidence of hostile takeovers in the U.K. and in themore developed U.K. takeover market.

We also find strong evidence that the means of payment in an offer has alarge impact on the share price reactions. All-cash offers trigger an abnormalreturn of almost 10% upon announcement (27.5% including price run-up)whereas all-equity bids or offers combining cash, equity and loan notesgenerate a return of 6% only (14% including the price run-up). Cash bids aremore frequent for smaller targets, though. Surprisingly, the market reacts morepositively ( + 1%) to bidding firms which resort to equity to pay for thetakeover. This implies that the choice of means of payment does not act as asignal to the market of the over- or undervaluation of the bidder’s equity.

Contrary to past research, the size of the target firm relative to the size of thebidder does not have an impact on target and bidder wealth effects. The reasonfor this may be that this study focuses on large takeover deals and that thereforethe average relative size is high. There is no evidence that the past returns oftarget and bidder firms influence the share price reactions around the bidannouncement. However, the market-to-book ratio of the target matters interms of the bid premium. A high market-to book ratio for the target leads toa higher bid premium combined with a negative price reaction for the bidder.


Finally, we find that bidding firms should not further diversify by acquiringtarget firms that do not match the bidder’s core business.

We also investigate whether the predominant reason for takeovers issynergies, agency problems or managerial hubris. We find a significant positivecorrelation between target shareholder gains and total gains for the mergedentity as well as between target gains and bidder gains. This suggests thatsynergies are the prime motivation for bids and that targets and bidders tend toshare the resulting wealth gains. However, these findings are only valid for thecompanies generating positive wealth gains. In companies with negative totalwealth gains, there is no significant correlation between target and total wealthgains whereas the correlation between target and bidder gains is significant andnegative. This implies that – given that the total wealth effect is not positive –a dollar gain to the target’s shareholders coincides with a dollar loss for thebidder’s shareholders. Thus, it seems that for a third of firms, managerial hubrisleads to poor decision making on takeovers.

NOTES

1. As reported in an M&A report by Morgan Stanley using Thomson FinancialSecurities Data, April 2001.

2. For an excellent overview of post-merger performance and of the motives formergers and tender offers: see Agrawal and Jaffe (2000).

3. Still, the empirical evidence investigating the creation of an internal capital marketshows that diversified firms do not rely significantly less on the outside capital marketthan non-diversified firms (Comment & Jarrell, 1995).

4. The systematic risk of all 6 estimation techniques is calculated using the all-shareindex for each country. For example, the betas of U.K. targets and bidders are calculatedusing the FT-All Share Index.

5. After the first announcement of a bid, it still takes several months before themerger or acquisition is accepted and the target firm stops trading. In only 11 out of 129cases, the target firm is no longer traded within 40 trading days subsequent to theannouncement. Respectively, 24 and 36 target firms are delisted 60 and 100 trading dayssubsequent to the announcement. We reduce the event window of target firms to 80 daysafter the event day.

6. The post-announcement correction in abnormal returns is not explained by the factthat the Continental European sample consists of more bids which fail ex post. Quite thecontrary is true: there are more failed bids (related to hostile takeover attempts) inthe U.K.

7. This choice between an all-cash offer or a combined offer consisting of cash andequity is given in all 12 cases at the first announcement of the bid. In contrast, in 4cases, a cash offer was added to an initial all-equity or combined offer as a sweetenersome time after the first announcement.

8. Upon the editors’ suggestion, we investigated whether the means of payment isstill significant after correcting for the payment of a premium. We find that cash offers


still have a (modestly significantly) negative impact (at the 10% level) on the share pricereaction of the bidder.

9. An analysis of the takeovers by year for the period 1993–1998 does not givesignificant differences in abnormal returns at the announcement and over longer timewindows.

ACKNOWLEDGMENTS

We are grateful to Marco Becht, Rafel Crespi, Julian Franks, Carles Gispert,Alan Gregory, Rez Kabir, Colin Mayer, and Joe McCahery for stimulatingcomments.

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McCahery, J., Moerland, P., Raaijmakers, T., & Renneboog, L. (2002). Corporate governanceregimes: convergence and diversity. Oxford University Press.

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Mulherin, J. H., & Boone, A. L. (2000). Comparing acquisitions and divestitures. Journal ofCorporate Finance, 6, 117–139.

Rau, P. R., & Vermaelen, T. (1998). Glamour, value and the post-acquisition performance ofacquiring firms. Journal of Financial Economics, 49, 223–253.

Roll, R. (1986). The hubris hypothesis of corporate takeovers. Journal of Business, 59, 197–216.Servaes, H. (1991). Tobin’s Q and the gains from takeovers. Journal of Finance, 46, 409–419.Shelton, L. M. (2000). Merger market dynamics: insights into behaviour of target and bidder firms.

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paper. Johns Hopkins University.


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THE OPERATING PERFORMANCE OFCOMPANIES INVOLVED INACQUISITIONS IN THE U.K.RETAILING SECTOR, 1977–1992

Steve Burt and Robin Limmack

ABSTRACT

Takeover activity has played an important role in the restructuring of theU.K. retail sector over the past two decades and appears likely to do so inthe future. Debate about the impact of this restructuring has focused to alarge extent on the impact on competition, customers and employees. Atthe micro level research on takeovers has generally been directed to thelikely shareholder wealth effects. Studies using methodologies based onthe analysis of security returns have generally concluded that whileshareholders of target companies experience wealth gains from takeoveractivity, on average shareholders of acquiring companies experiencewealth losses. If takeover activity is not even in the interests of theshareholders of companies that make acquisitions, then it may be that thepotential detrimental effects on other groups should produce a policy biasagainst takeovers. There are, however, a number of reasons why thisapproach ought not to adopted without question. First, questions havebeen raised about the methodologies adopted in studies based on analysisof security return behaviour, and in particular of those studies whichevaluate long-run behaviour. Second the studies themselves are not


147

unambiguous in their conclusions on the net wealth effects. Because of thecriticisms of studies based on security price behaviour, a number ofresearchers have taken an alternative approach to measuring the long-runeffects of particular economic events, including takeover activity. Thisapproach involves analysis of the cash flow operating performance ofcompanies involved. In the current paper we apply this approach to ananalysis of the operating performance of a sample of U.K. companiesinvolved in takeover activity in the retailing sector over the period1977–1992. We also investigate potential sources of changes in operatingperformance, together with the effect of the takeover activity onemployment in the retailing sector.

INTRODUCTION

Recent news announcements confirm that the period of restructuring of theU.K. retailing sector is not yet complete. Much of the public debate on thesedevelopments has related to the benefit, or otherwise, to the customer fromrestructuring activities and in particular to their effect on competition. In a fewcases concern has also been expressed about the effect of heightenedcompetition on employees, especially in those areas of retailing that are able toobtain inventories from non-U.K. suppliers. Surprisingly one stakeholder groupthat appear to have been taken for granted in this debate are the owners of thecompanies involved, and in particular the shareholders of the acquiring firm. Itis not clear whether this oversight has arisen because shareholders are not anobvious candidate for public support or because it is assumed that, of allgroups, shareholders are those most likely to benefit from takeover activity.However the latter assumption is not necessarily correct. Nor is the majority ofthe population of the United Kingdom unaffected by the impact of financialdecisions on the wealth of shareholders of companies involved.

There is currently a fairly large body of research that casts doubt on theability of the management of companies involved in takeover activity togenerate wealth for their shareholders. Studies generally agree that theshareholders of target companies experience large, significant wealth increasesfrom the premiums paid to their companies when acquired. However it is notclear that the latter does not simply involve a transfer of wealth from theshareholders of bidding companies rather than any net wealth gain arising fromsynergies. In particular those studies that have examined the long-run post-outcome share price performance of acquiring companies have generallyconcluded that takeovers are not in the interests of shareholders of biddingcompanies.1 Such a conclusion will not come as a surprise either to those who

148 STEVE BURT AND ROBIN LIMMACK

are familiar with literature on corporate governance or with the earlyaccounting studies on takeovers in the U.K., published in the late 1960s andearly 1970s.2 One of the features of governance literature relates to the inabilityof various governance mechanisms to overcome the agency problem. Therecent survey on corporate governance by Shleifer and Vishny (1997) begins byhighlighting the level of disagreement about the effectiveness of variousgovernance mechanisms. While the threat of takeover may be seen by some asa means by which inefficient management may be disciplined,3 takeoveractivity itself also appears to be one of the manifestations of the problem.

One of the problematic aspects of security market based studies of the wealtheffects of takeovers is that they are dependent on the choice of an appropriatemodel of expected share price behaviour.4 Studies of long-run security returnsbehaviour are to a certain degree inconsistent with the accepted efficientmarkets paradigm that provides the foundation for studies of economic events.The latter studies are based on the assumption that share prices react in aspeedy and unbiased manner to the expected present value of the future cashflow changes arising from the event under investigation. The apparentcontradiction between the results of long-run studies of post-bid share pricebehaviour and the efficient markets paradigm have led a number of authors tosuggest that the results may be a reflection of the choice of an inappropriatereturns prediction model rather than the acquisition per se. However such aconclusion then leaves the question as to what is an appropriate model?

While researchers have, in general, rejected early models of security pricebehaviour used in takeover studies, they are divided as to the choice of anappropriate alternative. As one alternative a number of authors have suggestedusing a methodology which tests for changes in operating performancefollowing the acquisition rather than focussing on the wealth effects, if any.5

This approach has already been adopted in studies of the performance ofcompanies following seasoned equity issues (Loughran & Ritter, 1997). It hasalso been used to a limited extent in studies of post-outcome acquiringcompany performance, both in the USA (Healy et al., 1992) and in the U.K.(Manson et al., 1994). The current study adopts this approach and tests forimprovements in operating performance following takeovers of companiesinvolved in the retailing industry in the United Kingdom. Thus our focus is noton the distribution of gains following takeovers but whether there is evidencefor operating improvements that would give rise to wealth gains, howeverdistributed. This approach itself is not without its critics as accounting-basedmeasures of performance are subject to potential manipulation, lack of risk-adjustment and choice of arbitrary time frame for analysis. However theapproach taken in this study uses cash flow measures that are subject to reduced

149The Operating Performance of Companies Involved in Acquisitions

opportunity for manipulation and uses a time frame for analysis beginning fiveyears prior to the acquisition and ending five years post-acquisition. We alsoadopt a matched firm approach that minimises any potential bias arising fromincomplete risk adjustment.

The structure of the remainder of this paper is as follows: Section (2)describes the sample and data used in the current study together with the basicmethodology; Section (3) describes the results of our preliminary analysis;Section (4) extends the analysis to investigate possible sources of operatingimprovement; finally Section (5) provides a summary and conclusions togetherwith suggestions for further research.

2. DATA AND METHODOLOGY

Data

The sample of takeovers selected for analysis was identified from thepopulation of takeovers of U.K. listed companies in the retail sector that wereinitiated and completed over the period 1 January 1977 to 31 December 1992.In order to obtain comparable data for the analysis it was necessary to furtherrestrict the sample to those takeovers in which both the acquirer and the targetwere publicly listed. The full set of tests used in the current paper also requireaccounting data to be available for our sample of bidding and target companies,and their respective controls, for a period of up to twelve financial years. Thisperiod commences six years prior to the year in which the takeover wasinitiated and, except for the target companies, extends to a period of fivefinancial years following the end of the financial year in which the takeover wascompleted. However in order to reduce survivorship problems we impose norequirement as to the minimum period for which financial data must beavailable beyond one year following the takeover year.6 A total of 49acquisitions satisfied this minimum requirement, representing £8.86 billion inpurchase consideration at an average size of £174 million. While our finalsample is fairly heavily biased towards large acquisitions it neverthelessrepresents a reasonable proportion of the value of takeovers of U.K. retailingcompanies in the period studied, and covers a range of retail sectors. The biastowards large acquisitions will be referred to in the final part of our analysis.

Methodology

Although we have identified disagreements over the choice of appropriatemethodologies to be used in studies involving security returns, the choice of


measurement bases for evaluating operating performance is itself notunambiguous. Earlier accounting-based studies in the U.K. (Singh, 1971;Meeks, 1977; Cosh, Hughes & Singh, 1980; Holl & Pickering, 1988) and theU.S. (Lev & Mandelker, 1972; Mueller, 1980) focused on changes in netincome to total sales as a performance measure. Other studies that have usedoperating income to total assets or sales to measure operating performanceinclude those by Ravenscraft and Scherer (1987) and Jarrell (1995) in the U.S.The use of earnings based on accrual accounting is not without criticism,including those relating to inconsistent accounting methods (Appleyard, 1980)and opportunities for earnings management. Erickson and Wang (1999)provide evidence that managers of acquiring firms manipulate earnings in thequarter prior to the bid for equity offerings.7 The potential problems ofearnings-based measures of operating performance has led a number of authorsto adopt measures based on operating cash flows. Rayburn (1986) and Bowen,Burgstahler and Daley (1986) provide evidence that cash flows can incremen-tally explain abnormal stock returns. Bowen, et al. (1986) found ‘that cashinformation is consistent with the information impounded in security prices andalso has incremental explanatory power beyond that contained in accrual flowsalone’ (p. 746). According to Dechow (1994, p. 5) ‘many financial analystregard operating cash flow as a better gauge of corporate financial performancethan net income, since it is less subject to distortion from differing accountingpractices.’ 8

The choice of operating cash flows as our numerator is consistent with thatadopted in other similar studies including those of Manson, Stark and Thomas(1994) in the U.K. and Healy, Palepu and Ruback (1992) and Clark and Ofek(1994), Anand and Singh (1997) and Harford (2000) in the USA. Our measureof operating performance is therefore pre-tax operating cash flows deflated bythe opening book value of operating assets. We use the book value, rather thanmarket values partly to avoid the problems associated with market anticipationof the gains from the takeover.9 In addition Barber and Lyon (1996)demonstrate that the use of market values, rather than book values, adds littleif anything to the measure of performance.10

Operating profit is calculated before the following items: depreciation andgoodwill amortisation, gains or losses on the disposal of fixed assets, interestreceivable and interest payable, tax, extraordinary items, and dividendsreceived and paid. Operating cash flow is calculated based on operating profitadjusted for non-cash changes in operating assets and liabilities. The definitionof operating cash flow used in this study is similar to that used by Manson etal. (1994) but differs from that used by Healy et al. (1992). The latter authorsdefine operating cash flows as sales minus cost of goods sold and selling and


administrative expenses, plus depreciation and goodwill expenses. In theirpaper Healy et al. (1992) make no adjustment for current accruals and non-operating gains.

Operating assets are defined as the total of net fixed assets plus currentassets, less cash and marketable securities.11 Growth in operating assets isdefined as the change in book value of operating assets over the year dividedby the book value of operating assets at the beginning of that year.

To avoid bias caused by the additional expenses involved in the acquisitionitself and the effect of timing differences for the date of consolidation withinthe acquisition year, financial results for that year (t = 0) are excluded fromcomparison with pre-bid periods.

In order to provide a benchmark measure of pre-acquisition performance foreach takeover we identify a pro-forma measure (Ppre i,t) for the acquirer andtarget combined in each of the five years prior to takeover. This measure iscomputed by deflating the operating cash flows for the acquirer (target) by theasset value of the acquirer (target) at the beginning of the correspondingfinancial year and then computing the weighted average value for acquirer andtarget combined using the relative asset values as weights. The measure of assetvalue used in this study is based on the book value of total assets, excludingcash and marketable securities. Thus for firm i in year t the measure iscalculated as:

Ppreit =�OCFA

AssetA�� AssetA

Asset(A + T )�+�OCFT

AssetT�� AssetT

Asset(A + T )�or

Ppreit =OCFA + OCFT

Asset(A + T )

A and T represent the acquirer and target respectively;OCF represents operating cash flow;Asset refers to the asset value of the respective company; andt is the financial year (t = –5 . . . , –1).

A matched-firm control is obtained for each target and acquirer with matchingbased on industry and size.12 In order to reduce problems caused by imprecisematching we adopt a procedure similar to that used by Healy et al. (1992) andweight control company returns by the relative asset values of the two samplefirms at the beginning of the relevant year.13 Although Barber and Lyon (1996)demonstrate that matching based on prior performance is more appropriate,


they also show that the use of industry matching can improve the power of testsover longer time periods. Because of a limited number of potential observationsin each industry group we are unable to match exactly by prior performanceand industry.14 We also use a series of tests, based on regression analysis, whichattempt to control for difference in performance between our sample and thecontrol companies.

Pre-acquisition control returns (Pcpre i,t) are calculated as described above for

the acquirer and target.The control-adjusted operating performance (APc) is obtained by subtracting

the pro-forma control company measure of operating performance from thepro-forma measures of operating performance for the respective takeover i foryear t.

APci,t = Ppre i,t � Pc

pre i,t

for t = –5, . . . –1

The post acquisition measure of operating performance is calculated as theoperating cash flow of the newly combined firm in each of years 1 to 5, deflatedby book value of operating assets at the beginning of the relevant year.15

As explained previously we use book values in order to exclude fromthe denominator the capitalised value of cash flow changes arising from thetakeover. In their study Healy et al. (1992) use market values and exclude thechange in market value of the target and acquirer from five days before the firstoffer until the date when the target is delisted on the assumption that this periodcaptures all the wealth effects of the bid. However one of the primary reasonswhich we state for using cash flow analysis is that the results of studies basedon the analysis of security returns have suggested that there is a long-run postoutcome wealth effect. It would therefore be more appropriate to exclude allpost-bid wealth changes in the denominator. Such an approach would, however,produce a denominator that was a mixture of market values and book values butmeasured at different points in time. We choose instead to use book value as theconsistent measurement base throughout the study. One of the potentialproblems with the use of book values as denominator relates to the impact onmeasures of performance of the use of fair value adjustments at the time of theacquisition. We refer to this potential problem in the discussion of results. Thecombined control company performance in post acquisition years is computedby weighting the performance of the individual control companies by therelative operating asset values of acquirer and target at the end of the lastfinancial year prior to the acquisition (t � 1).16 We also test the sensitivity of ourresults to the alternative weighting method.


In addition to the above, a summary measure of operating performance forthe combined acquirer and target is calculated for each acquisition based on themedian control-adjusted performance for the five years prior to acquisition anda similar summary statistics is constructed for the five years post-acquisition.

APcprei = Median [APc

i�5, . . ., APci�1]

APcposti = Median [APc

i,1, . . ., APci,5]

In order to control for relative pre-bid performance we then apply the followingmodel:

(PMpost,i � Pc

post,i) = � + �(PBTpre,i � Pc

pre,i) + �I

where

(PMpost,i � Pc

post,i) = the post acquisition median annual control-adjustedoperating return for ‘company’ i

(PBTpre,i � Pc

pre,i) = the pre-acquisition median annual control-adjusted operatingreturn for the same ‘company’

� = is the measure of the abnormal control-adjusted return and isindependent of pre-acquisition returns

� = the slope coefficient that captures any correlation in returnsbetween pre- and post acquisition years, and represents theperformance that would have been achieved independent ofthe acquisition.

3. PRELIMINARY RESULTS

We begin our analysis by compiling data on rates of growth in operating cashflows and operating assets for the acquirer, target and control companies.

