Advances in Mergers and Acquisitions, Volume 4 (Advances in Mergers and Acquisitions) (Advances in Mergers and Acquisitions)

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ADVANCES IN MERGERS AND ACQUISITIONS

ADVANCES IN MERGERS AND ACQUISITIONS Series Editors: Cary L. Cooper and Sydney Finkelstein Recent Volumes: Volume 1: Edited by Cary L. Cooper and Alan Gregory Volume 2: Edited by Cary L. Cooper and Alan Gregory Volume 3: Edited by Cary L. Cooper and Sydney Finkelstein

ADVANCES IN MERGERS AND ACQUISITIONS VOLUME 4

ADVANCES IN MERGERS AND ACQUISITIONS EDITED BY

CARY L. COOPER Lancaster University Management School, Lancaster University, Lancaster, UK

SYDNEY FINKELSTEIN Tuck School of Business, Dartmouth College, USA

2005

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© 2005 Elsevier Ltd. All rights reserved. This work is protected under copyright by Elsevier Ltd, and the following terms and conditions apply to its use: Photocopying Single photocopies of single chapters may be made for personal use as allowed by national copyright laws. Permission of the Publisher and payment of a fee is required for all other photocopying, including multiple or systematic copying, copying for advertising or promotional purposes, resale, and all forms of document delivery. Special rates are available for educational institutions that wish to make photocopies for non-proﬁt educational classroom use. Permissions may be sought directly from Elsevier’s Rights Department in Oxford, UK; phone: (+44) 1865 843830, fax: (+44) 1865 853333, e-mail: [email protected]. Requests may also be completed on-line via the Elsevier homepage (http://www.elsevier.com/locate/permissions). In the USA, users may clear permissions and make payments through the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA; phone: (+1) (978) 7508400, fax: (+1) (978) 7504744, and in the UK through the Copyright Licensing Agency Rapid Clearance Service (CLARCS), 90 Tottenham Court Road, London W1P 0LP, UK; phone: (+44) 20 7631 5555; fax: (+44) 20 7631 5500. Other countries may have a local reprographic rights agency for payments. Derivative Works Tables of contents may be reproduced for internal circulation, but permission of the Publisher is required for external resale or distribution of such material. Permission of the Publisher is required for all other derivative works, including compilations and translations. Electronic Storage or Usage Permission of the Publisher is required to store or use electronically any material contained in this work, including any chapter or part of a chapter. Except as outlined above, no part of this work may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the Publisher. Address permissions requests to: Elsevier’s Rights Department, at the fax and e-mail addresses noted above. Notice No responsibility is assumed by the Publisher for any injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use or operation of any methods, products, instructions or ideas contained in the material herein. Because of rapid advances in the medical sciences, in particular, independent veriﬁcation of diagnoses and drug dosages should be made. First edition 2005 British Library Cataloguing in Publication Data A catalogue record is available from the British Library. ISBN: 0-7623-1172-X ISSN: 1479-361X (Series) ∞ The paper used in this publication meets the requirements of ANSI/NISO Z39.48-1992 (Permanence of Paper). Printed in The

Netherlands.

CONTENTS LIST OF CONTRIBUTORS

vii

INTRODUCTION Cary Cooper and Sydney Finkelstein

ix

A CORPORATE LEVEL PERSPECTIVE ON ACQUISITIONS AND INTEGRATION Abhirup Chakrabarti and Will Mitchell

1

A NEW WAY TO LOOK AT THE INTEGRATION CHALLENGE: THE RECONCILIATION OF COLLECTIVE REPRESENTATIONS Joanne M. Roch

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IMPACT OF CULTURAL DIFFERENCES ON MERGER AND ACQUISITION PERFORMANCE: A CRITICAL RESEARCH REVIEW AND AN INTEGRATIVE MODEL Günter K. Stahl and Andreas Voigt

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AN UPPER ECHELONS EXPLANATION OF ACQUISITION OUTCOMES Patricia Doyle Corner and Angelo J. Kinicki

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TOP MANAGEMENT TEAM TURNOVER IN MERGERS & ACQUISITIONS Jeffrey A. Krug and Ruth V. Aguilera

121

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ACQUISITION AS A MECHANISM OF MARKET EVOLUTION: AN EVOLUTIONARY PERSPECTIVE ON HOW ACQUISITION CREATES VALUE Annetta Fortune

151

M&A STRATEGIES IN MATURE AND DECLINING INDUSTRIES: THEORETICAL PERSPECTIVES AND IMPLICATIONS Jaideep Anand

163

IN THE MARKET FOR FIRMS, HOW SHOULD A FIRM BE SOLD? Ilgaz Arikan

181

LIST OF CONTRIBUTORS Ruth V. Aguilera

University of Illinois at Urbana-Champaign, USA

Jaideep Anand

Fisher College of Business, Ohio State University, USA

Ilgaz Arikan

Georgia State University, Robinson College of Business, USA

Abhirup Chakrabarti

Fuqua School of Business, Duke University, USA

Patricia Doyle Corner

Faculty of Business, Auckland University of Technology, New Zealand

Annetta Fortune

LeBow College of Business, Drexel University, USA

Angelo J. Kinicki

W.P. Carey School of Business, Arizona State University, USA

Jeffrey A. Krug

Appalachian State University, Walker School of Business, USA

Will Mitchell

Fuqua School of Business, Duke University, USA

Joanne M. Roch

University of Sherbrooke, Canada

G¨unter K. Stahl

INSEAD, France and Singapore

Andreas Voigt

University of Giessen, Germany

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INTRODUCTION

Although mergers and acquisitions have been a fundamental part of business for the last three decades, they have been increasingly used in recent times as a strategic tool for growth, dealing with excess resource capacity, enhancing the base and scale of operations for competitive advantage and the like. One area of increasing concern in M&A research, however, has been in the area of understanding the integration process and how this might lead to enhanced performance and to the “2 + 2 = 5” hoped-for effect of M&As. The ﬁrst ﬁve chapters in this volume explore post merger/acquisition issues and their impact on performance and corporate activity in general. Two of the last three chapters highlight how acquisitions can create value, while the last chapter explores the decision making processes that entrepreneurs use in considering whether to be acquired or to sell their business. Whilst much research has been carried out on post acquisition integration of individual business units between the organizations, little has been done at the corporate level on integration processes. Abhirup Chakrabarti and Will Mitchell argue that corporate level acquisition activities and post acquisition integration processes are even more important because they inﬂuence long term corporate performance, particularly in businesses which comprise interdependent business units that are geographically diffuse. They strongly argue for active corporate level integration. Joanne Roch follows this nicely with her work on the reconciliation of collective representations, which identiﬁes “the factors that contribute to creating synergies between companies undertaking an integration process.” She applies a sociological approach called the theory of conventions. She contends that organizations involved in M&As “share representation systems that help forge interaction rules” and that mobilizing these systems or conventions helps the integration process and collective action. She highlights this process in a case study of a Canadian chartered bank’s acquisition of two brokerage subsidiaries. G¨unter Stahl and Andreas Voigt follow on from Roch’s work by exploring the impact of cultural differences on M&A performance. Very little work has been done to understand why some studies show a negative impact and others a positive one. This chapter provides a theory to understand the complex nature of the relationship between cultural differences and M&A performance. ix

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Patricia Corner and Angelo Kinicki assess “upper echelons theory” to explain post acquisition ﬁnancial performance. They explore a latent variable model that suggests that the demographic diversity of the top management team can inﬂuence ﬁnancial outcomes by affecting their collective beliefs. They highlight three constructs and two fundamental structural properties of team beliefs to understand the dynamic of TMT diversity on acquisition outcomes. Jeffrey Krug and Ruth Aguilera review the literature on top management team effects in M&As. They explore two aspects of these effects; why incumbent top managers depart at higher rates than normal following an acquisition; and why high turnover rates have negative post-acquisition performance effects. This circular process of recruited top managers leaving early, thus adversely affecting performance, is important in terms of recruitment and retention of top managers and in post M&A integration and success. Annetta Fortune explores an evolutionary perspective on how acquisitions can create value. She discusses the role of adaptive and selective forces in the capacity of an acquisition to function as a mechanism of market evolution. She highlights this work with various corporate examples. Jaideep Anand highlights an important challenge for ﬁrms in mature or declining industries by using business opportunities through M&As for redeployment of excess resources to new applications. He considers both redeployment strategies that make up for resource deﬁciencies via acquisition, and consolidation strategies that seek to create a larger pool of resources. He explores the various strategies and their implications for future research and practice. Ilgaz Arikan examines an often unexplored area of acquisition research by focusing on decision making processes entrepreneurs rely on when considering the sale of their ﬁrms. He highlights ﬁve conditions; bargaining power, resource value, risk propensity, market thickness and search costs. He tests his theory of exit decision making of entrepreneurs and its implications for M&As. In sum, the present volume brings together a set of papers on mergers and acquisitions from a variety of theoretical perspectives that speak to the essential questions of M&A strategy and integration. There is now a growing body of work on these issues, and the papers presented here offer important contributions to this exciting research stream. Cary Cooper and Sydney Finkelstein Editors

A CORPORATE LEVEL PERSPECTIVE ON ACQUISITIONS AND INTEGRATION Abhirup Chakrabarti and Will Mitchell ABSTRACT Most research of post-acquisition integration examines integration of individual business units. The research pays less attention to corporate level integration processes, by which we mean the standardization of integration routines and synchronization of integration activities across a ﬁrm’s business units. We argue that corporate level acquisition activities and post-acquisition integration processes strongly inﬂuence long term corporate performance, particularly as a ﬁrm which comprises interdependent business units becomes geographically diffuse. Acquisitions tend to increase system diversity and goal diversity across business units. Some goal diversity is beneﬁcial, but excessive goal diversity and the existence of system diversity can reduce long run corporate performance by requiring greater managerial effort and increasing the opportunity cost of managerial efforts. The negative effects become stronger as a ﬁrm becomes geographically diffuse or if business units are interdependent. Firms that employ active corporate level integration processes – particularly ﬁrms that acquire frequently and have interdependent business units – can enhance the beneﬁts and eliminate some of the problems of diversity. Many studies have examined post-acquisition integration. Questions include how acquiring ﬁrms retain, redeploy, reconﬁgure, and divest resources (Capron, Advances in Mergers and Acquisitions Advances in Mergers and Acquisitions, Volume 4, 1–21 Copyright © 2005 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1479-361X/doi:10.1016/S1479-361X(04)04001-3

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Dussuage & Mitchell, 1998; Capron, Mitchell & Swaminathan, 2001; Finkelstein & Haleblian, 2002; Karim & Mitchell, 2000); the background organization and human processes that occur during post-acquisition integration (Fried, Tiegs, Naughton & Ashford, 1996; Greenwood, Hinings & Brown, 1994; Schweiger & DeNisi, 1991); how the nature and extent of prior acquisition experience affects focal acquisition management (Haleblian & Finkelstein, 1999; Zollo & Singh, 2004); the choice of the level of integration (Datta, 1991; Pablo, 1994); and the performance implications of implementing high or low integration (Zollo et al., 2004). Most of this research has focused on the acquiring business unit, without explicit attention to corporate processes for managing acquisition-based growth. As the number of acquisitions that a ﬁrm implements increases and the geographic span of its acquisitions grows, it accumulates an increasingly diverse set of product lines and business practices, making it increasingly important for the ﬁrm to look beyond the process of integrating individual acquisitions and implement formal corporate level integration techniques. By corporate level integration, we mean the standardization of integration routines and synchronization of integration activities across business units. Little research has considered how the interdependence between geographically dispersed business units affects the nature and performance impact of corporate level integration techniques. This article argues that corporate integration processes inﬂuence long term corporate performance, particularly as a ﬁrm comprising interdependent business units becomes geographically diffuse. We argue that acquisitions increase system and goal diversity across business units. Incompatible differences in ﬁnancial and management reporting structures are examples of system diversity, while intangible differences between employees and groups of employees that may lead to incompatible differences in objectives are examples of goal diversity. Although goal diversity creates potential beneﬁts by allowing a ﬁrm to experiment with different ways of operating, excessive diversity can reduce long run corporate performance by requiring greater managerial effort and by increasing the opportunity cost of relatively unproductive activities. The negative effects increase as a ﬁrm becomes more geographically diffuse, owing to difﬁculties in managing intangible differences at a distance, or if business units are interdependent, owing to the greater negative impact of existing differences on performance. Our approach suggests that corporate integration is a dual-edged sword for growing ﬁrms. Firms that employ formal integration techniques may enhance the beneﬁts and eliminate some of the problems that diversity and variety cause. At the same time, though, integration may also be costly to implement. Nonetheless, despite the implementation costs, when the corporation acquires frequently or when its acquiring business units are strategically interdependent through vertical or complementary relationships, then corporate level formal integration techniques can play a signiﬁcant role in enhancing long term corporate performance.

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We start with a review of the literature on post acquisition integration, before extending the arguments and incorporating corporate level concerns. Existing studies on post acquisition integration have made signiﬁcant progress in the formulation and impact of post acquisition integration, while raising intriguing open questions. In particular, formal research has largely tended to treat the integration of a focal acquisition as independent of a corporation’s other acquisitions, but ﬁrms that integrate acquisitions independently of each other will face organizational constraints that arise from internal diversity. We build on this argument and discuss how corporations change during the process of acquisitions, and how they may need to revise their post acquisition integration design over time.

POST ACQUISITION INTEGRATION RESEARCH This section deﬁnes post acquisition integration and discusses the arguments and ﬁndings of existing research. We then identify challenges and distinguish between acquisition level and corporate level concerns. Post acquisition integration is the interactive and gradual process of strategic and administrative combination of acquiring and target ﬁrms (Shanley & Correa, 1992), in which individuals from the two organizations learn to work together and cooperate in the transfer of strategic capabilities (Haspeslagh & Jemison, 1991). The process is multidimensional, including the integration of ﬁnancial, information, human resource, purchase, production, marketing and distribution systems, as well as planning and public relations policies (Yunker, 1983). During the integration process, managers have to mobilize each department to act together in a combined entity. Integration is the engine of organizational change and development in acquisition-based growth and plays a critical role in overall corporate renewal strategy. The process changes organizational structures, systems, cultures and functional activity arrangements (Pablo, 1994), not only at the point of the focal acquisition, but also throughout the corporation. It involves the post acquisition reconﬁguration (Karim et al., 2000), redeployment (Capron et al., 1998), and disposal (Capron et al., 2001) of tangible (physical assets) and intangible (routines) resources of the acquiring and target ﬁrms. Integration encompasses several forms of organizational structure: (a) the target may become a stand-alone after acquisition; (b) the acquirer and the target may blend into a new organization; and (c) the acquirer may assimilate the target. This classiﬁcation of different approaches to integration mirrors Haspelagh & Jemison’s (1991, p. 145) categorization, which they base on the need for strategic interdependence and the need for organizational autonomy. Sometimes, acquirers can avoid the problems associated with integration by keeping the acquired ﬁrm

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as an autonomously operating unit. It often is not feasible to follow this approach, however, and most acquirers expect that the beneﬁts from synergies are greater than the costs associated with integration. When acquirers expect target ﬁrms to contribute to long term growth, the most general prescription is that integration is an important determinant of corporate performance and even survival. Integration Involves Retention, Redeployment, Reconﬁguration, Disposal of Assets While the industrial organization literature emphasizes market power (Scherer & Ross, 1990) and cost savings (e.g. Dutz, 1989; Sirower, 1997) that may arise from acquisition strategies, the strategic management literature now commonly considers the acquisition process as a means to organizational change and development (Berry, 1975; Capron et al., 1998; Capron & Mitchell, 1999; Karim et al., 2000; Penrose, 1959; Rock & Rock, 1990; Seth, 1990). The change process requires business reconﬁguration, including redeployment and disposal of resources. Capron, Dussuage and Mitchell (1998) found that acquiring ﬁrms frequently redeploy – i.e. share and cross utilize – R&D, manufacturing and marketing resources between themselves and target ﬁrms. Acquirers redeploy managerial and ﬁnancial resources, although to a lesser extent. The redeployment of resources can help create more efﬁcient use of existing resources, as well as expand the scope of the ﬁrm’s activities (Karim et al., 2000). Disposal of resources – reﬂected in retrenchment and sale of businesses and organizational assets –provides an important part of post acquisition reconﬁguration (Capron et al., 2001). Overall, this body of literature demonstrates that acquiring ﬁrms have greater potential to change than do non-acquiring ﬁrms (Karim et al., 2000). Moreover, acquisition based organizational change is unique for each acquisition. The nature of change and development in acquiring ﬁrms depends on the unique circumstances of strategic objectives and similarity between businesses surrounding particular acquisitions. Human and Organizational Factors in Integration The human resources and organizational behavior literatures delve into the human, managerial, and organizational processes that occur in the background of the process of resource addition and reconﬁguration (e.g. Cannella & Hambrick, 1993). These literatures identify human and organizational sources of resistance to integration, and inform how managers can bring about anticipated post acquisition performance improvements. Indeed, human and organizational factors could have

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a greater impact on post acquisition performance than do external strategic factors (e.g. Chakrabarti, 1990). Acquiring ﬁrms that underestimate the importance of human factors in the integration phase often face severe impediments to smooth post acquisition operations (e.g. Fried et al., 1996; Greenwood et al., 1994; Schweiger et al., 1991). Research shows that acquisition announcements – especially in combination with poor handling of the communication – increase uncertainty, stress, and absenteeism, while reducing job satisfaction, commitment, the intent to remain in the new organization, and perceptions about organization’s trustworthiness (Schweiger et al., 1991). Post acquisition changes often involve a forced reduction in the work force and structural redesign in order to cut cost and reduce redundancy. The impact of such organizational change is particularly strong on employees who perceive that they lack control on the forces of change. Such employees are likely to feel a greater reduction in job control, experience feelings of helplessness, withdraw psychologically from the work they do, and generate an intention to leave the organization (Fried et al., 1996). Another impact of acquisition activity is that middle level managers sometimes centralize authority in order to strengthen or protect their own position (Pfeffer, 1981; Sutton & D’Aunno, 1989). This can, in turn, lead to greater role ambiguity (Oldham & Hackman, 1981) and demotivation among subordinates, who then reduce their participation in organizational processes (Guth & MacMillan, 1986). Cultural incompatibility has been widely cited as a source of insurmountable post acquisition problems (Altendorf, 1986; Buono & Bodwitch, 1989; Nahavandi & Malekzadeh, 1988; Olie, 1994; Sales & Mirvis, 1984; Walter, 1985). Researchers have built on the theory of acculturation (Berry, 1980) to examine changes in behavior that result from forced interaction of two organizational cultures (Janson, 1994; Nahavandi et al., 1988; Sales et al., 1984). Some empirical evidence indicates that greater cultural differences lead to greater integration problems and hence to lower post acquisition performance (Chatterjee, Lubatkin, Schweiger & Weber, 1992; Datta, 1991). On the other hand, the existence of a strong culture in the acquirer can also assist performance impact if it can be transferred effectively to the acquired ﬁrm (Roberts, 1994). The current consensus, though, is that cultural compatibility typically reduces acculturative stress and eases the integration process.

The Level of Integration and Its Impact on Performance One part of the research on the post acquisition integration process attempts to explain the level of post acquisition integration. Pablo (1994) distinguishes between

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three levels of integration. At a low level of integration, a limited degree of technical and administrative changes share ﬁnancial risk and resources, while standardizing basic management systems and processes to facilitate communication. A moderate level of integration involves increased alterations in the value chain, including selective modiﬁcations in reporting relationships, authority, structure, and cultural bases of decision-making. At the highest level, integration involves sharing all types of resources, along with generalized adoption of the acquirer’s operating, control and planning systems and procedures, combined with deep structural and cultural absorption of the target ﬁrm. The level of integration depends on the strategic (Howell, 1970; Pablo, 1994; Shrivastava, 1986), organizational (Datta, 1991; Jemison & Sitkin, 1986), cultural (Nahavandi et al., 1988) and political (Pablo, 1994) characteristics of acquisitions. Because unrelated acquisitions typically involve minimal sharing of resources and hence less post acquisition integration, relatedness in products and services between acquirers and targets often leads to a high level of integration (Shrivastava, 1986). Other work differentiates between strategic and organizational tasks. Strategic tasks involve the successful sharing of resources and capabilities that form the foundation for value creation, while organizational tasks involve the preservation of key resources and capabilities of the acquired ﬁrm (Pablo, 1994). Using an experimental approach, Pablo found that the level of integration positively associated with strategic tasks and negatively associated with organizational tasks, and that managers are often unable to balance these requirements. Pablo (1994) also found that organizations that have tolerance and even a preference for cultural diversity have a tendency to implement lower levels of integration. Post acquisition integration has been empirically related to post acquisition performance. Capron (1999) found that performance increases with post acquisition reconﬁguration in targets and acquirers. Zollo et al. (2004) found that higher levels of integration contributed to post acquisition performance.

INTEGRATION IN PRACTICE The challenges in the process of integration arise out of the multidimensionality and diversity of the task. Integration involves the synchronized efforts of personnel associated with the ﬁnance, human resources, marketing, and production areas (Haspeslagh et al., 1991; Johnson, 1985; Lajoux, 1998; Pritchett, 1985; Yunker, 1983). Integration of ﬁnancial systems involves modifying the targets’ corporate chart of accounts in accordance with the acquirer’s account control manual. Usually, the

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acquirer’s corporate chart of accounts has many more subdivisions and is more detailed and complex than that of the acquirer. Similarly, reporting forms and instructions are also likely to differ between the acquirer and target ﬁrms, with acquirers having a more detailed corporate schedule for reporting than what the target has had experience with. Firms may face signiﬁcant constraints in their attempt to integrate ﬁnancial systems because of potential miscommunication and over-expectations (Yunker, 1983). Many post acquisition problems arise from the direct or indirect mishandling of human resources (e.g. Fried et al., 1996). Mismanaging the process of blending in corporate cultures or comparing two sets of employee relations policies, job descriptions, performance evaluation structures, salary structures, beneﬁt plans, pension, medical insurance policies, and proﬁt sharing plans – many of which differ signiﬁcantly across ﬁrms – can lead to a clash of priorities, create ambiguities that cause resistance to change (Pritchett, 1985; Yunker, 1983), and therefore increase the probability of failure of the acquisition. Purchasing and marketing interfaces of acquirers and acquired ﬁrms also often must be integrated. Most commonly, different sub-units (e.g. business divisions) catering to different markets have their own purchasing and marketing activities. Therefore, if the acquired ﬁrm operates in a new business area, it is likely to retain its own purchase and marketing teams. However, if the acquired ﬁrm is merged into an existing business unit with existing purchase and marketing teams, or if related products are grouped together and marketed by a common sales force then the ﬁrm must integrate the resources of suppliers and sales representatives in order to avoid overlaps and subsequent confusion. The acquirer needs to review which industries and markets to operate in, and which goods and services to offer. In turn, the acquirer must also judge the effectiveness of its existing purchasing and marketing resources, before making unilateral decisions. The integration of production and technology also is challenging because of the specialized nature of knowledge involved (Yunker, 1983), and the difﬁculty to quantify the value of technology during the time of acquisition (Slowinski et al., 2002). Top managers tend to be specialists in narrowly deﬁned production process and techniques, rather than general experts who understand the technological evolution taking place in all the corporation’s businesses. In sum, post acquisition integration is a critical part of an acquisition-driven corporate renewal strategy and has the potential to signiﬁcantly alter postacquisition performance. Acquiring ﬁrms change themselves during the process of integration by retaining relevant resources, redeploying resources to and from targets, and disposing redundant resources. However, problems can arise from employee or group related issues, from cultural incompatibility, and from mishandling of the integration process.

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These arguments raise further research questions. Acquisition-based growth tends to make corporations increasingly complex if acquiring business units – which are also interdependent, either vertically or as producers of complementary goods and services – evolve independently of each other. This is more so if acquiring business units are geographically dispersed and if a corporation acquires frequently. Although the literature acknowledges the role of the post acquisition integration process, it falls short of explicitly providing a basis to judge how acquisition and integration activities support overall corporate level growth and performance enhancement. By developing a corporate level perspective of post acquisition integration, we attempt to complement the arguments and evidence in the existing literature. We elaborate on the role of corporate integration in the next section.