In Table 1 we present preliminary data on the characteristics of the firmsinvolved in takeovers and the respective control companies. Panel Asummarises the rates of growth in cash flows for the five years prior to the bidfor targets, acquirers and their respective controls. Targets appear todemonstrate higher rates of growth on average than their controls from year –5to 4, –4 to –3, and –3 to –2 but lower rates of growth in year –2 to –1. Howeverthe results are influenced by a number of extremely high values in each of theseyears. Using both Analysis of Variance and Mann-Whitney tests we find nosignificant difference in cash flow growth rates between targets and theircontrols at the 5% level for any period. The rate of growth in operating cash


flows of acquirers is significantly higher (at the 10% level) than that of thecontrol companies only from year –3 to year –2. The median annual rate ofgrowth in cash flows for acquirers over the entire five-year pre-bid period is,however, significantly higher than that of the controls at the 1% level. Asdescribed in Panel B of Table 1, the rate of growth in operating assets issignificantly higher for targets than their controls in years –5,–3 (based onmean values) and in year –1. For acquirers, there is a significantly higher rateof growth in years –4 and –2 only. Based on this data alone there is only slightevidence of acquirers buying growth.

Table 1. Pre-Bid Rates of Growth in Operating Cash Flows and OperatingAssets for Companies Involved in Retail Acquisitions Undertaken in the Period

1977–1992. Figures in Cells Represent Mean Followed by Median Values.

Period relative tobid year (year 0)

Target Control Control-adjusted

Acquirer Control Control-adjusted

Observations

% % % % % % N

Panel A: Cash Flow Growth Rate:

Year –5 to –4 105, 21 101, 25 4, –17 64, 16 –29, 15 93, 5 36Year –4 to –3 386, 26 26, 8 360, 32 97, 19 37, 10 60, 8 39Year –3 to –2 38, 2 –23, 14 61, 1 101, 41 9, 10 97c, 25 41Year –2 to –1 –50, 9 6, 16 –57, 7 93, 32 39, 4 54, 43 44Median annualperformance overyears –5 to –1 –42, 32 19, 21 –61, 5 60, 38 22, 14 38a, 30a 44

Panel B: Operating Asset Growth Rate*

Year –5 34, 15 15, 15 18b, –4 –29, 15 22, 14 –51, 4 36Year –4 13, 13 13, 6 0, 4 37, 10 12, 14 25c, 3 39Year –3 22, 11 7, 6 15b, 9 9, 10 8, 5 1, 2 41Year –2 26, 12 14, 10 12, –3 39, 4 10, 10 29c, –4 44Year –1 56, 16 3, 5 53c, 16a 22, 14 14, 10 8, –2 44Median annualperformance overyears –5 to –1 36, 16 11, 9 25, 7 21, 13 9, 10 12, 4 44

Note: Asset growth rates are calculated using start-of-year values.Significance tests refer only to the control-adjusted returns.a Indicates significantly different from zero at 1% level of significance.b Indicates significantly different from zero at 5% level of significance.c Indicates significantly different from zero at 10% level of significance.


Panel A of Table 2 provides a summary of the post-bid rates of growth inoperating cash flows of the newly combined firm relative to the pro-formacontrol. The base year against which growth is measured is the financial yearending prior to the year in which the acquisition takes place. With the exceptionof the period from year –1 to year + 4, there is no significant difference in therate of growth of cash flows for the newly combined firm compared to thecontrol firms. As shown in Panel B of Table 2, the control-adjusted median rateof growth of operating assets is actually significantly negative in all five post-acquisition periods, relative to year-1. The results provide further support forthe view that the acquisition activity is not simply growth driven. Rather itappears that, as that the rate of growth in operating cash flows is notsignificantly lower than in the pre-bid period (Table 2, Panel A), the combinedcompany is making more efficient use of operating assets post-acquisition.

We next compare the pre-bid operating performance of both the target andacquirer sample relative to their control firms. The results of this analysis aresummarised in Table 3.

Panel A of Table 3 provides a summary of the deflated operating cash flowreturns of acquirers and control firms for years –5 to –1 prior to the bid yearwhile Panel B of the table provides similar data for the targets and their controlcompanies. Although there are large differences in mean performance reportedbetween acquirers and their controls, the variation in returns across observa-tions is large and in no year is the difference statistically significant. For targetcompanies, the only pre-acquisition year in which the control adjusted targetreturn is significantly different from zero is year –5. In that year both mean andmedian target returns are significantly lower than that of their matched firmcontrol. In the remaining four years the performance of the target companies isnot significantly different from that of their control companies. There is sometentative evidence from these results that acquirers generally achieve highercontrol-adjusted operating performance than their targets. However the resultsare not statistically significant. The lack of statistical significance in the resultsreported in Panel B do not allow the conclusion to be drawn that targets in retailacquisitions have a history of poor pre-bid performance. However neither of theabove results of themselves rule out the possibility of economic benefits fromtakeover activity. For consideration of this issue we need to examine post-bidoperating performance.

We measure operating performance of the pro-forma combined firms foreach year before the acquisition using the sum of acquirer and target operatingcash flows divided by the sum of acquirer and target book value of operatingassets at the beginning of that year. Control group cash flow returns are also


Table 2. Post-Bid Rates of Growth in Operating Cash Flows and OperatingBook Value of Assets for Companies Involved in Acquisitions in the Retailing

Industry in the U.K. Undertaken in the Period 1977 to 1992a.

Period relative to bid year(Year 0)

Year –1 Year –1 Year –1 Year –1 Year –1to Year + 1

%

to Year + 2

%

to Year + 3

%

to Year + 4

%

to Year + 5

%

PANEL A: Cash Flow Growth Rate

Median:Firm 65 50 61 98 117Control 24 39 43 63 81Control Adjusted 51 –2 4 64b –6Mean:Firm 103 156 153 322 272Control 69 47 139 96 156Control Adjusted 33 109 13 226c 116

PANEL B: Operating Asset Growth Rate

Median:Firm –24 –17 –7 0 4Control 21 45 48 66 76Control Adjusted –34b –36b –42b –69b –77b

Mean:Firm 44 86 106 175 206Control 27 51 59 81 93Control Adjusted 17 35 47 94 113

observations (n) 44 44 41 38 34

a Operating cash flow is defined as operating profit before tax and extraordinary items, adjusted fordepreciation and goodwill and changes in working capital (that is, changes in stocks, trade debtorsand prepayments and changes in creditors and accruals). The operating book value of assets at thebeginning of the year is the book value of shares plus net debt less cash and marketable securities.Before the acquisition (year –1), cash flow and asset values of the combined firm are weightedaverages of the acquirer and target values, with the weight being the relative asset values of the twofirms. The values of the combined firm are used in the post acquisition period. Pre- and post-acquisition control group returns are control target and control acquirer values, weighted by therelative asset values of the two corresponding sample firms at the beginning of the year prior toacquisition (year-1). Control adjusted values are computed for each firm and year as the differencebetween the firm value in that year and the value of the control firm in the same industry duringthat period. Significance tests refer only to the control-adjusted returns.b Significantly different from zero at the 5% level, using a two-tailed test.c Significantly different from zero at the 10% level, using a two-tailed test.


Table 3. Pre-Bid Operating Performance of Targets and AcquirersRelative to Controls.

Panel A: Operating performance for acquiring and control firms in years prior to acquisition1

Year relativeto acquisition

Acquirer Control Difference Observations

(Year 0) Median%

Mean%

Median%

Mean%

Median%

Mean% N

Year –5 23 44 21 22 3 21 36Year –4 19 31 20 23 1 9 37Year –3 25 122 20 24 1 98 41Year –2 24 –45 25 25 4 –70 44Year –1 29 39 27 28 2 11 44Median annualperformanceover years–5 to –1 26 28 23 26 1 2 44

Panel B: Operating performance for acquired and control firms in years prior to acquisition1

Year relativeto acquisition

Target Control Difference Observations

(Year 0) Median%

Mean%

Median%

Mean%

Median%

Mean% N

Year –5 0 2 16 18 –15a –15a 36Year –4 17 20 21 23 –3 –1 36Year –3 22 22 19 23 0 –1 39Year –2 21 29 21 23 0 6 42Year –1 21 24 21 22 –1 1 44Median annualperformanceover years–5 to –1 19 18 20 22 –4 –3 44

1 Operating performance is defined as operating cash flow deflated by the book value of operating assets.Operating cash flow is operating profit before tax and extraordinary items, adjusted for depreciation andgoodwill and changes in working capital. Operating assets at the beginning of the year is the book value ofequity plus debt less cash and marketable securities. Control adjusted values are computed for each firm andyear as the difference between the firm value in that year and the value of the control firm in the same industryduring that period. Significance tests refer only to the control-adjusted returns.a Significantly different from zero at the 1% level, using a two-tailed test.b Significantly different from zero at the 5% level, using a two-tailed test.c Significantly different from zero at the 10% level, using a two-tailed test.


measured over both pre and post-acquisition periods, using the weightsdescribed earlier.17

The first two columns of data in Table 4 provides a summary of the operatingperformance of the pro-forma combined firm in the eleven year period centredon the bid year, but excluding the bid year itself. Columns 3 and 4 provide thecorresponding data for the pro-forma control while columns 5 and 6 summarisethe control-adjusted operating performance. As the results in Panel A of Table 4indicate the weighted average operating performance of the pro-formacombined firm appears to be similar to that of the control firm in each of thefive years prior to the bid. The only significant difference in performance is foryear –2 in which the combined firm earns a 9% significantly higher meanoperating performance than the pro-forma control.18 The lack of significantdifference in pre-acquisition performance is not surprising given the chosenmatching criteria. What we are more concerned with is in identifying anysignificant change in operating performance following the acquisition. As theresults in Panel B of Table 4 demonstrate, although the operating performanceof the new combination is never less than that of the controls, it is significantlyhigher only in the first full year after the year of acquisition. In no post-acquisition year does the average performance of the newly combined firm fallbelow that of the pro-forma control.19

In order to test whether the operating performance of the combined firm hasimproved following acquisition we undertake a regression of post acquisitionoperating performance on pre-acquisition operating performance. The medianvalue of control-adjusted operating performance for each pro-forma combinedfirm is identified over the five years prior to the bid year. A similar figure is thenidentified for the five years following the bid year.20 The model adopted is asfollows:21

APcposti = � + �APc

prei + �I (1)

where

APcposti is the median (or average) annual adjusted cash flow returns for

company i for the post acquisition years.APc

prei is the pre-acquisition median (or average) for the pro-forma company i.

The abnormal adjusted cash flow returns is interpreted as the component ofpost acquisition operating performance that is not explained by the pre-acquisition operating performance but is caused by the acquisition.

The intercept � is used as the measure of the abnormal adjusted cash flowreturn (changes in performance caused by acquisition). The slope coefficient �represents the correlation in operating performance, if any, between pre- andposts acquisition years.


Table 4. Operating Performance for Combined Acquiring and Target Firms inYears Surrounding Acquisitions Completed in the Period 1977–19921.

Year Combined Firm Control Group Control-Adjusted Observationsrelative toacquisition(Year 0)

Median%

Mean%

Median%

Mean%

Median%

Mean% N

Panel A: Pre-Bid

Year –5 20 24 19 20 3 5 36Year –4 17 22 21 22 –3 –1 36Year –3 22 27 24 24 1 3 39Year –2 24 33 26 24 2 9c 42Year –1 26 27 26 28 1 –1 46Median annualperformanceover years–5 to –1 23 24 23 25 1 1 46

Panel B: Post-Bid

Year + 1 34 43 26 28 7b 15b 46Year + 2 34 30 25 30 3 0 46Year + 3 23 29 24 27 2 2 44Year + 4 28 30 23 25 7 6 40Year + 5 24 34 20 29 9 5 36Median annualperformanceover years+ 1 to + 5 25 31 24 27 4 4 46

1 Operating performance in the pre-acquisition period are pre-tax operating cash flow return onassets of target and acquirer, weighted by the relative asset sizes of the two firms. Post-acquisitionperformance used data of the combined firms. Pre-acquisition control group returns are controltarget and control acquirer values, weighted by the relative asset values of the acquirer and targetfirms at the beginning of the year. Post-acquisition control group returns are control target andcontrol acquirer values, weighted by the relative asset values of the acquirer and target firms at theend of year t � 1. Control adjusted measures of performance are computed for each combined firmas the difference between the firm measure in that year and the measure for the control ‘firm’ inthe same industry during that period.Significance tests refer only to the control-adjusted returns.a Significantly different from zero at the 1% level, using a two-tailed test.b Significantly different from zero at the 5% level, using a two-tailed t-test.c Significantly different from zero at the 10% level, using a two-tailed t-test.


The results of the regression on median abnormal control adjusted cash flowreturns are described in Table 5. Both the slope coefficient �, of 0.266, and theintercept, �, of 0.06, are significantly different from zero. The results show thatacquirers experience an improvement in operating performance post-bid oncepre-bid performance is controlled for.

The above results may be affected by a number of factors including thedefinition of operating performance employed in the study. In particular theseresults are sensitive to the choice of weighting adopted for control companies.The current study uses the same weights as those adopted by Healy et al.(1992), namely the relative value of operating assets of acquirer and target atthe end of the year prior to the bid. This choice helps avoid bias caused byimprecise size matching. The use of alternative weights based on the relativeoperating assets of the control companies at the beginning of each year resultsin a small but insignificant alpha.

We also examine the potential impact of the use of fixed asset write-downsfollowing the acquisition.22 Examination of the financial statements of thenewly combined group in the year of the acquisition reveals reference to fairvalue adjustments. In a number of cases these were not identified separately tothe goodwill that had been written-off to reserves. However we were ableto identify 39 cases in which there was specific reference to asset revaluations,with the majority (35 cases) involving writing down the value of the assetsacquired. We therefore examined the notes to the group financial statements forthe year of acquisition in order to identify the amount of the revaluationadjustment, if any. In 26 cases for which details were provided the total valueof asset write-down’s identified were £274.9 million with £122.4 million ofupward revaluations. The net amount of these revaluations amounted to lessthan 0.3% of the combined fixed assets of the target and bidders prior to theacquisition. We are therefore confident that any asset revaluation to fair valuewill have had an insignificant effect on the results reported above.

Table 5. Abnormal Adjusted Operating Cash Flow Returns.

APcpost i = 0.06 + 0.266 APc

pre i

(2.08) (3.42)

R2 = 19.9% F-statistic = 11.70

APcpost,i and APc

pre,i are the median annual adjusted operating cash flow returns in the post- and pre-acquisition period for firm i.


One additional potential problem associated with this data set is the impactof leased assets on our measure of performance. As Beattie et al. (1998) pointout, exclusion of leased assets from measures of performance is liable to affectinferences on profitability.23 We were, however, unable to undertake anyadjustment for the impact of leases as much of our data was extracted for theperiod prior to July 1987 when the disclosure requirements of SSAP21 becameeffective. Any change in the level of use of leased assets by the newly combinedgroup post-acquisition is however likely to offset in part at least by a change tothe retail sector as a whole, including our control companies.

We continue our analysis with an investigation of other factors that may haveled to the perceived improvement in post-acquisition operating performance.One possibility is that the acquiring firms’ may have used the opportunityprovided by the acquisition to undertake asset write-offs, thus reducing thepost-acquisition denominator.24 It is possible that the lower rate of growth inoperating assets post-acquisition, recorded in Table 2, reflects the above ratherthan an improvement in asset utilisation that is justifiably reflected in themeasure of operating performance. We test for the above possibility in twoways. First we test for any significant change in the level of depreciation andasset write-offs, as opposed to disposals, over the post-acquisition period.Secondly we examine the level of write-offs and asset disposals in the bid yearitself.

In our analysis we compare the post-acquisition level of depreciation for thecontrol-adjusted pre-acquisition level. First we calculate the combined level ofpre-bid depreciation for the acquirer and control sample in each of the fiveyears prior to the bid, weighted by their net fixed asset values at the beginningof each year. We then calculate a similar rate for the relevant control firms.Control adjusted rates of depreciation are then calculated for each year andmedian rates also calculated for each combination over the five years prior tothe bid year. In a similar fashion post-bid depreciation rates are then computedfor the acquirer firms, together with the relevant combined acquirer plus targetcontrol rates, in each of the five years following the year in which the bid wascompleted together with a median value over the five years. We then regress themedian post-bid depreciation rate against the pre-bid rate with the resultsdescribed in Table 6.

The results in Table 6 suggest that the rate of depreciation has significantlyreduced, rather than increased, in the five years following the bid aftercontrolling for pre-bid performance and external factors. As the lowerdepreciation charge will reduce the rate of change of the denominator, this willinduce a slight bias against finding any increase in post-bid performance. Wealso test for and find no significant difference in the level of depreciation write-


offs in the bid year compared to the pre-bid period. We therefore conclude thatthe improvement in post-acquisition operating performance is not a function ofhigher depreciation but reflects an improvement in the utilisation of operatingassets.

4. POTENTIAL SOURCES OF OPERATINGEFFICIENCY GAINS AND LOSSES

In the current section we analyse components of our measure of operatingperformance in order to identify whether there are any specific sources ofchange in operating performance. Initially we test for changes in operatingreturn on sales and then test for changes in sales turnover. Operating return onsales in the current study is measured as operating cash flow divided by sales.Table 7 provides summary statistics of the control-adjusted operating return onsales for acquirer and target firms and the pro-forma combined firms in the fiveyears prior to acquisition and for the acquiring firms for the five years post-acquisition.

As shown in Panel A of Table 7, acquirers and targets each experiencesignificantly lower control-adjusted operating return on sales in each year priorto the year of acquisition. A similar result is also obtained for the pro-formacombined acquirer and target firms, with median adjusted operating return onsales of –3.09% over years –5 to –1. The pattern of lower operating returnon sales is repeated in each of the five individual pre-bid years. The consistencyof the pattern is rather surprising but demonstrates lower operating marginsearned by both acquirer and target pre-bid.

The results for the post-acquisition period are reported in Panel B of Table 7.In the post acquisition period, years + 1 to + 5, the newly combined firmcontinues to earn a lower rate of operating cash flow on sales with a mediancontrol-adjusted return of –2.87% over the five years. Although not reported in

Table 6. Adjusted Depreciation Rates.

DRcpost i = –0.018 + 0.541 DRc

pre i

(–2.79)a (5.89)a

R2 = 43.4% F-statistic = 36.47 N = 45

DRcpost,i and DRc

pre,i are the median annual adjusted depreciation rates in the post- and pre-acquisition period for firm i.a Indicates significant at 1% level.


Table 7. Operating Return on Sales for Combined Acquiring and TargetFirms and their Control Companies for Acquisitions in the U.K. Retail

Industry, Completed in the Period 1977–19921.

Panel A: Pre-bid Operating Return on Sales

Yearrelative toacquisition(Year 0)

Control-AdjustedAcquirerReturn

Control-AdjustedTargetReturn

Control-AdjustedCombined

Return

Observations

Mean Median Mean Median Mean Median% % % % % % N

Year –5 –1.04 –3.35a –3.30a –2.60a –2.95a –2.54a 37Year –4 –3.25a –2.57b –5.03a –5.62a –4.36a –3.67a 40Year –3 –5.28a –3.18a –4.03a –3.28a –4.10a –3.14a 42Year –2 –4.41a –2.30a –4.55a –3.68a –3.59a –3.17a 46Year –1 –5.55a –2.90a –5.79a –4.44a –5.47a –2.78a 49Median annualperformanceover years(as Table 4):–5, –1 –5.10a –2.50a –5.05a –3.30a –4.88a –3.09a 49

Panel B: Post Acquisition Operating Return on Sales

Yearrelative toacquisition

Combined FirmReturn

Pro-formaControl

Control-AdjustedReturn

Observations

(Year 0) Median Mean Median Mean Median Mean% % % % % % N

Year + 1 11.15 10.16 11.96 11.59 –1.29 –1.43 49Year + 2 9.07 9.32 13.37 12.93 –4.15b –3.61b 49Year + 3 7.94 9.01 11.63 12.26 –3.84b –3.25a 47Year + 4 8.90 10.00 11.71 12.26 –2.62c –2.28c 43Year + 5 7.38 9.44 12.06 13.51 –4.30b –4.07b 39Median annualperformanceover years+ 1 to + 5 8.57 9.65 11.60 12.31 –2.87b –2.77b 49

1 Operating return on sales is defined as operating cash flow as a percentage of sales. Performancemeasures for the combined firm and control in the pre-acquisition period are weighted by the relativesales of the two firms. Post-acquisition performance used data of the combined firms. Post-acquisitioncontrol group returns are control target and control acquirer values, weighted by the relative sales.Control adjusted values are computed for each firm and year as the difference between the firm value inthat year and the value of the control firm during that period.a Significantly different from zero at the 1% level of significance.b Significantly different from zero at the 5% level of significance.c Significantly different from zero at the 10% level of significance.Significance tests refer only to the control-adjusted returns.


detail we also test for any change in operating return post-bid but are unable tofind any significant improvement.

We next turn our attention to asset utilisation and in particular sales turnoveron operating assets. We have already provided evidence, in Table 2 thatoperating asset growth rates were lower post-acquisition. Table 8, Panel A,provides summary data on acquirer, target and control firm sales turnover ratesfor each of the five year periods before and after the year of acquisition. Salesturnover is defined as the ratio of sales for the year to operating assets at thebeginning of that year. As the data shows the pro-forma acquirer, target andcombined firms have significantly higher sales turnover ratio in each of the fiveyears prior to the bid year relative to their controls. Similarly the combined firmachieves a significantly higher level of sales turnover than the pro-formacombined control in each of the five years post-acquisition. Once again theconsistency of the result is surprising. In order to test whether the turnover ratiohas changed significantly from the pre- to the post-bid period, we regress themedian value for the five years post-acquisition adjusted asset turnover onthe five year median pre-acquisition control adjusted asset. As shown in panelC of Table 8, the slope coefficient from this regression, of 0.645, is significantlydifferent from zero at the 5% level. The intercept, of 1.43, is also significant atthe 5% level, indicating that there is a significant improvement in the combinedfirms’ asset turnover in the post acquisition period.

In summary the results of the above analysis indicate that, relative to theircontrols, both acquirers and targets have significantly lower operating profitmargin both prior to and following acquisition but significantly higher levels ofsales turnover. The improvement in operating performance, reported in Table 5,appears to have been generated by an increase in sales turnover, whereas casualobservation would have suggested a greater potential for improvement in theprofit margin. This unexpected pattern may find an explanation in the nature ofthe retail sector. Discussions with management in this sector suggest that theprime motive is the acquisition of stores and floor-space. Planning controlstogether with characteristics of the property market can create a scarcity valuefor floor-space. The acquisition of additional floor-space will (or should) leadto an immediate improvement in sales turnover. The scope to leverage profitgrowth is more limited, and as noted from our preliminary results is more likelyto be dependent on asset utilisation rather than disposals or write-offs. Thedesire to acquire sites and floor-space plus the scarcity value and, for high streetstores in particular, rental/leasing arrangements make asset disposal bothunlikely and at certain times difficult.

Pointers to other potential sources of improved margin may be found in thecost structure of retail companies. Although retail cost structures do vary from


Table 8. Sales Turnover for combined acquiring and target firms and theircontrol companies for acquisitions in the U.K. retail industry, completed in theperiod 1977–19921 Figures in table represent mean values, followed by

medians.

Panel A: Pre-Bid Turnover Ratios


Control-AdjustedAcquirer

Control-Adjusted

Target

CombinedFirm

Pro-formaControl


Obser-vations

(Year 0)

% % % % % N

Year –5 3.63b, 1.09a 2.27a, 1.32a 4.55, 3.19 2.42, 2.24 2.13a, 0.66a 39Year –4 3.03a, 1.16a 1.85a, 1.21a 4.29, 3.41 2.31, 2.08 1.98a, 0.78a 41Year –3 2.20a, 0.94a 2.12a, 1.03a 4.64, 3.27 2.26, 2.07 2.38a, 1.03a 43Year –2 2.86a, 1.29a 1.51a, 0.83a 5.17, 3.30 2.43, 2.16 2.74a, 1.16a 44Year –1 2.53a, 1.12a 1.40b, 1.33a 5.29, 3.57 2.49, 2.31 2.80a, 1.43a 47Median annualperformanceover years–5 to –1 2.34a, 1.40a 1.76a, 1.12a 4.67, 3.56 2.34, 2.16 2.29a, 1.33a 48

Panel B: Post-Acquisition Turnover Ratios

YearRelative toAcquisition

CombinedFirm

Pro-formaControl


Obser–vations

(Year 0) Median Mean Median Mean Median Mean N

Year + 1 3.24 5.20 2.08 2.59 1.09a 2.61b 49Year + 2 2.97 3.81 1.88 2.32 0.96a 1.49a 49Year + 3 2.71 3.55 1.99 2.50 0.92a 1.05b 47Year + 4 2.79 3.46 1.86 2.24 0.96a 1.22a 44Year + 5 2.99 3.73 2.00 2.30 0.98a 1.42a 43Median annualperformanceover years+ 1 to + 5 2.73 3.62 2.04 2.41 0.92a 1.24a 49


sector to sector, the largest items are the cost of goods sold (typically 70–80%of sales in the grocery sector) and labour costs (8–10%). Whilst increased scaleclearly contributes to the ability of companies to administer purchasingactivities more effectively, the scope for immediate profit improvement fromother areas is more limited. Although productivity gains may accrue fromdistribution efficiencies, these make up a relatively small proportion of totalcosts. Any immediate benefits from the acquisition will also be offset in manycases by the costs of rebranding the acquired chain with the acquirers facia,store concept and reporting systems.

Evidence on the internal investment activities of acquiring firms suggeststhat management groups are often optimistic about the future prospects fortheir company. The optimism is reflected to a certain extent in the relativelyhigh level of new investment undertaken in these firms in the periodsurrounding the acquisition. The optimism is often shared by other groups,including analysts. Evidence from studies on security return behaviour ofacquiring companies, however, suggests that this evidence may often bemisplaced. We examine the rate of new fixed asset acquisitions as a proxy forthis optimism. The rate of fixed asset acquisition is defined as new fixed assetsacquired during the year divided by net fixed assets at the beginning of the year.We report summary statistics for both acquirers and targets in our sampletogether with that of the control companies in Table 9. In addition we provide

Table 8. Continued.

Panel C: Abnormal adjusted post acquisition sales turnover (t-values in parentheses)

ATcpost i = 1.43 + 0.645 ATc

pre i R2 = 11.1% F-statistic = 5.64(2.03) (2.37)

ATcpost,i and ATc

pre,i are the median annual control adjusted sales turnover ratios in the post and prioracquisition period for firm i.

1 Sales turnover is calculated as sales for the year divided by operating assets at the beginning ofthe year. Performance measures for the combined firm and control in the pre-acquisition period areweighted by the relative book value of operating assets of the two firms. Post-acquisition turnoveruses data for the combined firms. Post-acquisition control group turnover rates are based oncontrol target and control acquirer values, weighted by the relative operating assets. Controladjusted values are computed for each firm and year as the difference between the firm value inthat year and the value of the control firm during that period.a Significantly different from zero at the 1% level of significance.b Significantly different from zero at the 5% level of significance.c Significantly different from zero at the 10% level of significance.Significance tests refer only to the control-adjusted returns.


Table 9. Rate of Acquisition of Fixed Assets for combined acquiring andtarget firms and their control companies.1 Figures in table represent mean

values, followed by medians.

Panel A: Pre-Bid Acquisition Rates

Yearrelative toacquisition(Year 0)

Control-AdjustedAcquirer

Control-Adjusted

Target

CombinedControl-AdjustedReturn

Obser-vations

% % % N

Year –5 14.2, 3.3 21.9b, 12.3 5.67, –0.28 33Year –4 43.1b, 4.0 9.3, 10.5 12.64c, 1.78 37Year –3 21.0, 3.4 21.3a, 6.1a 14.94c, 2.88 41Year –2 18.7a, 6.1a 7.7, 7.0b 11.97a, 3.03c 44Year –1 21.3a, 13.8a 50.3c, 16.8a 18.58b, 3.81c 47Median annualperformanceover years–5 to –1 17.5a, 3.6b 30.8b, 9.6a 14.04b, 3.67c 48

Panel B: Post-Acquisition Fixed Asset Acquisition Rates


CombinedFirm

Pro-formaControl


Obser-vations

(Year 0) Median Mean Median Mean Median Mean% % % % % % N

Year + 1 29.0 45.4 29.4 34.5 4.8 10.6 36Year + 2 20.8 31.3 29.0 28.0 1.2 3.3 34Year + 3 25.7 30.2 23.8 27.9 0.6 2.2 31Year + 4 15.7 21.9 25.0 32.3 –5.7c –10.4 18Year + 5 18.1 26.8 22.5 27.5 –2.2 –0.7 12Median annualperformanceover years+ 1 to + 5 22.5 25.8 26.2 27.2 –3.0 –1.4 36


a pro-forma estimate of the rate of new asset acquisition by the combinedcompany in the five years prior to the financial year in which the acquisitionoccurred and compare this with the results for the combined control companies.We weight the rate of acquisition of the acquirer and target by the relative valueof their fixed assets and apply the same weighting to the control companies forthe pre-acquisition years. In the post-acquisition period we apply the relativefixed asset values of acquirer and target at the end of year t � 1 as weights tothe control companies.

As the results in Panel A of Table 9 demonstrate both acquirers, targets, andthe pro-forma combined companies have significantly higher rates of fixedasset acquisition than their control companies for a number of years prior to theyear of acquisition. However in the post acquisition period (Table 9, Panel B)there is only one year (year 4) in which the rate of asset acquisition issignificantly higher than that of the combined control companies. The resultsmay be interpreted in a number of ways. One interpretation of the results is thatthey demonstrate an excessive level of investment prior to the acquisition inboth acquirer and target companies, reflecting over-optimism. An alternativeinterpretation is that they represent an investment programme in a period ofhigh growth for the companies involved that has subsequently producedbenefits in terms of the higher sales turnover as reported earlier in Table 8. Asfloor-space is typically the main asset that a retailer will invest in, the period

Table 9. Continued.

Panel C: Abnormal adjusted fixed asset acquisition rates (t-values in parentheses):

ATcpost i = –0.017 + 0.031 ATc

pre i R2 = 0% F-statistic = 0.25(–0.70) (0.50)

ATcpost i and ATc

pre i are the median annual control adjusted rates of new fixed asset acquisition in thepost- and prior-acquisition period for firm i.

1 New fixed asset acquisition rate is calculated as new fixed asset acquisitions for the year dividedby net fixed assets at the beginning of the year. Acquisition rates for the combined firm and controlin the pre-acquisition period are weighted by the relative net fixed assets of the acquirer and target.Post-acquisition turnover uses data for the combined firms. Post-acquisition control groupacquisition rates are weighted by target and acquirer net fixed assets at time t � 1.27 Controladjusted values are computed for each firm and year as the difference between the firm value inthat year and the value of the control firm during that period.a Significantly different from zero at the 1% level of significance.b Significantly different from zero at the 5% level of significance.c Significantly different from zero at the 10% level of significance.Significance tests refer only to the control-adjusted returns.


following the acquisition of new sites and floor-space is likely to result inmanagement turning its attention to integration of that asset rather than thesearch for further “new” assets. Such activities would, as noted above, includerebranding and refitting of stores together with changes in systems andpractices. Furthermore, as the number of potential sites is theoretically finite (acertain catchment area is required to justify operating a store), one could arguethat with each successive takeover the scope for further investment is reduced.

A number of studies of takeover activity have questioned whethershareholder groups have gained at the expense of other stakeholder groups, inparticular employees. It is clear that, in the USA in particular, takeovers (or thethreat of takeover) have been used to justify changes, i.e. reductions in wagerates.25 In addition to the above, if potential economies of scale were to ariseas result of the takeover then one source of gains would be through moreefficient use of employees. In the current study we investigate changes in thelevel of employment of the firms involved in takeovers. We use employment inthe control groups to compare the numbers employed in acquirer and targetover the eleven years centred on the takeover year, but excluding that year. Themedian value of numbers employed in acquirer and target combined iscalculated separately over the five years prior to the bid and the five yearsfollowing the bid year, using data extracted from the annual accounts. We thenadjust each of these figures for the level of employment in control groups in thecorresponding periods. Finally we regress the median control-adjusted usingthe following model:

EMPcposti = � + � EMPc

prei + �I (2)

EMPcposti is the median annual (or average) control-adjusted number of

employees for company i for the post acquisition period (t = 1, t = 5) andEMPc

prei is the corresponding figure for the pre-acquisition period(t � 5, t � 1).

As an alternative we calculate changes in employment, deflated by theopening level of employment, both for our combined acquirer and targetcompanies and also for their respective controls. We then run the regressionusing control-adjusted change in pre and post-bid employment rates as thevariables. The results of this regression are shown in Panel B of Table 10 andindicate a high correlation between pre- and post-bid control-adjusted levels ofemployment. Neither the results in Panel A for levels of employment, nor thosein Panel B, based on changes, indicate that, after controlling for externalfactors, takeovers of themselves reduce the level of employment in the firmsinvolved. Again this finding is less of a surprise for the retail sector. The labourdeployment characteristics of the sector differ markedly from that of


manufacturing. Retailing is a multi-site business with a relatively smallproportion of staff employed in central functions. The bulk of the work-forceis dispersed at store level. Employment losses following an acquisition aremost likely to occur in the relatively less-numerous head office and middle-management functions. Furthermore with some central support functions suchas distribution and IT support often sub-contracted to third parties, anyimmediate job losses may occur outside of the immediate business boundaries.Employment would only be significantly affected if a major part of the storenetwork were to be closed after acquisition. Given the stated motives for retailacquisitions, the mass disposal of store assets is unlikely.

As the final stage in our analysis we consider whether the results obtained inthe current study are unrepresentative of the performance and characteristics oftakeovers in the retailing sector in general. As explained earlier in the paper, thesample selected for analysis in the current study is biased towards largeracquisitions. It is possible that this explains why the negative post-outcomeperformance reported in studies using security returns data is not repeated inthe current study. In order to test this possibility we compare the post-bidsecurity return performance of companies in the current sample with that ofacquirers in a more comprehensive data set (reported in Burt & Limmack,2001). This latter set consists of 216 acquisitions by U.K. quoted companies inthe retail sector during the period 1977–1992. We use two alternative controlbenchmarks for measuring expected security returns, the first being thecorresponding return on the FT All Share Index and the second being the return

Table 10. Comparison of Pre- and Post-bid Control-adjusted Employment forFirms Involved in Retail Mergers.

Panel A: Levels of Employment (t values in parentheses):

EMPcposti = 13 + 0.989 EMPc

prei

(0.0) (7.67)

Adjusted R2 = 59.1% F = 58.85 N = 41

Panel B: Change in Employment Levels

Changecposti = –0.008 + 0.0053 Changec

prei

(–0.99) (1.45)

Adjusted R2 = 3.0% F = 2.09 N = 36


on size-matched portfolios.26 The analysis is somewhat restricted as we possesssecurity returns for the full data set only for the two-year period following thebid month. However the aim of this analysis is not to compare the twoalternative performance matrices but rather to determine whether the sub-sample of acquirers used in the current study has similar security performancecharacteristics to those in alternative studies.

As the results in Table 11 demonstrate, the two-year post-bid excess returnsfor the companies in the current data set is negative (although not statisticallysignificant), using both control models and whether measured using means ormedians. The excess returns for the group of retail acquirers not includedin the analysis of operating performance are significantly negative. Howeverthe excess returns for the latter sub-group are not significantly differentfrom the returns for the sub-sample of acquiring companies analysed in thecurrent study. We are therefore unable to conclude that the sub-set ofretail acquirers used in the current study have superior performance to retailacquirers generally.

Table 11. Control-adjusted acquirer returns for the sub-sample of acquirersused in the current study compared to those on a more comprehensive set ofreturns on acquirers in the retailing sector, 1977–1992. Returns are measuredover the period from bid month to two years thereafter, and adjusted relative to

(a) Size-matched portfolios; (b) FT All Share Index.

Size Decile Control Market Relative Observations

Mean Median Mean Median% % % % N

OperatingPerformancesub-sample:

CAR (0,24) –10.48 –14.44 –8.34 –11.76 49Remainingsub-sample:CAR (0,24) –14.76a –16.5 –16.45a –13.31 167

F (H) statistic 0.31 0.03 0.99 0.35

Probability 0.58 0.85 0.32 0.56

a Significantly different from zero at the 1% level, using a two-tailed test.


5. SUMMARY AND CONCLUSIONS

The current paper has examined operating performance of a sample ofcompanies involved in acquisitions in the retail sector which were initiated andcompleted in the period January 1 1977 to December 31 1992. We use ameasure of operating performance based on operating cash flows, similar tothat used in Manson et al. (1994). Our results suggest that neither the pre-bidoperating performance of the acquirer or the target is significantly different tothat of their control companies. However we find that the post-acquisitionoperating performance of the combined company improves relative to a pre-bidcontrol-adjusted benchmark. While this result is partly sensitive to the choiceof control benchmark (i.e. the weighting used) we believe that the approachadopted here, and that by Healy et al. (1992), is the most appropriate.

In addition to the above we find that acquirers and targets on average earn alower operating margin on sales prior to the bid and that there is no change incontrol-adjusted profit margin post-bid. By contrast, however, we find that bothacquirers and targets achieve a higher rate of sales turnover on total assets inthe five years prior to the year of acquisition and that control-adjusted salesturnover improves significantly post-acquisition. We are unable to report anysignificant change in employment levels following acquisition, after controllingfor other factors. The data requirements for the current study mean that thesample of acquisitions for which data was available are likely to be larger inabsolute size than the full population of acquisitions, even in the retail sector.It is possible, therefore, that the results reported here are not representative ofretail mergers in general. We provide one test of this by comparing theabnormal security returns to shareholders in this sub-sample of acquiring firmsover two years post-acquisition to those of a larger sample of retail acquirers.Although the results provide some evidence that our sub-sample may performless badly, when measured using security returns, than retail acquirersgenerally, the differences do not appear to be sufficient to invalidate our results.The conclusion of the study is that takeovers in the retailing sector lead to animprovement in operating performance over the five years post-acquisition thatis mainly generated by improved asset utilisation. The results do not, ofthemselves, contradict those involving analysis of security returns. Rather theysuggest that the benefits of the improved operating performance are likely tohave been passed on to the owners of the target company, rather than to havebeen shared with the owners of the acquiring firm. One caveat to our results isthe potential differential impact of operating leases on the companies involved.Given the data limitations in the current study we were unable to determinewhether this would effect the above conclusions.


NOTES

1. See for example Agrawal, Jaffe and Mandelker (1992), Gregory (1997).2. See for example Meeks (1977), Singh (1971, 1975), Utton, (1974).3. There is also evidence that the threat of takeover can force management to

introduce changes that might not otherwise have occurred. Denis (1994) describes theleveraged buy-out of Safeway Stores Inc. in the USA, and subsequent restructuringactivities, following an unsuccessful takeover bid from the Dart Group.