PROPOSITIONS: CORPORATE LEVEL ACQUISITION INTEGRATION In this section, we develop propositions linking acquisition activity to the objective of corporate renewal, growth and development. We argue that formal corporate level integration techniques reduce incompatible differences that tend to arise across the corporation’s business units, hence contributing to better post acquisition performance. We ﬁrst state the baseline assumptions and frame the problem. We then address a set of related issues: how acquirers change as they grow; how the increase in complexity and diversity across business units affects the corporation; how corporate level integration may mitigate such problems; and, ﬁnally, how spatial, structural and strategic factors moderate the impact of corporate level integration on long run corporate performance.

Assumptions In order to examine the impact of integration design on performance, we assume that managerial limitations form the primary constraint to post acquisition performance enhancement. We assume that corporations have ﬁnite managerial resources at any given point of time, and that managers have physical and cognitive limitations. These assumption reﬂect arguments extended in a body of literature that regards managerial resources as a key input but also the primary source of constraint to performance enhancing and sustainable ﬁrm growth (reﬂecting arguments in Gander, 1991; Penrose, 1959; Richardson, 1964; Slater, 1980).

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In combination, these studies imply that an inefﬁcient allocation of managerial resources can marginalize long run performance. For example, there is a trade off involved if managers spend greater than desired effort on future productive activities, because they will not be able to allocate as much time and effort on current productive activities. In the present context, the above assumption implies that any external or internal condition that leads to the expenditure of greater than expected, feasible, or available managerial resources on any current or future productive activity, could lead to tradeoffs and opportunity costs, requiring managers to shift attention from productive activities into relatively unproductive activities. This, in turn could reduce the post-acquisition performance of the corporation. We treat the ﬁrm’s decision to acquire as exogenous. Moreover, we do not judge the strategic value of these decisions. We also assume that all ﬁrms have an average level of managerial capability. For example, we do not account for the performance impact of excessive product diversiﬁcation. We also do not focus on external factors that can inﬂuence performance. A broader evaluation of post acquisition performance must consider the interaction between internal and external factors, but this is beyond the scope of the present discussion.

Acquisitions Increase System and Goal Diversity Across Business Units This section conceptualizes a net level of differentiation that exists between business units – from the time any business unit acquires to the time it ﬁnishes implementing post acquisition integration – in dimensions of external diversity (product diversity and geographic diffusion) and internal diversity (system diversity and goal diversity). We argue that these factors increase with acquisition activity, irrespective of the level of integration at the acquisition level. Figure 1 illustrates the basic model. Acquisitions lead to increasing external corporate diversity. External diversity includes two dimensions – product diversity and geographic diffusion. Product diversity refers to the number of related and unrelated business the ﬁrm operates in, while geographic diffusion refers to the geographic expanse of the ﬁrm’s business units. Product diversity may or may not be an explicit objective of acquirers, but most ﬁrms are likely to at least diversify into related areas by acquiring. At the very crux of the gains from expansion is the ability of the ﬁrm to utilize its existing underutilized productive resources (Penrose, 1959). However, the very act of expansion gives rise to new directions to expand, often leading ﬁrms to diversify. Acquirers are also likely to become increasingly geographically diffuse. Some studies have explicitly reported that acquisition based growth can lead a ﬁrm

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Fig. 1.

steadily away from its core region of operation (e.g. Chapman & Walker, 1987; Green & Cromley, 1984; Leigh & North, 1978; Watts, 1980). Proposition 1a. The greater the number of acquisitions a ﬁrm has implemented, the greater the product diversity and geographic diffusion across its business units. Acquisitions also lead to increasing internal diversity within the corporation. Internal diversity, which exists across business units, includes system diversity and goal diversity. System diversity refers to differences across business units in the corporate chart of instructions, corporate schedule of reporting, ﬁnancial systems, employee relations policies, job descriptions, performance evaluation structures, beneﬁt plans, pension plans, medical insurance policies, proﬁt sharing plans, and purchase and marketing setups. Goal diversity refers to intangible differences that exist in employees and groups of employees within the organization. As we noted earlier, the literature on acquisitions indicates that in the absence of any effort, acquiring business units of a corporation tend to evolve independently of each other, since the nature of renewal, reconﬁguration, redeployment and disposal of resources is peculiar to the particular strategic and managerial issues surrounding individual acquisitions. This independent evolution increases system and goal diversity across business units of the acquiring ﬁrm.

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Proposition 1b. The greater the number of acquisitions a ﬁrm has implemented, the greater the system and goal diversity across its business units. Moreover, geographic diffusion can further increase the system and goal diversity, because geographic expansion is likely to involve acquisitions in distant areas, which are likely to differ signiﬁcantly in the manner in which ﬁrms operate and interact with their economic environments. Proposition 1c. The greater the geographic diffusion of business acquisitions, the greater the system and goal diversity within the acquiring corporation. In sum, the tendency of acquiring business units to evolve independently of each other will increase with the number of acquisitions the ﬁrm has implemented. We capture this independent evolution in terms of system and goal diversity that exists across business units of the corporation as a consequence of its acquisition activities. Moreover, ﬁrms that implement geographically diffused acquisitions are likely to have higher levels of system and goal diversity across its business units.

Impact of System and Goal Diversity on Performance This section discusses how system and goal diversity affect the acquiring corporation’s performance. Prahalad and Bettis (1986) argue that the diversity of the ﬁrm arises not so much from the variety in technologies or markets, as from strategic variety among business units. Top management is constrained by an upper limit – by virtue of ﬁnite managerial resources and by limited cognitive ability (also see Duhaime & Schwenk, 1985) – to the capability of managing diversity relating to strategic variety. Managing strategic variety requires variety in the dominant logics that top management use, For such a “diversiﬁed” ﬁrm to perform well, it has to respond quickly and appropriately to competitors’ moves. Prahalad & Bettis (1986) infer that top managers are less likely to respond quickly and appropriately to situations where the dominant logic is different, and where they ﬁnd it difﬁcult to interpret information regarding unfamiliar businesses. These arguments apply to the presence of sub-unit level diversity in ﬁnancial, human resources, purchase and marketing, and production and technology related business systems and control mechanisms, which similarly constrain the availability of managerial resources. Different sub-units in a corporation often have different ﬁnancial reporting systems because of differences in the size, scale, scope and complexity of manufacturing, operational and managerial functions. However, if they are also incompatible, then coordination and strategic functions become very challenging. Therefore, the existence of system diversity hampers

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growth and development because it draws on ﬁnite managerial resources into relative unproductive activities. Proposition 2a. The greater the system diversity across business units, the lower the corporate performance. Goal diversity induced by business unit diversity, in turn, is likely to have a nonmonotonic impact on corporate performance. Goal diversity could help ﬁrms at moderate levels, but become sources of constraints at excessive levels. At moderate levels, goal diversity allows ﬁrms to avoid an overwhelming preoccupation with any particular strategic process, objective, activity, division or world view. This can contribute to the management and operations of the ﬁrm. Goal diversity, which is the inverse of simplicity (Miller, 1993), can contribute to the long run performance and survival of the ﬁrm (Lumpkin & Dess, 1995). Some variety within the ﬁrm often enhances decision making, problem solving, and creativity. Excessive goal diversity, though, can cause resource allocation problems such as interdepartmental and intergroup competition for limited resources, while causing conﬂicting opinions and practices. A direct impact of such problems is that the ﬁrm will ﬁnd it difﬁcult to generate cohesive corporate level core values and strategy. Many successful ﬁrms have a core set of values that do not change or change only slowly as the ﬁrm itself changes and grows over time. Collins and Porras (1994) articulated this view of preserving the core while stimulating progress. Core ideology refers to the organization’s guiding principles, above and beyond speciﬁc operating practices. Embedded in the meaning of core is the ﬁrm’s fundamental reason for existence, which extends beyond the appropriation of short run proﬁts. This reﬂects the long run focus of such ﬁrms. The argument of excessive variety suggests that the ﬁrm may lose its core set of values if the top management makes inadequate effort to ensure that all business units adhere to the values. At the business unit level, decision makers that produce different goods and services in different markets will often have different views about how to ensure sustainable performance. Diverse sub-unit level mission statements, dispersed objectives, and disagreements over the nature of core values arising out of the existing diversity of perspectives and practices can reduce current efﬁciency, interfere with long-term core ideology, and damage performance. Therefore, goal diversity initially improves long run corporate performance, but excessive goal diversity reduces long run corporate performance. Proposition 2b. Increasing degrees of goal diversity have a nonmonotonic impact on corporate performance, ﬁrst increasing and then decreasing. The negative inﬂuences of system and goal diversity will tend to be more pronounced when business units are interdependent. The more that business units

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of a corporation share resources with each other, the greater the interdependence between them. While interdependence could take many forms, examples of interdependent business units include those that are vertically related and those that produce complementary products. Interdependent business units depend on the resources that other business units within the corporation share with them. In such cases, coordination and planning activities are also critical in the smooth functioning of the ﬁrm. Resource sharing, coordination, and planning activities become difﬁcult if the business units have incompatible systems and if they differ in their objectives to the extent that the ﬁrm cannot carry out key activities quickly. Proposition 2c. The greater the interdependence between business units, the more that system diversity and goal diversity will reduce corporate performance. In sum, we argue that excessive system and goal diversity can hurt corporate performance. Performance disruptions are likely to be greater if the acquiring business units are interdependent.

Corporate Level Integration Reduces System and Goal Diversity While the integration of individual acquisitions alleviates some problems associated with excessive internal diversity, initial integration primarily occurs at the business unit level. This section deﬁnes corporate level integration, discusses how formal integration techniques may guide the direction of acquisition based expansion, and addresses how corporate level integration may help acquiring ﬁrms control excessive system and goal diversity. Corporate level integration is the implementation of consistent post acquisition policies across all acquisitions that a corporation implements. For instance, acquires may need to generate a uniform ﬁnancial structure across its sub-units and integrate the ﬁnancial systems of acquired ﬁrms so that they are compatible with other units of the corporation. Corporate integration also commonly includes maintaining uniform human resource practice across business units owing to needs for equity, efﬁciency, and personnel transfers. Corporate level integration may help ﬁrms control the system and goal diversity that results from acquisition activity. As we discussed earlier, most ﬁrms differ in the manner in which they conduct their internal organization. Therefore, each target is likely to differ in its internal organization. Unless adjusted, such differences are likely to increase the acquirer’s corporate diversity of systems and goals, creating organizational complications. By implementing consistent general policies across all its acquisitions, an acquiring ﬁrm can control diversity in control mechanisms,

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reporting structures, codiﬁcation strategies, and other tangible routines that follow from acquisition activity. Proposition 3a. The greater a ﬁrm’s emphasis on corporate level integration, the lower the system and goal diversity in acquiring corporations. Acquiring ﬁrms implement corporate level integration in two ways. Firstly, they can acquire only targets that are organizationally similar. Second, they may choose any target and then implement necessary organizational change in the targets, in order to make their systems compatible with those of the acquiring corporation. We state these possibilities as propositions. Proposition 3b. The greater a ﬁrm’s emphasis on corporate level integration, the more likely that acquiring corporations will select targets that are similar. Proposition 3c. The greater a ﬁrm’s emphasis on corporate level integration, the more that acquiring corporations will implement organizational change in targets. Nonetheless, each of these strategies will be costly to implement, which can affect corporate performance. For instance, it may be costly for acquiring ﬁrms to limit their acquisitions to organizationally similar targets, both because it may be costly to search for such targets and because of the opportunity costs that arise if a ﬁrm limits itself to similar targets. Moreover, it can be costly to implement organizational change in dissimilar targets. The next section considers the performance implications of corporate level integration.

The Performance Impact of Corporate Level Integration This section combines the previous arguments to identify the performance implications of corporate level integration. We argue that geographic diffusion of business units, the interdependence between business units, and the frequency of acquisitions moderate the performance impact of corporate level integration. Figure 2 illustrates the basic relationships. Formal integration techniques can enhance performance by reducing system and goal diversity within the organization, but can hurt performance if integration is costly to implement and maintain. On one hand, it may be costly to implement corporate level integration in geographically diffuse acquisitions because acquirers face limits in their ability to evaluate and monitor geographically distant targets. Acquiring ﬁrms that implement corporate level integration by limiting themselves to similar targets face cost and information constraints in

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Fig. 2.

the search for organizationally similar targets, especially if the targets are also geographically dispersed. Moreover, acquirers may ﬁnd it costly to implement organizational change in dissimilar targets, particularly if these targets are also geographically dispersed. Acquiring corporations have to shift personnel who will have to ﬁt in integration routines to different integration contexts. This is often a challenging process, requiring signiﬁcant effort. However, the magnitude of the difﬁculty and cost involved depends on the nature and level of dissimilarity prevailing across acquiring business units, and between acquiring units and target ﬁrms. If system diversity increases with geographic distance – reﬂecting regional differences in cultural, business, and legal factors – then the cost of implementing corporate level integration also increases with geographic dispersion. On the other hand, increase in geographic diffusion of business units increases the need for an emphasis on corporate level integration. Theoretical and empirical research notes that organizational and spatial structures are very much interrelated (e.g. Chapman et al., 1987; Keeble & McDermott, 1978; Taylor & McDermott, 1982; Wood, 1978). Geographic dispersion of business units implies greater system and goal diversity because of the cultural, business, and legal differences across geographic areas. This implies that corporate level integration could play an important role in geographically dispersed acquisitions.

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Simon (1960) suggested a hierarchical internal structure with manufacturing activities and plant level routing administrative activities at the bottom; coordination functions that bind the different elements of the corporation in the middle; and strategic decision making, planning and monitoring functions at the top of the hierarchy. As the ﬁrm grows in size, this structure becomes more visible, while the importance of middle and top level functions gain importance. While Simon was mostly concerned about lines of authority and ﬂows of information within organizations, Hymer (1972) translated Simon’s (1960) administrative structures into physical terms and was considered the relative location of each of these (also see Chapman et al., 1987, p. 102). As ﬁrms increase in size, more complex functional and spatial divisions of labor emerge. Because people responsible for coordination and strategic functions need to access information across business units quickly, the opportunity cost of not implementing corporate level integration may be signiﬁcantly higher than the cost of actually implementing it. Therefore, it is useful to judge the impact of corporate level integration from the point of view of the importance of coordination and planning activities in a ﬁrm. If these activities are crucial for the functioning of the ﬁrm, then the presence of system and goal diversity can lead to signiﬁcantly greater than expected expenditure of managerial resources, and can hence reduce long run performance of the corporation. As discussed earlier, these activities are of prime importance when different business units within a ﬁrm are interdependent, either because they are vertically related or because they produce complementary goods. The frequency of acquisitions also impacts the ability of the ﬁrm to integrate successfully. Penrose (1959, p. 47) states that “if a ﬁrm deliberately or inadvertently expands its organization more rapidly than the individuals in the expanding organization can obtain the experience with each other and with the ﬁrm that is necessary for the effective operation of the group, the efﬁciency of the ﬁrm will suffer (even if optimal adjustments are made in the administrative structure) leading to stagnation.” Thus, ﬁrms face increasing managerial costs to growth – these costs prevent ﬁrms from moving immediately to any desired size (e.g. Slater, 1980) . In turn, the greater the frequency of its acquisitions, the greater a ﬁrm needs to integrate quickly. Under conditions of ﬁnite managerial limitations and cognitive limitations of managers, corporate level integration plays an important role in choosing feasible targets and quickly integrating businesses. The argument that formal integration techniques play an important role for acquirers that have geographically diffused business units, interdependent business units, and those that acquire at a high frequency leads to the following propositions.

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Proposition 4a. The greater the geographic dispersion of business units, the greater the performance enhancing impact of corporate level integration. Proposition 4b. The greater the interdependence between business units, the greater the performance enhancing impact of corporate level integration. Proposition 4c. The greater the frequency of acquisitions, the greater the performance enhancing impact of corporate level integration. In sum, we argued that the acquisitions tend to increase system and goal diversity across business units, especially if business units are geographically diffuse. The diversity requires extensive managerial effort to tackle problems as the corporation grows and becomes geographically diffuse. This evolution makes it increasingly important for acquiring corporations to implement corporate level integration as well as integrate individual acquisitions. While corporate level integration may reduce some of the problems associated with incompatible practices across business units, corporate integration may also be costly to implement. Firms will beneﬁt most from accepting these costs when the corporation acquires frequently, when its acquiring business units are strategically interdependent, and when its units are geographically diverse.

DISCUSSION Research has long suggested that the process of implementing acquisitions is an important determinant of post acquisition performance outcomes. The research further indicates that human and organizational resistance can severely limit an acquiring corporation’s attempts to change and evolve. Resistance to acquisition based growth arises at two levels. The ﬁrst source of resistance arises is at the level of the acquiring business unit – reﬂecting unique circumstances surrounding individual acquisitions – and has an immediate impact on performance. At the unit level, the process of reducing the impact of resistance involves synchronizing the efforts of ﬁnance, human resources, marketing, production, technology, and other personnel, leading to the strategic and administrative combination of the acquirer and target. The second source of resistance, which has longer term effects on performance, is at the level of the corporation. At this level, the process of reducing resistance involves controlling and limiting the tendency for acquired business units to function as independent entities with respect to business systems and goals, while facilitating the sharing of resources and other coordination and strategic corporate functions.

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This article explores corporate level integration concerns. We argued that corporate level integration plays an important role in corporations with geographically dispersed and interdependent business units, which is true of many acquisition-active corporations today. We argued that the acquisition process tends to increase system and goal diversity across business units, especially if business units are geographically diffuse, which means that ﬁrms require extensive managerial effort to tackle organizational problems as the corporation grows. This makes it increasingly important for acquiring corporations to look beyond the process of managing individual acquisitions and to also undertake corporate level integration. While corporate level integration may reduce some of the problems associated with incompatible practices across business units, they may also be costly to implement. However, when the corporation acquires frequently or when its acquiring business units are strategically interdependent then it is often worthwhile to undertake the costs of corporate level integration. The paper also has implications for the general acquisition strategy literature. Many studies have failed to generate a consensus about the average impact of acquisitions on ﬁrm performance. As a result, researchers have focused on factors that may explain the variance in post acquisition performance outcomes. These studies indicate that prior experience, strategic and organizational ﬁt, and post acquisition integration play important roles in explaining the variance in post acquisition performance. We discuss how acquiring corporations change during the process of acquisitions, and how the increased internal diversity in systems and goals may marginalize corporate level performance, even though the corporation may be identifying appropriate targets, negotiating good deals, and integrating these individual acquisitions successfully.

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Karim, S., & Mitchell, W. (2000). Reconﬁguring business resources following acquisitions in the U.S. medical sector. Strategic Management Journal, 21(Special Issue on the Evolution of Business Capabilities), 1061–1081. Keeble, D., & McDermott, P. (1978). Organization and industrial location in the United Kingdom. Regional Studies, 12, 139–141. Lajoux, A. R. (1998). The art of M&A integration: McGraw-Hill. Leigh, R., & North, D. J. (1978). Acquisitions in British industries. In: F. E. I. Hamilton (Ed.), Contemporary Industrialization (pp. 158–181). London: Longman. Lumpkin, G. T., & Dess, G. D. (1995). Simplicity as a strategy-making process: The effects of state of organizational development and environment on performance. Academy of Management Journal, 38(5), 1386–1407. Miller, D. (1993). The architecture of simplicity. Academy of Management Review, 18, 116–138. Nahavandi, A., & Malekzadeh, A. R. (1988). Acculturation in mergers and acquisitions. Academy of Management Review, 13, 79–90. Oldham, G. R., & Hackman, J. R. (1981). Relationships between organizational structure and employee reactions: Comparing alternative frameworks. Administrative Science Quarterly, 26, 66–83. Olie, R. (1994). Shades of culture and institutions in international mergers. Organization Studies, 15, 381–405. Pablo, A. L. (1994). Determinants of acquisition integration level – a decision-making perspective. Academy of Management Journal, 37(4), 803–836. Penrose, E. (1959). The theory of the growth of the ﬁrm. New York: Wiley. Pfeffer, J. (1981). Power in organizations. Boston: Pitman. Prahalad, C. K., & Bettis, R. (1986). The dominant logic: A new linkage between diversity and performance. Strategic Management Journal, 7, 485–492. Pritchett, P. (1985). After the merger: Managing the shock waves. Homewood, IL: Dow Jones-Irwin. Richardson, G. B. (1964). The limits to a ﬁrm’s rate of growth. Oxford Economic Papers, 16, 9–23. Roberts, P. (1994). Culture change in acquisition targets. Proceedings of the Administrative Science Association of Canada Conference. Halifax. Rock, L., & Rock, R. H. (Eds) (1990). Corporate restructuring. New York: McGraw-Hill. Sales, A. L., & Mirvis, P. H. (1984). When cultures collide: issues in acquisitions. In: J. Kimberly & R. Quinn (Eds), New Futures: The Challenge of Managing Corporate Transitions. Homewood, IL: Dow Jones-Irwin. Scherer, F., & Ross, D. (1990). Industrial market structure and economic performance (3rd ed.). Boston: Houghton Mifﬂin. Schweiger, D. M., & DeNisi, A. S. (1991). Communication with employees following a merger: A longitudinal ﬁeld experiment. Academy of Management Journal, 34(1), 100–135. Seth, A. (1990). Sources of value creation in acquisitions. Strategic Management Journal, 11(2), 431–446. Shanley, M. T., & Correa, M. E. (1992). Agreement between top management teams and expectations for post acquisition performance. Strategic Management Journal, 13, 245–266. Shrivastava, P. (1986). Post-merger integration. Journal of Business Strategy, 7, 65–76. Simon, H. A. (1960). The new science of management decision. New York: Harper and Row. Sirower, M. (1997). The synergy trap: Free Press. Slater, M. (1980). The managerial limitation to the growth of ﬁrms. The Economic Journal, 90, 520–528. Slowinski, G., Raﬁi, Z. E., Tao, J. C., Gollob, L., Sagal, M. W., & Krishnamurthy, K. (2002). After the acquisition: Managing paranoid people in schizophrenic organizations. Research Technology Management, 45(3), 21–32.

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A NEW WAY TO LOOK AT THE INTEGRATION CHALLENGE: THE RECONCILIATION OF COLLECTIVE REPRESENTATIONS Joanne M. Roch ABSTRACT The diversiﬁcation phase observed in the American economy since 1975 (Leontiades, 1980) has led to signiﬁcant questioning about the dimensions constituting related diversiﬁcation. During the 1980s, the disappointing performances of businesses that had implemented related diversiﬁcations pushed researchers to take a closer look at the challenges involved in integration to discover commonalities in progressing from potential synergy to synergy achieved. As a result, many recent research endeavors have attempted to describe the management and integration process best suited to the context (Haspelagh & Jemison, 1991; Marks & Mirvis, 1998; Pablo, 1994; Shrivastava, 1986). Obviously, their attention focused primarily on initiatives targeting integration on the functional, structural, and operational levels, without really taking into account the historical, cognitive, and cultural baggage that each business carries around with it.

Advances in Mergers and Acquisitions Advances in Mergers and Acquisitions, Volume 4, 23–50 Copyright © 2005 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1479-361X/doi:10.1016/S1479-361X(04)04002-5

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This research is intended to provide a better understanding of the factors that contribute to creating synergies between companies undertaking an integration process involving related diversiﬁcation. Based on the cognitive approach, it is premised on the notion that creating synergy primarily depends on reconciling the collective representations of the companies involved rather than on simply implementing measures designed to achieve technical and operational integration. This study places particular emphasis on the concept of collective representations, which recognizes that organizational players come to adopt a relatively homogeneous view of the world. It proposes an analysis framework and research method enabling it to go beyond the limits of attempts that, up until now, have strived to quantify and substantiate the mental schemata of organizations involved in merger acquisition. Moreover, these attempts have been criticized as being too vague (Cˆot´e, Langley & Pasquero, 1999; Grant, 1988; Lampel & Shamsie, 2000). In order to characterize the content of collective representations speciﬁc to each of the organizations undergoing integration, we propose applying a new approach in the sociology of organizations called the theory of conventions (Boltanski & Th´evenot, 1991, 1994). The convention theory posits that organizational players share representation systems that help forge interaction rules. Collective, concerted action is made possible by mobilizing common frameworks, that is, conventions. These conventions are characterized by higher principles speciﬁc to each city. The outcome can be agreement or conﬂict, depending on whether player justiﬁcations are rooted in the same city or not. Through the longitudinal analysis of the case of related diversiﬁcation, speciﬁcally a Canadian chartered bank’s acquisition of two brokerage subsidiaries (1987, 1994), this study examines the evolution of the integration initiatives and collective representations of the businesses involved. We made two signiﬁcant observations in examining the various integration initiatives undertaken by the bank during the period under study. First, the integration initiatives could be described as falling into the technical, structural, and operational categories. Second, their outcomes, both qualitatively and quantitatively, were far from conclusive. Concurrent analysis of justiﬁcatory fragments of the three organizations, during the period under studied, revealed divergence between the justiﬁcation modes that each of the businesses opted for. This divergence of dominant collective representations enabled us to interpret the issues encountered during these initiatives and posit a new explanation for their qualiﬁed success.