4. Or to be more precise, security returns behaviour.5. See for example Agrawal, Jaffe and Mandelker (1992), Healy, Palepu and Ruback

(1992), Manson, Stark and Thomas (1994) and Jarrell (1995).6. Obviously excluding targets for the latter period.7. Their results also suggested that target firm managers did not manipulate earnings

(possibly because of the lack of warning prior to the bid).8. Quoting from Chemical Week, May 8, 1991, p. 28.9. This introduces a potential measurement error in our analysis because of the

likelihood of off-balance sheet assets and financing. However the extent of the potentialmeasurement error will be a function of the extent to which our sample are more likelyto use this form of financing than the respective controls. Lack of publicly-availabledata over the relevant period prevents any formal test of this.

10. Although Barber and Lyon (1996) also advocate the use of operating income,rather than operating cash flows, they do also recognise that the former may be moreappropriate in situations in which there is a potential for earnings management.

11. The exclusion of cash and marketable securities, although common practice inthis type of analysis, may produce an understatement of assets used in retailing andhence to an overstatement of operating performance.

12. We select the firm that is closest in size (based on equity market value) fromwithin the Retail Sector which is not itself an acquiring or acquired firm.

13. Healy et al. (1992) actually use industry median values, rather than matchedfirms.

14. Barber and Lyon (1996) also recognise that the power of performance matchingdecreases as the lagged interval increases as in the current study.

15. We test the sensitivity of our results to the choice of alternative deflators, asdiscussed later.

16. Healy et al. (1992) use industry groups as their chosen control performance andalso weight the performance of each group by the relative asset value of acquirerand target at the end of year t � 1.

17. Weights used are the relative operating assets of acquirer and target at the end ofthe last financial year preceding the year of the acquisition.

18. At the 10% level of significance.19. When the post-acquisition performance of the control companies is weighted by

their relative operating assets the results are even in stronger in favour of significantlypositive post-acquisition control-adjusted operating performance.

20. To avoid problems associated with survivorship bias we take a median value overall years for which data is available.

21. See also Healy et al. (1992), Manson et al. (1994) and Ghosh (1998).22. This analysis was undertaken following a suggestion by Alan Gregory.


23. The authors recognise helpful comments by Alan Goodacre on this issue.24. As we use operating cash flows in the numerator, rather than operating profits,

there would be no impact from an consequent reduction in the depreciation charge.25. See, for example Baker (1992) and Denis (1994).26. Further details of these may be obtained from Burt and Limmack (1999).27. The results are similar if the weights are based on the net fixed assets of the

control companies at the beginning of the relevant years.

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Anand, J., & Singh, H. (1997). Asset redeployment, acquisitions, and corporate strategy indeclining industries. Strategic Management Journal, 18 (Summer Special Issue), 99–118.

Appleyard, A. R. (1980). Takeovers: accounting policy, financial policy and the case againstaccounting measures of performance. Journal of Business Finance and Accounting, 7,541–554.

ASC (1984). Accounting for leases and hire purchase contracts. Statement of Standard AccountingPractice No. 21. London: Accounting Standards Committee.

Baker, G. P. (1992). Beatrice: a study in the creation and destruction of value. The Journal ofFinance, 47(3), 1081–1119.

Barber. B. M., & Lyon, J. L. (1996). Detecting abnormal operating performance: the empirical andpower specification of test statistics. Journal of Financial Economics, 41, 359–399.

Beattie, V., Edwards, K., & Goodacre, A. (1998). The impact of constructive lease capitalisationon key accounting ratios. Accounting and Business Research, 28, 233–254.

Bowen, R., Burgstahler, D., & Daley, L. (1986). Evidence on the relationship between earningsand various measures of cash flow. The Accounting Review, 65, 713–725.

Burt, S., & Limmack, R. J. (2001). Takeovers and shareholder returns in the retail industry.International Review of Retail, Distribution and Consumer Research, 11, 1–21.

Clark, K., & Ofek, E. (1994). Mergers as a means of restructuring distressed firms: an empiricalinvestigation. Journal of Financial and Quantitative Analysis, 29(4), 541–565.

Cosh, A., Hughes, A., & Singh, H. (1980). The causes and effects of takeovers in the U.K.: Anempirical investigation for the late 1960s at the micro-economic level. In: D. C. Mueller(Ed.), Determinants and Effects of Mergers (pp. 227–270). Cambridge, Mass.: Oelgeschl-ager, Gunn and Hain.

Dechow, P. M. (1994). Accounting earnings and cash flows as measures of firm performance: Therole of accounting accruals. Journal of Accounting and Economics, 18, 3–42.

Denis, D. J. (1994). Organizational form and the consequences of highly leveraged transactions.Kroger’s recapitalization and Safeway’s LBO. Journal of Financial Economics, 36,193–224.

Erickson, M., & Wang, S-W. (1999). Earnings management by acquiring firms in stock for stockmergers. Journal of Accounting and Economics, 27, 149–176.

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Gregory, A. (1997). An examination of the long run pattern of U.K. acquiring firms. Journal ofBusiness Finance and Accounting, 7 & 8, 971–1002.

Harford, J. (1999). Corporate cash reserves and acquisitions. Journal of Finance, 54 (December),1969–1997.

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Jarrell, S. (1995). Long-term performance of corporate takeovers: an improved benchmarkmethodology. Working Paper. University of Chicago, Chicago, Illinois.

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Loughran, T., & Vijh, A. (1997). Do long-term shareholders benefit from corporate acquisitions?The Journal of Finance, 52(5).

Manson, S., Stark, A. W., & Thomas, H. M. (1994). A cash flow analysis of the operational gainsfrom takeovers. The Chartered Association of Certified Accountants, Research Report 35,CAET, London.

Martin, K. J. (1996). The method of payment in corporate acquisitions, investment opportunities,and management ownership. The Journal of Finance, 51(4), 1227–1246.

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Economy, 21(1), 13–28.


SHAREHOLDER WEALTH EFFECTS OFDIVERSIFICATION STRATEGIES:A REVIEW OF RECENT LITERATURE

Robin Limmack

ABSTRACT

Diversification strategies, in particular those associated with acquisitionactivity, offer companies an opportunity for growth in a less restrictedenvironment than is available to companies pursuing a policy of focusedgrowth. Not only are there likely to be fewer legal restrictions but also thechoice of potential target company is much greater. However easier accessto growth through diversification also provides more opportunity formanagerial opportunism and the pursuit of policies that are unlikely tobenefit shareholders. In addition to the standard agency problems thereare likely to be additional problems associated with cross-subsidisation ofinefficient segments. Potential benefits from diversification strategiesinclude increased debt capacity together with creation of internal capitalmarkets. Whether benefits outweigh costs is an empirical issue. As withmany such issues, however, the empirical evidence is not unambiguous.While a number of studies have suggested that diversified firms generallytrade at a discount to non-diversified firms, it appears for some periodsof time the benefits of diversification have outweighed the costs.Additionally it appears that companies who choose the diversificationroute may come from industries that were experiencing problems andthat any ‘discount’ may be present in these companies before they make


177

the diversification decision. It may be that for these companies at least thediversification decision is not the source of the value loss but the result.The current paper provides a review of contemporary literature on theperceived benefits and costs of diversification strategy and of the empiricalevidence surrounding this. While no definitive conclusions can be reachedfrom the evidence, it does appear that an assumption that diversificationis a value-reducing activity in all circumstances is unwarranted.

1. INTRODUCTION

One of the many strategic issues facing corporate management relates to thedegree of specialisation that their firm should attempt to achieve. Companieshave varied in the extent to which they have followed a focused rather than adiversified strategy. The focusing decision may be related either to a particularproduct or service or indeed to the geographical market in which the firmattempts to operate. Examples exist of companies that have at various timesadopted different strategies, at one time diversifying then later refocusing.1

Changes in strategy may reflect the time varying nature of the relative benefitsand costs or may simply indicate the correction of previous errors in strategy.In the current paper we will examine both the claimed benefits and costs ofdiversification (and refocusing strategies) and the evidence provided byempirical research on the impact on shareholders’ wealth. As with manycorporate strategic decisions these benefits and costs will impact on bothshareholders and management. However the impact on the latter group is oftenunobservable except in relation to remuneration packages. Our review istherefore confined mainly to a discussion of shareholder wealth effects.

Although diversification may be achieved either through internal growth orexternal acquisition much of the published literature on this topic concentrateson diversification through external acquisition. There are a number of differentreasons why acquisition may be the preferred motive for diversification,including speed, tax motives, and the use of equity financing. Our review willtherefore also include reference to literature on the relative merits of relatedversus unrelated acquisitions. In addition, the continued survival of diversifiedfirms may be seen as evidence of the efficiency of that particular organisationalform, although Jensen (1989) suggests that survival may be more dependent onthe high costs of corporate control transactions. Evidence from value-increasing refocusing activities in recent years does, however, suggest thatthese latter costs may be worth bearing in some circumstances at least.

Section 2 provides an overview of the motives for diversification whilesection 3 examines in more detail those motives that are related to shareholders

178 ROBIN LIMMACK

interests. The view adopted by many commentators is that the diversificationdecision is potentially highly correlated with the pursuit of managementobjectives. We therefore proceed in Section 4 to a review of agency problemsand diversification. In Section 5 we explore issues raised in the literaturerelating to the methodological approaches to the measurement of diversifica-tion benefits and costs. In the penultimate section we provide a review ofliterature on refocusing activities and end this review with a brief summaryof what we appear to know (and what we do not know) about the benefits, orotherwise, of diversification.

2. CLASSIFICATION OF MOTIVES FORDIVERSIFICATION

Montgomery (1994) provides a threefold classification for considering motivesfor diversification. The first set of motives, based on market-power, views adiversification strategy as a means of exploiting ‘conglomerate power.’Conglomerate power refers to the opportunity for a firm to exercise power ina particular market by ‘virtue of the scope and character of its activitieselsewhere’ (Edwards, 1955). Exercise of conglomerate power may be achievedthrough cross-subsidisation, for example to support predatory pricing, mutualforbearance, to reduce the degree of competitiveness, and reciprocal buying, inorder to deny markets to smaller competitors.2 In many countries the regulatoryframework of the corporate sector includes provisions to limit opportunities forthe exercise of conglomerate power. Economists also differ as to whethermarket power may be enhanced by greater concentration rather than throughdiversification.

The second set of motives, based on resource utilisation, argues that rent-seeking firms diversify in response to excess productive capacities (Penrose,1959). Penrose articulates a theory that assumes firms will not achieveequilibrium positions because of problems caused by indivisibility ofresources, alternative uses of resources in different circumstances, and thecreation of new productive services. Within this theory firms have incentives toexpand, although not necessarily through diversification. If resources are fairlyspecific then expansions should be in related areas. With less-specific resourcesbenefits may also be obtained through diversification (Montgomery &Wernerfelt, 1988). In a similar vein Drucker (1981) suggests that economicallysensible mergers must follow a certain set of rules which include therequirement for a ‘common core of unity’. This common core may includetangible factors (Weston, 1986) or intangibles, including the corporate culture(Barney, 1988)

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The final set of motives, based on agency relationships, views thediversification decision as a convenient means for management to pursue theirown interests rather than those of the owners of the firm (Mueller, 1969;Jensen, 1986; Shleifer & Vishny, 1989). Problems arise according to thisperspective from use of free cash flow in over-investment (Jensen, 1986),increasing management entrenchment (Shleifer & Vishny, 1989), and diversifi-cation of risks associated with human capital (Amihud & Lev, 1981).

The above framework is not the only possible classification of diversificationmotives (see also Cable, 1977). Nevertheless it provides a useful framework forseparation of those motives that are most likely to be aligned with shareholderwealth maximisation from those that are not. It therefore provides a usefulframework for discussion of relevant research in the remainder of this paper.

3. EXPLORING MARKET POWER AND RESOURCEUTILISATION MOTIVES

3.1. Market Power Motives

Motives that are related to the exercise of market power may also be consistenteither with goals that consider shareholder interests or with those that favourmanagement interests, although they may be inconsistent with the interests ofother potential stakeholder group. Evidence relating to increased market powerthrough diversification is relatively sparse. In addition it may be unwise to infermotive from the results of such actions, although the later is generally all thatresearchers are able to measure.

A number of studies have attempted to distinguish between market powerand efficiency arguments for related acquisitions, but with only limitedsuccess.3 While Eckbo (1983) identified a positive relationship between themerger-induced change in concentration ratios and bidders abnormal returnsthis was not, of itself, sufficient to distinguish between the two sets of motives.Even evidence of a positive share price reaction for the competitors of theacquiring firm was not considered to be sufficient evidence to distinguishbetween the two sets of motives as Eckbo argued that the acquisition mayconvey information to investors about the potential for general efficiencyimprovements. Eckbo (1985) did, however, suggest that examination of theshare price reaction of competitors to the instigation of an anti-trust complaintover a proposed related acquisition may distinguish between the two sets ofmotives. In this latter instance a negative share price response was viewed asevidence that the potential for increased collusion had disappeared. As Eckbo(1985) was unable to identify a negative response he concluded that there was

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no evidence for collusion. However, as Limmack and McGregor (1995)suggest, a negative reaction to competitors may also be a response to the likelychallenge to any further acquisitions. In addition, a positive response to theanti-trust complaint may reflect a larger anticipated gain to competitors throughthe loss of market share by the original bidder (Huth & Macdonald, 1989).

While the above refers to related acquisitions, a number of studies haveidentified a negative relationship between diversification and corporateperformance, rather than the anticipated positive relationship that may beexpected if the market power motive dominated.4 While these results aresuggestive of the view that market power is not the dominant motive they donot rule out the possibility that this motive may also be present together withmanagerial motives, with the impact from the latter dominating the eventualperformance of the company.

3.2. Resource Utilisation (Efficiency) Motives

Weston et al. (1998) suggested that the diversification decision should be madewithin a strategic framework that is based on examination of organisationalstrengths and weaknesses. Anslinger and Copeland (1996), for example,identified intensive acquirers who consistently outperformed the S&P 500index over the period 1985–1994 while Weston (1999) illustrated the strategybehind the acquisition policy of the General Electric Company in making 509acquisitions and 310 divestitures over the period 1981–1997. Prahad and Bettis(1986) have examined the issue of related vs. unrelated diversification andconclude that it is the selection of an appropriate strategy rather thandiversification per se that will produce superior performance. Pandaya and Rao(1998) suggest that ‘dominant firms operating with core competencies andoperating in less competitive environments are better off concentrating on onebusiness segment’ (p. 76). Other firms, however, may be better off diversify-ing.

One motive, in particular, often claimed for diversifying acquisitions is theutilisation of skills developed by one management team to the control of assetscurrently managed by a less efficient team. While Jensen and Ruback (1983)refer to the application of this ‘market for corporate control’ as a disciplinarymechanism for acquisitions in general, firms following a diversified strategywill be able to consider a greater number of opportunities for the application oftheir perceived superior skills. By contrast there will also be a greateropportunity to exercise poor judgement or ‘hubris’ (Roll, 1986) and thepotential for over-valuation based on asymmetric information may also begreater (Chatterjee & Lubatkin, 1990).5 Superior management skills may either


be those developed in specific management functions or in general manage-ment capabilities. One example of application of the latter may be found in theacquisition strategy adopted by Beatrice Company (USA) in the 1960s.According to Gazel (1990) the most important aspect to the management ofBeatrice of any acquisitions in that period was ‘the quality of the company’sincumbent management’ rather than the acquisition of inefficiently managedfirms.

The acquisition of relatively small, well-managed companies allowed themanagement of Beatrice to apply their existing decentralised managementstructure to the newly acquired organisation and to concentrate seniormanagement resources on strategic planning and hands-off monitoring (Baker,1992). It is interesting to note that one of the reasons identified by Baker for thesubsequent failure of Beatrice was a movement away from this particularorganisational structure towards one with a more centralised decision-makingstructure. Matsusaka (1993) similarly found that firms making diversifyingacquisitions in the period 1968 to 1974, but who also retained the managementof the target company, achieved positive abnormal returns.6 The resource-basedtheory, developed by Penrose (1959) among others, is perhaps a moregeneralised form of the above in which excess capacity in valuable resources(including management ability) is transferable across industries and leading tosituations in which the diversified firm may emerge as the most efficient formof organisation.

While the resource-based motive for diversification expressed above appearsto focus mainly on economies of scale in the utilisation of various resources,7

other potential sources of efficiency gain have also been identified fordiversifying activities including the following:

• Increased debt capacity (Lewellen, 1971).• Utilisation of tax losses (Levy & Sarnat, 1994).• Reduction of information asymmetries in capital markets (Alchian, 1969;

Williamson, 1970; Weston, 1970; Stein, 1997; Hubbard & Palia, 1999).• Reduction in the under-investment problem (Stultz, 1990).

Potential costs include:

• Over-investment (Stultz, 1990; Berger & Ofek, 1995).• Subsidisation of loss-making segments (Meyer et al., 1992; Berger & Ofek,

1995).

According to Lewellen (1971) increased debt capacity may arise fromdiversification through the combination of companies with imperfectlycorrelated cash flow streams.8 The increased debt capacity then provides the

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opportunity for greater utilisation of tax shields from interest payments andhence higher shareholder wealth. Asquith and Kim (1982), however, found that,while target shareholders obtain gains from diversifying acquisitions, it was notat the expense of bondholders. Shleifer and Vishny (1992) suggested that debtcapacity may also be increased in conglomerates that are more likely to be ableto identify marketable assets for disposal when faced with liquidity problems.By contrast to the above Mansi and Reeb (2001) suggested that wealth lossesto shareholders in diversified firms are related to the level of debt financingwith all-equity firms suffering no wealth losses. The latter authors suggestedthat diversification involves a transfer of wealth from equity investors tobondholders. In addition a recent paper by Lamont and Polk (2001) suggeststhat, rather than reducing risk, diversified firms appear to have a highervariability of expected future cash flows and expected future returns thanportfolios of single segment firms. Porter (1985) also suggested that relatedacquisitions are more likely to reduce systematic risk through the increasedability of the merged firm to defend its market position.

Possible tax gains from acquisition include the use of otherwise under-utilised tax losses. Where one company has experienced taxable losses that areunlikely to be offset against taxable profits in the foreseeable future,combination with another firm that is currently earning taxable profits willprovide an increase in shareholder wealth that is equivalent to the present valueof the tax saved.9 While such wealth increases may not be restricted tounrelated acquisitions tax savings are more likely to be obtained through thecombination of profit streams with a relatively low correlation. Levy and Sarnat(1994) refer to research by Blume et al. (1984) in which tax considerationsfeature among the main reasons for corporate acquisition. Evidence on the taxbenefits of diversification is however sparse and while Berger and Ofek (1995)report some evidence of tax savings from diversification, the amount involvedwas considered to be too small to have any significant impact on firm value.

The utilisation of more efficient internal capital markets to eliminateproblems caused by information asymmetries has been cited by a number ofauthors as a motive for diversified acquisition, both in the USA during the1960s and, more recently, in relatively under-developed economies. Alchian(1969) and Williamson (1970, 1975), among others, have suggested that asmanagers of a firm possess information advantages over external providersof capital, internal capital markets may produce a more efficient allocation ofresources than is possible with external markets. Myers and Majluf (1984) referto the under-investment problem that can result from information asymmetryalthough Stein (1997) also suggests that similar asymmetries may be present inlarge diversified firms. Matsusaka and Nanda (2000) also suggested that


internal markets might be a cheaper source of finance in the presence of highexternal financing costs. In particular they argued that ‘internal flexibilityallows them to avoid costly external financing in more states of the world thanseparated firms’ (ibid p. 30). Against this, however, must be set the potentialdisciplinary power of the external capital market and the potential over-investment problem when access is available to internal financing. Hubbard andPalia (1999) reported that higher returns were available for diversifyingacquirers in the 1960s when financially unconstrained acquirers boughtconstrained targets.10 In addition they identified that the management of targetfirms were generally retained, suggesting that the motives for acquisition didnot include replacement of an inefficient management team. Their results areconsistent with those reported by Baker (1992) who includes in his paper ananalysis of the source of diversification benefits for Beatrice Company. Supportfor the benefits of an internal market is also provided in the study by Khannaand Palepu (2000) of the financial performance of affiliates of diversifiedIndian companies.11 While they report that accounting and stock marketmeasures of performance initially declined with diversification, this pattern wasreversed at higher levels of diversification. It appears that in less-welldeveloped economies there may still be benefits from the presence of aninternal market in finance and management expertise. Further support for thebenefits of an internal capital market is also provided in a recently reportedstudy by Klein (2001) of the valuation of conglomerate acquirers over theperiod 1966–1974. For the earlier period studied Klein reports a diversificationpremium that becomes a discount in the later period. The higher valuation inthe earlier period is ascribed to the benefits of internal markets. Once therelative advantages of internal markets disappear, however, the costs ofdiversification will outweigh the benefits (Bhide, 1990; Stultz, 1990).

A recent paper by Billet and Mauer (2000) suggested that benefits of aninternal market may have persisted for some U.S. companies into the 1990s.The authors investigated stock market reaction to the announcement by asample of U.S. companies of the introduction of tracking stock into their capitalstructure. Tracking stock is a form of equity capital that has been designed tobe linked to the performance of a particular line of business within acompany.12 The use of such stock allows different rights to be assigned toownership of different lines of business and also allows managerial compensa-tion to be linked to the performance of the line of business tied to the particulartracking stock. The use of tracking stock allows a company to continue tooperate an internal capital market, by contrast with other forms of corporaterestructuring. From their analysis Billet and Mauer (2000) identified that theannouncement of tracking stock issues was seen as a positive event by the stock

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market and that diversified companies that issue tracking stock are valued at alower discount than other diversified companies.13 The authors concluded that,for some companies at least, there are still benefits to be provided from internalcapital markets. However as the authors are only able to identify a smallnumber of companies that use tracking stock they suggested that ‘ a drivetoward focus . . . is probably more value-enhancing for the vast majority ofdiversified firms’ (ibid p. 1489).

Berger and Ofek (1995) reported that one of the sources of value-loss fordiversified companies was over-investment in poorly performing segments.Their proxy for over-investment was based on the sum of depreciation-adjustedcapital expenditures, scaled by total assets, for segments operating in industrieswhose median Tobin’s q is in the lowest quartile. Cross-subsidisation of poorlyperforming subsidiaries was also identified as a potential source of value lossin diversified firms. While the maximum loss suffered for a stand-alonecompany is restricted to the total value of that unit because of limited liability,within a diversified organisation the loss may also reduce the value of othersegments. Myers et al. (1992) also reported greater value losses through cross-subsidisation of unprofitable lines of business. Similarly Berger and Ofek(1995) also report results that are consistent with the view that diversified firmssuffer a significant value-loss through cross-subsidisation. In the latter case,however, the authors also acknowledged that their results were also consistentwith the view that the security market interprets a negative cash flow in one ormore segments as a signal of poor management quality. Further evidence ofinefficient transfer of resources across divisions was supplied in recent papersby Lamont (1997), Shin and Stultz (1998), and Rajan, Servaes and Zingales(2000). A number of studies have also suggested that power struggles amongstmanagers of divisions of diversified firms leads to a sub-optimal allocation ofresources (Rajan et al., 2000; Scharstein & Stein, 2000). However Whited(2001) suggested that prior evidence of inefficient investment by divisions ofconglomerates was a consequence of methodological error in measurement ofq values. Using generalised method of moment estimators (Hansen, 1982)Whited reports that any evidence of cross-subsidisation of inefficient divisionsin diversified firms disappears.

Published research of the impact of diversification on shareholders wealthsuggests that many of the claimed benefits may not have materialised or elsemay have been more than offset by greater agency costs. Indeed recent yearshave produced a reversal of diversification strategies with many firms followinga more focused approach. One possible reason for the diversification discountand subsequent reversal in strategy is that ‘shocks’ in competitive andregulatory conditions occurred in the 1980s and reduced the previously


obtainable benefits from diversification. Potential shocks include changes in theexternal capital markets, technological change, and in the regulation ofcompetition and industrial concentration. Support for the impact of shocks onthe relative merits of focused and diversified strategies is provided in literatureon the benefits of internal vs. external markets (Baker, 1992; Hubbard & Palia,1999), limited availability of superior management skills (Baker, 1992), andchanges in the regulatory environment (Shleifer & Vishny, 1991). Khanna andTice (2001) document the response of firms to the specific ‘shock’ induced bythe entry of Wal-Mart into their market. The authors find that diversified firmsappear to respond faster to the threat, either by exiting the discount market orby instituting a campaign against the new entrant. Khanna and Tice (2001) alsoreported that diversified firms were more sensitive to the productivity of theirdiscount division than were more focused firms and that internal marketstransferred funds efficiently to more profitable sectors.

Contrary evidence to that reported above is found in those studies that haveidentified the presence of a diversification discount in the 1960s and 1970s(Lang & Stultz, 1994; Servaes, 1996) and those that have suggested thatdiversified firms react slowly, and generally only in response to externallyimposed pressure, to diversification costs (Berger & Ofek, 1996; Dennis, Denis& Sarin, 1997). In addition Chevalier (2000) reported that the investmentbehaviour documented in diversified firms was present prior to the absorptionof the individual firms rather than being a function of diversification per se. Inthe next section we examine in more detail the impact of agency issues on thediversification decision.

4. DIVERSIFICATION AND AGENCY ISSUES

According to a number of commentators diversification strategies provide clearexamples of the agency problems described by Jensen and Meckling (1976),among others. In particular diversification provides greater opportunity forgrowth and managerial labour capital risk reduction than is likely to beavailable in more focused strategies. Growth opportunities may be followedwithout many of the restrictions imposed by competition within a primaryindustry or the threat of government legislation.14 In addition diversificationoffers the opportunity for senior managers to reduce the risk to their ownpersonal labour capital (Amihud & Lev, 1981; May, 1995) although Aggarwaland Samwick (2001) find little evidence that mangers diversify their firms toreduce their risk exposure.

Jensen and Murphy (1990) suggest that diversification may provide greateropportunity for managers to increase their power and prestige as well as their

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level of remuneration. Hoskisson and Hitt (1990) support this argument bypointing to the high correlation between diversification, firm size, andmanagement remuneration. Avery et al. (1998) report that the main benefit toCEO’s from acquisition is the opportunity to gain outside directorships, ratherthan increased compensation. This result holds irrespective of whether theacquisition increased shareholder wealth or was diversifying in nature. Theyconclude that acquisitions increase the prestige and standing of CEO’s in thebusiness community. Private benefits obtained from managing a morediversified firm may also include increased career prospects (Gibbons &Murphy, 1992) and increased prestige from dealing with the greater complexity(Jensen, 1986; Stultz, 1990). In addition Shleifer and Vishny (1989) suggestthat managers may become more indispensable (entrenched) in diversifiedfirms and may therefore undertake unrelated acquisitions when their position isthreatened.

Denis, Denis and Sarin (1997) identified a strong negative relationshipbetween the degree of diversification and inside share ownership based onanalysis of a sample of U.S. companies in 1984. However their results alsofound ‘little support for the hypothesis that the value loss from diversificationis greater in firms with low managerial ownership’ (ibid p. 144). Their resultsappear to be inconsistent with the finding by Servaes (1996) that diversificationincreased in the 1970s among firms with high inside ownership ‘when the coststo shareholders was negligible’ (ibid p. 1203). The result is also inconsistentwith the finding by Lewellen, Loderer and Rosenfeld (1989) who reported thatdiversifying acquisitions led to higher abnormal returns in firms with highermanagement share ownership.

Rajan, Servaes and Zingales (2000) demonstrated that in diversified firmsresources flow to inefficient investments to the detriment of investment in other,more profitable, divisions. Similarly Scharfstein and Stein (2000) identifiedmisallocation of resources by divisional management. As reported earlier,however, Whited (2001) suggested that the relationship between the diversifica-tion discount and inefficient investment may have been produced as a result ofmeasurement error in the use of Tobin’s q as a proxy for investmentopportunities. After correction for the measurement error Whited finds noevidence of inefficient allocation of investment funds.15

Aggarwal and Samwick (2001) tested a model that combines both the riskreduction and private benefits explanation for diversification. They initiallyreported that firm performance increased with incentives but decreased with thelevel of diversification. However when they controlled for firm-specific featuresthey then found that managers’ incentives were positively related todiversification in contrast to reported findings of earlier papers (Denis et al.,


1997). In addition the authors concluded that ‘diversification decisions aredriven by the private benefits managers receive from greater diversification’ (opcit p. 26). Aggarwal and Samwick did however reject the inference by May(1995) that the positive relationship between diversification and incentivesprovided support for a risk-reducing motive for diversification. Instead theysuggested that managers with the greatest need for risk reduction would havethe lowest incentives and that there should in those circumstances be a negativerelationship between the two. However in both their paper and that by May(1995) a positive relationship had been identified. Hence Aggarwal andSamwick (2001) concluded that management risk reduction was not a primarymotive for diversification.

5. MEASUREMENT ISSUES

Examination of diversification effects involves decisions relating to at least twomeasurement issues. The first involves the measurement of the degree ofdiversification while the second relates to performance issues. On the first issuemost studies have tended to separately identify diversified vs. undiversifiedfirms based either on the number of separate segments identified in financialreports or by reference to identified Standard Industrial Classification (SIC)codes. Classification errors may arise through the absence of segmentalinformation.16 Alternative measures of diversification include the number ofreporting segments (Berger & Ofek, 1995; Servaes, 1996) and measures ofconcentration such as the Herfindahl index (Berger & Ofek, 1995) or theSpecialisation ratio (Rumelt, 1974, 1982; Pandya & Rao, 1998).

Studies of the impact of diversification on firm performance have generallyused accounting measures and/or security market measures. Early research intothe effects of diversifying acquisitions used measures of accounting perform-ance. Thus Reid (1968) reported that conglomerate acquirers had higher levelsof profitability than other types of acquirer. Weston and Mansingka, (1971)found that conglomerate firms had lower operating profit margins during theearly part of the 1960s, but that profitability improved during the later half ofthat decade. The suggestion that the improvements in performance reported bythem may have been an artifact of some form of profit averaging, in theacquisition of more profitable targets (Mueller, 1977, p. 322) was rejected inpapers by Conn (1973) and Melicher and Rush (1973). Conn found nodifference in profitability between acquirer and acquired firm for conglomerateacquisitions made in the period 1954 to 1969. Melicher and Rush (1973), foundthat for acquisitions conducted in the period 1960 to 1969 conglomerateacquirers were less profitable than non-conglomerates, pre-acquisition, but that

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there was no significant difference in pre-acquisition profitability of the twogroups of target firms. Improvements in profitability did not therefore appear tocome from acquiring more profitable targets. In a more recent study of theimpact of diversification on U.S. company performance, Pandya and Rao(1998) found that risk-adjusted accounting performance increased with thedegree of diversification. For U.K. acquisitions in the period 1964–1971,Meeks (1977) reported greater improvements in profitability for non-horizontalacquirers relative to horizontal acquirers. By contrast Cosh, Hughes and Singh(1980) identified a post-acquisition decline in the performance of unrelatedacquisitions.

More recently much of the research into the wealth effects of diversificationstrategies has adopted one of two methodological approaches based on analysisof market prices. The first approach uses an ‘events’ framework and isconcerned with measuring the wealth effects for the acquiring firm share-holders of the decision to make a diversifying acquisition. In this type of studyit is common to find comparison made with the wealth effects of relatedacquisitions, sometimes using multi-variate analysis. Thus Elgers and Clark(1980) concluded that diversifying acquirers earned higher returns than relatedacquirers. Similarly Matsusaka (1993) reported that in the years 1968, 1971,and 1974 acquisition announcements by diversified bidders produced positiveabnormal returns. By contrast Morck, Shleifer and Vishny (1990) found nodifference in returns in related and unrelated acquisitions in the 1970s butidentify negative abnomal returns for acquirers of unrelated targets in the1980s, while Kaplan and Weisbach (1992) reported mixed returns and Hyland(1999) identified positive returns to unrelated acquisitions. Limmack andMcGregor (1995) found no significant difference in returns to U.K. bidders inrelated versus unrelated acquisitions in the period 1977–1986 although they dididentify a positive relationship between the change in concentration ratio andbidding company returns in related acquisitions. Gregory (1977), however,reported that for U.K. acquisitions in the period 1984 to 1992 conglomerateacquirers achieved lower returns than non-conglomerate acquirers, although healso noted that his results were sensitive to the choice of benchmark. Morerecently Pandaya and Rao (1998) report that both absolute and risk-adjustedmonthly returns are positively related to the degree of diversification for U.S.companies over the period 1984–1990. The latter authors use the Sharpe Indexas their measure of risk adjustment and make no distinction between relatedand unrelated diversification.

One problem with the above approach relates to the identification of therelevant event period. In particular conglomerates may be formed in the processof a programme of acquisitions that has been previously announced by the


company. Schipper and Thompson (1983) suggested that the expected value ofan acquisition programme should be reflected in the share price of the acquireraround the time of the programme announcement. Share price reaction toindividual takeovers subsequent to that event will reflect the incremental effectof each acquisition.17 They examined the share price behaviour of 30companies that announced acquisition programmes during the period1953–1968. While there was some ambiguity about the exact date ofannouncement of the programme for a number of these companies, Schipperand Thompson nevertheless reported significantly positive abnormal returns inthe announcement month. Although their study was not explicitly concernedwith conglomerate acquirers many of those companies most active in thetakeover market are likely to be involved in unrelated (diversifying)acquisitions.

An alternative approach to the above has been to compare the value ofdiversified companies at specific points in time with the value of stand-aloneequivalents. This approach first requires the establishment of a relationshipbetween market value and financial characteristics of non-diversified com-panies and subsequently, the application of that relationship to observablesegmental information of the diversified companies. A discount (or premium)is then identified for the diversified company based on the difference betweenthe actual market value and the combined value based on the imputed value ofindividual segments. The approach is limited by the availability of segmentalinformation for the diversified firm and is generally based on quasi valuationratios such as market value to sales, total assets or profits.

In one of the first studies to use the valuation approach Lang and Stultz(1994) calculated Tobin’s q values for diversified firms and compared thesewith the combined stand-alone equivalent value of the separate divisions.18

They found that Tobin’s q for diversified firms was lower than that for single-industry firms in the late 1970s and 1980s. Although adjustment for industryfactors reduced the relative discount on diversified firms, it did not eliminatethe discount completely. The authors also reported that their result held evenafter controlling for other factors that may explain cross-sectional differencesin q values, including size, access to capital markets and intensity of researchand development expenditure.19 Lang and Stulz (1994) also reported that the qvalue falls as the level of diversification increases. Firms that diversify alsoappear to have poor performance relative to other firms that do not, but thatthey are not significant under-performers relative to non-diversifying firms inthe same industry. The evidence provided by Lang and Stultz (1994), whileindicating that diversified firms are valued at a discount relative to non-diversified firms also suggests that the reasons for the low valuation may in part

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be a function of the industry and other conditions in which these firms operate.The authors are cautious about inferring from their analysis that diversification‘hurts performance’. Rather they conclude that their evidence suggests thatdiversification ‘is not a successful path to higher performance’ (ibid p. 1278).One possible explanation proposed for their results is that firms seek growththrough diversification because they have exhausted profitable growth opportu-nities in their existing activities. Recent research (discussed in the next section)has explored a number of the issues raised by Lang and Stultz.

Using a similar methodology to the above, Berger and Ofek (1995) alsotested for the presence of a diversification discount. Their approach was basedon the identification of industry segments for diversified firms and thecalculation of median ratio for single segment firms in the same industry basedon the relationship between total value and (separately) one of three accountingvariables, namely assets, sales and earnings.20 The valuation ratio computed isthen applied to the relevant segmental information of the diversified firm. Thesum of these segmental values is identified as the ‘pseudo’ stand-alone value ofthe diversified company. The natural log of the firms actual value to its imputedvalue is then identified as the valuation premium (or discount). Using a sampleof companies from the Compustat Industry Segment database for 1986 to 1991,Berger and Ofek (ibid) reported significant discounts in the median (and mean)value of diversified companies, whichever valuation multiple was used. Theyalso reported that the value loss increased with the number of segments (ibidp. 49). Berger and Ofek also distinguished between related (at the SIC two-digit level) and unrelated diversification and found that the value loss wasreduced in the former.

Servaes (1996) adopted a similar methodology to the above in testing for thepresence of a diversification discount in the period 1961–1976. However hisanalysis was made more difficult by the absence of disclosed segmentalinformation for many of the companies in his sample. Servaes solves thisproblem by calculating Q values for multi-segment firms based on twoalternative assumptions.21 First he calculated industry-adjusted values afterdeducting the mean (median) of the q-ratio of single segment companies in theindustry identified as the primary industry for each firm. Second he calculatedthe equally weighted industry-adjusted value after deducting the mean(median) of the q-ratio of single segment companies in each segmentseparately. The first approach may give excess weight to the primary industryof the diversified firm while the second approach may give undue weight toother segments. An average of the two should therefore reduce the impact ofthe individual sources of measurement error. Servaes identified a significantmean and median industry-adjusted diversification discount to the firms in his


sample in 1961, 1967, and 1970 whichever method of adjustment was applied.In 1964 the discount was found to be negative but insignificantly different fromzero. His results suggested, however, that ‘there is little evidence of a discountpenalty’ for 1973 and 1976.22 Overall Servaes found that the diversificationdiscount had reduced significantly from the period 1961–1970 to 1973–1976.While this pattern is contrary to what might be expected if diversification wasmotivated by the comparative advantage of internal capital markets, Servaessuggested an alternative explanation based on changes in the level of insiderownership. In the first time period examined diversified firms had lower insideshare ownership than single segment firms. However in the later time period thedifference in inside share ownership between the two groups was insignificant.Servaes concluded that in the later periods firms choose to diversify when therewas no financial penalty. In the earlier years, however, the lower level of insideownership did not prevent firms from diversifying even when there was asignificant penalty. By contrast with the results from Berger and Ofek (1995),Servaes found no evidence that the discount increased with greater diversifica-tion beyond two segments. He was also unable to find any explanation for thediversification discount in differences in profitability, capital structure orinvestment policy. Nor did it appear from the above analysis that thediversifying decision was caused by lower prior profitability. His results alsoconflict with those reported by Klein (2001) on a restricted sample of 39conglomerate acquirers over the period 1966–1974. While Klein reported adiversification premium for the period 1966–1968 he found that this turned intoa discount in the later period of his study. Klein ascribed his results to thechange in benefits from internal markets. Other papers have suggested thatthere may be exogenous factors that lead to the decision to diversify andthat any observed discount (or premium) is not caused by the diversificationdecision alone. Research into the latter hypothesis is reviewed in the nextsection.