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INTRODUCTION Diversiﬁcation, deﬁned as a growth strategy making it possible to take advantage of a surplus of resources and seize opportunities, has not only generated positive performances. During the 1980s, a dual trend in research emerged, the ﬁrst of which attributed a primarily subjective aspect (Prahalad & Bettis, 1986) to the concept of “relatedness.” The second trend granted dominant importance to the integration process. Our longitudinal research integrates these two aspects since, based on a related diversiﬁcation case, it identiﬁes the main challenge associated with integration as being the reconciliation of the different mental schema held by the players from the organizations involved. In order to characterize the content of collective representations speciﬁc to each organization involved, we opted for the convention theory as presented by Boltanski and Th´evenot (1991) as our analysis schema.

PERFORMANCE CHALLENGES ASSOCIATED TO RELATED DIVERSIFICATION The growth of merger acquisitions and the emergence of various forms of strategic alliances have shown up over the last two decades. According to Leontiades (1980), this is not a new phenomenon. Since 1975, the American economy has entered its ﬁfth wave of merger acquisitions. This phase of related diversiﬁcation has been characterized by continued acquisitions targeting complementarity. It constituted a type of strategic recentering in response to the failure of the wave of conglomerate-type unrelated diversiﬁcation (1960–1970), which was followed by many disinvestments from 1970 to 1975 (Fig. 1). Underlying this recentering is the idea that the development of synergy between a company’s diversiﬁed business line is central to the process of creating value, which is easier to achieve when the companies are related. During this period, many investigations into strategy focused on discovering what shared dimensions could be used in deﬁning related diversiﬁcation and which of them could create synergy and lead to performance (Rumelt, 1974). It could be inputs, product type, transformation process, markets, or different combinations. The indicators that constitute the boundaries between companies, namely Moody’s Standard Industrial Classiﬁcation (SIC), traditionally used by economists, were unable to clearly reﬂect all the dimensions relevant to evaluating the degree of similarity (“relatedness”). Consequently, the research moved away from a strict deﬁnition based on objective criteria in order to take into account the subjective dimension of the

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Fig. 1.

players. Stimpert and Duhaime (1997) conﬁrmed the importance of the perception of managers. In their opinion, the concept of relatedness is a multidimensional construct that corresponds to a perceived reality anchored in the mental schemas of top managers. Similar or dissimilar . . . everything depends on the mental schemas of top managers! But could the potential synergies be brought about simply by identifying and conceptualizing them? Obviously, many organizations have failed to generate the expected synergies. Despite having a signiﬁcant history, related diversiﬁcation strategic initiatives have a disappointing track record, as conﬁrmed by a number of studies: “Separate studies by McKinsey and Company, and Coopers and Lybrand report that 70% of strategic alliances fail or fall short of expectations (Kanter, R. M., AMR, 1989)” (Marks & Mirvis, 1998). Faced with the disappointing outcomes produced by many acquisitions with promising synergy potential, researchers were forced to turn to the challenges of integration as well as the shift from potential synergy to synergy achieved.

INTEGRATION AS A MANDATORY TRANISTION In his 1977 work The Visible Hand: The Managerial Revolution in American Business,” Chandler afﬁrmed that the expected synergies cannot be produced without structured intervention by top managers. A signiﬁcant amount of recent research has put integration in the role of a mandatory transition and dwells on describing the management and integration processes better adapted to the context (Haspelagh & Jemison, 1991; Marks & Mirvis, 1998; Pablo, 1994; Shrivastava, 1986). Researchers and managers have given a great deal of attention to integration processes by adopting a functionalist mind set and by concentrating on management processes and current administrative processes with scant attention paid to business culture (the historical, cultural, and cognitive baggage that each company carries).

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Yet some of these studies recognize that the success of integration goes beyond operational and ﬁnancial integration of tangible assets and depends primarily on intangible dimensions. Nevertheless, they remain vague when it comes to specifying the import of these sociocultural dimensions in the merger acquisition context. Consequently, such studies have been criticized for applying a lax theoretical framework to the sociocultural component (Elssas & Veiga, 1994). A trend in cognitivist research (Grant, 1988; Prahalad & Bettis, 1986) surfaced in the 1980s based on the recognition that intangible dimensions have a determining effect on integration success. These researchers saw the cognitive level as the prime factor in integration success.

SCOPE AND LIMITATIONS OF THE CONCEPT OF DOMINANT LOGIC Prahalad and Bettis (1986) became interested in the concept of dominant logic and felt that the key success factor in integration lay with the skill of the corporate management team in managing strategic diversity. The management team has a duty to adapt its dominant logic to take into account the distinctive strategic management characteristics of the organization to be integrated. Often, a single dominant logic is not enough to ensure optimal management of the speciﬁcity of each business line. Consequently, the dominant logic must be revised or the organization must develop the capacity for accommodating multiple dominant logics. Many researchers deplore the fact that the concept of dominant logic has remained quite vague and been subject to little empirical testing: The problem of dominant logic is that it is a cognitive concept – it is a mind set or a world view or a conceptualization of the business. As such, its applicability, either to empirical research or to formulating and implementing diversiﬁcation strategy, is limited (Grant, 1988).

Unfortunately, it is obvious that, up to now, few researchers have succeeded in empirically deﬁning and convincingly substantiating the concept of dominant logic. Grant (1988) attempted to objectivize it according to predeﬁned dimensions, despite the fact that dominant logic remains a concept anchored in the cognitive subjectivity of the players involved. In an attempt to empirically validate the concept of dominant to logic within the context of diversiﬁed strategic management, Grant proposed a grid for analyzing strategic diversity based on the functions of the corporate management group. He identiﬁed three critical functions performed by general management:

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(1) Allocate resources among business units. (2) Formulate and coordinate business-unit strategies. (3) Set and control business-unit objectives and performance. For each of these key functions, Grant identiﬁes factors that can determine strategic similarity. My argument is that, if we can specify these ‘administrative tools,’ we can operationalize the concept of dominant logic and turn it into a potentially valuable instrument of strategic analysis (1988, p. 64).

The concept of dominant logic as deﬁned by Grant (1988) appears reductionist. In attempting to objectivize the concept of dominant logic and by assigning it a priori dimensions (functions), Grant obfuscates the fact that consist in cognitive ties that must come from the players and not from a typology deﬁned by researchers. Ginsberg (1990) claims that Grant, in attempting to organize the concept, has missed its essential character, which is the management team’s capacity to reconceptualize the strategic issues: Grant’s (1988) efforts have been helpful in linking Prahalad and Bettis’s framework to the existing economics-based literature, but they appear to sidestep its central contribution: a shift from business domain extension issues emphasized by economic-based theories to business domain construction issues emphasized by cognition-based theories. This shift requires a framework that stresses the role of managerial abilities [. . .] enabling them to reconceive and reconﬁgure the existing portfolio of businesses (1990, p. 514).

Unfortunately, Lampel and Shamsie’s most recent work (2000) does not lead to a fuller deﬁnition of dominant logic, adopting instead a rather reductionist view of the concept. In their study, the authors analyzed the effects of dominant logic on strategic alliances between General Electric (GE) business units. GE’s dominant logic limited itself to an “injunction to the business units to be number one or number two.” The research dealt with 70 strategic alliances between GE business units from 1984 to 1993. It aimed at assessing the impact of dominant logic on these decisions. The study demonstrated that dominant logic effectively inﬂuenced the choice of partners “[. . .] only where such collaboration would help to clearly enhance the competitive position” (Lampel & Shamsie, 2000). On the other hand, the authors qualiﬁed General Electric’s dominant logic as aiming for ﬁrst or second ranking in the market. We consider that it is rather a positioning objective and that the concept of dominant logic cannot be reduced to such a narrow deﬁnition. Opting for a different method, termed unstructured, the recent study carried out by Side, Langley and Pasquero (2000) focused on highlighting the cognitive structures held by the prevailing coalition in SNC Lavalin with respect

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to growth through acquisition (13 acquisitions and 6 strategic alliances from 1977 to 1986). Dominant set of beliefs and premises associated with the management of growth by acquisition (2000, p. 927).

While interesting, the study carried out by Cˆot´e, Langley and Pasquero (1999) limits organizational dominant logic to the view held by managers with respect to strategic acquisition decisions. As with Lampel and Shamsie (2000), performing an analysis of dominant logic based on a certain type of strategic decisions (acquisition decisions or strategic alliances) primarily reﬂect the mental schemata of those who make this type of decision, namely senior management. This type of analysis makes it possible to conclude that it is a question of elements constituting the dominant logic of decision-makers. On the other hand, it doesn’t reveal if the logic is widespread within the organization. Determining that would require analyzing the acquisition process and its implementation, not limiting the analysis to the decision-making component. A second important criticism that can be aimed at studies dealing with the concept of dominant logic is that they are based in cognitive psychology. They assume that the players adopt cognitive models (interpretative schemata) that enable them to deal with uncertainty in the environment, to save time, and to classify and order events that could otherwise give the appearance of chaos. These studies adopt a perspective termed internalist1 and are interested, above all, in individual interior mental states. It’s hard to understand how members of a group or even the same organization come to share the same schemata and coordinate their actions when viewed from an internalistic perspective. The social component in these studies is described as an aggregate of individual actions: [. . .] collective phenomena are perceived as being the involuntary result of the aggregation of individual decisions (Orl´ean, 1994, p. 24).

This involuntary and nearly unpredictable character precludes the possibility of associating the notions of order and regularity. The internalistic perspective, with its individual bias, is not very effective in taking into account how members of an organization come to share models and regularities on the cognitive level. Furthermore, it remains vague about the training process resulting from collective knowledge and modes for organizing collective action. In attempting to explain the concepts of collective knowledge (see “group thinks”), do not the proponents of the cognitive perspective place themselves in the position of breaking with methodological individualism?

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JOANNE M. ROCH [. . .] is it possible to give meaning to the idea that a group of individuals knows something as a group? Isn’t this in contradiction with the principle of methodological individualism? (Orl´ean, 1994, p. 24).

Consequently, for many proponents of the cognitive approach (Brockmann & Anthony, 1998; Kim, 1993), the passage from individual representations to collective representations involves a type of organizational memory that serves as a cumulative store of past experiences and knowledge. According to Kim (1993), this organizational memory or “shared mental models” comprises an operational dimension, speciﬁcally organizational routines (SOPs: standard operating procedures) and a conceptual dimension called Weltanschauung: Weltanschauung is also a reﬂection of its culture, deep-rooted assumptions, artifacts, and overt behavior rules (1993, p. 45).

It consists of a store of knowledge that the players can delve into and that they transform through new experiences and learning. Many authors hold that this reserve has an unconscious component populated with experiences and knowledge that are both individual and collective. According to Vaughan (1979), the collective reservoir is associated with a sort of vast storehouse of shared knowledge and experiences that certain people refer to as collective unconscious: At any given moment one is conscious of only a small section of what one knows. Intuition allows one to draw on the vast storehouse of unconscious knowledge that includes not only everything that one has experienced or learned or either consciously or subliminally, but also the inﬁnite reservoir of the collective or universal unconscious, in which individual separateness and ego boundaries are transcended (1979, p. 64).

In our opinion, the image of the storehouse or reservoir is not innocent. While it evokes an area outside of agents, it doesn’t appear to constrain their actions in any way. Individuals appear to be able to draw on it as they wish. Collective unconscious does not seem to exert a coercive force on action. Consequently, the concept of storehouse that embraces the collective unconscious is presented by the proponents of the cognitive approach as an explanation of the passage from individual representations to collective representations. Although the image of the “self-service store” enables them to avoid breaking with the methodological individualism approach, we claim that it falls quite short in accounting for the convergence of collective representations towards coordinated organizational activity. Although we consider that the dominant logic concept can help us understand the reasons underlying the success or failure of various integration initiatives, it also appears important to take into account the perspective of the organizational players. To do so, we have given precedence to the concept of collective representations over

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dominant logic. Organizational players come to adopt a relatively homogeneous view of the world. As a result, the main challenge in integration lies with reconciling worldviews or different collective representations. The divergence or convergence of collective representations can impede or facilitate the integration process.

COLLECTIVE REPRESENTATIONS AND THE THEORY OF CONVENTIONS In order to characterize the content of collective representations speciﬁc to each of the organizations involved in integration, we have emphasized applying a new approach in organizational sociology known as the theory of conventions. The theory of conventions posits that organizational players share representation systems that help forge interaction rules. Concerted collective action depends on the globalization of shared frameworks, that is, conventions. French sociologists Boltanski and Th´evenot (1987, 1991) view conventions as analysis frameworks that players use to perceive, analyze, and solve problems. Conventions enable them to make agreements. Players have the cognitive capacity to come together and to achieve agreement on general issues. This cognitive operation is based on principles of justice and is subject to justiﬁcation. The system of shared equivalencies (shared grandeurs) provide this order of justiﬁcation: These systems of shared equivalencies (grandeurs communes) enable individuals to locate reference points (objects, individuals, relations) that guide relationships in the situation and yield the situation’s basic characteristics. These systems are deployed in “cities” governed by the coherency of the principles at work (Amblard et al., 1996, p. 78).

Proponents of the theory of conventions label coherent systems of founding principles “mondes d’´equivalence.” The founding principles speciﬁc to each city, based on different political philosophies, make it possible to qualify a situation as fair and legitimate. Consequently, the convention is founded on coherent systems of founding principles (seven cities) that players use to support their justiﬁcations. The seven “cities”2 (inspired by political philosophy) constitute the coherent system of reference points and that enable players to justify themselves in difﬁcult situations. The outcome can be agreement or conﬂict, depending on whether player justiﬁcations are rooted in the same city or not. The conceptual framework based on ideal-type standards (pure cities) proposed by Boltanski and Th´evenot (1987, 1991) serves as an analysis grid that enables us to identify logics within an organization based on the justiﬁcations presented by players to legitimize their decisions and behaviors. Below, we present a short summary of each of the seven cities.

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Description of the Shared Upper Cities 1. The Merchant City (competition, opportunism). The work of Adam Smith provided the inspiration for the structure underlying this city. It is based on the establishment of a merchant trade connection, making it possible to implement individual interests. This merchant connection unites individuals who desire the same rare goods. Competition becomes the coordinating principal (shared higher principal). From Smith’s perspective, people are driven by a natural penchant for trading and doing business. They also tend to covet rare goods from the outside: A higher overall authority must intervene in order to contain the blind interests of men (Boltanski & Th´evenot, 1990, p. 26).

Competition acts as an authority by setting a fair price. People and goods circulate freely. Liberalism and opportunism imply that the individual makes the best of it, but while exercising a certain level of regard for others. Striving for proﬁt is a worthy desire based on an egotistical desire that works for the common good. The dominant characteristic of the object is to be desirable, not to be effective or functional. 2. The Industrial City (effectiveness, performance, technical object) This is the city of technical objects and scientiﬁc methods that are ordered in terms of efﬁcacy, performance, and productivity. Is based on regularity and predictability. It depends on the ability of individuals to actively and effectively integrate into the organization’s machinery. The production space can be projected onto a sheet of paper, modeled, deﬁned, measured, and even standardized. Its temporal dimension can be expressed in terms of plans, objectives, schedules, and calendars. Analysis of objects from the industrial city implies the possibility of calculating mathematical relationships based on quantiﬁed variables (Boltanski & Th´evenot, 1991, p. 258).

The quantiﬁable dimension intimates the possibility for rational optimization. Moreover, harmony of the industrial order relies on system organization, which implies an ordering of functional relations. This hierarchical ordering helps ensure temporal stability and predictability. 3. The City of Inspiration (creation, spontaneity) In this city, people can be great depending on their inspiration. Inspiration appears as a ﬂash of genius, an illumination. It consists of a spontaneous,

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involuntary state that “manifests itself with emotions and passions, and is consuming, frightening, enriching, enthusing . . .” (translated from Boltanski & Th´evenot, 1991). Inspiration is a state that fosters the desire to create, which is associated with artists, poets, and scientists bent on discovery. Achieving the state does not require a consistently focusing on efﬁcacy and rationality, but rather on sacriﬁcing stability. This greatness is never predictable; it demands openness and receptivity. 4. The Domestic City (opposition to progress, tradition) Relations between people in the domestic city are interpersonal and expressed by proprieties, tradition, and principles: The greatness is a state that, in order to be measurable, must be related to the dependency relations from which people draw authority that they can exercise over others (Boltanski & Th´evenot, 1990, p. 70).

The state of greatness depends on the hierarchical position held in the string of dependence with respect to the generation, tradition, and hierarchy that it establishes. The superior-inferior relationship gives the impression that individuals belong to the same household. They are deﬁned based on a subordinate relationship like that of children to their father. The more powerful in this order have responsibilities and must have respect for their subordinates. The principles are transmitted and shared by teaching customs. 5. The City of Opinion (appearance, stardom, superﬁciality) In this city, subordination is based on renown and depends solely on the opinion of others. This renown is the product of reputation recognition by the largest number of people. It is established independently of the individual’s self-esteem. Its source is not stable, varying according to public opinion. 6. The Civic City (adherence to rules and procedures) In this environment, the common good and social peace are provided for by an impartial sovereign who is “above individual interests” (Boltanski & Th´evenot, 1991, p. 138). Unlike in the domestic city, the common good is not incarnated in a single person (“the person of the king”), but rather the general will. The key principles representing this city are fairness, democracy, and solidarity. A 7th Order . . . In Le Nouvel Esprit du Capitalisme, Boltanski and Chiapello (1999) identiﬁed a 7th city, referred to as project-oriented. This city emerged in the mid-seventies

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when capitalism replaced the Ford principles of work organization with those for a new network organization. The reticulated (networked) city comprises a multitude of temporary connections. The project, pretext for the connection, represents a sort of “temporary accumulation” of these connections (Boltanski & Chiapello, 1999, p. 159). The deﬁnition of the project-oriented city was inspired by the structure of a company comprised of a number of successive projects. The end of a project distributes the greatness based on contribution. The greatness is expressed as the actors’ ability to insert themselves into a new project. The temporary nature and entails the necessity of developing one’s employability and versatility. The analysis frameworks proposed by Boltanski and Th´evenot (1991) and Boltanski and Chiapello (1999) also enable us to grasp the complexity of sources that inﬂuence the collective representations of an organization. The analysis of preferred justiﬁcation modes based on shared founding principles can be also be applied equally well to organizations as to markets and industries. Similarly to companies, industries adopt preferred justiﬁcation modes that help give them their speciﬁc, distinct characters (industry recipes, Spender, 1989).

TWO SOURCES OF INFLUENCE ACTING ON COLLECTIVE REPRESENTATIONS: ORGANIZATIONAL HISTORY AND INDUSTRIAL MEMBERSHIP The contextualist approach proposed by Pettigrew (1985) provides the means for grasping the complexity of sources of inﬂuence that act on the collective representations of an organization. On one hand, the vertical linkages make it possible to understand the organization with respect to its environment. On the other, horizontal linkages provide a means for analyzing from a temporal standpoint and acknowledging the inﬂuence that past experiences and history have. Lyles and Schwenck (1992) state that the dominant organizational mental schemata develop in response to two levels of pressure. Administrative inheritance exerts inﬂuence through past experiences leaving a mark on the organization’s history. Past experience acts as a ﬁlter when processing information and limits sensitivity to context and the organization’s capacity to adjust. This ﬁrmspeciﬁc inheritance makes the organization unique and gives it an idiosyncratic character. Moreover, when sources of inﬂuence derive from circumstantial or contextual factors, information processing and the interpreting process are guided by the current context, in particular the inﬂuence of the industrial sector the organization belongs to (industry speciﬁc). Child and Smith (1987) refer to taking these two

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Table 1. Sources of Inﬂuence on Collective Organizational Representations.

dimensions of perspective into account as a “ﬁrm-in-sector” approach. They advocate performing dynamic analysis of the historical characteristics that have marked ﬁrm evolution with respect to the company’s industrial sector. The following model illustrates the inﬂuence according to the ﬁrm-in sector approach, speciﬁcally impact of the ﬁrm’s history and industrial membership on collective organizational representations (Table 1). By analyzing the collective representations of organizations involved in integration following related diversiﬁcation, including one in the banking sector and two in the same industrial sector (brokerage), we are able to break down the inﬂuence that each of these sources would have.

RESEARCH METHODOLOGY We opted for an in-depth longitudinal qualitative study of a case of related diversiﬁcation making it possible to understand the unfolding and sequence of events. We studied a Canadian chartered bank that, after deregulation of the ﬁnancial sector, acquired two brokerage subsidiaries (Subsidiary A in 1987 and Subsidiary B in 1994), in order to analyze integration efforts, impediments, difﬁculties, successes, and adjustments involved and to attempt to understand how

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Table 2. Three Levels of Research.

they came about. To achieve this goal, we paralleled the integration initiatives with the content of collective representations and how they changed over time. Based on the analysis of the acquisition of the two brokerage subsidiaries, we initially identiﬁed the various integration initiatives undertaken from 1987 to 2001. Then, we attempted to account for the success or failure of these initiatives by the degree of convergence or divergence of the collective representations in each of these organizations. Lastly, we assessed the level of inﬂuence of industrial membership on the content of the respective collective representations of each of these organizations. Table 2 illustrates the three levels of research. Our interest was not limited to deﬁning the justiﬁcation modes given preference in each of the organizations (cities of equivalence). We also wanted to determine how they converged or diverged as well as how these collective representations generated tension and possibly compromise over time. The preferred justiﬁcation modes were identiﬁed from analysis of actor statements. The statements were collected over the course of semi-structured interviews lasting from 45 to 75 minutes during which the actors were asked to comment on the various integration initiatives. A total of 36 interviews with representatives from various levels within both organizations were carried out. The transcripts of these 36 interviews enabled us to analyze the patterns in the justiﬁcative statements put forward by groups of actors to account for the difﬁculties encountered with respect to the various integration initiatives. The third level of analysis (industrial membership) consisted in bringing out the presence and evolution of collective representations speciﬁc to the members of a single industrial sector.

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Collective representations result from two series of inﬂuences: the inﬂuence of the organization’s history, which reﬂects its identity (idiosyncrasy) and a homogenizing inﬂuence produced through the dynamic interface with the rest of its industry. This third level of analysis therefore aimed at identifying and deﬁning the inﬂuence that industrial membership had on collective representations. Two types of data were involved in analyzing the impact of industrial membership. On one hand, we used information sources such as scientiﬁc books and journals dealing with the market trends in these two sectors. On the other hand, we used interviews with six expert analysts in an effort to determine: If there were collective representations shared by the actors in these two industrial groups (brokerage and chartered banks) and, if so, what trends did they follow from 1987 to 2001; If we were able to characterize these collective representations based on justiﬁcation modes within the meaning of Boltanski and Th´evenot (1987, 1989, 1991).

STUDY FINDINGS In order to better understand how the collective representations of organizations can affect the integration process, we have analyzed how integration efforts were implemented in a case of related diversiﬁcation. Overtime, we will see what have been the impediments, difﬁculties, and adjustments. We shall also endeavor to understand why they came about. Weak Performance of Integration Initiatives (Level 1) The various integration initiatives undertaken by the bank during the study (system for pairing branches, implementation of a system for managing customer information, and the introduction of incentive programs associated with customer referrals fall into the categories of technical, structural, and operational integration. Their outcomes, both qualitatively and quantitatively, were far from conclusive. Since 1988, the key indicator for determining the success of integration initiatives has been the number of customer referrals. Analysis, however, reveals a drop of referrals in customer groups from 1995 to 2000.3 Moreover, managers with the bank and to brokerage subsidiaries felt that the initiatives had failed or were not qualiﬁed successes. They conﬁrmed that no atmosphere of cooperation had been developed, nor was there any genuine desire between the organizations to share customer referrals. In order to understand the causes underlying the failure of

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these initiatives to bring about the desired results, we felt it was necessary to go beyond simply describing technical initiatives and to attempt to understand that cognitive dynamics driving each of the groups involved based on an analysis of player statements from the theory of conventions perspective.

The Industry Effect (Level 3) Inﬂuence of Industry Logic in the Brokerage Sector Analysis of the justiﬁcation modes associated with the brokerage industry allowed us to determine that it is based primarily on a merchant justiﬁcation mode. Consequently, unlike major banks, brokerage ﬁrms are smaller and prefer less formal organizational modes based more on mutual adjustment. The merchant mode requires actors to be free and independent in order to take advantage of all opportunities for transactions. It therefore calls for a ﬂexible organizational structure that lends itself to fast action. Remuneration on a commission basis is expressed as a form of transaction-based remuneration. The consultant’s beneﬁt (salary) reﬂects his merchant performance and not his hierarchical position (domestic). Ownership is inherent in the merchant component. The ownership of the company as capital stock leads to another form of hierarchy based on capital. The proﬁtability of such organizations is cyclic; it is subject to the market and subjective assessment by consumers. The structure of the merchant city constitutes an order based on the demand of consumers conditioned by subjective desires. The brokerage industry is mainly driven by customer anticipation, making it even more unpredictable. Risk and risk assessment are more or less raw materials for brokers. Risk and the instability it generates are the sources of proﬁts. “You can be unlucky, but you can also take advantage of insecurity” (Boltanski & Th´evenot, 1991, p. 245). The merchant component is atemporal. It has “no memory of the past or projects for the future.” (1991, p. 245). The merchant transaction occurs in the here and now. This immediacy is what gives rise to the feeling of urgency and a vigilance to seize the market opportunities that appear. Lastly, the personalization of relations with customers and the relationship of trust it produces reﬂect a kind of compromise between merchant and domestic relations. Inﬂuence of Industry Logic in the Banking Sector Analysis of the predominant justiﬁcations in the banking industry led us to place them primarily in the industry city. As stated above, the banking industry is comprised of very large organizations with centralized and bureaucratic organizational modes. From the standpoint of the theory of conventions, the

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effectiveness of large organizations requires the implementation of industry devices that yield a coordinated, effective structuring of the work to be performed. Industrial integration and coordination are made possible through a hierarchical structure in which the responsibilities and tasks of each individual are clearly stated. The responsibilities of the greater take in those of subordinates. The fact that a subordinate remains nonetheless responsible for the decisions the people reporting to him may give rise to centralizing behavior. Moreover, the devices associated with the industry city aim at ensuring a certain degree of stability and predictability over time. The industrial component can consequently become rigid. It can be associated with a number of perverse effects characterizing bureaucracies (Crozier, 1963). In the industry component, remuneration for the employment contract is associated with the position. Status gives the incumbent his level of importance and determines his remuneration. Only a marginal portion of remuneration in the banking world is variable and dependent upon performance. The sources of bank proﬁtability are based on assets that remain on the books on the medium and long term. It was indicated that up to 90% of income is related to retaining assets already entered in the books. As a result, assets and income can be provisionally planned each year. The industry devices for planning and programming are designed to ensure predictability that is scarcely compatible with random market ﬂuctuations (merchant logic). With respect to risk, the industrial devices for measurement and assessment aim at ensuring system predictability. Variables that might have random unpredictable impact must be assessed and measured so that they can be integrated into the workings of the industrial reality. Industrial commitment also conditions the time relation between these organizations. Banking operating modes aim at anticipating and planning for the future: “the smooth operation of people extend the present into the future, thereby opening up the possibility of predicting” (1991, p. 254). Precautions related to current actions contribute to the company’s tomorrow. Lastly, the bank primarily handles customer relations. The institution’s stability is guaranteed by its solvability. The administrative machinery ensures the stability of the industrial structure. The effectiveness of service delivery depends more on system effectiveness than on a personalized relation between client and employee. Table 3 compares the characteristics and operating modes of securities brokers to the industry character of the banking sector. The analysis of organizations based on the theory of conventions reveals the differences between the organizations and industries that may appear as being closely related. The differences between the justiﬁcation modes opted for by the organizations from different industry sectors can reveal account for the sources

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Table 3. Characteristic and Operational Modes in the Banking (Industrial) and Securities (Merchant) Sectors.

JOANNE M. ROCH

Source: Adapted from Saunders and Thomas (2000).

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of tension and explain some of the problems that will be encountered during integration initiatives. The clash of the industry justiﬁcation mode preferred by the banking industry with the merchant mode used by the brokerage industry helped pave the way to failure for the bank’s initiatives to integrate its subsidiaries and develop synergy between its business lines. In integrating its two brokerage subsidiaries, the bank put forward a panoply of technical and operational integration initiatives, which are indicative of the industrial city. Faced with implementation problems, bank players made industrialtype adjustments (specialized sales team, incentive programs, more rigorous controls, etc.), which constantly collided with the merchant approach favored by the brokerage subsidiaries. Faced with the failure of its industrial measures, the bank then implemented other industrial methods and actions. In the industrial city, dysfunctions are negative signs related to size. It is therefore necessary to correct them by implementing more industrial devices in order to make the system effective again. This perpetual calibration helped push the merchant reality to the back of the bank’s concerns, despite its assertions. By opting to implement industrial and devices, the bank strayed further away from the concerns of its brokerage subsidiaries. As a result, the subsidiaries were not very inclined to buy into the bank’s integration initiatives. The bank, as the acquiring ﬁrm, maintained an industrial style in its management relations with the two subsidiaries. It had little or no sensitivity towards the merchant force that could have been beneﬁcial in implementing the desired shift toward a sale’s culture. The investment advisors from the two brokerage subsidiaries based their assessment of the impact of the merger on their organizations on their common justiﬁcation perspective: the merchant city. The justiﬁcations of the advisors were rooted in the merchant city perspective, which values free enterprise, independence, opportunism, and entrepreneurship. Coming from a context in which market opportunities are to be seized without constraint when they arise, the players from the two brokerage ﬁrms denounced the bank’s bureaucratic measures. They also speciﬁcally denounced the formalized structure and many levels involved in obtaining approval as barriers to merchant performance, which must be free and unfettered in order to respond to the constantly changing market conditions. The tensions between the justiﬁcation approaches valued by the bank (industrial) and its brokerage subsidiaries (merchant) would account for the bank’s problems in implementing its various integration measures. Moreover, our study also demonstrates that industrial membership and organizational history exert a double inﬂuence. Consequently, analysis of the collective representations in each of these organizations reveals that they have also been inﬂuenced by their respective histories.

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Inﬂuence of History – Level 2 Our analysis reveals that the bank and its ﬁrst brokerage subsidiary, both of which were founded at the beginning of the last century, had signiﬁcant historical baggage and shared the inﬂuence of domestic logic. This domestic inﬂuence, however, evolved differently in the different organizational realities and therefore failed to yield the desired rapprochement. The domestic inﬂuence that characterized the ﬁrst brokerage subsidiary also repelled it from the purely merchant character of the second. As a result, despite the fact that each brokerage ﬁrm valued a merchant approach, which is speciﬁc to their industry, the ﬁrst ﬁrm acquired (Brokerage subsidiary A) showed traces of domestic inﬂuence going back to its founding, reﬂecting its history and giving it an idiosyncratic nature. This resulted in a merchant-domestic compromise. The domestic component of the compromise relates to developing merchant relationships that are professional, customer-centered, and based on trust. This trust is based on the ﬁrm’s reputation and makes it possible to put time into merchant relationships, which, by deﬁnition, are deemed atemporal. The merchant-domestic compromise contrasts with the purely merchant nature of the second acquisition, which, because of its young staff, has little historical baggage. The historical domestic baggage of the ﬁrst brokerage subsidiary acquired (Brokerage subsidiary A) seems to have had a determining inﬂuence on its relationship with the second (Brokerage subsidiary B), all the more so since they belong to the same industry. The dominant style of Brokerage subsidiary A, characterized by many merchant-domestic compromises, was in opposition to the merchant style of Brokerage subsidiary B. The constant references made by actors in Brokerage subsidiary A to the ﬁrm’s reputation, personalized service, and the development of sustained relations with customers are forms of domesticmerchant compromises reﬂecting its history. In contrast to Brokerage subsidiary A, Brokerage subsidiary B comprised a major proportion of new recruits and had little historical baggage. Consequently, its dominant logic reﬂected its industry (merchant) rather than its history. Evidence suggests that the organization’s history mitigates the inﬂuence of industrial membership. An organization comprised of a large number of new recruits does not carry signiﬁcant historical baggage that can mitigate the inﬂuence of the industrial recipe. Table 4 illustrates the tensions between the collective representations of the two brokerage subsidiaries. Consequently, the domestic inﬂuence that characterized the ﬁrst brokerage subsidiary and reﬂected its history would also have helped push it away from the purely merchant character of the second. The inﬂuence of organizational history

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Table 4. Parallel Between the Collective Organizational Representations of Brokerage Subsidiaries A and B.

refers to the idiosyncratic character and singularity of these organizations. It would have mitigated any rapprochement possible through the inﬂuence of their industry’s merchant logic.

DISCUSSION The analysis of organizations involved in merger acquisitions based on the theory of conventions reveals similarities between the organizations where differences were expected and vice versa. The similarities and differences between the justiﬁcation approaches used by both organizations provide the means for understanding the sources of agreement, tensions, and the emergence of compromises: In this way, rapprochement is possible between organizations who are often in opposition when viewed through only one of their aspects: the industrial process for producing businesses or general interest for administrations (Boltanski & Th´evenot, 1989, p. VI).

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This approach gives a new meaning to the concept of relatedness in the context of related diversiﬁcation and leads us to redeﬁne it. Accordingly, by using the same justiﬁcation approaches (founding principles), two organizations can achieve greater progress towards rapprochement and facilitate integration than by sharing the same technology, the same distribution network, and so on. We also believe that our study sheds light on the key success factors associated with related diversiﬁcation. By placing the collective representations of the organizations involved in the forefront, our study attributes successful integration to their degree of convergence or similarity. It is therefore important to pay particular attention to the content of collective representations that characterize companies involved in merger acquisition and to adapt the integration process accordingly. Such an analysis could even be integrated into the due diligence phase, which is the analysis period preceding acquisition. Acquiring ﬁrms would beneﬁt greatly from paying particular attention to the history of the businesses they intend to acquire and to the compatibility of the representational baggage of the organizations involved. Our study also shed light on the inﬂuence of history on the nature of collective organizational representations. Their history gives them an idiosyncratic character that can conﬂict with the inﬂuence of industrial membership, as indicated by the tensions that between the two brokerage subsidiaries. Isn’t this tension between the strengths of the industry and the historical baggage of an organization a dilemma for any business? These conclusions are similar to those of Porac and Thomas (1995) and those of Child and Smith (1987), who recognize that industry collective representations are mitigated by organizational representations: This suggests that the legacy of a ﬁrm’s history will bear heavily upon its ability to effect a present transformation. Competitive pressures to adopt a superior strategy and structural conﬁguration are therefore likely to be mediated by an organization’s inherited tradition, structured power distributions and particular inherited competences (1987, p. 568).

Consequently, this study brings out the fact that organizations can resist certain organizational initiatives based on ﬁrm uniqueness, that is, their historical baggage, regardless of industry recipes.

CONTRIBUTIONS FOR PRACTITIONERS We believe that our study sheds light on the key success factors associated with related diversiﬁcation. By placing the collective representations of the organizations involved in the forefront, our study attributes successful integration

A New Way to Look at the Integration Challenge

45

to their degree of convergence or similarity. It is therefore important to pay particular attention to the content of collective representations that characterize companies involved in mergers/acquisitions and to adapt the integration process accordingly. Such an analysis could even be integrated into the due diligence phase, which is the analysis period preceding acquisition. It would complement analyses to assess, for example, current management teams. The resultant conclusions make it possible to perform a priori assessment of the level of compatibility between two organizations by analyzing their preferred justiﬁcation modes. This study can also yield more information for the professionals assigned to integration issues resulting from the merger/acquisition. Again, analysis of the preferred justiﬁcation modes can allow the professionals to adapt the integration measures they wish to implement in ways that work around avoidable tensions. In summary, it is fully in the acquiring company’s interest to pay particular attention to the history of the organization to be acquired and to compatibility between the representational baggage of the organizations involved.

FUTURE RESEARCH We are currently considering a number of avenues of research to advance our understanding of collective organizational representations based on the convention theory. First of all, we think that it would be relevant to study other Canadian banks and how they integrated their brokerage subsidiaries. Studies of organizations in the same industrial sector would enable us to carry out comparative analyses, thereby bringing out the legacy inﬂuence. Secondly, it would be important to test our conclusions with industries other than ﬁnancial institutions. The sectors of activities related to telecommunications, for example, may appear similar in theory but organizations involved in these ﬁelds can display striking differences in their collective representations. This poses a speciﬁc challenge in sectors of activity in which a high number of consolidations are occurring. Thirdly, studying organizations that have successfully integrated their acquisitions could allow us to determine if they exhibited content similarities in their collective representations.

NOTES 1. “An internalist theory accounts for the acts of an agent through his interior states . . . The psychological interpretations of the action in terms of mental states are paradigmatic internalistic theories.”

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JOANNE M. ROCH

Taken from Chap. 4, Ferejohn, J. and Satz, D. in Analyse e´ conomique des conventions. ´ A.Orl´eans, Economie. PUF 1994, p. 98. 2. See the city descriptions in Appendix A. 3. See Appendix B. 4. Taken from Amblard et al., in Les Nouvelles Approches Sociologiques de l’Organisation, p. 88.

REFERENCES Amblard, H., Bernoux, P., Herreros, G., & Livian, Y.-F. (1996). Les nouvelles approches sociologiques des organisations (245 pp.). Seuil. Boltanski, L., & Th´evenot, L. (1987). Les e´ conomies de la grandeur (361 pp.). Paris : Presses Universitaires de France. Boltanski, L., & Th´evenot, L. (1989). Justesse et justice dans le travail (321 pp.). Paris: Presses Universitaires de France. Boltanski, L., & Th´evenot, L. (1991). De la justiﬁcation – Les e´ conomies de grandeur (483 pp.). Ed. Gallimard. Brockmann, E., & Anthony, W. (1998). The inﬂuence of tacit knowledge and collective mind on strategic planning. Journal of Managerial Studies, X(2, Summer), 204–222. Chandler, A. D. (1977). The visible hand the managerial revolution in American business (608 pp.). Harvard University Press. Child, J., & Smith, C. (1987). The context and process of organizational transformation: Cadbury Limited in its sector. The Journal of Management Studies, 24(6), 565–594. Cˆot´e, L., Langley, A., & Pasquero, J. (1999). Acquisition strategy and dominant logic in an engineering ﬁrm. Journal of Management Studies, 36(7), 919–952. Ginsberg, A. (1990). Connecting diversiﬁcation to performance: A sociogognitive approach. Academy of Management Review, 15, 514–535. Grant, R. M. (1988). On dominant logic, relatedness and the link between diversity and performance. Strategic Management Journal, 9, 639–642. Haspelagh, C., & Jemison, B. (1991). Managing acquisitions: Creating value through corporate renewal (p. 416). New York: Free Press. Kim, D. H. (1993). The link between individual and organizational learning. Sloan Management Review (Fall), 37–50. Lampel, J., & Shamsie, J. (2000). Probing the unobstrusive link: Dominant logic and the design of joint ventures at general electric. Strategic Management Journal, 21, 593–602. Leontiades, M. (1980). Strategies for diversiﬁcation and change (199 pp.). Boston: Little, Brown & Company. Lyles, M., & Schwenck, C. (1992). Top management, strategy and organizational knowledge structures. Journal of Mangement Studies, 29(2, March). Marks, M. L., & Mirvis, H. P. (1998). Joining force (297 pp.). Jossey-Bass. Orl´ean, A. (1994). Analyse e´ conomique des conventions (403 pp.). Paris: PUF. Pablo, A. (1994). Determinants of acquisition integration level: A decision-making perspective. Academy of Management Journal. Mississippi State. Pettigrew, A. (1985). The awakening giant continuity and change in ICI. Oxford. Porac, J., & Thomas, H. (1995). Rivalry and the industry model of Scottish knitwear producers. Administrative Science Quarterly, 40, 203–227.

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Prahalad, C. K., & Bettis, R. A. (1986). The dominant logic: A new linkage between diversity and performance. Strategic Management Journal, 7(6), 485–501. Rumelt, R. (1974). Strategy, structure and economic performance (235 pp.). Saunders, A., & Thomas, H. (2000). Financial Institutions Management (2nd Canadian edition). McGraw-Hill Ryerson. Shrivastava, P. (1986). Postmerger integration. The Journal of Business Strategy, 7(1), 65–76. Spender, J. C. (1989). Industry recipes: The nature and sources of managerial judgement. Oxford: Basic Books. Vaughan, F. E. (1979). The awakening intuition. Garden City, NY: Anchor Press.

48

APPENDIX A Shared Cities4

Domestic

Opinion

Civic

Merchant

Industrial

ProjectOriented

Founding Principle

Burst of inspiration

Personal relationships, hierarchy, tradition

Opinion of others

Precedence

Competition

Technical and scientiﬁc method, efﬁciency, performance

Activity, projects, network, and proliferation of links

State of greatness

Spontaneous, unusual

Kind, sensible

Famous, well-known

Representative

Desirable, worth

Efﬁcient, functional

Committed, engaging, mobile

Dignity

Love, passion, creation

Ease, common sense

Desire for consideration

Freedom

Interest

Work

Need for attachment

Repertory of Objects

Spirit, body

Precedence, gifts

Names, brands, messages

Legal form

Wealth

Means

All tools for connecting

Repertory of Subjects

Children, artists

Superiors, subordinates,

Celebrities

Communities

Competitor, customer

Professionals

Mediator, project leader

Investment Formula

Risk

Indebted to

Give up secrecy

Renouncing the particular and personal

Opportunism

Investment, progress

Adaptability

JOANNE M. ROCH

Inspiration

Peculiarity

Subordination, honor

Identiﬁcation

Membership, delegation

Possession

Mastery

Redistribution of connections

Relations between Subjects

Dream, imagine

Educate, reproduce

Persuasion

Gathering for collective endeavor

Interested business relationships

Function

Connection

Harmonious Fig.

Imaginary

Family, setting

Audience

Republic

Market

System

Network

Ideal Event

Interior adventure

Family ceremony

Event presentation

Demonstration for a worthy cause

Business, done deal

Test

End of one project and the start of another

Method for Expressing Judgment

Flash of genius

Appreciation

Judgment of the opinion

Electoral outcome

Price

Effective, correct

Be called on to participate

Form of Proof

Certitude of inspiration

Example

Success, being known

Legal text

Money, proﬁt

Measurement

State of pettitness

Routine

Unashamed, vulgar

Commonplace, unknown

Divided, isolated

Ineffectual loser

Ineffectual

A New Way to Look at the Integration Challenge

Relation between degrees of greatness

Unengaging

49

50

JOANNE M. ROCH

APPENDIX B Trends in Customer Referrals (Bank to brokerage subsidiaries) – 1995–2000.

IMPACT OF CULTURAL DIFFERENCES ON MERGER AND ACQUISITION PERFORMANCE: A CRITICAL RESEARCH REVIEW AND AN INTEGRATIVE MODEL G¨unter K. Stahl and Andreas Voigt ABSTRACT This paper provides a review of theoretical perspectives and empirical research on the role of culture in mergers and acquisitions [M&A], with a particular focus on the performance implications of cultural differences in M&A. Despite theoretical and anecdotal evidence that cultural differences can create major obstacles to achieving integration beneﬁts, empirical research on the performance impact of cultural differences in M&A yielded mixed results: while some studies found national or organizational cultural differences to be negatively related to measures of M&A performance, others observed a positive relationship or found cultural differences to be unrelated to M&A performance. We offer several explanations for the inconsistent ﬁndings of previous research on the performance impact of cultural differences in M&A and develop a model that synthesizes our current understanding of the role of culture in M&A. We conclude that the relationship between cultural differences and M&A performance is more complex than

Advances in Mergers and Acquisitions Advances in Mergers and Acquisitions, Volume 4, 51–82 Copyright © 2005 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1479-361X/doi:10.1016/S1479-361X(04)04003-7

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¨ GUNTER K. STAHL AND ANDREAS VOIGT

previously thought and propose that, rather than asking if cultural differences have a performance impact, future research endeavors should focus on how cultural differences affect M&A performance. The “cultural distance” hypothesis, in its most general form, suggests that the difﬁculties, costs, and risks associated with cross-cultural contact increase with growing cultural differences between two individuals, groups, or organizations (Hofstede, 1980). Cultural distance, as measured in terms of differences in management style, business practices or work-related values, has been shown to have a profound impact on processes such as the choice of foreign entry mode and the perceived ability to manage foreign operations (e.g. Kogut & Singh, 1988), organizational learning across cultural barriers (e.g. Barkema, Bell & Pennings, 1996), the longevity of global strategic alliances (e.g. Parkhe, 1991), and cross-cultural adjustment and effectiveness of expatriate managers (e.g. Black, Mendenhall & Oddou, 1991). In the context of mergers and acquisitions [M&A], it has often been argued – but less often been researched – that cultural differences can be a source of confusion, hostility and distrust between the members of merging organizations (e.g. Buono & Bowditch, 1989; Cartwright, 1997; Krug & Nigh, 2001; Olie, 1990), and a major contributor to the high failure rates reported in M&A literature (see Datta, Pinches & Narayanan, 1992; King, Dalton, Daily & Covin, 2004 for meta-analyses of postacquisition performance research). In a survey of more than 200 chief executives of European companies conducted by Booz, Allen and Hamilton, respondents ranked the ability to integrate culturally as more important to the success of acquisitions than ﬁnancial and strategic factors (cited in Cartwright & Cooper, 1996, p. 28). Problems may be exacerbated in international settings. Cross-border M&A are difﬁcult to integrate because they require what Barkema and his colleagues have called “double layered acculturation” (Barkema et al., 1996, p. 151), whereby not only different corporate cultures, but also different national cultures have to be combined. Fundamentally different values, goals and beliefs concerning what constitute appropriate organizational practices may lead to conﬂicts and political struggles, and limit the potential for trust to emerge between the parties involved in an M&A (Elsass & Veiga, 1994; Olie, 1990; Stahl & Sitkin, 2005). In international settings, such conﬂicts tend to be fueled by cultural stereotypes, increasing nationalism or even xenophobia (Vaara, 2001, 2003). Foreign language barriers, different legal systems and administrative practices, and other aspects of organizational life that differ between countries pose additional obstacles to integrating the different cultures and workforces in cross-border M&A. Not surprisingly, a survey of top managers in large European acquirers showed that

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61% of them believed that cross-border acquisitions are riskier than domestic ones (Angwin & Savill, 1997). Despite anecdotal claims that cultural differences create major obstacles to successful integration in M&A, the empirical research evidence is mixed (Schoenberg, 2000; Schweiger & Goulet, 2000; Teerikangas & Very, 2003). While some studies found national or organizational cultural differences to be negatively related to different measures of M&A performance, others found cultural differences to be unrelated or even positively related to the success of M&A. These ﬁndings suggest that the relationship between cultural differences and M&A performance is more complex than how it is portrayed in M&A literature. More conceptual and empirical work is needed to examine how cultural differences affect the post-combination integration process and to determine which variables moderate the effects of cultural differences on M&A performance. We begin with a discussion of our current understanding of the role of cultural differences in M&A, followed by a review of previous studies that examined the impact of cultural differences on three types of M&A outcome measures: accounting-based performance measures, stock market returns, and socio-cultural integration outcomes. We will offer several explanations for the inconsistent ﬁndings that emerge from this review, and present a framework for studying the role of cultural differences in M&A that synthesizes the extant research in this area. We will conclude with a discussion of avenues for future research on the role of culture in M&A.

THEORETICAL PERSPECTIVES ON THE ROLE OF CULTURE IN MERGERS AND ACQUISITIONS Various theories and models have been proposed to explain the role of culture in M&A and how cultural differences may affect the integration process following M&A. The Appendix provides a synopsis of the most widely used theories and models. They can be grouped into three categories: cultural ﬁt models, acculturation models, and models adopting a social constructivist perspective on culture. Each of them is discussed below.