6. EXOGENOUS FACTORS AND DIVERSIFICATIONDISCOUNTS

A number of recent papers (Burch et al., 2000; Campa & Kedia, 2000;Villalonga, 2000; Graham et al., 2001) have suggested that the diversificationdecision ought to be considered as related to the economic environment inwhich the decision is made, rather than as a completely endogenous decision.In particular this approach requires controlling for the characteristics of thediversifying firms, or their industries, and possibly also of the firms that areacquired. The argument is that firms do not diversify at random but in response

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to various factors relating either to their own characteristics, those of the targetcompanies, or to the economic environment in which they operate.

Burch, Nanda and Narayan (2000) provide a framework in which thediversification decision is viewed as a value-increasing response to industryconditions that had produced a discount in the value of the firm prior to thediversification decision. Their model is based in an agency setting in whichmanagers in a declining industry are reluctant to reduce assets under theircontrol and instead diversify into more profitable sectors.23 The firms that aremost likely to diversify are those that are described as ‘less innovative’ in thesense that they are less able to cope with changes to their primary industry,whether caused by new technology, marketing and distribution patterns, orregulatory framework. Such firms are likely to be valued at a discount to theirmore innovative peers prior to any diversification decision. All other thingsbeing equal, the decision of such firms to diversify will be inversely related tothe availability of profitable investment opportunities within their primaryindustry. Burch et al. (2000) find support for their hypotheses using panel dataof fifty of the largest U.S. industries over the period 1978–1997. In particularindustry market-to-book ratios and excess value measures are lowest in thoseindustries with a higher proportion of firms that have chosen to diversify.Support for their hypotheses is also present in the finding reported earlier byLang and Stultz (1994) that diversified firms previously operated in poorlyperforming industries. Similarly in a study of U.S. corporate performance inthe 1950s Weston and Mansingka (1971) concluded that conglomerates wereachieving a policy of ‘defensive diversification’ that was designed both ‘topreserve the values of ongoing organisations as well as restoring the earningspower of the entities’ (ibid p. 928).

Villalonga (2000) also reported that diversifying firms trade at a significantindustry-adjusted discount prior to the diversifying decision and that thesefirms were present in industries with lower q values than their non-diversifyingcounterparts. Institutional and inside share ownership was also found to belower in diversifying firms. Villalonga also reports that diversifying firms hadhigher risk and were more likely to diversify into industries with lowerleverage.

Campa and Kedia (2000) suggested that it was the characteristics ofdiversifying firms that produces the diversification discount, not the decision todiversify per se. They began their analysis by comparing firm characteristics fordiversified firms in years in which they were not diversified (single segmentyears) with the characteristics of firms in other samples. Using a data set ofcompanies from the Compustat database for the period 1978–1996 the authorsreported that in their single segment years conglomerate companies were likely


to be larger, have greater leverage and have lower research and developmentexpenditure than multiple segment firms.24 In addition single segment years ofdiversified firms had higher capital expenditure rates and lower sales marginsthan single segment years of refocusing firms. Diversified firms in multi-segment years tended to invest more in research and development and to havehigher rates of capital expenditure and higher profitability than multiplesegment years of refocusing firms.25 However diversified firms that do notchange their status seem to be in mature industries with lower growth rates,lower research and development but higher profitability and, perhapssurprisingly, higher rates of capital investment. As stated earlier the authorsconcluded that it was the characteristics of the diversified firms that appearedto account for the discount rather than diversification itself.

Campa and Kedia (2000) also found that there was a higher exit rate of singlesegment firms from industries in which diversified firms operate and that theexiting firms generally had lower values than remaining firms. A benchmarkbased on average returns of surviving firms is therefore likely to be biased.After controlling for exogenous factors that appear to predict the likelihood thata firm will diversify the authors reported that the diversification ‘discount’becomes a premium. Their evidence therefore suggests that diversification maybe a value increasing decision that results from changes to the economicenvironment in which diversifying firms operate.

A number of authors, including Hyland (1999) and Villalonga (2000) havealso suggested that the discount in firm value was present prior to the decisionto diversify. Matsusaka (2001), however, appears to go beyond Campa andKedia (2000) above by suggesting that the causal relationship is such that thepresence of a discount in potential targets provides the reason for makingdiversifying acquisitions. This view is consistent with the theory that takeoversprovide a disciplinary mechanism for the management of inefficientlyperforming firms (Jensen & Ruback, 1983).

Graham, Lemmon and Wolf (2001) compared value changes for acquiringfirms making related and unrelated acquisitions. They adopted two measures ofvalue change, the first based on standard event study methodology and thesecond based on the excess value multipliers used by Berger and Ofek (1995),among others. The authors identified significantly positive three-day combinedabnormal returns around the acquisition announcement date for both relatedand unrelated acquisitions, indicating that these events were not viewed asvalue-destroying on average, at least initially. However when identifyingexcess values based on sales multiples the authors reported that, whileacquirers appear to possess significantly positive excess values one year priorto acquisition, there was a significant fall in these values post-acquisition.26 The

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reported value loss was found to be greatest in related acquisitions in contrastwith expectations based on the results of previous research. Indeed the medianvalue loss in unrelated acquisitions was not significant at the 10% level. Oneconfusing finding from their analysis was that firms reporting an increase in thenumber of business segments following acquisition suffered greater valuelosses than those reporting no increase. However it also appeared that many ofthe firms making unrelated acquisitions did not report any increase in thenumber of business segments. The results of this latter analysis are thereforedifficult to interpret.

As indicated above, one implication of the analysis by Graham et al. (2001)above is that acquisitions lead to value losses but that these losses are mainlyconfined to related acquisitions. The authors, however, suggested that theirresult may be driven by acquisitions of targets that had previously sufferedvalue losses. The apparent discounted value of the subsequent combination willhave therefore appear as the result of averaging the excess values of the twopreviously separate entities rather from the market response to the acquisition.In support of this hypothesis the authors reported that target companies hadsignificantly negative mean (and median) excess values one year prior toacquisition. Their interpretation is also consistent with the reported greaterpost-acquisition reduction in value following related acquisitions, as targets inrelated acquisitions suffer the largest pre-acquisition discount. The authors alsoreported that there was no significant difference between the actual change inexcess value for the combined companies and the change projected through aweighted-average of pre-acquisition values. In summary Graham et al. (2001)concluded that ‘the characteristics of acquired units are an important factor indetermining the valuation discount’ and that the standard methodology used indiversification studies for comparing values with stand-alone companies maybe flawed.

Additional explanations for the previously reported diversification discounthave also been offered in recent papers by Lamont and Polk (2001) and Mansiand Reeb (2001). Lamont and Polk (2001) suggested that much of thediversification discount might be explained by greater risk, both in highervariability of future expected cash flows and of future expected returns. Finallya recent paper by Mansi and Reeb (2001) found that the diversification discountdisappeared when account was taken of leverage. They found that all-equitydiversified firms in the period 1988 to 1999 appear to suffer no diversificationdiscount while leverage was associated with the diversification discount infirms with debt financing. They also suggested that the use of book value fordebt in valuation ratios of diversified firms leads to a downward measurement


bias and reported that the discount disappeared if market values were adoptedfor measuring the value of debt rather than book values.

There is little international evidence on the relationship between thevaluation of diversified firms and other factors. Lins and Servaes (1999) foundno evidence of a diversification discount in a sample of German companies for1992 and 1994 but did identify a discount in Japanese and U.K. companies.They found no evidence that inside share ownership mitigated against value-reducing diversification for the latter two countries but did report that adiversification discount was present in German companies in which insideownership was below 5%. By contrast Fleming, Oliver and Skourakis (2001)reported that diversified Australian companies appeared to trade at a premiumin the period 1988 to 1998 when adjustment was made for excess profitability.The study, referred to earlier, by Khanna and Palepu (2000) of diversifiedcompanies in India also suggest that diversification may be positively valued ina country with a less well-developed financial market.

7. REVERSING THE DIVERSIFICATION DECISION

Indirect evidence on the costs and benefits of diversification has been imputedfrom examination of situations in which companies change their strategy to amore focused approach. Indeed there is now considerable evidence to suggestthat many of the diversifying acquisitions in the 1960s and 1970s have beenreversed subsequently (Ravenscraft & Scherer, 1987; Porter, 1987; Bhagat,Shleifer & Vishny, 1990; Kaplan & Weisbach, 1992). Thus Berger and Ofek(1996) identified that higher value loss for diversified firms led to a greaterprobability of takeover. They also found a relationship between the likelihoodof takeover in the form of leveraged buyout (LBO) and the size of the value losspreviously suffered by the diversified firm. Finally they identified a greaterprior value loss to those firms that are ‘broken up’ subsequent to takeover.Overall Berger and Ofek (1996) suggested that their results were consistentwith ‘the market for corporate control targeting and breaking-up combinationsof business lines which have a greater value when each line is operated on astand-alone basis’ (ibid p. 1178). Comment and Jarrell (1994) also reportedthat the 1980s in the USA were characterised by a trend towards refocusingwith a positive relationship identified between stock returns and an increase infocus. John and Ofek (1994) reported that the positive impact on the sellersshare price at the time of the divestiture announcement was related to thesubsequent improvement in performance of the remaining assets of the seller.In addition the latter authors found that sellers share price gains appeared to be

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related in part to an improved fit between the divested assets and those of thebuyer.

Subsequent studies have also identified that buyers of divested assets tend tobe companies operating in related areas. Increased focus appears to providepotential efficiency gains both in the divested and the remaining assets. Denis,Denis and Sarin (1997), for example, reported that a sample of companies thatdecreased their level of diversification in the period 1985 to 1989 experiencedsignificant negative excess values prior to the decrease in diversification. Theyalso identified that 54% of the cases of refocusing were in response to a marketdisciplinary event in the year prior to refocusing. They concluded that there waslittle evidence to support the hypothesis that diversified firms with largenegative excess values refocused voluntarily. A recent study by Gillan et al.(2000) of the actions of Sears, Roebuck & Co. provides a detailed examinationof some of the tactics adopted by entrenched management in an attempt toovercome shareholder pressure to divest.

While the evidence from U.S. studies generally supports the notion that poorperformance leads to divestment and refocusing, evidence from a studyundertaken by Haynes, Thompson, and Wright (2000) of a sample of U.K.companies in the period 1985 to 1989 found no such relationship. The authorsdid, however, find that the level of divestment was related to the size and degreeof diversification of U.K. firms. In addition they identified a significantrelationship between divestment and a number of governance variables,including board composition, management share ownership and gearing. Thereduction in level of diversification appeared to be related to the extent to whichthe firm was monitored effectively.

An alternative view of the reason for corporate refocusing was provided byMiller (1995), who argued that the higher value from refocusing wasattributable to a ‘clientele’ effect. He suggested that the diversification discountidentified in various studies was a consequence of investors’ lack of preferencefor diversified firms in which they hold less confidence or for risk-reducingaspects that they have no need of. However when a spin-off occurs the price ofeach component is then set by the group of shareholders who wish to invest inthat particular segment. Miller also cited tax reasons why this shareholder-oriented motive may be under-stated by managers. Although Miller’s viewshave produced very little reaction from others in this field, additional supportfor the clientele effect was provided in an earlier paper by Kudla and McInish(1988), which suggested that the greatest potential for post-spin-off benefitswould arise in firms in which owners and non-owners differed most aboutvalue.


Weston (1989) also argued that companies often divest previously acquiredfirms for non-performance related reasons, including changes in externalfactors that have reduced synergistic benefits. Kaplan and Weisbach (1992)reported that 44% of large acquisitions completed between 1971 and 1982 weresubsequently divested but that only 34% of these could be classified asunsuccessful based on accounting performance. The latter authors did,however, report that divestitures were four times more likely followingunrelated acquisitions. While related acquisitions were more likely to beidentified as ‘successful’ there was a similar proportion of divestmentsreporting a gain on divestment following both related and unrelatedacquisitions.

8. SUMMARY AND CONCLUSIONS

Motives ascribed to the diversification decision range from those relating toshareholder wealth maximisation (e.g. improved resource utilisation) to thosealigned with management interests. Empirical evidence is available to supportboth sets of motives. While there is little evidence in support of the exercise ofmonopoly power as a diversification motive, this may be a function of thedifficulty in obtaining relevant data and constructing unambiguous tests.

Early evidence supported the hypothesis that diversified firms trade at adiscount to their stand-alone equivalent. This evidence, and that relating tomanagerial shareholdings, suggested that the diversification discount was likelyto be aligned with managerial interests, including the pursuit of growth and riskreduction. When management interests were more closely aligned with those ofshareholders then the result was either a reduced probability of diversificationor a lower value loss. The absence of a diversification discount for some recenttime periods suggests that there may be external factors that have a differentimpact on the balance of costs and benefits at different points in time. Howeverthe evidence is also consistent with the ‘hubris’ hypothesis, with managementpursuing a strategy that is designed to allow their (assumed) ‘superior’ skills tobe applied to inefficiently managed firms, irrespective of their industry. In thelatter case the motive may well have been to act in the interests of shareholdersbut the implementation of the decision appears to have led to the reverse.Support for the hypothesis that management interests have driven thediversification decision has been provided in the literature describing thesubsequent ‘break-up’ of previously diversified firms. One of the main featuresof this literature is the apparent reluctance of senior management to reverse thediversification decision in the absence of external threat.

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Evidence that provide support for the resource utilisation (shareholderwealth maximisation) motive for diversification may be found mainly in thatliterature relating to the greater efficiency of internal capital markets and to theelimination of information asymmetries. According to this literature thediversification discount appeared when the comparative advantage of internalmarkets was overtaken by the agency costs arising from the pursuit ofmanagement objectives. However the finding by Servaes’ (1996) that thediversification discount disappeared in the 1970s appears to be inconsistentwith this view. An alternative, and potentially more plausible explanation, hasbeen provided in recent literature with the suggestion that the lower valueassociated with diversified firms may have been present prior to the decision todiversify. The non-survival of other firms in these industry that decided not todiversify has also produced a valuation bias against diversifying survivors.Although there is as yet only limited evidence in support of the latterhypothesis it does appear to offer a plausible explanation for the diversificationdecision and of the time-varying nature of the discount (or premium). Therelatively high number of companies that continue in their diversified state alsosuggests that for many companies any costs associated with diversification maybe more than outweighed by the benefits or by the relatively higher costsinvolved in refocusing.

NOTES

1. Hanson Trust was for many years identified as an example of successfuldiversification but has, in recent years, transformed itself into a specialised buildingproducts company.

2. See also Dugger (1985).3. Chappell and Cottle (1983), Eckbo (1983, 1985).4. See for example Utton (1977), Montgomery (1985), Palepu (1985), Montgomery

and Wernerfelt (1988).5. The impact of information asymmetry leading to under-valuation will not be as

easily observable.6. See also Elgers and Clark (1980).7. See also Chandler (1977).8. See also Stultz (1990).9. Majd and Myers (1987).10. A related explanation proposed by Fluck and Lynch (1999) is the inability of a

marginally profitable entity to obtain financing as a stand-alone entity because ofagency problems between managers and potential financial sources.

11. See also Fauver et al. (1999).12. Hass (1996).13. See also Zuta (1997).


14. See for example the diversifying actions of Beatrice in the 1950s following anti-trust scrutiny of their related acquisitions. (Baker, 1992.)

15. See also Erickson and Whited (2001).16. Although various Companies Acts and Accounting standards require U.K.

companies above a certain size to report segmental information there is a considerablediscretion as to the form. Business segment information was made available in 1974from Compustat for U.S. companies.

17. Asquith, Bruner and Mullins (1983) reported that acquisitions subsequent to theannouncement of the programme also produced gains.

18. The definition of Tobin’s q adopted in the study was based on a numeratordefined as the market value of equity plus the book value of debt and preference capital,rather than the replacement cost of assets. The numerator was calculated as acombination of book values and replacement costs (computed using the Lindenberg &Ross, 1981, algorithm). The authors also state that their results are similar when usingthe ratio of market value to book value of total assets.

19. The adjustment for size is based on the possibility that size and corporateefficiency are related (Lichtenberg, 1992). Firms with heavy investments in research anddevelopment (R&D) will have larger q values if the R&D is not capitalised. Differencesin R&D between diversified and non-diversified firms would therefore lead todifferences in q values, irrespective of the relative merits of diversification. Finally lackof access to capital markets by specialised firms may reduce the investmentopportunities for these firms and maintain an artificially high q value.

20. Defined as earnings before interest and taxes.21. Q ratios are calculated using the algorithm developed in Lindenberg and Ross

(1981) and Hall et al. (1988).22. Although in Table III of his paper the median discount, adjusted by the weighted

average of all industries, was reported to be significant.23. Refer also to Lang and Stultz (1994).24. It is possible that differences in the accounting treatment of Research and

Development expenditure may produce some bias in the calculation of valuationratios.

25. Earlier studies have also identified the presence of Research and Developmentexpertise as one aspect of non-specific resources that may be used efficiently indiversified expansion (Montgomery, 1994).

26. A similar result is also observed when asset multipliers were applied.

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INTERNATIONAL MERGERS ANDACQUISITIONS: PAST, PRESENT ANDFUTURE

Pervez N. Ghauri and Peter J. Buckley

INTRODUCTION

Mergers and acquisitions (M&As) have played a dominant role in the worldeconomy for the past ten years. In 1998, mergers were worth US$2.4 trillionworldwide, a 50% increase on 1997, which was itself a record year. In 1999,this figure exceeded US$3.3 trillion and in 2000 US$3.5 trillion. In Europe, amajor M&A activity area, the value of M&As rose to $1.2 trillion in 2002. Thepace of M&A activity has slowed down in the last two years, mainly becauseno mega mergers, over $50 billion, were announced in these years.

We define a merger as combination of assets of two previously separate firmsinto a single new legal entity. In a takeover or acquisition, the control of assetsis transferred from one company to another. In a complete takeover, all theassets of the acquired company are absorbed by the acquirer; and the takeover“victim” disappears. In fact, the number of mergers in ‘mergers andacquisitions’ is almost vanishingly small. Less than 3% of cross border M&Asby number are mergers (UNCTAD, 2000, p. 99). Full or outright acquisitions(100% control) accounted for more than half of all cross border M&As in 1999,although the proportion was lower in developing countries, largely because oflegislation. In reality, even when mergers are supposedly between equalpartners, most result in one partner dominating the other. The number of “real”mergers is so insignificant, that for practical purposes “M&As” should besimply referred to as “acquisitions” (UNCTAD, 2000, p. 99).


207

Friendly M&As can be distinguished from hostile ones. In a friendly M&A,the Board of the target firm agrees to the transaction (this may be after a periodof opposition to it). Hostile M&As, on the contrary, are undertaken against thewishes of the target firm’s owners. The price premium tends to be higher inhostile than in friendly M&As even in situations where only one bidder isinvolved. The overwhelming proportion of both international and domesticM&As are friendly. In 1999, there were only 30 hostile takeovers out of 17,000M&As between domestic firms. Hostile cross-border completed M&Asaccounted for less than 5% of total value and less than 0.2% of the total numberof M&As during the 1990s (UNCTAD, 2000, p. 105; Thomson FinancialSecurities Data Company). There are of course some high profile battles whichattract attention to hostile M&As. M&As are conventionally grouped into threecategories (Buckley & Ghauri, 2002):

• Horizontal – between competing firms in the same industry.• Vertical – between firms in buyer-seller, client-supplier and value chain

linkages.• Conglomerate – between companies in unrelated businesses.

Acquisitions differ according to the size of the acquired assets relative to theacquiring firm. In situations where the acquirer can leverage its assets to buy afirm which is as big or bigger than itself, the problems posed are quite differentfrom ‘bolt-on’ deals where the new assets can be integrated with an existingpart of the buying firm.

A firm that takes over another firm makes two assumptions. The first is thatthe acquiring firm can extract more value from the same assets than can thecurrent owners. This is a strong statement of comparative management ability.The second assumption is that not only the acquiring firm can extract morevalue from the same assets than the present owners, but also that the valueextracted will be more than the market price paid for the assets. In order words,an acquiring firm is saying “our valuation of the assets is superior to the currentvaluation”. The fact that this assumption is often erroneous is the core reasonwhy many acquisitions fail as profit enhancing tools – if the market price fullyreflects the future profit stream of the acquired assets, then there is no scope forprofit from the acquisition. However, opportunities for profit arise in situationswhere assets do not have a market price, as is the case with private firms ordivisions of multi-unit companies. Here, ‘guesstimates’ of the market pricehave to be made, which provides scope for some firms to be more skilled thanothers in this estimation (Buckley & Ghauri, 2002).

208 PERVEZ N. GHAURI AND PETER J. BUCKLEY

The uncertainty in the valuation of future income streams is an importantissue in takeovers. Superior competitive performance may well be unique to thefirm, viewed as a team, which is not obtainable by others except by thepurchase of the whole firm (Alchian & Demsetz, 1972). The firm may have areputation or goodwill that is difficult to separate from the firm itself. Possiblymembers of the employee team derive their productivity from the knowledgethey possess about each other in the particular environment of that unique firm.This gives rise to concern about “knowledge management” within firms.Knowledge may be difficult to transfer piecemeal to other firms by M&A or byany other means. The complexity of the modern firm defies easy analysis; sothe inputs responsible for (long term) success may be difficult to identify andmay be overvalued or undervalued for some time. The success of firms will bereflected in higher returns and stock prices, not higher input process. This iscompounded by the fact that inputs are acquired at historic cost, but the usemade of these inputs yields only uncertain outcomes. The acquisition cost ofthese inputs may fail to reflect their value to the firm at some future date. Bythe time their value is recognised, they are beyond acquisition by other firmsat the same historic cost, and meanwhile the shareholders of this lucky firmhave enjoyed higher profits. When such input acquisition decisions are made,they can give rise to high accounting returns for several years (Demsetz,1973, p. 1).

By the same token, once assets are embodied into a firm, their value becomesdifficult to separate from the other assets which comprise the firm. Takeoversoften involve the search for undervalued assets packaged into an existing firm.In a takeover, the potential acquirer is seeking some otherwise unavailableassets. Key examples of such assets are brand names, distribution networks,R&D facilities, management team skills, a loyal customer base, or specificknowledge. Often, the only way to acquire such assets is to purchase the wholefirm. On the positive side for the acquiring firm, all the other assets of theacquired firm which are not required can be sold off. This gives rise tothe phrase “asset stripping”. On the negative side, the remaining assets may notprovide the value which the purchaser envisaged. This may be due to a simplemisvaluation of the assets or it may result from the inability of the acquirer torelease the synergy between the new assets and the firm’s existing ones.

The purpose of this paper is to review the field of Mergers and Acquisitionsand to analyse the present boom in order to provide guidance and evidence formanagers engaged in M&A activities. The purpose is also to bring forwardunderpinning theoretical and societal implications of M&As, thus stimulatingfurther research in the field.

209International Mergers and Acquisitions: Past, Present and Future

MERGER WAVES

M&A activity has experienced growth and downfall in different time periodsover the last century, giving rise to the notion of ‘merger waves’. Table 1 showssuccessive waves of merger activity in the U.S. industry and features five suchwaves – the latest running from 1997 until 2000 and continuing into 2001(Buckley & Ghauri, 2002, p. 4).

The chief reason why M&As occur is “that control of corporations is avaluable asset; that this asset exists independently of any interest in eithereconomies of scale or monopoly profits; that an active market for corporatecontrol exists; and that a great many mergers are probably the result of thesuccessful workings of this special market” (Manne, 1965, p. 112). Thus,management teams compete for the right to control corporations, and operatingefficiency is ensured by a natural selection mechanism in which the threat andact of a takeover by raiders ensures the survival of the fittest managementteams. The key mechanism works as follows: Inefficiency or abuse ofmanagerial discretion by present managers leads to weak share prices. Potentialraiders see the opportunity to alter policies and make capital gains as shareprices respond to their improved management of the victim’s assets, and try totake over the company. Several conditions are necessary for this stock marketselection process to work (Hughes, 1993):

(1) Share prices should reflect the relative expected profitability of firms.(2) Raiders should be able to distinguish managerial shirking from poor

performance arising from external circumstances.(3) Raiders should be motivated by the desire to remove policies that do not

maximize shareholder value.

Table 1. Merger Waves in U.S. Industry.

Merger WaveApproximate Dates

Current$ AmountBillion

Constant (2000)$ AmountBillion

Number ofDeals*

1. 1898–1902 6.9 136 30122. 1926–1939 7.3 69.3 48283. 1966–1969 46 236 Na4. 1983–1986 618 Na 96175. 1997–2000 4,500 4,500 31,152

* Involving U.S. companies.Source: Buckley and Ghauri (2002), p. 4


(4) Raiders should be able to obtain a sufficient payoff to make their activitiesworthwhile.

If (1) does not hold, scope for changes in corporate control occurs because ofdifferences of opinion about the accuracy of stock market valuations betweenseller and raiders, rather than (potential) changes in managerial objectives orcorporate efficiency. Failures to generate acceptable returns in the market forcorporate control are also caused by transaction costs and because acquiringcompanies cannot capture all the benefits of the raid. Acquisitions andtakeovers incur large transaction costs (legal, advisory, and information costs).Defensive tactics on the victims’ part aim to increase these costs. They include:“shark repellents;” constitutional or voting arrangements to protect incum-bents; “golden parachutes” to raise the costs of firing incumbent managers;counterbidding; seeking a “white knight” to contests an unwanted bid; orraiding a third party.

It has been suggested (Grossman & Hart, 1980) that the incentive structuresin bids may lead to too few M&As for them to serve as a disciplining force forinefficient managers. There can be an incentive for individual shareholders to“free ride” on post-merger gains rather than to sell out. In this case, the privatereturn to the raider is less than the overall return which is split between theraider and the free riders. However, the presence of huge “merger waves”suggests that free riding may not be a major problem. Alternatively, partial bids(e.g. 51% acquisitions) may be undesirable given that while incurringtransaction costs they may merely redistribute wealth between the raiders andthe “oppressed” minority shareholders. Smaller companies with substantialowner control may be overvalued by the owners, making the costs ofdisciplinary M&A action prohibitive.

MOTIVES FOR M&As

There are several motives for choosing M&A as a strategy. The most important,as seen from the experience of the last decade, has been economies of scale andscope. Companies aim to achieve economies of scale by merging the resourcesof two companies, or create economies of scope by acquiring a companyallowing product/market diversification. Daimler’s merger (acquisition) withChrysler and AOL’s merger with Time Warner are good examples. Othermotives include accessing each other’s technology or market reach, achievinga dominant position in the industry, and consolidation of the industry. Overall,value creation for either company, or at least for the acquiring company, is theunderlying reason. This value is created through either cost cutting or through


increased scope. However, not all the possible motives can be consideredrational from the business perspective. Fashion, too often, has led managers topursue a strategy of M&A. As a consequence, M&A strategy has become anend in itself or a means of empire-building.

Another motive for M&A is differences in asset valuation between differentnational markets. In examining cross-border mergers, Gonzalez et al. (1998)suggest that assets at a national level are systematically undervalued.Imperfections that cause friction in the product and service markets lead toasset undervaluation. This leads to acquisitions being the most cost-effectivestrategy for penetrating certain national markets.

The idea that knowledge acquisition is frequently the motive of corporateacquisitions has been pointed out by many studies (Buckley & Ghauri, 2002).Knowledge is a key focus because often it cannot be acquired in efficient factormarkets as it is bundled with other assets and because of asymmetricinformation. The range of buyer responses to the possibility of overbiddingincludes the following: lower bid premia, contingent buy-outs, and lengthynegotiations designed to elicit tacit information. Where the firms draw onunrelated forms of expertise, these strategies are not used, leading to theconclusion that either lower post-merger integration is envisaged or thatunrelated buyers are simply unaware of extra information needs.

Seth et al. (2000) suggest three motives for the foreign acquisitions of U.S.firms – synergy, managerialism, and hubris. The synergy hypothesis proposesthat M&As take place when the value of the combined firm is greater than thesum of the values of the individual firms. The managerialism hypothesissuggests that managers embark on an acquisition to maximise their ownutilities at the expense of the firm’s shareholders. The hubris hypothesissuggests that bidding firm managers make mistakes in evaluating the targetfirm, but undertake the acquisition presuming that their valuations are correct.There is something of a conflation of these motives with outcomes in theempirical testing where positive and negative gains are attributed to acquirersand targets, and total gains and losses are distributed among motives on asomewhat arbitrary basis.

In addition to all the possible motives listed in the previous section, M&Asmay be the result of empire-building behaviour by managers. Growthmaximizing implies that some management teams have a lower discount ratethan the market as a whole. Such teams are then faced with a wealth of“undervalued” takeover opportunities. In the international arena, the explana-tion of takeovers can have a two-fold aspect. If we use the simple formula forcapitalising a future income stream:


C =1

r

where “C” is the value of a capital asset, “I” is the stream of income itproduces, and “r” is the rate of return on investment, then a foreign firm cansuccessfully buy out a domestic one if either “I” is higher or “r” is lower (orboth). International business theory suggests that “I” will be higher where theforeign firm can raise the income stream by infusing the victim with bettermanagement, technology, organisational skills, or superior marketing (Kindle-berger, 1969; Buckley & Ghauri, 1999). Alternatively, the capital market mayapply a lower discount rate to the asset when it comes under foreign ownership,perhaps in the belief that higher returns will result. Thus, Aliber (1970, 1971)suggests that a foreign asset owned by a U.S. firm will be evaluated by thecapital market as if it were a dollar asset. Differences in capitalisation ratios setby the market on the basis of ownership may provide a rationale for foreigntakeovers even if no increase in earnings occurs.

Morck et al. (1988) align the categories of hostile and friendly takeoverswith disciplinary and synergistic motives. “Disciplinary takeovers” are aimedat correcting non-value-maximising practices of the managers of target firms.Here, the actual integration of the acquirer and the target firm is not essential.A takeover is the best way to change control and therefore strategy.“Synergistic takeovers” are motivated by the possibility of benefits ofcombining the businesses of the two firms. Morck et al strongly suggest thathostile and friendly takeovers should not be lumped together in an analysis ofM&As, but that they should be separated and inferences about one type shouldnot be drawn on takeovers undertaken for the other motive. The empirical worksamples from the Fortune 500 in 1980 and examines takeovers between 1981and 1985. They found that firms which were the target for hostile take-over bidscompared to the universe of firms, were smaller, older, more slowly growing,and had lower Tobin’s q, more debt, and less investment of their income. Theywere less likely to be run by the founding family and had lower officerownership than the average firm. Compared to the universe of Fortune 500firms, friendly targets were smaller and younger but had comparable Tobin’s qvalues and growth rates. The friendly targets were more likely to be run by amember of the founding family and had higher officer ownership than theaverage firm. The decision of a CEO to retire with a large stake in the firm orwith a relationship to the founder often precipitated a friendly takeover – highofficer ownership was the most important attribute predicting friendlyacquisitions.


ARE M&As THE RIGHT CHOICE?

Kogut (1991) examines joint ventures (JVs) as an option to acquire. He seeksto explain JVs as “real options” to expand in response to future technologicaland market developments. In this sense, the exercise of the option is the moveto acquisition. JVs thus reduce the risks associated with uncertainty in entryinto a new (national) market or technology. Investment in acquisition thenbecomes a second stage choice made after the firm acquires additionalinformation from its initial venture. Such a strategy is useful in times of greatvolatility (Buckley & Casson, 1998), but entrant firms should be aware of therisk of being locked into a joint venture where it is captured by the localpartner.

Brouthers and Brouthers (2000) examine the impact of institutional cultural,and transaction cost factors on the “buy or build” (acquire or establish newfacilities) choice. As joint ventures and wholly owned subsidiaries areownership choices, the “buy or build” decision can be related to the entry modechoice of acquiring existing assets vs. establishing new facilities or a“greenfield” site. Greenfield entry is more likely to take place in high-techindustries where the entrant firm has strong intangible competitive advan-tages.

The option perspective is widely recognised as a means of understanding thedynamics of JVs as the partners have the option to acquire, divest, and expandtheir stake. However, as Chi (2000) points out, the nature of the option, itsvalue to the “buyer” and the “seller” varies markedly with its structure. “Eventhe most commonly recognised option in a JV – the option to acquire thepartner’s stake – tends to have some unique structural attributes” (Chi, 2000,p. 665). A typical JV contract, as Kogut (1991) points out, does not give eitherpartner the right to acquire or divest the venture at an ex ante specified price.Thus, the partners have to negotiate a price ex post making the options exerciseprice indeterminate ex ante. Partners have good reasons for believing that newinformation will arrive during the operation of the JV, which can result in oneof them moving to a full acquisition.

Hennart and Reddy (1997, p. 1) examine the choice between “two alternativemethods of pooling similar and complementary assets: the merger/acquisitionand the greenfield equity joint ventures”. This conflates the ownership choice(wholly owned versus joint venture) with the entry choice (takeovers versusgreenfield entry). In fact, there are technically four potential choices of entrymode viz:

(1) Greenfield/Wholly Owned;


(2) Greenfield/Joint Venture;(3) Takeover/Wholly Owned; and(4) a partial takeover, Takeover/Joint Venture.

Hennart and Reddy compare (3) with (2) leaving out wholly owned greenfieldentry and partial acquisitions presumably because they are not methods of“pooling similar and complementary assets”. Hennart and Reddy contrast “twocompeting theories of why joint ventures exist” (p. 1): asymmetric informationin the pre-merger situation versus “indigestibility” which refers to the (post-merger) problems of acquiring indivisible resources. In a commentary, Reuerand Koza (2000) point out that these views are complementary andoverlapping.

Kogut and Singh (1988) examine the effect of national culture on choice ofentry mode after accounting for firm and industry level variables. They classifyentries into “greenfield” (equals wholly owned greenfield ventures), “jointventures” (greenfield shared ownership), and “takeovers” (purchase of stock inan already existing company in an amount sufficient to confer control). Theyclaim that all acquisitions in their sample conferred a controlling equity shareso the partial takeover (takeover/joint venture) category conveniently dis-appeared. After allowing for the impact of firm and industry variables, theyfound that cultural distance was significant in influencing the entry modechoice into the U.S. They used a conflation of Hofstede’s (Hofstede, 1980) fourcultural dimensions (power distance, uncertainty avoidance, masculinity/femininity, and individualism) as a measure of cultural distance. It should benoted that this measure is open to great objections even if the separaterelevance of the four dimensions to the decision is accepted.

Baumann (1975) sets out a theory of (international) mergers. He examines“monopoly power, economies of scale, synergistic effects” and “non-profitmaximising behaviour, differences in attitudes towards risk” and economicdisturbance theory as alternative explanations for mergers, and applies propertyrights theory to foreign direct investment. The theoretical base, following anearly version of internalisation theory (McManus, 1972, following Coase,1937, see also Buckley & Casson, 1976) is tested on U.S. FDI in Canada. Boththe improvement in the profit stream and the lower discount rate for assetsdenominated in stronger currencies are included as explanatory variables as areimprovements due to superior management post takeover. Although Baumann’smodel is unable to distinguish between M&As and greenfield FDI, he is ableto show the close relationship between the determinants of M&As and ofFDI.


EVALUATION AND TACTICS

Mergers and Acquisitions face two rather distinct groups of issues andproblems: the motives and valuation at pre-merger stage and then integrationand performance evaluation at post-merger stage. This section discusses thequestions of valuation that arise in the pre-merger stage, post-mergerintegration and performance evaluation.

Valuation has been and is one of the most difficult problems in M&As.Keenan (1980) examines a situation in which real economic adjustments evolvefrom the mergers and focuses on the valuation problems related to synergisticbenefits arising from M&A. He claims that capital budgeting theory is notdeveloped enough to handle such “multi-period” problems where risk levels areshifting and where project-tied financing consideration exists. Moreover, thetheory is rather generalised at the firm level, considering equations for demand,supply, and budget constraints in the economy. The valuation of M&Asbecomes particularly complex because the real economic markets for labourand capital are not strongly efficient. Most of the research on M&As since the1960s focused on two questions: (1) Are there any real benefits to conglomeratetype mergers? and (2) What are the portfolio implications of a merger betweentwo firms? According to this research, statistically there are few valuationbenefits, and many M&As are in fact detrimental to profit maximising goals.While the stockholders of acquired firm may reap some benefits, thestockholders of the acquiring firm do not.

Keenan (1980) also demonstrates the complexities of valuation in ahypothetical case where a firm (A) wants to take over a firm (B) and becomesa new firm (C). He claims that a merger between two firms with differentconstant growth rates yields a firm that does not have a constant growth rate.This leads to the question of whether mergers generate any real benefits.Kennan (1980) also builds up a scenario with acquisition of labour-intensivefirms and demonstrates how the value of the acquired firm may, in fact,decrease. This suggests that there may be serious problems in the expected-value determination, negotiated-price determination, and accounting standardsapplied to the acquisition of a service firm where the value of the labourproduct is greater than the wage rate paid.

Singh and Montgomery (1987) find that acquired firms in relatedacquisitions have higher returns than acquired firms in unrelated acquisitions.For acquiring firms, abnormal returns directly attributable to the acquisitiontransaction are not significant. However, announcement effects are less easilydetectable for the acquirers rather than targets because the acquisition affectsonly part of the acquiring firm but the whole of the target firm. In addition, as


the acquisition is an event in a series of an implicit diversification programme,its effect as a unique market signal is mitigated. Expected gains for acquiringfirms are thus often competed away in the bidding process, while stockholdersof the target firm obtain high proportions of the gains.

M&A literature cites culture as one of the dominating factors that influenceperformance. Buono et al. (1985) studied a merger between two banks from theperspective of organisational culture. Data on organisational culture is collectedand analysed through pre- and post-merger interviews. The interesting point isthat the study shows that culture is an important issue even when the firmscome from the same country and same industry. The study thus enhances ourunderstanding of culture and its consequences on the merger process. It alsoclarifies and helps us understand how a new culture emerges in a newly formedorganisation. It looks at objective and subjective organisational culture andsuggests that although both aspects of culture are important, subjective cultureprovides more distinctive interpretations of similarities and differences amongpeople in different groups, as it is particularly unique to an organisation.Another issue discussed is the organisational climate. These are the issues thatinfluence behaviour, satisfaction, expectations of organisational members andthereby success or failure of a merger.

Bresman et al. (1999) focus on the factors facilitating the post-acquisitiontransfer of knowledge over time. They find that the transfer of technologicalknow-how is facilitated by communication, visits, and meetings and increasesas time goes by. The transfer of patents is associated with the articulability ofthe knowledge, the size of the acquired unit, and the recency of the acquisition.High quality reciprocal knowledge transfer takes time to develop but itgradually replaces the one-way transfer of knowledge from acquirer toacquired. This parallels the increasing transfer of tacit knowledge which ismore time consuming to transfer than knowledge which is more articulated.The human relations processes across the merged unit develop in similarfashion (Buono & Bowditch, 1989).