The Cultural Fit Perspective Cultural ﬁt models rest on the idea that the degree of culture compatibility between the organizations involved in a merger or an acquisition is a critical determinant of the subsequent integration process (Cartwright & Cooper, 1996; David & Singh,

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¨ GUNTER K. STAHL AND ANDREAS VOIGT

1994; Javidan & House, 2002; Morosini & Singh, 1994). Cultural ﬁt models focus mainly on the relationship between pre-merger cultural differences (both national and organizational) and post-merger integration outcomes. They are inherently static and do not fully capture the dynamics of the integration process. Perhaps the most widely cited cultural ﬁt model is Cartwright and Cooper’s (1993, 1996) model of culture compatibility in M&A. The model is based on a typology of organizational cultures that vary along a continuum from high to low individual constraint: power, role, task, and person cultures, with the former imposing the highest and the latter imposing the lowest degree of constraint on individuals. Cartwright and Cooper propose that in mergers of equals (“collaborative marriages”), the cultures of the combining ﬁrms must be similar or adjoining types (e.g. role and task cultures) in order to integrate successfully. The logic is that if there is a balance of power, the organizations involved in the merger have to adapt to each other’s culture and create a coherent “third culture.” Since organizations normally strive to retain their own culture, mergers between culturally distant partners are proposed to result in major integration problems. In the case of an asymmetrical relationship (“traditional marriages”), Cartwright and Cooper propose that the impact of cultural differences depends primarily on the direction of the culture change, rather than the cultural distance between the acquirer and the target. If the degree of individual constraint increases as a result of the takeover (e.g. a ﬁrm with a task culture is acquired by one with a power culture), this is likely to lead to employee resistance and major integration problems. The important contribution of cultural ﬁt models such as the one proposed by Cartwright and Cooper (1996) is that they illustrate that cultural differences can pose signiﬁcant barriers to achieving integration beneﬁts, and that they have to be considered at an early stage of the M&A process – as early as the evaluation and selection of a suitable target and the planning of the integration process.

The Acculturation Perspective Another perspective centers on the acculturation process (Elsass & Veiga, 1994; Larsson & Lubatkin, 2001; Nahavandi & Malekzadeh, 1988; Sales & Mirvis, 1984), rather than on stable cultural differences between the parties involved in an M&A. In anthropology, the term “acculturation” is deﬁned as “changes induced in (two cultural) systems as a result of the diffusion of cultural elements in both directions” (Berry, 1980, p. 215). In the context of M&A, Larsson and Lubatkin (2001) deﬁne acculturation as the outcome of a cooperative process whereby the beliefs, assumptions and values of two previously independent work forces form a jointly determined culture. Acculturation is achieved through development of

Impact of Cultural Differences on Merger and Acquisition Performance

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a common organizational language, mutual consideration, and values promoting shared interests. As such, acculturation can be considered a prerequisite for M&A success, especially when high levels of integration are required. In contrast to Larsson and Lubatkin’s (2001) conceptualization of acculturation as an inherently cooperative process, it has been suggested that acculturation outcomes can be positive or negative (Elsass & Veiga, 1994; Nahavandi & Malekzadeh, 1988; Sales & Mirvis, 1984). Nahavandi and Malekzadeh’s (1988) model of acculturative stress proposes that the degree of congruence between the acquiring and acquired ﬁrms’ preferred modes of acculturation will affect the amount of stress and conﬂict experienced during the acculturation process. According to this model, the acquired ﬁrm’s preferred acculturation mode depends on the extent to which organizational members want to preserve their own cultural identity and to which they feel attracted to the acquirer’s culture. The acquiring ﬁrm’s preferred acculturation mode is largely determined by its diversiﬁcation strategy and tolerance for diversity. The model suggests a variety of factors that moderate the impact of cultural differences on post-acquisition integration outcomes, most notably the acquirer’s diversiﬁcation strategy and the integration mode chosen. If the level of attempted integration is high, this is proposed to result in acculturative stress and disruptive culture clashes, as the members of the acquired organization struggle to preserve their cultural identity. Consistent with the Nahavandi and Malekzadeh model, a longitudinal casestudy conducted by Mirvis and Sales (1990) suggests that the outcome of the acculturation process depends on the extent to which the acquired ﬁrm is allowed to determine its preferred mode of acculturation, to which the relationships between the members of the two companies are positive and involve reciprocity, and to which the acquired ﬁrm desires to retain its own cultural identity.

The Social Constructivist Perspective While the extant cultural ﬁt and acculturation models rest on a predominantly functionalist and objectivist understanding of culture (Morgan & Smircich, 1980), social constructivists view culture as based on shared or partly shared patterns of interpretation which are produced, reproduced, and continually changed by the people identifying with them (e.g. Kleppestø, 1998; Vaara, 2002). This perspective emphasizes symbolization and communication processes and sees culture as an essentially dynamic and emergent phenomenon that comes into existence in relation to and in contrast with another culture (Gertsen, Søderberg & Torp, 1998).

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Kleppestø (1993) deﬁnes culture as “constantly ongoing attempt of the collective to deﬁne itself and its situation” (cited by Gertsen et al., 1998, p. 33). This view of culture as an interpretative and evolving process rather than a stable system of norms and values differs markedly from Hofstede’s (1980) widely cited deﬁnition of culture as “collective mental programming.” According to Kleppestø (1998, 2005), each organization consists of numerous individuals with distinct self-identities that are socially produced and that help create meaning at both the individual and collective level. Organizational culture is seen as a process by which distinct organizational identities are created and maintained. Cultural contact can then be understood as a confrontation between different organizational self-images and interpretation patterns which develop and unfold in interaction with one another. Building on social identity theory (Tajfel, 1982; Turner, 1982), the social constructivist position suggests that the problems surrounding the integration process after M&A may be best understood in terms of in-group out-group bias and a quest for social identity. Under this perspective, the exaggerated view of differences and lack of attention to similarities that can often be observed in M&A can be interpreted as a sense-making mechanism: “we” cannot establish an identity without stressing “our” uniqueness and “their” otherness (Kleppestø, 1998, 2005). In summary, extant theories and models of the role of culture in M&A have adopted one of three perspectives to explain how cultural differences affect the M&A process: a cultural ﬁt perspective, an acculturation perspective, or a social constructivist perspective. Cultural ﬁt models are rooted in a functionalist and objectivist understanding of culture as relatively stable system of norms, values, and behavior patterns. In contrast, the social constructivist perspective emphasizes cultural transformation processes during which organizational self-images develop and change through interaction, so that new socially negotiated cultural identities are being formed. Cultural ﬁt and acculturation models highlight the inherent potential of M&A for culture clash and the need for cultural assessment to predict and minimize integration problems. Social constructivists take a more nuanced view in suggesting that it is not cultural differences per se that create problems in M&A but rather the way cultural boundaries are drawn and managed. Under this perspective, analysis of pre-combination cultural differences has little prognostic value in predicting M&A outcomes. Despite fundamental differences between the three paradigms, the cultural ﬁt, acculturation, and social constructivist perspectives seem to converge on the assumption that cultural issues cannot be considered in isolation from other aspects of the integration process, such as the integration approach taken by the acquirer, the degree of retained autonomy on the part of the acquired ﬁrm, and the interventions chosen to manage cultural differences.

Impact of Cultural Differences on Merger and Acquisition Performance

57

THE PERFORMANCE IMPACT OF CULTURAL DIFFERENCES IN MERGERS AND ACQUISITIONS: A RESEARCH REVIEW While theoretical models of the role of culture in M&A emphasize the “dark side” of cultural diversity, empirical research evidence indicates that cultural differences, under some conditions, may be an asset rather than a liability in M&A (see Schoenberg, 2000; Schweiger & Goulet, 2000; Teerikangas & Very, 2003 for reviews). To explain the lack of consensus that emerged from previous research on the role of culture in M&A, we conducted a comprehensive review of studies that examined the performance impact of cultural differences in M&A, with the goal of identifying key moderators of the culture-performance relationship. It was hoped that a research review that is sensitive to potential moderating effects, as well as differences in research design characteristics between studies, would shed light on the complexity of the process by which cultural differences affect M&A outcomes. Using multiple search strategies (including computerized searches of various databases, manual searches of published materials, and consultation of M&A researchers to identify unpublished research), we identiﬁed a total of 36 empirical studies with a combined sample size of 9,431 M&A, which had been consummated over a 50-year period. The majority of the studies had been published in academic journals while the rest were doctoral dissertations, book chapters, and unpublished working papers. For the purpose of this research review, we grouped the identiﬁed studies into three categories, based on the M&A outcome variable that was examined (Stahl & Voigt, 2004): Studies using accounting-based measures, such as return on assets, return on equity, and sales growth. These measures evaluate the relatively long-term performance of an M&A and thus capture whether envisaged synergies could be reached. Studies using stock market-based measures. These measures reﬂect the investment communities’ evaluations of the immediate and longer term impacts of the M&A. They are usually measured around the time of the announcement of the deal and can thus be considered a predictor of future performance. If measured some time after the announcement, stock market returns may reﬂect actual performance. As additional information about the M&A and its success or failure becomes known, it is usually assimilated by the market and the value of the ﬁrm is affected (Datta et al., 1992).

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¨ GUNTER K. STAHL AND ANDREAS VOIGT

Studies examining socio-cultural integration outcomes, such as employee satisfaction, voluntary turnover, and acculturative stress. These variables capture the degree of conﬂict and strain at the socio-cultural level and can thus be considered an important dimension of M&A success and failure from the perspective of the employees and the organization as a whole. Next, we will summarize the key ﬁndings of studies that examined the impact of cultural differences on the three types of M&A outcome measures.

Impact of Cultural Differences on Accounting-Based Performance Measures We identiﬁed 18 studies that examined the impact of cultural differences on accounting-based measures of post-acquisition performance. Table 1 summarizes the key ﬁndings of these studies. Consistent with the “cultural distance” hypothesis, eight of the studies found a negative relationship between cultural differences and M&A performance. Organizational cultural differences were found to be negatively related to various accounting measures in samples of domestic M&A (Datta, 1991; Datta, Grant & Rajagopalan, 1991; Weber & Pliskin, 1996). A negative relationship between organizational cultural differences and postacquisition performance could be observed under conditions of low and high integration levels (Datta, 1991), and was most pronounced when the degree of autonomy given to the target ﬁrm was low (Datta et al., 1991). Consistent with Datta et al. (1991), Very, Lubatkin, Calori and Veiga (1997) found that cultural incompatibility had the most negative impact on post-acquisition performance when autonomy was removed from the target. In contrast, Schoenberg (1996), in a study of cross-border acquisitions, found that cultural differences were negatively associated with post-acquisition performance regardless of the integration approach taken. This negative relationship could only be observed for acquisitions in the service industry but not in manufacturing. Contrary to expectations, several studies revealed a positive relationship between cultural differences and M&A performance. Krishnan et al. (1997), in a study of domestic acquisitions, found organizational cultural differences to be positively related to accounting-based measures of post-acquisition performance. This is consistent with a study conducted by Zollo (2002), who found that organizational cultural differences were signiﬁcantly and positively associated with accounting returns of the combined organization, measured over a three year period. In a similar vein, Morosini, Shane and Singh (1998), in a survey of cross-border acquisitions, found that national cultural differences enhanced post-acquisition

Impact of Cultural Differences on Merger and Acquisition Performance

59

Table 1. Studies Examining the Impact of Cultural Differences on Accounting-Based Measures. Author(s) and Year

Sample

Cultural Dimension

Performance Measure

Impact of Cultural Differencesa

Anand, Capron and Mitchell (2003) Barkema, Bell and Pennings (1996) B¨uhner (1991)

Mixed

Domestic vs. cross-border

Performance index

n.s.

/

Crossborder

Hofstede index

Return on equity

Pos.c

/

Mixed

Proﬁtability

Neg.

Datta (1991)

Domestic

Performance index

Neg.

Datta, Grant and Rajagopalan (1991)

Domestic

Domestic vs. cross-border Differences in management style Management style incompatibility

Performance index

Neg.

Krishnan, Miller and Judge (1997)

Domestic

Return on assets

Pos.

Larsson and Finkelstein (1999)

Mixed

Dissimilarities in functional backgrounds between top management teams Management style dissimilarity Domestic vs. cross-border Corporate cultural differences

Synergy realization

n.s.

Integration leveld

n.s.

Employee resistanced /

Larsson and Risberg (1998)

Lubatkin, Calori, Very and Veiga (1998) Morosini, Shane and Singh (1998) Schoenberg (1996)

Domestice

Crossbordere Mixed

Synergy realization

n.s.f

Moderator(s) Identiﬁedb

Owner control /

Degree of target autonomy removal /

Pos.f Domestic vs. cross-border

Growth in sales

n.s.

/

Crossborder

Hofstede index

Growth in sales

Pos.

/

Crossborder

Differences in management style

Performance index

Neg.

Industry

¨ GUNTER K. STAHL AND ANDREAS VOIGT

60

Table 1. (Continued ) Author(s) and Year

Sample

Cultural Dimension

Performance Measure

Impact of Cultural Differencesa

Moderator(s) Identiﬁedb

Schoenberg (2004)

Crossborder

Differences in management style

Performance index

Neg.g

Cultural measures Integration Approach Trust

Neg.

Domestic vs. cross-border

Sales growth and realized proﬁts Performance index

n.s.

Nationality of target

Mixed

Cultural incompatibility

Performance index

Neg.

Weber (1996)

Domestic

Corporate cultural differences

Return on assets

n.s.

Weber and Pliskin (1996)

Domestic

Performance index

Neg.

Zollo (2002)

Mixed

Corporate cultural differences Corporate cultural differences

Degree of target autonomy removal Nationality of Target Degree of target autonomy removal /

Performance index

Pos.

/

Stahl, Kremershof and Larsson (2004) Very, Lubatkin and Calori (1996) Very, Lubatkin, Calori and Veiga (1997)

Mixed

Organizational cultural differences

Mixed

Notes:

Neg. = negative and statistically signiﬁcant; n.s. = non-signiﬁcant; Pos. = positive and statistically signiﬁcant; b / = no moderator identiﬁed; c Based on data of acquisitions only (joint-ventures were excluded); data was provided by ﬁrst author on request; d Mediated effect (see text); e Results separately reported for sub-samples; f No signiﬁcance levels reported, but differences were considered meaningful by authors; g Differences in attitude towards risk were negatively related to performance; differences in other dimensions of management style were unrelated to performance. a

performance by providing access to the target’s or acquirer’s diverse set of routines and capabilities. Other studies found cultural differences to be unrelated to accounting-based performance measures, but found evidence of mediating or moderating effects. For

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example, Weber (1996), in a study of U.S. M&A in banking and manufacturing, observed a moderating effect of autonomy removal on the relationship between cultural differences and target ﬁrms’ ﬁnancial performance. The same study found a positive effect of autonomy removal on ﬁnancial performance but a negative effect on commitment, suggesting that “related mergers with higher levels of autonomy removal outperform related mergers with lower autonomy removal in spite of the associated human resource problems” (pp. 1197–1198). Other studies suggest that integration process variables such as the level of integration or the use of social integration mechanisms may mediate the effects of cultural differences on M&A performance. For example, Larsson and Finkelstein (1999) found that the effects of organizational cultural differences on synergy realization were mediated by the level of organizational integration and employee resistance, suggesting that cultural differences affect M&A performance primarily through the process of socio-cultural integration.

Impact of Cultural Differences on Stock Market-Based Performance Measures As in the review of studies of accounting-based performance measures, no clear pattern of effects emerged from the review of studies that examined the impact of cultural differences on stock market performance. Table 2 summarizes the results of the 13 studies identiﬁed through the literature search. Only two of them found evidence of a negative impact of cultural differences on stock market returns. Datta and Puia (1995) found acquiring ﬁrms’ cumulative excess returns to be negatively associated with national cultural distance in a sample of cross-border acquisitions. Chatterjee, Lubatkin, Schweiger and Weber (1992), in a study of domestic acquisitions, observed a negative relationship between organizational cultural differences and acquiring ﬁrms’ cumulative abnormal returns. Interestingly, acquirer’s multiculturalism (i.e. the degree to which the acquirer tolerates the acquired ﬁrm’s culture) was positively related to abnormal returns, suggesting that the degree of cultural tolerance exhibited by the acquirer may be more important in determining the success of an acquisition than preacquisition cultural differences. In direct contradiction to the “cultural distance” hypothesis, six studies found a positive relationship between cultural differences and stock market performance. For example, in a study by Harris and Ravenscraft (1991), target ﬁrms’ cumulative abnormal returns were higher in cross-border acquisitions than in domestic ones, suggesting that national cultural differences do not always have a negative impact on M&A performance. This is consistent with Swenson (1993), Wansley, Lane

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Table 2. Studies Examining the Impact of Cultural Differences on Stock Market-Based Measures. Author(s) and Year

Sample

Cultural Dimension

Performance Measure

Impact of Cultural Differencesa

Moderator(s) Identiﬁedb

Bessler and Murtagh (2002) B¨uhner (1991)

Mixed

Domestic vs. cross-border Domestic vs. cross-border Corporate cultural differences

Cumulative abnormal returns Cumulative abnormal returns Cumulative abnormal returns

n.s.

Industry

Pos.

Neg.

Owner control Acquisition experience /

Cross-border

Hofstede index

Neg.

/

Dewenter (1995)

Mixed

Eddy and Seifert (1984)

Mixed

Harris and Ravenscraft (1991)

Mixed

Domestic vs. cross-border Domestic vs. cross-border Domestic vs. cross-border

Cumulative excess returns Cumulative abnormal returns Stock prices and dividends Average bid premiums

Markides and Ittner (1994)

Cross-border

Hofstede index

n.s.

Markides and Oyon (1998)

Cross-border

Masculinity

Olie and Verwaal (2004) Swenson (1993)

Cross-border

Hofstede index

Mixed

Domestic vs. cross-border

Cumulative abnormal returns Cumulative Abnormal returns Cumulative abnormal returns Cumulative abnormal returns

Chatterjee, Lubatkin, Schweiger and Weber (1992) Datta and Puia (1995)

Mixed

Domestic

n.s.

n.s.c

Pos.

n.s.

Hostile target maneuvering Rival bidders /

Industry Strength of acquirer’s home currency relative to the dollar /

/

Pos.

Host country experience

Pos.

Target growth rate Target’s price-earnings ratio Likelihood of competition

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Table 2. (Coninued ) Author(s) and Year

Sample

Cultural Dimension

Performance Measure

Impact of Cultural Differencesa

Wansley, Lane and Yang (1983) Zollo (2002)

Mixed

Domestic vs. cross-border Corporate cultural differences

Cumulative abnormal returns Cumulative abnormal returns

Pos.

Notes:

Mixed

Pos.

Moderator(s) Identiﬁedb

/

Time of measurement

Neg. = negative and statistically signiﬁcant; n.s. = non-signiﬁcant; Pos. = positive and statistically signiﬁcant; b / = no moderator identiﬁed; c The original study reported a nonsigniﬁcant effect based on estimated beta coefﬁcients for a market model; however, based on the reported mean differences, a negative and signiﬁcant correlational effect size was calculated.

a

and Yang (1983), and Olie and Verwaal (2004), whose ﬁndings suggest that crossborder acquisitions may generate higher returns than domestic ones. However, several studies (e.g. Dewenter, 1995; Eddy & Seifert, 1984; Markides & Ittner, 1994) found acquirers’ stock market performance to be unrelated to national cultural differences, thus making it impossible to draw any ﬁrm conclusion about the relationship between cultural differences and stock market returns. In interpreting these ﬁndings, it is important to note that seven of the thirteen studies that examined the impact of cultural differences on stock market performance used a dichotomous measure of domestic versus cross-border M&A as a proxy for national cultural differences. In these studies, the effects of national cultural differences are confounded with the effects of other variables on which international M&A differ from domestic ones. Rather than assuming a causal effect of cultural differences on stock market returns, a more likely explanation is that the investment communities evaluate cross-border M&A differently (in some instances, more favorably) than domestic deals, e.g. because they open up new foreign market opportunities, provide greater economies of scale, and so forth.

Impact of Cultural Differences on Socio-Cultural Integration Outcomes Table 3 summarizes the results of 14 studies that examined the relationship between cultural differences and socio-cultural integration outcome variables, such as employee stress, commitment, and voluntary turnover. Only one of them (Krishnan et al., 1997) found unambiguous evidence of a positive relationship between cultural differences, measured in terms of dissimilarities in functional backgrounds

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64

Table 3. Studies Examining the Impact of Cultural Differences on Socio-Cultural Integration Outcomes. Author(s) and Year

Sample

Cultural Dimension

Performance Measure

Impact of Cultural Differencesa

Krishnan, Miller and Judge (1997)

Domestic

Top management turnover

Pos.

Krug and Hegarty (1997) Krug and Hegarty (2001) Krug and Nigh (1998)

Mixed

Dissimilarities in functional backgrounds between top management teams Domestic vs. cross-border Domestic vs. cross-border Hofstede Index

Top management turnover Top management turnover Top management turnover

Neg.

Larsson and Finkelstein (1999)

Mixed

Management style dissimilarity Domestic vs. Cross-border Domestic vs. cross-border Corporate cultural differences

Employee resistance

Neg.

Larsson and Lubatkin (2001) Larsson and Risberg (1998)

Mixed Cross-Border

Mixed Domesticd

Cross-borderd

Lubatkin, Schweiger and Weber (1999) Schoenberg (2004)

Stahl, Kremershof and Larsson (2004)

Domestic

Cross-border

Mixed

Corporate cultural differences Differences in management style Organizational cultural differences

Neg.

Moderator(s) Identiﬁedb

/

Combination year c

Neg.

Relative standing of target executives International and country-speciﬁc acquisition experience /

Neg. Degree of acculturation Degree of acculturation Employee resistance Degree of acculturation Employee resistance Top management turnover

n.s. Neg.e

Nationality of acquirer /

Neg.e Pos.e Neg.e Neg.

Combination year industry

Top management turnover

Neg.c

/

Trust, job satisfaction, commitment, acceptance of change, intention to stay, willingness to cooperate, Job performance, and open communication

Neg.

/

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Table 3. (Continued ) Author(s) and Year

Sample

Cultural Dimension

Performance Measure

Impact of Cultural Differencesa

Moderator(s) Identiﬁedb

Van Oudenhoven and van der Zwee (2002)

Cross-border

Cooperation success

Neg.g

Country-speciﬁc acquisition experience

Very, Lubatkin and Calori (1996) Weber (1996)

Mixed

National and corporate cultural differences Domestic vs. cross-border Corporate cultural differences

Acculturative stress

n.s.

Effectiveness of integration process

Neg.

Attractiveness of acquirer’s culture /

Top management commitment Top management commitment, cooperation, stress, and negative attitudes toward organization

Neg.

Weber, Shenkar and Raveh (1996)

Notes:

Domestic

Domesticd

Corporate cultural differences

Cross-borderd

Corporate cultural differences Hofstede dimensionsf

Neg.

Degree of target autonomy removal

Pos.

Pos.

Neg. = negative and statistically signiﬁcant; n.s. = non-signiﬁcant; Pos. = positive and statistically signiﬁcant; b / = no moderator identiﬁed; c Data provided by the author(s) on request; d Results separately reported for sub-samples of study; e No signiﬁcance levels reported, but differences were considered meaningful by authors; f The four Hofstede dimensions were analyzed separately; g Based on data of acquisitions only (joint-ventures and strategic alliances were excluded); data was provided by ﬁrst author on request.

a

between the top management teams of the two companies, and socio-cultural integration outcomes (in this case, top management turnover). Weber, Shenkar and Raveh (1996) found national cultural differences to be positively associated with various aspects of the socio-cultural integration process in a sample of crossborder M&A, but found organizational cultural differences to be negatively related to socio-cultural integration outcomes in a sample of domestic M&A. The same pattern emerged in a case survey conducted by Larsson and Risberg (1998). Largely consistent with these ﬁndings, Very et al. (1996), in a study of acculturative stress in European cross-border M&A, observed that national cultural differences elicited perceptions of attraction rather than stress, depending on the nationalities of the buying and acquiring ﬁrms. As indicated by Table 3, the bulk of empirical studies found a negative relationship between cultural differences and socio-cultural integration outcomes.