Calori et al. (1994) examine the influence on national culture on the choiceof integration mechanisms used by French and U.S. entrants into Britain andBritish and U.S. acquirers in France. They find that firms are influenced by theirnational administrative heritage when they acquire foreign firms. In the U.K.comparison, the French acquiring firms relied more on formal control ofstrategy and of operations than U.S. firms. The American acquiring firms reliedmore on informal communication and cooperation (teamwork) than the French.In examining the acquisition of French firms, it was found that the U.S.acquiring firms relied more on formal control by procedures than the British,and American managers became more personally involved, suggesting a


“hands off” attitude from the managers of British acquiring firms. In terms ofimpact on post-merger performance, the article is suggestive. It points out thatthe health of the acquired firm prior to the merger is negatively correlated toimprovements in attitudinal performance, and both informal communicationand cooperation (teamwork) and informal personal efforts from the managersof the buying firms are positively correlated with improvements in attitudinalperformance. This confirms the view that socialisation is a key factor inreducing post-merger conflicts and demotivation (Haspeslagh & Jemison,1991). Two other variables are significant in economic performance of theacquired firms – time elapsed since acquisition and the level of sharedresources and transfers. Thus the implementation of synergies between themerging firms contributes to economic performance but there seems to be adelay before the economic performance becomes evident. Two measures ofcontrol mechanisms are also correlated with economic performance. Informalpersonal effects of the buying firm’s managers positively affect performance,and the level of control of operations exercised by the buying firm is negativelycorrelated with performance.

Chatterjee et al. (1992) deal with the compatibility of the merging firms andits relationship to shareholder gains and relatedness. They surveyed theperceptions of top management teams in 168 M&As. Based on the responsefrom 73 firms, their findings show an intense relationship between the acquiredmanagers’ perceptions of cultural difference and shareholder value. Theirresults support the hypothesis that changes in shareholder value of acquiringfirms are directly related to the degree to which buyer’s top management teamtolerates multiculturalism. Their findings also show that a lower culturaltolerance will influence shareholder value negatively. This study providessystematic evidence linking equity and human capital in M&As.

Morosini et al. (1998) examine cross-border acquisition activity in Italy.They measure post acquisition performance using the percentage rate of growthof sales over the two-year period following the acquisition. This is clearly a lesssatisfying measure of performance than stock market pricing or profitability.The results of the study are quite surprising. The authors found that nationalcultural distance enhances cross-border acquisition performance. They explainthis result by the argument that cross-border acquisition in more culturallydistant countries might provide a mechanism for multinational companies toaccess diverse routines and repertoires which have the potential to enhance thecombined firm’s performance over time. Post-acquisition strategies are alsoadduced to enhance this result.

Deepak Datta (1991) studies the relationship between organisational andacquisition performance. Using a sample of 173 U.S. acquisitions he evaluates


post-merger performance of the firms involved in acquisition. This studydemonstrates that differences in top management styles of two firms have anegative impact on post-merger performance as well as integration. He alsoexamines difference in reward and evaluation systems and suggests that thesedifferences do not have the same kind of negative impact on performance asdifferences in management styles. A possible reason is that differences inreward and evaluation systems are more easily and quickly reconciledfollowing an acquisition than are differences in management styles. Althoughthe study only takes two aspects of organisational fit into account and there aresome flaws in data collection, it brings forward important issues in post-acquisition integration of firms.

Villinger (1996) deals with post-acquisition learning by Western firms inHungary, Czech Republic, Slovakia, and Poland. By focusing on thesecountries, he covers the most important market area for M&A activity inCentral and Eastern Europe. He points out that in these countries, cross-bordermanagement skills seem to be more important than general business skills forpost-acquisition management efforts. The knowledge of acquired partner’slanguage and sensitivity about cultural issues are crucial. He claims thatlearning is the central aspect rather than integration, at least in the earlierphases of the post-acquisition stage, as it is more important to transform theEast European target than to integrate it in its Western parent. It then proposesthree levels of learning based on Senge (1968) and Child et al. (1992) as“single-loop learning,” “double-loop learning,” and “deuterolearning.” Thesedifferent levels pose different problems for learners and learning entity but inthe Eastern Europe context and for a successful transition, this framework isconsidered to be the most “elegant.” Empirically examining 35 cases, Villinger(1996) concludes that general business competence dominates cross-borderskills, which creates post-acquisition problems. A lack of communication andunderstanding is generally blamed for insufficient learning. Language andcultural awareness is thus considered the most important issue for post-acquisition integration in Eastern Europe.

THE IMPACT OF M&As ON COMPANY STRATEGIES

Many problems can arise in the assessment of the impact of M&As onefficiency and economic performance. In terms of the stock market selectionprocess, the choice of the control group is critical. Control groups are classifiedinto acquirers, acquired, and neither acquiring nor acquired. Some firms maybelong to both the first two categories. Characteristics of firms may affect therelevant comparisons – the size of firms, industry, and time may affect


the choice of the most appropriate control group. M&A performance, too, canbe measured in various ways – profitability, growth, changes in profitability,and market value are possible measures. The impact on technical change mayalso be relevant in certain contexts; and again, it is important to choose theappropriate counterfactual.

Total gains in cross-border acquisition are estimated to be 7.6% of the pre-acquisition value of the combined firm (Seth et al., 2000). This is similar to theestimate of total gains for domestic acquisitions (Bradley, Desai & Kim, 1988)but larger than that reported by Eun et al. (1996). Seth et al. find that positivetotal gains occur in 74% of the acquisitions in their sample, similar to theproportions reported by Berkovitch and Narayanan (1993) at 76% and Bradley,Desai and Kim 75%. However, Seth et al. find that targets realise the majorityof the gains, whilst acquirers appear to neither gain or lose on average.Successful acquirers in single bidder acquisitions retain around 40% of the totalgains on average, whilst acquirers in multiple bidder transactions make smalllosses.

Researchers find that only about one-third of recent M&As have positiveeffects on the shareholder value for the buying firm (Schenk, 2000).Performance results, reported by earlier research, are quite mixed (Cowling etal., 1980; Magenheim & Mueller, 1988; Sirowar, 1997). Dickerson et al. (1997)show that company growth through acquisition yielded a lower rate of returnthan growth through internal investment. A survey of 22 accounting datastudies from nine countries showed that the average acquiring firm does notearn a significantly higher profit than the industry average (Bild, 1998). Earlierresults from Mandelker (1974) found that the market for acquisitions can beregarded as perfectly competitive, supporting the hypothesis that informationregarding mergers is efficiently incorporated into the stock price. Stockholdersof acquiring firms seem to earn normal returns from mergers as compared toother ventures of similar risks. Stockholders of acquired firms earned abnormalreturns of approximately 14% on average in the seven months preceding themerger. The fact that the market anticipates mergers, at least three months onaverage according to Franks et al. (1977), before announcement furthercomplicates the analysis. Aiello and Watkins (2000) suggest that leveragedbuyouts (LBO) are more successful than M&As in general. “Between 1984 and1994, some 80% of LBO firms exported that their fund investors had receiveda return that matched or exceeded their cost of capital, even though in manycases the prices paid for the companies those funds acquired were pushed upby competing bidders” (p. 101). This, they suggest, is due to the fact that seniormanagers at financial investors, like the most successful corporate acquirers,approach potential acquisitions with sensitivity and a well established process.


They contrast this approach with that of “most corporate managers” who try tobeat down prices and often delegate actual deal management to outside experts,investment bankers and lawyers.

Literature from the strategic management and international business fieldssuggests that M&As are not a uniform phenomenon (Lubatkin, 1983).Outcomes of M&As depend on the strategic fit between the firms and on thequality of pre- and post-merger management. In addition, market conditionsinfluence M&A outcomes. Halpern (1973) showed that since most mergersoccur in rising markets, this effect needs to be removed in estimating gains andpremia. Size of company is a factor too. If we accept that acquisitions are oftena search for a unique asset embedded in a company, then returns from that assetwill vary as the size of the unique element varies as a proportion of the totalcompany. Because quality of management, too, is a factor, uncertainty aboutwhen that management will be replaced will be reflected in the current stockprice. When the merger is announced, there is a positive total adjusted gainwhich reflects the markets’ re-evaluation of the company under its newmanagement. Bargaining strategies also will affect the distribution of gains.

THE IMPACT OF M&As ON SOCIETY

Siegfield and Sweeney (1981) discuss the most important characteristics ofM&A, namely, market concentration, firm size, product diversification, andgeographic dispersion, and discuss their impact on society. Based on empiricalevidence, they then assess other social consequences such as effect on workers,distribution of income, and on community welfare and explain reasons whyM&A might increase and/or decrease social goals. Finally, they stress the needfor more systematic research in this area that will assist policy makers inhandling these problems.

Franks and Mayer (1993) examine the relationship between capital marketsand corporate control. They compare the relationship in France, Germany, andthe U.K. and include buy-out and buy-ins by managers. They find thatregulation (company laws, competition policy, stock exchange rules, and labourlaws) explains much of the difference in control and ownership changes acrosscountries, even within an economic area such as the European Union (EU). TheEU’s Competition Commissioner heads a competition authority which iscurrently “seen by business as overburdened and unpredictable in its decisionmaking” (Hargreaves, Financial Times 18.9.2000, p. 16). The EU’s mergerregulation has a theoretically clear remit to prevent mergers which inhibitcompetition and allow others to proceed. In practice, European mergers stillneed clearance from several national competition authorities. The unit that


reviews mergers, the Merger Task Force, is under-resourced. The absence of asingle European regulatory organisation, let alone a global one, vastly increasesthe transaction costs of M&As. In practice, European authorities veto very fewmergers (of 1500 deals in the decade of the 1990 only 13 were vetoed and 12more withdrawn after it became clear that Commission would intervene overexcessive market power). The increase in number and complexity of deals isputting pressure on regulatory authorities – particularly those like the EUwhich wants to examine ever smaller sized M&As. In Europe in particular,labour organisations play a role in M&As. Given the high rate of failurebecause of the human factor, this is perhaps to be welcomed. The InternationalLabour Office (ILO) is currently calling for increased dialogue betweenmanagement and workers in the M&A process in an attempt to minimise thenegative effects.

The number of the significant regulatory authorities with which mergingcompanies have to comply in the world has mushroomed. Reports of the dealbetween Coca-Cola and Cadbury-Schweppes suggest that their lawyers soughtanti-trust approval in more than 40 jurisdictions around the world. In the failedeffort to merge, Alcan Aluminium of Canada, Pechiney of France and Algroupof Switzerland, lawyers from 35 firms filed for regulatory approval in 16jurisdictions and 8 languages. Pernod Ricard’s £2.1 billion purchase of 38.6%of Seagram’s drinks portfolio (with Diageo) has required filing for regulatoryapproval in 70 countries (Kemeny, Sunday Times 21.1.01, pp. 3/6). Simplifica-tion of competition laws and creating a consensus among regulators to makeantitrust laws coherent and predictable is the current extent of feasibility. Thereis little current prospect of a new international bureaucracy to oversee mergers.The United States has recently opposed a European proposal to give the WorldTrade Organisation (WTO) a central role in policing mergers. However,harmonisation is made urgent by the increased number of merger cases whichamounted to 26,000 filings between 1994 and 2000, with the U.S. Departmentof Justice and the Federal Trade Commission (FTC).

In case of regulations and antitrust laws, firms often jump into bed with eachother without even considering regulatory concerns. MCI and WorldCom, twoAmerican telecommunication firms were totally surprised by objections to their$37 billion marriage from European regulators (The Economist, Jan. 9, 1999).The liberalizations in FDI regimes has encouraged companies to expandthrough M&As. The international regulatory framework, bilateral investment,and double taxation agreements and the WTO have also supported these trends.In Europe, the EU has stimulated restructuring for national, regional, and cross-border M&As which has resulted in major changes in corporate ownership.One impact of all these changes is that there is an increased acceptance of


M&A all over the world, even though there are mixed opinions on the impactof M&A on industrial concentration. According to one opinion, cross-borderM&As can have a positive effect on competition if the foreign firm takes overailing domestic firms that would otherwise have been forced out of the market.They can also challenge established domestic firms to create effective rivals.

The opposing view is that “monopolizing M&As” can occur in the followingsituations (UNCTAD, 2000, p. 193):

(1) The acquiring firm was exporting substantially to a market before it buysa competing firm in it;

(2) A foreign firm with an affiliate already in the market acquires another,thereby acquiring a dominant or monopolistic market share;

(3) The foreign firm acquires a market leader with which it has previouslycompeted;

(4) The acquisition is intended to suppress rather than develop the competitivepotential of the acquired firm;

(5) A foreign firm with an affiliate in a host country acquires an enterprise ina third country that has been a source of import competition in the hostcountry market;

(6) Two foreign affiliates in a host country merge, although their parent firmsremain separate, eliminating competition between the two and leading to adominant market position.

Although we can accept that higher concentration by itself does not indicateanti-competitive conduct, the crucial issue is that it differs from market tomarket and from industry to industry. In the United States and the EuropeanUnion, only a small number of M&As are scrutinized to assess negativeimpacts on competition. An even a smaller number are asked to sell off partsof the business or are completely ruled out. In the United States, for example,only 1.6% of 4,679 M&As notified to antitrust authorities resulted inenforcement actions, with only about 1% being challenged in the end (U.S.Department of Justice, 2000). In the EU, the situation is not much different. In1999, only 14 out of 292 M&As (less than 5%) were challenged or subject toa second phase investigation, while an additional 19 cases were reported butcleared in the first phase of investigation. In Japan, all 3,813 M&As notified in1998 were cleared, only 2 transactions were revised during pre-notificationconsultation (ibid, p. 7). This means that the authorities do not believe M&A tobe against the public interest even if concentration does increase. This reallyneeds further research.


CONCLUSIONS

Mergers and acquisitions have become the most dramatic demonstration ofvision and strategy in the corporate world. With one single move you canchange the course of your company, the careers of your managers, and createvalue for your shareholders (Puranam et al., 2000). Time and again, we haveseen how share values increase or decrease due to the mergers announced andcompleted. Daimler-Chrysler, a $38 billion merger, is a good example wherethe share values dropped by almost 40% from the time of the announcement ofmerger, May 1998 to December 2000 (Bert & Trait, 2000). More than 50% ofthe mergers so far have led to a decrease in share value and another 25% haveshown no significant increase.

As well as the strategies of actual and potential acquiring firms, the defensivestrategies of potential victims also impact taxpayers, employees, managers, andworkers in other firms, consumers and the pace of technological change.M&As have a profound impact on social and political processes as well as thepurely business and economic ones.

The merger wave, which in the early 1990s was considered an Americantrend, became a worldwide trend and the latter part of the 1990s and the year2000 has shown increased M&A activity in other parts of the world. Europe ledin M&A activities in 2000. In 1999–2000, the total value of M&A reached $3.5trillion (from $0.4 billion in 1990). Out of this, the USA accounted for about$1 trillion and Asia for $144.6 billion, the rest came from Europe (TheEconomist, Jan. 27, 2001, p. 59). In spite of this popularity, more than 50% ofthe M&As are reporting post-merger problems. While in the past, firms havejustified these deals arguing for synergistic benefits, more and more M&A arereporting synergistic losses.

Only about one-third of M&As were found to have positive effects on theshareholder value for the buying firm in one study (Schenk, 2000).Performance results, reported by earlier research, are quite mixed (Magenheim& Mueller, 1998; Sirower, 1997). A survey of 22 accounting data studies fromnine countries showed that the average acquiring firm does not earn asignificantly higher profit than the industry average (Bild, 1998).

As for achieving efficiency gains, the most cited justifications for M&As, thescope for rationalization and improving company performance by achieving aninternational specialization of the value chain can be particularly high inM&As (UNCTAD, 2000). Moreover, size can have a large influence on R&Dand the expansion of distribution networks as well as adoption of newinformation and innovations.


More than 50% of the total M&A activity in the last few years have beenbetween cross-border firms, and a lot of these mergers and acquisitionsexperienced problems stemming from cultural and institutional countrydifferences. For example, in Upjohn-Pharmacia, a lot of time and energy wasspent on “American” versus “European” practices rather than on achievingsynergistic benefits. Daimler Chrysler was taken to court by its biggestshareholder for misleading information. The fact that cross-border M&As placehost country assets under the governance of TNCs and contribute to the growthof an international production system does not necessarily mean that it createssynergistic benefits. In addition, as a result of these cross-border mergers,concentration has increased in many industries such as: banking, pharmaceuti-cals, automobiles, telecommunication, insurance, and energy. After the Asiancrisis, cross-border M&As in the five main crisis-hit countries accounted formore than 60% of the total Asian M&As in 1998–1999. Since cross-borderM&As have become an important element in the expansion of the internationalproduction system, there is a need for a better understanding of what impactthey have on countries, especially the host country (UNCTAD, 2000).

A great omission in the literature on M&As and their performance is that toolittle attention is given to cultural clashes, while many mergers faced enormousproblems due to cultural differences. Bankers Trust and Deutsche Bank,Upjohn and Pharmacia, and Daimler Chrysler are good examples. As put byMr. Hubert of Daimler Chrysler, “We are absolutely happy with thedevelopment of the merger, we have a clear understanding: one company, onevision, one chairman, two cultures.” This is also due to the fact that in mostM&As more attention is given to the financial and legal aspects of the dealrather than to the integration of the companies involved. In many cases, themerged company ends up with two bosses, two accounting systems and neitherpartner really know what the other is doing (The Economist, Jan. 9, 1999).

The literature so far (see e.g. Cooper & Gregory, 2001; Buckley & Ghauri,2002) contains many fascinating insights from experienced M&A executives.M&As possess several important advantages: speed of entry and speed tomarket, the ability to acquire critical assets, platforms for future growth, andentry into new geographical markets. Speed of entry is felt to be particularlycritical in the internet age (UNCTAD, 2000). At the same time, disadvantagesare significant: asset values go down as well as up, cultural barriers ininternational acquisitions often mean that M&As do not replace internal growthand alliances. However, the failure of M&As is often very visible whereas start-ups and new venture failures often go unnoticed.

Industry differences are obviously important – it may be that where thepurpose of the M&A is to cut costs, these benefits are more obvious and


quantifiable than revenue enhancing strategies, where there may be more risk.R&D synergies are often to be the major reason for M&As, as inpharmaceuticals. Keeping the focus on the acquisition of products andtechnologies rather than companies may be important. Venture capitaloperations in biotechnology, for instance, are alternatives to M&As. Thisdiscussion and the views on the need to integrate internet start-ups stronglysuggest that M&A strategy should be part of an overall strategy, and notseparate from it.

Further research is needed to fully understand the impact of Mergers andAcquisitions on companies and societies. M&As can be approached from anumber of perspectives (Buckley & Ghauri, 2002):

(1) the market for corporate control;(2) transaction cost theory;(3) the resource based view of the firm;(4) the impact of national and organizational cultures;(5) processes: pre- and post-acquisition strategies;

There are a number of key constituencies whom M&As directly impact:

(1) the acquiring firm including managers, workers, and its shareholders;(2) the acquired firm including managers, workers, and its shareholders;(3) potential rival acquirers and non-acquired firms;(4) in international M&As, the host country and source country (competitive

environment) and welfare impacts.

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