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For example, Weber (1996), in a study of U.S. acquisitions, found that differences in corporate culture were negatively associated with target ﬁrm managers’ level of commitment and the perceived effectiveness of the integration process. Largely consistent with Weber (1996), research conducted by Larsson and his colleagues suggest that differences in organizational culture lead to employee resistance and poor acculturation outcomes, and may thus create obstacles to synergy realization (Larsson & Finkelstein, 1999; Larsson & Risberg, 1998). A sizable number of studies have documented a negative effect of cultural differences on top management turnover. Lubatkin, Schweiger and Weber (1999) found that organizational cultural differences were associated with higher top management turnover in the ﬁrst year after acquisition. Krug and his colleagues observed a similar effect in both domestic and cross-border acquisitions (Krug & Hegarty, 1997, 2001; Krug & Nigh, 1998). In general, executives were more likely to depart when their ﬁrm was acquired by a foreign ﬁrm, as opposed to a domestic ﬁrm. The negative impact of cultural differences on turnover was less pronounced in the short-term when the acquirer had international acquisition experience, and it was less pronounced in the long-term when the acquirer’s acquisition experience was in the target’s home country (Krug & Nigh, 1998). However, cultural distance was only one of several factors that affected turnover in these studies. For example, executives were more likely to stay when they were offered challenging positions with greater status and when they viewed the long-term effects of the combination to be positive (Krug & Hegarty, 2001). Interestingly, the accumulated research evidence suggests that in cross-border M&A, cultural differences may have a positive effect on aspects of the sociocultural integration process such as the cultural sensitivity and tolerance exhibited by the acquiring ﬁrm managers (Larsson & Risberg, 1998; Very et al., 1996; Weber et al., 1996). In contrast, (organizational) cultural differences were generally found to have a negative impact in domestic settings. The only exception is the Krishnan et al. (1997) study, which used a cultural distance measure that is incompatible with the ones used in other studies, namely dissimilarities in functional backgrounds between top managers. These ﬁndings support the conclusion that national cultural differences are more salient than organizational cultural differences, thereby increasing managers’ awareness of the signiﬁcance of cultural factors in the integration process and possibly leading to more culturally sensitive integration management (Larsson & Risberg, 1998; Schweiger & Goulet, 2000; Teerikangas & Very, 2003). In summary, the foregoing research review suggests that cultural differences are more closely associated with socio-cultural integration outcomes than ﬁnancial performance measures. However, it is important to note that the studies included in the literature review differ widely in terms of sample characteristics, geographic

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67

regions covered, methodologies used, dimensions of cultural differences examined, and degree of control for potential moderators, thereby making it difﬁcult to draw any ﬁrm conclusion about the impact of cultural differences on M&A outcomes.

IMPACT OF CULTURAL DIFFERENCES ON MERGER AND ACQUISITION PERFORMANCE TENTATIVE EXPLANATIONS AND AN INTEGRATIVE MODEL Several possible explanations for the lack of consensus that emerged from previous research on the performance impact of cultural differences in M&A have been offered (e.g. Cartwright, 1997; Gertsen et al., 1998; Schoenberg, 2000; Schweiger & Goulet, 2000), and sources of complexity underlying the culture-performance relationship in M&A have been discussed (Teerikangas & Very, 2003). Building on and extending this research, we will offer several explanations for the anomalies observed in previous research on the performance impact of cultural differences in M&A and develop a framework that synthesizes our current understanding of the role of culture in M&A.

The Impact of Cultural Differences Depends on the Outcome Variable Examined M&A performance can be assessed in various ways. While the majority of existing post-acquisition performance research uses stock market-based measures, researchers have also relied on accounting measures to evaluate post-acquisition performance (see Datta et al., 1992; King et al., 2004 for meta-analyses). Recently, M&A researchers have called for a more inclusive deﬁnition of M&A success that also encompasses non-ﬁnancial variables in order to overcome some of the problems associated with accounting- and stock market-based measures, to facilitate cumulating research across disciplines, and to bring the dependent variable of interest closer to the phenomenon under investigation (Larsson & Finkelstein, 1999; Schweiger & Walsh, 1990). For the purpose of this review, we expanded the deﬁnition of M&A success to include socio-cultural integration outcome measures. They capture the degree of conﬂict and strain at the sociocultural level and represent an often neglected, but critical indicator of M&A success and failure from the perspective of the employees and the organization as a whole. Accounting-based performance measures, stock market returns, and sociocultural integration outcome measures represent very different dimensions of

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M&A success. How the investment communities react to the announcement of a merger or an acquisition may differ signiﬁcantly from the reactions of employees or customers – if for no other reason than the interests of these constituencies are different, and sometimes at odds. Also, these measures vary in terms of unit of analysis (individuals or groups versus the organization), the objectivity and reliability of measurement (self-report measures or objective data), and time of measurement (assessed shortly or some time after the announcement). Thus, they may share little common variance. Of the three categories of M&A outcome variables considered in the present research review, socio-cultural integration outcomes were the ones most strongly and consistently related to cultural differences. In contrast, accountingand stock market-based measures of post-acquisition performance showed no clear pattern of correlations with cultural differences. This ﬁnding is not surprising, as socio-cultural integration outcomes are much closer to the phenomenon under investigation than ﬁnancial performance measures.

Cultural Issues Cannot be Viewed in Isolation from Other Variables M&A performance may be subject to many other inﬂuences aside from those that arise from cultural differences. Variables that potentially moderate the relationship between cultural differences and M&A performance, and that must be controlled for in studies of the performance impact of cultural differences in M&A, include the degree of relatedness and the integration level chosen (e.g. Datta, 1991; Larsson & Lubatkin, 2001), differences in power and size (e.g. Larsson & Finkelstein, 1999; Schoenberg, 1996), the degree of retained autonomy on the part of the acquired ﬁrm (e.g. Datta & Grant, 1990; Haspeslagh & Jemison, 1991), the mode of takeover (e.g. Hambrick & Cannella, 1993; Stahl, Chua & Pablo, 2003), prior acquisition experience of the acquirer (e.g. Finkelstein & Haleblian, 2002; Singh & Zollo, 2004), and the interventions chosen to manage cultural differences (e.g. Cartwright & Cooper, 1996; Stahl, Pucik, Evans & Mendenhall, 2004). Based on the present research review, the single most important factor inﬂuencing the relationship between cultural differences and M&A performance is the degree of relatedness between the acquiring ﬁrm and the acquired ﬁrm, which, in turn, determines the level of integration, the extent of inter-ﬁrm contact, and the degree of retained autonomy and change in the acquired ﬁrm (Pitkethly, Faulkner & Child, 2003). M&A can be part of a strategy of related diversiﬁcation in which the acquired business is expected to provide new resources, product lines, and managerial expertise, or foster growth through unrelated diversiﬁcation with no intention of achieving synergies (Chatterjee et al., 1992; Haspeslagh & Jemison, 1991; Larsson & Finkelstein, 1999). While more closely related M&A

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usually require a higher degree of operational integration, integration efforts in unrelated M&A tend to be minimal. Cultural differences are unlikely to be as critical an issue for M&A that require low levels of integration due to minimal interdependencies between the acquiring and target ﬁrms’ businesses (Javidan & House, 2002; Larsson & Lubatkin, 2001).

Shift in Focus from the Initial Conditioning Factors to the Integration Process With a few notable exceptions, the theoretical models and empirical studies reviewed in this chapter have taken a rather static approach to understanding the role of culture in M&A. In focusing on either pre-acquisition cultural differences or the situation at the time of the takeover, these models and studies essentially treat integration as a “black box.” In contrast, relatively little attention has been paid to the dynamics of the integration process and the potentially critical role that the acquirer’s integration decisions and actions play in determining the success of an M&A. A “process perspective” on M&A (Birkinshaw, Bresman & H˚akanson, 2000; Haspeslagh & Jemison, 1991; Jemison & Sitkin, 1986) suggests that the extent to which projected synergies are realized in an M&A depends on the ability of the acquirer to manage the integration process in an effective manner. One of the implications of this perspective is that the strategic, ﬁnancial and organizational conditioning factors at the time of the merger or acquisition – including cultural differences – can only predict the long-term success if integration process variables are taken into consideration. While factors such as buyer strategy, acquisition premium paid, or organizational ﬁt determine the value creation potential of an M&A, the acquirer’s integration decisions and actions determine the extent to which that potential is realized (Morosini, 1998; Stahl, Mendenhall, Pablo & Javidan, 2005). Future research on the performance impact of cultural differences in M&A – and management practice as well – would beneﬁt from opening up the “black box” and paying greater attention to the integration processes and management actions that affect M&A success and failure.

Culture as a Multi-Level Construct and Emergent Process The use of non-traditional concepts of culture and multiple measures of cultural differences has consistently been encouraged by M&A scholars (e.g. Gertsen et al., 1998; Teerikangas & Very, 2003; Vaara, 2003) to improve the understanding of

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how various dimensions and levels of culture interact in inﬂuencing the integration process in M&A. Despite the call for a more sophisticated conceptualization of culture and a more ﬁne-grained analysis of cultural differences, the bulk of empirical research relies on a rather simplistic and one-dimensional approach to understanding the performance implications of cultural differences in M&A. Practically all of the studies reviewed in this chapter focused on organizational or national cultural differences (or sometimes both), but few studies looked at other dimensions of cultural differences. This is despite evidence that differences in professional, functional, and industry cultures play a critical role in the M&A process (David & Singh, 1994; Schweiger & Goulet, 2000). The majority of existing M&A integration research has adopted the notion of a monolithic and stable culture, implicitly assuming that all members of an organization share the same cultural orientation and that this orientation is relatively stable over time. M&A researchers have recently challenged both of these assumptions (e.g. Gertsen et al., 1998; Kleppestø, 2005; Schrey¨ogg, 2005; Vaara, 2002), arguing instead that culture is an essentially dynamic and emergent phenomenon that comes into existence in relation to and in contrast with another culture, and that each organization consists of numerous individuals with distinct self-identities that are socially and contextually produced. A more sophisticated understanding of culture in research on the performance impact of cultural differences in M&A would require researchers to focus on multiple levels of analysis, pay attention to the interplay between different culture levels, acknowledge the existence of subcultures within merging organizations, and conceptualize culture as a dynamic and emergent phenomenon.

Towards an Integrative Framework The model depicted in Fig. 1 synthesizes theoretical perspectives and empirical ﬁndings on the role of culture in M&A. It accounts for some of the complexity underlying the culture-performance relationship in M&A and can guide future research by delineating the main mechanisms through which cultural differences may affect M&A performance. Although it is rooted in a predominantly functionalist and objectivist understanding of culture as a relatively stable system of norms, values, and patterns of behavior, it recognizes the existence of multiple layers or dimensions of culture and captures some of the dynamics of the integration process. The model builds on a conceptual split between the sub-processes of task integration (or value creation), measured in terms of transfers of capabilities and resource sharing between the acquiring and the acquired ﬁrm (Birkinshaw et al., 2000); and socio-cultural integration (or human integration), which involves

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Fig. 1. Framework for Studying the Role of Culture in Mergers and Acquisitions. Note: Dotted arrows indicate moderating effects.

generating satisfaction, commitment and a shared identity among the employees from both companies (Birkinshaw et al., 2000; Shrivastava, 1986). Proceeding from left to right, it proposes that cultural differences affect M&A performance through their impact on task integration and socio-cultural integration. Previous research has shown that effective management of these integration sub-processes is critical in determining the extent to which envisaged synergies can be reaped (Haspeslagh & Jemison, 1991; Hitt et al., 2001; Morosini, 1998). To the extent that information about the post-acquisition ﬁnancial performance, as reﬂected in accounting measures such as sales growth and return on assets, is assimilated by the market, the sub-processes of task integration and socio-cultural integration may also affect stock market returns (Datta et al., 1992). Although task integration and socio-cultural integration are conceptually distinct, they are not independent of one another. Aspects of socio-cultural integration such as employee commitment, trust, and shared identity facilitate the transfer of strategic capabilities and resource sharing (Birkinshaw et al., 2000). Successful task integration, in turn, is likely to enhance employee satisfaction, commitment, and the quality of the interpersonal relationships between the

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members of the combining organizations (Haspeslagh & Jemison, 1991; Schweiger & Goulet, 2000). At the same time, it is possible for task integration and socio-cultural integration to diverge, for example, when synergies are realized at the expense of the employees (Cartwright & Cooper, 1996; Marks & Mirvis, 2001). The M&A integration process is subject to several other factors aside from those that arise from cultural differences. The model depicted in Fig. 1 proposes that the sub-processes of task integration and socio-cultural integration are affected by a set of conditioning factors, particularly ones related to the nature of the relationship between the acquirer and the target, as well as integration process variables that are directly related to the acquirer’s integration decisions and actions. Research evidence indicates that factors such as prior acquisition experience of the acquirer (Finkelstein & Haleblian, 2002; Singh & Zollo, 2004), the mode of takeover or social climate surrounding the acquisition (Hambrick & Cannella, 1993; Hitt et al., 2001), the pattern of dominance between the acquiring and the acquired ﬁrm (Jemison & Sitkin, 1986; Pablo, 1994), the socialization mechanisms used by the acquirer (Birkinshaw et al., 2000; Larsson & Lubatkin, 2001), and the quality and quantity of communication (Schweiger & DeNisi, 1991; Stahl & Sitkin, 2005) are all likely to affect the extent to which synergies are realized and a shared identity is established in M&A. In addition to the proposed direct effects on task integration and socio-cultural integration, the conditioning factors and integration process variables proposed by the model constitute potential moderators of the relationship between cultural differences and integration outcomes. Factors such as the degree of relatedness between the acquiring and the acquired ﬁrm, differences in power and size, and the mode of takeover or social climate surrounding an acquisition are likely to moderate the effects of cultural differences on task and socio-cultural integration outcomes. For example, there is evidence to suggest that the potentially negative effects of cultural differences on trust building and the creation of a shared identity are augmented by hostile takeover tactics and imposition of control by the acquirer (Angwin, 2001; Datta & Grant, 1990; Stahl, Chua & Pablo, 2003). Interestingly, the theoretical perspectives and empirical ﬁndings reviewed in this chapter suggest that cultural differences, if properly understood and managed, can be an asset rather than a liability in M&A, and that cultural differences may affect the sub-processes of task integration and socio-cultural integration in different ways. National cultural differences, which are more salient than organizational cultural differences, may increase the awareness of the signiﬁcance of cultural factors in the integration process and lead to more culturally sensitive integration management (e.g. greater use of social integration mechanisms, lower levels of imposed control, etc.). In addition, national cultural differences may enhance the

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combination potential and boost performance by providing access to the target’s or acquirer’s diverse set of practices and capabilities (Morosini et al., 1998). For example, Olie and Verwaal (2004) found that acquisitions in unfamiliar markets can trigger new solutions, foster innovation and enhance the development of technological skills. Thus, cultural differences can be a source of value creation and learning in M&A, but they can also create obstacles to reaping projected synergies by exacerbating social integration problems and diminishing the ﬁrms’ capacity to absorb capabilities from the other party (Stahl, Bj¨orkman & Vaara, 2004).

CONCLUSION This chapter provided a review of theoretical perspectives and empirical research on the role of culture in M&A, with a particular focus on the performance implications of cultural differences in M&A. Consistent with the “cultural distance” hypothesis and extant cultural ﬁt and acculturation models, empirical evidence indicates that national and organizational cultural differences are often associated with negative outcomes at the socio-cultural level, such as increased top management turnover, reduced employee commitment, and acculturative stress. However, the impact of cultural differences on post-acquisition ﬁnancial performance is less clear. While some studies found cultural differences to be negatively associated with accounting- or stock market-based performance measures, others observed a positive relationship or found cultural differences to be unrelated to post-acquisition performance. These ﬁndings lead us to conclude that the relationship between cultural differences and M&A outcomes is more complex than previously thought. Whether cultural differences have a positive or a negative impact on M&A performance, or any performance impact at all, depends on the performance measures examined and is also likely to depend on the nature and extent of cultural differences, the integration approach taken, the interventions chosen to manage cultural differences, and a variety of other factors. Rather than asking if cultural differences have a performance impact in M&A, future research endeavors should focus on how cultural differences affect the integration process, and what other factors facilitate or constrain successful socio-cultural and task integration in M&A.

ACKNOWLEDGMENTS We extend our gratitude to Harry Barkema, Ingmar Bj¨orkman, Chei Hwee Chua, Olivier Irrmann, Philip Goulet, Eero Vaara and Yaakov Weber for their

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helpful comments on earlier drafts of this paper. We would also like to thank Harry Barkema, Laurence Capron, Jeffrey Krug, Constantinos Markides, Richard Schoenberg, and Maurizio Zollo for providing us with unpublished data for inclusion in the research review.

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APPENDIX Theoretical Perspectives on the Role of Culture in Mergers and Acquisitions

Author(s)

Basic Assumptions

Proposed Impact of Cultural Differences

Proposed Moderators

Cartwright and Cooper (1996)

The attractiveness and acceptability of a combination partner’s culture is dependent on whether that culture is perceived as increasing or reducing employee participation and autonomy. The success of traditional combinations depends on accepted assimilation; that of collaborative combinations (e.g. mergers of equals) on smooth integration.

In traditional combinations differences in organizational culture are accepted by the target as long as employee autonomy is increased. Diminishing autonomy may result in strong employee resistance. Cultural differences in collaborative combinations are supposed to lead to integration problems no matter what the direction of cultural change is. The greater the dissimilarity between cultural types, the longer the integration period.

Direction of cultural change Power differential

David and Singh (1994)

Strategic, legal, and cultural issues can be integrated in a multi-level system of sources and loci of cultural differences to determine the degree of acquisition cultural risk. Cultural distance can originate from differences in organisational, professional, or national culture.

Post-acquisition cultural risk varies depending on several contingencies, e.g. divisions and functions of the target ﬁrm. Post-acquisition regimes imposed on the target by the acquiring ﬁrm have a signiﬁcant inﬂuence on integration outcomes as perceptions of injustice (relative deprivation) can easily lead to employee stress and resistance.

External conditions (e.g. legal systems) Integration level Integration mode Post-acquisition regime of acquirer Cultural risk of target ﬁrm operations

Elsass and Veiga (1994)

Organizational acculturation can be described as dynamic interaction between the opposing forces of cultural differentiation (the desire of groups to maintain their cultural identity), and organizational integration (the organizational need for cultural groups to work together).

Cultural differences between combining organizations strengthen the forces of cultural differentiation, which tend to resist the post-combination integration forces. The resulting acculturative tension can cause cross-cultural conﬂicts.

Degree of acculturative tension

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80 Author(s)

Basic Assumptions

Proposed Impact of Cultural Differences

Proposed Moderators

Javidan and House (2002)

National cultural differences affect the post-merger ﬁrm’s strategic intent and organizational alignment in cross-border mergers.

Cultural differences between merging organizations complicate communication, decision-making, and the formulation of a joint strategic intent. Country speciﬁc external conditions make external adaption more difﬁcult. To overcome these difﬁculties organizational alignment must be reached by successful integration management.

Country speciﬁc external conditions Integration management

Kleppestø (1998)

Organizational culture is seen as a process which is shaped by the highly contextual creation of (narrated) meaning. In M&A the need of the combined organizations for a (re)negotiation of meaning, identity, and relations increases and descriptions of the situation at hand are frequently exchanged to renegotiate their meaning and reveal implications for organizational identities and inter-organizational relationships.

Cultural differences reinforce the creation of ingroup vs. outgroup bias and strengthen the claim for distinction in both organizations. Consequently, the notion of being culturally different is stressed when communicating with each other as the need to identify differences is an essential part of the dynamic process of identiﬁcation and sense-making. Images of culture clashes may be used to maintain and legitimize organizational identities, which can lead to serious integration problems.

Inter-organizational communication

Larsson (1990)

Acculturation, deﬁned as the development of jointly shared meanings fostering co-operation between joining ﬁrms, is a key process in M&A. The development of productive joint organisational cultures in M&A is complicated by barriers to constructive cultural cooperation.

Cultural differences reinforce all barriers to acculturation: Initial dilution as less meanings will be shared by members of the combined organization; Lack of joint socialisation mechanisms; Separate cultural maintenance mechanisms as the own culture is gloriﬁed by both combination partners.

Management of acculturation barriers

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Author(s)

Basic Assumptions

Proposed Impact of Cultural Differences

Proposed Moderators

Marks and Mirvis (1998)

The extent of post-combination change taking place in the acquiring and acquired ﬁrms deﬁne different integration types.

The degree of cultural differences determines whether these are beneﬁcial or detrimental. Two identical organizational cultures can be no better than the sum of its parts while too much distinction in underlying values and ways of approaching work is unhealthy. A medium degree of cultural differences is beneﬁcial as it prompts positive debate about what is best for the post-combination organization.

Degree of cultural differences

Nahavandi and Malekzadeh (1988)

Both acquired and acquiring ﬁrm choose preferred modes of acculturation which have to be congruent for successful integration. The acquired ﬁrm’s preferred mode of acculturation is determined by the desire to preserve its own cultural practices and the attractiveness of the acquirer. The acquiring ﬁrm’s preferred mode of acculturation is determined by its multiculturalism and the degree of relatedness between the ﬁrms.

When the integration level is high cultural differences are considered to be an obstacle. Perceptions of cultural differences create a strong desire to preserve its own culture in the target organization, which makes the acquirer’s culture less attractive. The resulting incongruence of preferred acculturation modes leads to acculturative stress and puts successful M&A implementation at risk.

Integration level Relatedness Multiculturalism of acquirer Target’s desire to preserve own culture Attractiveness of acquirer

Olie (1990)

M&A integration approaches depend on the level of integration, the degree of cultural exchange, the extent to which the own cultural identity is valued and the other ﬁrm’s culture is regarded as attractive, and external conditions. The “symmetry” of power between combination partners plays a major role in predicting combination outcomes.

As long as the acquiring organization is able to exert “asymmetric power” to impose its culture on the target, cultural differences will not endanger M&A success. Serious integration problems are expected in mergers of equals due to power “symmetry” and the need to create a coherent “third culture.”

Integration level Degree of cultural exchange Strength of cultural identities Attractiveness of combination partners External conditions Power differential

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82 Author(s)

Basic Assumptions

Proposed Impact of Cultural Differences

Proposed Moderators

Sales and Mirvis (1984)

Acculturation form and type depend on the power differential between combining ﬁrms, the nature of relations between them, and whether the acquired ﬁrm is allowed to keep its own cultural identity.

Given two different organizational cultures, whether the M&A will be successful depends on the quality of the relationship between the parties and the acquired ﬁrm’s chance to participate in selecting the acculturation approach. Tension is created when cultural differences are combined with power imbalances.

Nature of relations between combination partners Power differential Degree of target autonomy removal

Vaara (2003)

Post-acquisition decision-making is a contextual process which is characterized by uncertainty and ambiguity while being charged with political tension. Different social identities of decision-makers are created through the responsibility for the acquisition and previous organizational and cultural backgrounds. These distinct social identities lead to different frames for interpreting integration issues.

Cultural differences increase the degree of ambiguity surrounding an acquisition as people of different backgrounds and social identities are brought together. Cultural confusion is created due to problems of social interaction and communication which in turn drives organizational hypocrisy when integration rhetoric is only loosely coupled with actions. Cultural confusion and ambiguity facilitate politicization of signiﬁcant integration issues.

Integration management

AN UPPER ECHELONS EXPLANATION OF ACQUISITION OUTCOMES Patricia Doyle Corner and Angelo J. Kinicki ABSTRACT The article applies upper echelon theory to explain variation in parent ﬁrms’ post-acquisition ﬁnancial performance. We develop and test a latent variable model hypothesizing that top management team (TMT) demographic diversity affects ﬁnancial outcomes through teams’ collective beliefs. In so doing we identify three constructs which potentially underlie classic TMT demographic diversity measures. Also, we propose two fundamental structural properties of team beliefs extrapolated from individual level cognitive complexity theory. Results show both positive and negative effects on ﬁnancial outcomes from the TMT demographic diversity constructs through the belief constructs. We discuss the importance of including mediating constructs when attempting to unravel TMT diversity’s effects on ﬁrm level outcomes. Merger and acquisition activity occurred at a frenzied pace during the last two decades. The 1980s yielded about 55,000 mergers and acquisitions valued at $US1.3 trillion in the United States alone. The 1990s far surpassed the eighties with twice as many deals valued at approximately $US11 trillion (Hitt, Ireland & Harrison, 2001). The nineties wave represents the ﬁfth and largest wave of merger activity in the twentieth century, and suggests that acquisitions remain an important growth strategy for ﬁrms despite evidence showing that mergers are a sub-optimal strategy for acquiring ﬁrms. Speciﬁcally, a meta-analysis of 41 studies Advances in Mergers and Acquisitions Advances in Mergers and Acquisitions, Volume 4, 83–120 Copyright © 2005 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1479-361X/doi:10.1016/S1479-361X(04)04004-9

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by Datta, Pinches and Narayanan (1992) revealed that acquirers gained, on average, less than half of one percent at merger announcement while target shareholders’ value increased 20%. Such evidence prompts researchers to continue exploring acquisition outcomes in the hope of understanding why acquisitions have such a high likelihood of negative outcomes. We suggest that an upper echelons perspective may shed new light on acquisition outcomes because a ﬁrm’s top executives make acquisition decisions and their inﬂuence on ﬁrm outcomes is well documented by empirical research (see Finkelstein & Hambrick, 1996, for a review). Given its potential to account for variation in ﬁrm outcomes, it is surprising that the upper echelon perspective has not been empirically applied to explain variation in acquisition outcomes. The overall purpose of this study thus is to apply this perspective to an investigation of manufacturing acquisitions. Speciﬁcally, the current study examines the inﬂuence of top management teams (TMTs) on 60 ﬁrms’ post-acquisition ﬁnancial performance. The focus of our study represents a departure from the traditional approach used to investigate acquisition outcomes – the content approach. The content approach is based on explaining an acquisition’s ﬁnancial outcomes through the “content” of acquisition strategies used to initially make an acquisition (i.e. related versus unrelated acquisitions). Content research has provided a rich but mixed set of empirical ﬁndings regarding the determinants of acquisition outcomes (see Datta et al., 1992). We thus are hopeful that an alternative theoretical lens, such as the upper echelons framework, can provide fresh insights that enhance our understanding about the predictors of ﬁnancial performance following an acquisition.

AN UPPER ECHELONS PERSPECTIVE Hambrick and Mason (1984) focused on TMTs in their upper echelon theory in an effort to improve prediction and explanation of strategic leaders’ inﬂuence on organizations beyond that possible when just the CEO was examined. Also, a focus on the top team or group enhances the external validity of strategic decision research because these decisions are often made by a team of executives. Collectives are believed to deal with the uncertainties and ambiguities inherent in making strategic decisions better than individuals (Finkelstein & Hambrick, 1996; Hambrick, 1994; Schweiger, Sandberg & Rechner, 1989). Recent research describes the beneﬁts of this collective approach as advancing the strategy ﬁeld past the methodological individualism of studying only CEOs (Chakravarthy, Mueller-Stewens, Lorange & Lechner, 2003).

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Empirical research examining upper echelons has operationalized TMTs predominantly through demographic variables such as age, organizational tenure, functional background, and educational level (Bantel & Jackson, 1989; Haleblian & Finkelstein, 1993; Michel & Hambrick, 1992; Murray, 1989; Smith, Smith, Olian, Sims, O’Bannon & Scully, 1994). Researchers have typically computed mean values of these demographics across team members to capture variation across TMTs that might, in turn, account for variability in ﬁrm outcomes such as innovation (Bantel & Jackson, 1989), strategic change (Boeker, 1997), and ﬁnancial ﬁrm performance (Haleblian & Finkelstein, 1993; Murray, 1989; Smith et al., 1994). More recently, researchers have computed coefﬁcients of variation in team members’ demographics in order to examine relationships between TMT diversity and various outcomes (Williams & O’Reilly, 1998). Despite its contributions, the TMT demography research yields mixed results and does not provide a consistent picture of demography’s effects on organizational outcomes (Miller, Burke & Glick, 1998). For example, the relationship of TMT tenure diversity with ﬁnancial ﬁrm performance was found to be weakly negative (Haleblian & Finkelstein, 1993), insigniﬁcant (Michel & Hambrick, 1992), and positive for a subsample of oil companies (Murray, 1989). That said, however, there are two plausible explanations for these mixed results. First, researchers do not fully understand what demography measures may reﬂect about teams (Lawrence, 1997). Stated differently, although demographics are convenient proxies to use for teams given their wide availability, research has not identiﬁed the true construct being represented by these proxies. For example, we do not understand the underlying theoretical properties of teams that are represented by various proxies. The current study thus extends team demographic research by hypothesizing and testing for speciﬁc constructs thought to underlie TMT demographics. The fact that testing is done with actual TMTs making real-world decisions for companies in the ﬁeld further enhances the contribution of this study because most research in this area is done in the laboratory with experimental teams that did not have an ongoing relationship (Williams & O’Reilly, 1998). Further, conceptual research cautions that the constructs underlying demographics may be different for top teams than they are for teams at lower levels of an organization given the unique role TMTs play in spanning organizational boundaries, reducing environmental uncertainties, and making strategic decisions (Finkelstein & Hambrick, 1996). Our testing of constructs underlying TMT demographics allows us to test this notion which has only been hypothesized in existing literature. Second, the presence of unmeasured, mediating variables may be attenuating the relationships between TMT demographics and organizational outcomes. Researchers often allude to the presence of variables that may intervene between

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team demographics and outcomes but these variables typically remain unmeasured and untested in the vast majority of empirical studies (Lawrence, 1997). Potential mediators thus remain part of what Lawrence (1997) and others (Hambrick, 1994; Jackson, 1992; Pelled, Eisenhardt & Xin, 1999) label the “black box” of TMT demography. This trend stiﬂes theory development regarding the inﬂuence of TMT demography on ﬁrm outcomes because demography’s effects through potential mediators can only be surmised or assumed. The current study helps to unpack the “black box” by supplementing TMT demographic measures with operationalizations of mechanisms hypothesized to translate TMT demography into ﬁrm outcomes – TMT collective beliefs (Glick, Miller & Huber, 1993; Kilduff et al., 2000; Markoczy, 1997; Miller et al., 1998). Moreover, we offer a contribution to the general management literature in that the current study measures beliefs speciﬁc to acquisitions, a particular subset of a TMTs’ broad sets of beliefs that is both discrete and concrete. Research shows top executives likely access a speciﬁc, content-based belief subset that matches the content domain of their decision making task when a judgment is required (Ajzen & Fishbein, 1980; Amason, 1996). Contrastingly, past operationalizations of TMT beliefs have been broadly focused on any possible organizational goal, strategy, or means-to-goals that might eventuate for a TMT (see Glick et al., 1993; Miller et al., 1998). Although TMTs may possess broad sets of beliefs, research from psychology shows that teams actually access a narrower subset of beliefs speciﬁcally tied to the content of the required decision when grappling with a particular decision (Ajzen, 1991; Ajzen & Fishbein, 1980). For example, TMTs may access one subset of beliefs when making a product introduction decision and a different subset when considering an acquisition. We propose that eliciting a subset of beliefs that matches the content of the particular decision made – an acquisition – will yield more consistent results than those reported in studies that broadly operationalize TMT beliefs. In particular, the current study builds on belief elicitation techniques from the social psychology literature that are designed to achieve this match (see Ajzen, 1991; Axelrod, 1976; Brief, 1998). Moreover, addressing these two explanations for inconsistencies in TMT demography research helps to nudge the upper echelon perspective beyond the tendency to rely solely on demographic proxies when studying TMTs. The next section extends the upper echelon perspective to the study of acquisitions by providing a theoretical framework for this study. The framework identiﬁes theoretical factors that may underlie TMT demographics and discusses how these factors inﬂuence two fundamental beliefs thought to inﬂuence ﬁnancial ﬁrm performance following an acquisition. The theoretical framework is tested using longitudinal data collected from the ﬁeld and analyzed using structural equation modeling (SEM).

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THEORETICAL FRAMEWORK TMT Demography It is clear from past research that team diversity is not a unitary construct (Williams & O’Reilly, 1998). For example, a team’s functional diversity and organization tenure diversity had different effects on team performance (Ancona & Caldwell, 1992). Similarly, Smith et al. (1994) found educational diversity positively inﬂuenced ﬁrm ROI while experience diversity negatively inﬂuenced this criterion. These unexpectedly disparate results led scholars to theorize about the constructs that might underlie demographics and, in particular, to conjecture separate underlying constructs giving rise to demographics that produced different effects. We extend this theorizing by considering three constructs that may underpin demographics: visible diversity, background diversity, and organizationbased diversity. Let us consider these fundamental components of TMT diversity. Visible diversity reﬂects team members’ differences in basic or primitive social categories such as age, race, or gender and represents a primary dimension of diversity (Gardenswartz & Rowe, 1994). This dimension of diversity has also been labeled physiological diversity (Pelled, 1996). Visible diversity is considered highly observable and results in individual team members cognitively categorizing other members into groups based on these very visible characteristics (Tsui et al., 1992). Unfortunately, such basic categorization may lead members to perceive differently categorized members as less trustworthy, honest, and cooperative than similarly categorized members (Williams & O’Reilly, 1998). Categorization thus creates distinct subgroups in a team and can inhibit communication within team members (Lau & Murnighan, 1998). Scholars conclude that the lack of communication and distancing result in visible diversity potentially creating negative outcomes for groups. For example, Pelled et al.’s (1999) results revealed that outcomes such as team performance and group satisfaction were negatively affected by visible diversity for teams working at lower levels of an organization. Visible diversity is unlikely to be a factor underlying much of the diversity within TMTs, despite its presence and inﬂuence in teams at lower levels of an organization, because TMTs show very little diversity with respect to age, gender, and race (Stangor, Lynch, Duan & Glass, 1992; Williams & O’Reilly, 1998). Stated differently, top teams have very few women, minorities, and young people serving on them. We thus expect visible diversity to exert very little inﬂuence on acquisition outcomes in the current study. Although we measure diversity in age and gender within our TMTs, we do not hypothesize effects emanating from

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this construct because we expect no effects and verifying a null hypothesis is problematic (Frick, 1995). A second underlying construct that emerges from the literature is what we label background diversity (Williams & O’Reilly, 1998). This construct reﬂects diversity in technical skills and informational background and is believed to bring different perspectives to a top management team. The speciﬁc demographics associated with this construct are thought to be education and functional background (Pelled, 1996; Williams & O’Reilly, 1998). Scholars have pointed out the extent to which this kind of diversity supports speciﬁc tasks a team performs (Pelled, 1996) by enriching the information and knowledge base available for the task (Williams & O’Reilly, 1998). For example, TMTs considering an acquisition are likely to call upon background diversity by having the ﬁnance director evaluate a target’s cash ﬂows and ﬁnancial statements while the marketing director assesses its distribution channels and advertising campaign. The information richness conjectured to emerge from this type of diversity led researchers to hypothesize positive outcomes from background diversity. Interestingly, prior research has uncovered an inconsistent relationship between TMTs’ background diversity and ﬁrm outcomes (Williams & O’Reilly, 1998). Organization-based diversity is the third construct underlying TMT demographics. This construct is associated with the classic demographic measures of organization tenure and team tenure and has not yet been explicitly studied. Nevertheless, we think this dimension of diversity is important because focal team members may identify more strongly with other members who entered the organization or team at approximately the same time. In turn, this identiﬁcation with certain members of a group or team is more likely to foster cohesion among these organizational members. Separate cohort groups may differ on views of an organization’s strategy, customers, and internal processes given the different experiences created by diverse tenures (O’Reilly et al., 1993). We believe it is important to identify organization-based diversity as a construct separate from background diversity because empirical ﬁndings show organization tenure has different effects from background diversity. For example, Williams and O’Reilly (1998) conclude that background diversity enhances communication while organization tenure diversity shuts it down. This third construct extends the organizational demography literature by proposing a factor that may underlie the classic demographics of organizational and team tenure. This is a departure from prior research which has included organization tenure as part of background diversity (see Pelled, 1996). Moreover, the current study tests this theorized linkage in a sample of real-world top management teams making actual acquisition decisions.

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TMT Beliefs Scholars began theorizing about the relationships among executive beliefs, strategic decisions and the outcomes of those decisions decades ago. For example, Thompson (1967) conjectured that beliefs about cause and effect relationships shaped the decision processes of a dominant coalition or TMT. Axelrod (1976) also deﬁned beliefs as relationships between causes (i.e. acquiring a company with similar process technology) and effects (i.e. reducing operating costs). He developed a way to operationalize beliefs at the collective or team level by eliciting individual team members’ beliefs and aggregating these across all members. More recently, scholars labeled these aggregations belief structures and viewed these structures as the knowledge base a top team had to draw on when making strategic decisions (Ginsberg, 1990; Walsh & Fahey, 1986; Walsh, Henderson, & Deighton, 1988), particularly acquisition decisions (Corner, Kinicki & Keats, 1994). We adopt this belief aggregation view in the current study. Consistent with Chan’s (1998) typology of composition models, which specify the functional relationships among variables or constructs at different levels of analysis, we propose that the structural properties of individual beliefs within a team can be aggregated to reﬂect a TMTs’ collective beliefs. Chan referred to this type of composition model as an additive model. Additive models suggest that a higher level construct such as TMT beliefs is a summation or average of individuallevel beliefs. Our speciﬁc conceptualization of TMT beliefs that affect acquisitions is derived from cognitive complexity theory developed at the individual level of analysis. Cognitive complexity holds that an individual’s belief framework has two fundamental structural properties which we extend to the TMT level (Ginsberg, 1990) and these are labeled belief homogeneity and belief richness. Belief homogeneity Belief homogeneity, which is deﬁned as the extent to which TMT members hold common beliefs, has been called different things by the few researchers that have studied it (Axelrod, 1976; Glick et al., 1993; Miller et al., 1998; Walsh et al., 1988). Belief homogeneity is the degree to which TMT members possess the same beliefs (Hambrick, 1994) and represents an agreement or convergence in team members’ beliefs (Daft & Weick, 1984). As such, TMTs low in belief homogeneity have few, if any, beliefs in common while TMTs high in belief homogeneity hold many beliefs in common. We submit that team members’ beliefs coalesce into a uniﬁed perspective or paradigm as the level of belief homogeneity increases within a team (Hambrick, 1994). This uniﬁed perspective can be missing for teams low in belief homogeneity such that multiple, fragmented perspectives prevail (Walsh & Fahey, 1986).

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Although a minimal level of belief homogeneity is required for teams to communicate and begin to make sense of information (Ginsberg, 1990), scholars suggest that a low level of belief homogeneity results in better outcomes than a high level of homogeneity (Walsh & Fahey, 1986; Walsh et al., 1988). Better outcomes are expected for low homogeneity teams because their fragmented perspectives force them to examine differences across perspectives (Walsh et al., 1988). This helps TMTs avoid premature consensus on interpretations (Ginsberg, 1990) and compels teams to search for more environmental data when making decisions (Weick & Bougon, 1986). The current study measures top teams’ belief homogeneity as the percentage of total acquisition beliefs shared by top team members and examines its effects on parent ﬁrm acquisition outcomes. Belief richness Belief richness is the second property of TMT belief aggregations and is deﬁned as the comprehensiveness of or number of different beliefs possessed by a TMT. The inﬂuence of this construct on acquisition outcomes remains hypothesized but untested (see Ginsberg, 1990 for a conceptual treatment of this construct). This is unfortunate because decision making theories suggest that an extensive information base, such as that available to a TMT rich in beliefs, may lead to positive outcomes for ﬁrms (Williams & O’Reilly, 1998). For example, richness in team beliefs can enhance its sensemaking abilities because it increases the team’s capacity to process information (Daft & Lengel, 1986; Walsh et al., 1988; Weick, 1979). Teams high in belief richness can also achieve more effective interpretations of the environment because richness allows them to better reﬂect the complexity of the environment (Weick, 1979) and to be more creative in their decision making (Daft & Lengel, 1986; Jackson, 1992). The current study operationalized top teams’ belief richness as the number of different beliefs present in a team’s aggregation of beliefs.

HYPOTHESES This section draws on existing literature to explicate relationships among the two dimensions of TMT diversity, the two belief constructs, and the outcome of interest in the study, parent ﬁrms’ post-acquisition ﬁnancial performance. These relationships are depicted in Fig. 1 (please recall that visible diversity is not included when formulating hypotheses because it is unlikely to underlie top team demographics). The model in Fig. 1 addresses the “black box” of TMT demography in two ways. First, it depicts constructs we’ve hypothesized to underlie demographic indicators.

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Fig. 1. Hypothesized Relationships for Upper Echelon Perspective on Acquisitions.

Lawrence (1997) indicates that establishing demographics as indicators of precise constructs is an important step in illuminating the “black box” of demography. Second, the model portrays the belief constructs as mediators of the relationships between the demographic diversity constructs and ﬁnancial ﬁrm performance. This notion of beliefs mediating between demographics and outcomes enjoys consistent support in theoretical treatments of TMT demographics but is typically left untested in empirical studies (Hambrick, 1994; Lawrence, 1997).

Demographic Antecedents of Team Belief Constructs Antecedents of Belief Homogeneity Building on Dearborn and Simon’s classic (1958) study, scholars have long believed that different functional backgrounds created diverse belief sets in managers (Walsh, 1988). More recently, scholars broadened the component of functional diversity into background diversity and described it as producing different perspectives within a TMT (Pelled, 1996; Pelled et al., 1999). Similarly, Hambrick (1994) conjectures that top team members reﬂect different paradigms or world views if they come from diverse backgrounds. This occurs quite simply from the development of functionally-based scripts or schemas regarding many different aspects of running a business. As such, differences in background diversity among TMT members are likely to result in greater differences in beliefs within the TMT.

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For example, a vice president in marketing’s belief set is likely to have few beliefs in common with that of the vice president of ﬁnance. The resulting team level aggregation of beliefs would therefore have few beliefs in common or, stated differently, would be low in belief homogeneity. Based on this discussion we proposed the following hypothesis: H1a. Background diversity is negatively related to TMTs’ belief homogeneity. Carroll and Harrison (1998) argued that diversity in organizational tenure or length of service produces a heterogeneous culture in which individuals share very few beliefs and values. Extrapolating from these results, TMTs with high levels of organization-based diversity (i.e. different amounts of organizational tenure among TMT members) are more likely to possess divergent beliefs. Belief homogeneity among a TMT also is expected to be associated with the variance in individual TMT member’s tenure on the TMT because of the nature of organizational decisionmaking. TMTs make decisions on an ongoing basis, and this process results in the reinforcement, replacement, and creation of beliefs. This occurs because beliefs essentially represent cause-effect associations and such associations are formed as the result of decisions made by a TMT. For example, if a TMT makes a decision to implement six-sigma training in an attempt to improve quality, the outcome associated with this decision either reinforces, replaces, or creates new beliefs about the value of using training to improve quality. This particular TMT is more likely to have homogeneous beliefs about using training to improve quality due to its decision to invest in six-sigma training. These beliefs, however, are less likely to be shared by another individual who was not employed in the organization and was not involved with the original decision. Diverse tenures within a TMT are thus likely to result in different perceptions and beliefs about organizational acquisitions because of the different experiences associated with TMT decision-making. The above discussion resulted in the following hypothesis: H1b. There is a negative relationship between organization-based diversity and TMTs’ belief homogeneity. Antecedents of Belief Richness Belief richness plays a signiﬁcant role in acquisition outcomes to the extent that individual TMT members’ belief sets actually get surfaced during discussions regarding a potential acquisition target. As individual team members articulate their beliefs during discussion of an acquisition target, they each add to the richness of beliefs available for the collective TMT to draw upon when deciding to acquire the target or not (Corner et al., 1994). Research suggests that communication

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and discussion is stimulated when a high level of background diversity exists (Williams & O’Reilly, 1998). Background diversity prompts discussion in contrast to other kinds of diversity which can shut discussion down because it is part of a TMT member’s job to reﬂect this diversity (Amason, 1996; Pelled et al., 1999). For example, a TMT would expect the marketing vice president to consider a target from a marketing perspective and speak to issues of distribution channels, potential advertising synergies, and product line and pricing considerations. The vice-president of ﬁnance is unlikely to challenge the marketing vice-president on this perspective because he/she: (1) expects the marketer to take a marketing perspective; and (2) likely acknowledges the marketer’s training and expertise in marketing issues. As such, background diversity prompts discussion around ideas and substantive issues as opposed to dialogue which centers on personal issues and can shut down effective communication (Amason, 1996). Moreover, TMT members are likely to have professional, functionally-based networks that include many people from outside their current organization (Higgins & Kram, 2001). These networks are not only helpful from a career perspective, but they represent a source of additional beliefs and knowledge which focal TMT members can communicate to other members of a TMT. As such, a high level of background diversity within a TMT is expected to result in team members communicating more frequently with colleagues in similar functional networks external to the ﬁrm than is the case when background diversity is low (Ancona & Caldwell, 1992). Therefore, we predicted the following hypothesis: H2a. There is a positive relationship between background diversity and a TMTs’ belief richness. Forty years of research suggests that people tend to communicate with those whose perspective on the organization and its goals is similar to their own (Williams & O’Reilly, 1998). In the case of teams with great organization-based diversity there can be wide divergence about an organization’s goals (O’Reilly et al., 1993). This is because organization-based diversity reﬂects TMT members that entered an organization at different times and thus had different experiences of business cycles, and the organization’s goals, strategies, and products designed to cope with these disparate business cycle stages. Such diversity creates divergence of opinion about organizational goals so that teams may not move beyond goal disagreements to considering task –related issues of substance. TMTs stuck in goal divergence engage in political behavior among team members (Eisenhardt & Bourgeois, 1988; O’Reilly et al., 1993). In this way, organization-based diversity can result in ineffective patterns of interaction among TMT members so that the focus is on political maneuvering instead of on information surfacing and idea sharing (O’Reilly et al., 1993). Unfortunately, these TMTs appear to have little

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communication across members. Little communication means individual team members’ beliefs remain unexpressed and unavailable for the team to draw on collectively. If communication occurs where there is high organization-based diversity, it is usually associated with increased conﬂict (Williams & O’Reilly, 1998), particularly affective conﬂict (Amason, 1996). Affective conﬂict is caused by personality differences as opposed to substantive issues. Because this form of conﬂict is about gamesmanship where one member tries to gain inﬂuence at the expense of another (Amason, 1996), it tends to shut down communication about substantive issues. In turn, this type of communication limits the sharing of information and the number of beliefs that are surfaced from team members. Smith et al.’s (1994) results supported this pattern. Their ﬁndings indicated that organization-based diversity was negatively related to informal communication (Smith et al., 1994). We thus proposed the following hypothesis: H2b. There is a negative relationship between organization-based diversity and TMTs’ belief richness.

Belief Constructs as Mediators Belief Homogeneity Although there is conceptual support for predicting that belief homogeneity mediates the relationship between demographic diversity and outcomes (Bantel & Jackson, 1989; Wiersema & Bantel, 1992), there is a lack of empirical veriﬁcation. For example, Glick et al. (1993) point out that much literature assumes that demographic diversity inﬂuences outcomes through beliefs, an operationalization of TMTs collective cognition (see Hambrick & Mason, 1984). Unfortunately, empirical evidence in support of this mediation is scant because collective cognition is not often measured in upper echelon studies (Glick et al., 1993). The present study overcomes this limitation by directly measuring TMTs beliefs. The above discussion resulted in the following hypothesis: H3a. Belief homogeneity mediates the relationships between the demographic diversity constructs and ﬁnancial ﬁrm performance. To further clarify Hypothesis 3a, let us consider the relationship between belief homogeneity and ﬁnancial ﬁrm performance. Recalling that belief homogeneity represents the extent to which acquisition beliefs overlap, some scholars propose a negative, direct relationship between belief homogeneity and ﬁrm outcomes. This relationship is clearly consistent with the threat to group decision-making

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labelled groupthink. Janis deﬁnes groupthink as “a mode of thinking that people engage in when they are deeply involved in a cohesive in-group, when members’ striving for unanimity override their motivation to realistically appraise alternative courses of action” (1982, p. 9). He adds, “Groupthink refers to a deterioration of mental efﬁciency, reality testing, and moral judgment that results from ingroup pressures” (1982, p. 9). In the current context, belief homogeneity reﬂects identical beliefs across TMT members that can lead to premature consensus on a particular acquisition target instead of considering multiple targets (Walsh et al., 1988). A high level of belief homogeneity can also render a team unable to question their assumptions about a potential target and its ﬁt with the parent company (Jackson, 1992). Hitt et al.’s (1998) results indirectly support these possibilities. Their results revealed that inadequate target evaluation, which likely was fostered by high belief homogeneity, resulted in unsuccessful acquisitions. Whether caused by group think or making mistakes (Roll, 1986), belief homogeneity is more likely to reduce the analysis of a target ﬁrm as well as scenarios for integrating it within the parent company. Although there is some conjecture about a positive relationship between belief homogeneity and ﬁnancial outcomes (see O’Reilly et al., 1993; Wiersema & Bantel, 1992), empirical evidence supports a negative relationship between TMT belief homogeneity and the outcomes of ending market share and return measures in a marketing simulation experiment (Kilduff et al., 2000). On the basis of the above discussion, we hypothesized the following relationship: H3b. Belief homogeneity is negatively related to ﬁnancial ﬁrm performance. Belief Richness Recall that belief richness is the number of beliefs a TMT possesses as a collective. Conceptual discussion of TMT demographics supports the notion that belief richness mediates the relationship between TMT demographic characteristics and organizational outcomes. Hambrick and Mason (1984), for example, drew from Carnegie School research to conclude that TMT members’ experiences and observations affect ﬁrm outcomes through the knowledge developed from those experiences (see Cyert & March, 1963). Similarly, Wiersema and Bantel (1992) suggested that the demographic traits of top teams inﬂuence ﬁrm level outcomes in that traits shape the amount of TMT members’ beliefs. Finally, Finkelstein and Hambrick (1990) provided theoretical support for mediation speciﬁc to the demographic characteristic of organizational tenure – an indicator included in this study. These authors hypothesized that tenure and the knowledge gained through tenure shapes cognitive characteristics which, in turn, affect ﬁrm

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outcomes. Based on the above theoretical perspectives, we proposed the following hypothesis: H3c. Belief richness mediates the relationships between the demographic constructs and ﬁnancial ﬁrm performance. There is consensus in the literature regarding the relationship between belief richness and ﬁrm performance. Belief richness reﬂects a TMT with higher levels of knowledge and such top teams perform better in problem solving than TMTs with lower levels of knowledge (Bantel & Jackson, 1989). Similarly, belief richness implies an extensive and comprehensive knowledge base that is considered one of the necessary conditions for creativity. This is the case because a comprehensive understanding of current knowledge is required to extend or create new knowledge (Sternberg & Lubart, 1996). Such creativity is seen as the key to maintaining satisfactory ﬁnancial performance in the globally competitive environment. Finally, TMTs rich in beliefs are likely to achieve high quality decisions and outcomes because the extensiveness of their beliefs enables a better reﬂection of environmental complexity (Weick, 1979). Again, high quality decisions and outcomes imply enhanced ﬁrm performance for teams rich in beliefs. Considering the above discussion, we predicted the following relationship: H3d. Belief richness is positively related to ﬁnancial ﬁrm performance. The previous hypotheses are summarized in the model shown in Fig. 1. The model is not intended to be a comprehensive model that includes all possible constructs mediating between TMT demographics and ﬁrm performance. Indeed, such a comprehensive model seems premature given the paucity of research in this area as seen in the continuing discussion of the “black box” of demography in the literature. We thus take an initial step in examining belief constructs as mediators. The reader may note that Fig. 1 depicts only the indirect effects of TMT demographics on ﬁrm performance, suggesting that demographics’ effects are fully mediated by the belief constructs. We test this model against an alternate one that includes both indirect and direct effects of TMT demographics on performance.

METHODS Design The design was a longitudinal ﬁeld study using data gathered from two independent sources. Speciﬁcally, teams of top executives that made manufacturing acquisitions were investigated and their ﬁrms’ performance was followed for 2 years after the

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acquisition. Acquisitions were restricted to SIC codes of 2000–3999 to assure that only acquisitions of manufacturing ﬁrms were studied. Service acquisitions were not included in order to control for possible variations due to sector context (Lumpkin & Dess, 1995). Moreover, the numerous studies of manufacturing acquisitions provided a rich source of information for designing the questionnaire items described below (see Chatterjee, 1986; Fowler & Schmidt, 1989; Lubatkin, 1987; Lubatkin & O’Neill, 1987). Acquisitions were also restricted to those in which parent and target were treated as one unit for ﬁnancial accounting purposes after the acquisition. This was done to insure that acquisitions were integrated into parent ﬁrm systems after the acquisition. Finally, acquisitions were included only if the parent company did not make another acquisition within the two year period during which we assessed their performance. This restriction helped control for effects from other signiﬁcant events in the lives of studied companies.

Sampling Procedure and Sample CEOs of 320 parent ﬁrms were identiﬁed through Standard and Poor’s and Ward’s Business directories. CEOs were sent letters asking them to participate in the current study. One hundred CEOs returned a form agreeing to participate and listing names and titles of top management team members. This method of identifying TMT members is established in the literature (see Amason, 1996; Bantel & Jackson, 1989; Bourgeois, 1980). Of these 100 CEOs, 85 made acquisitions that involved TMTs and met the criteria for acquisitions detailed above. Top team members and CEOs were surveyed using identical questionnaires. Teams were included in the sample only if 50% of team members identiﬁed by the CEO completed questionnaires. This guideline was set to insure representativeness. Sixty TMTs completed questionnaires for a response rate of 70%. Responding teams were compared to non-respondents on 2 items: parent ﬁrm size and geographical location. There were no differences across these characteristics. The sample of 60 TMTs was very complete in that, on average, 78% of each CEO designated top team returned questionnaires. (This was computed by dividing the number of TMT members from each team that completed questionnaires by the number of members identiﬁed by the CEO and averaging this percentage across all top teams.) The 60 teams were composed of 194 individuals including only 3 women. This dearth of women corroborates the claim of researchers that visible diversity is not an issue for TMTs (Williams & O’Reilly, 1998). TMT size ranged from 2 to 5 individuals. Ninety percent of non-CEO top team members reported directly to the CEO. Sample TMTs thus are comparable to TMTs examined in past upper echelon research in that they reﬂect the top two levels of management (see

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Bantel & Jackson, 1989; Wiersema & Bantel, 1992). These 60 teams acquired manufacturing ﬁrms that averaged sales of $65 (U.S.) million. TMTs’ parent companies were diverse geographically and averaged 12,062 employees and sales of $2,174 (U.S.) million. Eighty ﬁve percent of parent companies were manufacturing ﬁrms. Questionnaire and Measures Questionnaire items used to collect data from TMT members were derived from a two-step process. Step 1 involved developing items based on the extensive literature on manufacturing acquisitions. Items targeted generic acquisition beliefs and are listed in the appendix. Such beliefs are expected to be stable over time, changing only when negative events in cash ﬂows and failure to meet goals happens at the same time and persistently over several years so that a clear discontinuity from the past is felt by the TMT (Donaldson & Lorsch, 1983). Step 2 consisted of revising and extending these items based on expert feedback (Bantel & Jackson, 1989; Nunnally, 1978). Experts included 5 CEOs who, as a whole, possessed 80 years experience making manufacturing acquisitions. None of these CEOs provided data to test hypotheses. The questionnaire was administered after the acquisition identiﬁed for each ﬁrm was completed but before the ﬁrst year of post-acquisition performance results were known. This timing helped minimize any retrospective revision that may have occurred in the generic beliefs. Regarding beliefs, our goal was to elicit beliefs speciﬁc to acquisitions because it is this focused subset of beliefs that inﬂuences choice of target (Ajzen & Fishbein, 1980). Moreover, we required two measures for each of the belief constructs in order to have the multiple measures needed to perform structural equation modeling. We thus implemented two belief elicitation techniques from the literature and used these to create two measures of each belief construct. The ﬁrst was Axelrod’s technique (1976) and the second was a technique developed by Fishbein (Ajzen & Fishbein, 1980). Each is described in more detail below. Functional Diversity The data here were categorical in that TMT members indicated their predominant functional background from one of 5 possible options including marketing, ﬁnance/accounting, general management, engineering or R&D, and manufacturing. When data are categorical an entropy-based index of diversity (H) is appropriate (see Ancona & Caldwell, 1992; Smith et al., 1994). The measure used was as follows (Ancona & Caldwell, 1992): s H = − P i (lnP i ). i=1

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As Pfeffer and O’Reilly (1987) show, if there are N possible states in which the system can be, Pi is the probability that the system will be found in state i, then this formula can be used to index the heterogeneity in the system. For our purposes, P represents the fractional share of team members assigned to each of the functional categories listed above. The only exception occurs when an area is not represented. In that case, the value assigned that state is zero. Using this formula, if a team was comprised of nine individuals from ﬁnance, one from marketing, and no one from manufacturing, the functional diversity index would be 0.32. If the group consisted of ﬁve engineers, three marketing specialists, and two people from manufacturing, the functional diversity index would be 1.03. Thus the greater the distribution across functional areas, the higher the functional diversity score. Educational Diversity This was calculated using the same entropy based index of dispersion as was used for functional diversity. TMT members indicated their majors or areas of study and this was used to construct the categories for the entropy-based measure. Organizational and Team Tenure Diversity For interval data such as organizational tenure and team tenure, Pfeffer and O’Reilly (1987) suggest that the coefﬁcient of variation (the standard deviation divided by the mean) provides the most direct and scale-invariant measure of dispersion. We thus used the coefﬁcient of variation to assess the diversity of TMTs’ organizational tenure and team tenure. The mean coefﬁcients of variation for these two indicators are reported in Table 1. Belief Homogeneity The ﬁrst measure of this construct relied on TMT beliefs elicited using a technique developed by Axelrod (1976). Axelrod recommends eliciting team members’ generic beliefs or general cause and effect associations about acquisitions. The questionnaire items used for this are displayed in the appendix. Such beliefs are stable over time (Axelrod, 1976; Donaldson & Lorsch, 1983) and are highly inﬂuential in acquisition decisions (Thompson, 1967; Walsh & Fahey, 1986). Speciﬁcally, belief homogeneity was measured as the ratio of the number of beliefs that were identical across TMT members relative to the total number of identical beliefs that were possible. The ratio was computed as follows. We ﬁrst counted the number of pairwise matches across team members for each cause/effect belief using the formula n(n − 1)/2 where n is the number of team members indicating a particular belief on the questionnaire. For example, for the ﬁrst possible belief of “acquisition’s marketing capabilities being associated with cost savings” (see appendix), we computed the actual number of pairwise matches for this belief using

100

Table 1. Means, Standard Deviations, Correlations, and Reliabilitiesa , of Study Variables. Variable

M

SD

1

2

3

1. Educational diversity 2. Functional diversity 3. Organization tenure (coefﬁcient of variation) 4. Team tenure (coefﬁcient of variation) 5. Belief homogeneity (Axelrod) 6. Belief homogeneity (Fishbein) 7. Belief richness (Axelrod) 8. Belief richness (Fishbein) 9. Return on sales 10. Return on Assets 11. Return on Invested Capital 12. Return on Common Equity 13. Pre-acquisition performance 14. Industry 15. Team Size

0.52 0.66 2.98

0.42 0.44 3.22

– 0.44** −0.03

– 0.11

–

0.17

0.36

−0.10

0.06

0.21

0.08

0.16

−0.28** −0.31*

−0.29*

0.73

0.24

0.10

0.18

−0.19

−0.21*

−0.23

0.86**

0.75

−0.21*

−0.22

0.20

0.22

0.88

−0.21

0.19

0.24

0.69** 0.82

0.29*

6

7

8

9

10

11

1.12

0.36**

0.45** −0.18

−0.18 −0.02 −0.06

1.48 0.39 1.31

0.17 0.21 0.28*

0.14 0.16 0.32*

−0.17 −0.22 −0.31*

−0.17 −0.30* −0.23 −0.32* −0.29* −0.29*

−0.42** 0.17 −0.48** 0.18 −0.44** 0.29*

0.35* – 0.30* 0.90** 0.32* 0.86**

– 0.56**

−0.09

1.56

0.30*

0.35*

−0.29*

−0.22

−0.33*

−0.44** 0.30*

0.32* 0.95**

0.88** 0.80*

−0.09

1.49

0.25

0.22

−0.25

−0.21

−0.28*

−0.29*

0.20

0.29* 0.55*

0.45*

0.504 1.05

0.12 0.03

0.17 0.09

0.09 0.13

0.16 0.15

0.05 −0.03

0.12 0.08

0.11 0.10

0.10 0.09

0.50 3.33

12

13

14

15

–

4.35

Reliabilities are reported in the main diagonal. Signiﬁcant at p < 0.05. ∗∗ Signiﬁcant at p < 0.01. ∗

0.34**

5

0.08 0.00

−0.01 −0.02

–

0.43* 0.03 0.00

– 0.48* 0.83 0.05 −0.01

0.02 – 0.02 0.09 –

PATRICIA DOYLE CORNER AND ANGELO J. KINICKI

a

37.93 11.63

0.55**

4

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the above formula. These counts were summed across all beliefs to give a total of actual pairwise matches. Second, a number of total possible pairwise matches across team members were calculated for each belief by using the formula n(n−1)/2 where n is the number of members in the TMT. These counts were summed across all acquisition beliefs elicited in the study (see appendix). Third, actual pairwise matches were divided by possible pairwise matches. This ratio served as the measure of belief homogeneity. The maximum possible belief homogeneity score was 1.00. A second belief homogeneity measure was constructed from beliefs elicited as suggested by Fishbein and his colleagues (see Ajzen & Fishbein, 1980). Beliefs were operationalized for this measure by giving respondents a behavior – their parent ﬁrm making an acquisition – and asking them to identify the most likely outcomes of this behavior. Speciﬁcally, respondents were given seven general acquisition outcomes and asked to identify the most likely to occur if their parent ﬁrm made an acquisition. This approach was followed because beliefs represent the expected relationship between a behavior (making an acquisition in this instance) and its associated outcomes (Ajzen & Fishbein, 1980). We used generic outcomes that the literature and our pilot CEO sample identiﬁed as applying across many manufacturing acquisitions. The 7th item was an “other” item included to allow TMT members to express idiosyncratic outcomes. We cut outcomes from 7 to 6 when the 7th “other” item was selected/identiﬁed by only 4 of 184 responding TMT members. Identiﬁed outcomes were considered beliefs and were examined for pairwise overlaps as explained above. Belief Richness Similar to belief homogeneity, the ﬁrst measure of belief richness utilized the beliefs acquired through the Axelrod (1976) technique. As a reminder, this approach to eliciting beliefs had TMT members match acquisition “causes” and “outcomes.” Again, generic acquisition beliefs were operationalized as relationships between causes and outcomes where causes were particular acquisition characteristics like target’s market share and target’s distribution channels (see appendix). Outcomes were classic goals for the parent company believed to be achieved through acquisitions (see Appendix). More precisely, TMT members were given a list of 15 possible “causes” and 6 possible “outcomes” the acquisition literature indicates as generic causes and outcomes across diverse manufacturing acquisitions. Causes and outcomes were culled from the literature and reﬁned by expert feedback as described above. However, both lists (causes and outcomes) included a ﬁnal “other” item to allow a team to indicate a unique belief. Respondents indicated, for each cause, which outcomes their ﬁrm might realize given the cause. Causes were cut to 14 and outcomes to 5 when the ﬁnal “other” item was completed by only 3 of the 198 (1.8%) responding team members. Finally, this measure of belief richness

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was calculated by counting the number of acquisition cause/outcome combinations that were present across TMT members. It is important to note that the presence of any cause/outcome combination or belief was counted only once, despite the number of TMT members who indicated the belief. For example, if 4 or 5 TMT members indicated one of the cause/effect outcome combinations it was counted only once. This was done because, for this measure, we were interested simply in the presence or absence of a particular belief in the TMT’s belief aggregation, not in the extent to which a belief was shared across team members. A second measure of belief richness was derived by following Fishbein’s approach to eliciting beliefs as described above for the second measure of belief homogeneity. Beliefs were operationalized for this measure by giving respondents a behavior – their parent ﬁrm making an acquisition – and asking them to identify the most likely outcomes of this behaviour. Speciﬁcally, respondents were given seven general acquisition outcomes and asked to identify the most likely to occur if their parent ﬁrm made an acquisition. To quantify this second measure we again counted the number of beliefs present for the collective TMT, as was done for the beliefs elicited via the Axelrod technique. Post Acquisition Financial Performance Parent ﬁrms’ ﬁnancial performance was followed for two years after speciﬁc acquisitions were made, in keeping with a longitudinal design recommended by Fowler and Schmidt (1989). Financial performance data were sourced from the “Compact D/SEC” database which is compiled by the U.S. Securities and Exchange Commission (SEC). The database tracks ﬁnancial and management information for over 12,000 U.S. public corporations whose securities trade on the New York Stock Exchange, the American Stock Exchange, NASDAQ, and other over-the counter markets. The SEC reports data extracted from 10K and annual reports. Speciﬁcally, performance was measured using 4 different ﬁnancial accounting items available from the MARS data base: net income/sales, net income/total assets, net income/invested capital, and net income/common equity. Use of such ﬁnancial accounting items is consistent with previous research on acquisitions where market return data is sketchy or unavailable (Lubatkin, 1983). Post acquisition returns were computed by averaging annual returns for the two years after the acquisition. Two year return averages were used to guard against one year outlier performance (see Thomas et al., 1993). Control Variables Three control variables were included in the study: type of industry, parent ﬁrms’ pre-acquisition ﬁnancial performance, and TMT size. Type of industry was included as a control because past research shows industry level variables

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explain variation in ﬁrm performance. The sample was broadly classiﬁed into two industry categories, durable and non-durable manufactured goods, dummy coded as “1” and “0”, respectively. We also controlled for pre-acquisition performance using the same four measures described above. This data was recorded for the annual accounting period before the studied acquisition was made. Including pre-acquisition performance as a control variable renders the dependent variable of post-acquisition performance similar to a difference score (post acquisition performance minus pre-acquisition performance) without causing the methodological difﬁculties inherent in an actual computed difference score. TMT size was identiﬁed as a control because it could be a confound with belief richness and measured as the number of members on a top team.

Analytical Techniques Covariance structure analysis was used to conﬁrm the validity of our measures and to examine construct relationships. This method of analysis permits a powerful test of the causal relationships speciﬁed in a model (Bagozzi, 1980). Bentler’s (1995) EQS program was used to evaluate the proposed model. All models were tested by using the elliptical estimation procedure within EQS because it allows parameter estimation for data that are not multivariate normal: Mardia’s coefﬁcient revealed that our data violated this assumption. Overall model ﬁt was assessed by three ﬁt indices: the comparative ﬁt index (CFI, Bentler, 1990), the non-normed ﬁt index (NNFI, Bentler & Bonnet, 1980), and the root mean-square error of approximation (RMSEA, Brown & Cudeck, 1992). The CFI and NNFI are resistant to errors associated with sample size (Bentler, 1990), and RMSEA assesses lack of model ﬁt and is sensitive to model parsimony. CFI and NNFI values of 0.90 and greater are evidence of adequate model ﬁt (Bentler & Bonnett, 1980). RMSEA values of 0.05 or less indicate close ﬁt while values of 0.08 or less indicate a reasonable error or approximation in relation to the degrees of freedom in the model (Browne & Cudeck, 1992). Following Anderson and Gerbing’s (1988) recommendation, covariance structure analysis was used both for measurement and structural assessment. First, a latent variable baseline measurement model was ﬁtted to the data. This model was subsequently contrasted to two measurement models each of which presumed two of the latent constructs were alike. The baseline model also was contrasted to a single factor measurement model to test overall discriminability (Bagozzi & Phillips, 1982). Model structural linkages were assessed following measurement analyses. Fit indices were used to determine omnibus goodness of ﬁt and overall model

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evaluation, and structural path estimates were tested for signiﬁcance. Following baseline model assessment, we performed a series of nested model comparisons to see if the baseline model (see Fig. 1) provided the best ﬁt to the data. The ﬁrst comparison examined the baseline against a model with no mediating belief constructs. Empirical ﬁndings showing direct effects between demographics and ﬁnancial ﬁrm performance suggest this is an important model to test. The second nested model comparison examined the proposed mediating properties of the belief constructs. First, the three conditions of mediation were assessed (Baron & Kenny, 1986). However, in order to assess complete mediation, a fourth condition must hold; an independent construct must have no direct effect on the dependent variable when the mediator is held constant (Prussia & Kinicki, 1996). Two models were compared to the baseline structural model to evaluate the fourth condition for mediation: (1) a model with a direct path from background diversity to ﬁrm performance; and (2) a model with a direct path from organization-based diversity to ﬁrm performance. The CFI difference between two nested models and the sequential chi-square difference test (SCDT) were interpreted to evaluate nested models. An insigniﬁcant SCDT suggests acceptance of the more parsimonious of the nested models. Alternatively, a signiﬁcant value indicates acceptance of the less constrained model (James et al., 1982).

RESULTS Table 1 reports means, standard deviations, intercorrelations, and reliabilities. Reliabilities are reported in the diagonal of the matrix where appropriate and all recorded reliabilities meet Nunnally’s (1978) minimum criteria of 0.70. Variables were rescaled before data were entered into EQS so that input variables had similar variances. This provides for better start values in the EQS program and easier convergence on solutions (Bentler, 1995). It is important to note that rescaling the variables in this way does not change the magnitude or sign of estimated relationships (Bentler, 1995). Variables were scaled such that the ratio of the largest to the smallest variance was no more than 3:1.

Measurement Model Results Initial conﬁrmatory factor analysis results supported the convergent validity of all the construct indicators. Results shown in Table 2 indicate that the baseline measurement model (Model 1) accurately reproduced the observed covariance matrix: CFI = 1.0; NNFI = 1.03; RMSEA = 0.00. Furthermore,

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Table 2. Fit Indices for Measurement and Structural Equation Models. Model

DF

CFI

NNFI

RMSEA

Chi Square Difference

DF

CFI Difference

Model 1, Baseline Measurement Model Model 2, Four-Factor Measurement Model collapsing belief constructs Model 3, Four Factor Measurement Model collapsing TMT diversity constructs Model 4, One-Factor Measurement Model Model 5, Baseline Structural Model Model 6, Model without mediating belief constructs Model 7, Model with direct path from background diversity to performance Model 7-5 difference Model 8, Model with direct path from organization-based diversity to performance Model 8- 5 difference

42

1.00

1.03

0.00

n.a.

n.a.

n.a.

48

0.80

0.78

0.09

n.a.

n.a.

n.a.

48

0.73

0.69

0.15

n.a.

n.a.

n.a.

54

0.78

0.64

0.12

n.s.

n.a.

n.a.

48

0.98

0.98

0.02

n.a.

n.a.

n.a.

25

0.65

0.59

0.23

n.a.

n.a.

n.a.

47

0.96

0.95

0.03

n.a.

n.a.

n.a.

47

0.95

0.94

0.03

2.89 n.a.

1 n.a.

0.02 n.a.

3.14

1

0.03

results shown in Fig. 2 reveal that all standardized factor loadings were signiﬁcant (M = 0.88). In contrast to the 5-factor model, a four factor model was ﬁt to the data wherein the two belief constructs were collapsed into one underlying factor (see Table 2, Model 2). This model assessed the discriminant validity of the proposed belief constructs. A measurement model with one belief factor provided a poor ﬁt to the data as seen in Table 2 (Model 2; CFI = 0.80, NNFI = 0.78, RMSEA = 0.09). Similarly, we ﬁt a four factor model wherein the TMT diversity constructs were collapsed into one latent factor to assess these constructs’ discriminant validity (see Table 2, Model 3). This model was also a poor ﬁt to the data as seen in the ﬁt indexes reported in Table 2 (Model 3: CFI = 0.73, NNFI = 0.69, RMSEA = 0.15). Finally, a single-factor model used to assess overall discriminability poorly accounted for the sample data. In particular, specifying perfect correlation among all model constructs signiﬁcantly reduced model ﬁt (see Model 4 in Table 2, CFI = 0.78, NNFI = 0.64, and RMSEA = 0.12). These ﬁndings provide

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Fig. 2. Standardized Parameter Estimates for Measurement Equations. Note: ∗ p < 0.05.

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support for the theoretical independence and discriminant validity of the proposed constructs. Structural Model Results Structural model results revealed that the baseline latent variable model (Model 5 in Table 2) accurately ﬁt the sample data (CFI = 0.98; NNFI = 0.98; RMSEA = 0.02). This shows the baseline model explained 98% of the variance beyond the null model where a researcher assumes no relationships among the variables (Bentler, 1995). Furthermore, ﬁve of six path coefﬁcients yielded signiﬁcant parameter estimates (see Fig. 3). Together, these results provide support for the proposed model and all but one hypothesis. Signiﬁcant standardized path coefﬁcients from the baseline model are shown in Fig. 3. The predicted positive effect of background diversity on belief richness (0.417) was upheld. Further, the predicted negative inﬂuence of organizationbased diversity on belief homogeneity (−0.509) was corroborated while the negative effect of organization based diversity on belief richness (−0.345) also was supported. As predicted, belief homogeneity (−0.622) and belief richness (0.299) were signiﬁcantly associated with ﬁnancial ﬁrm performance in the hypothesized direction. Contrary to Hypothesis 1A, Fig. 3 also shows that background diversity was not signiﬁcantly related to belief homogeneity as predicted in Hypothesis 1A.

Fig. 3. Standardized Parameter Estimates for Hypothesized Relationships. Note: Asterisk denotes parameter estimates signiﬁcant at 0.05 level.

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The ﬁrst alternative model test was conducted to determine the value of including the two belief constructs as mediators in the model. To do this we compared the baseline structural model to a model which excluded the constructs of belief homogeneity and belief richness. Table 2 reveals that this model is a poor ﬁt to the data (see Model 6, CFI = 0.65; NNFI = 0.59; RMSEA = 0.23). The baseline model thus was used to make further nested model comparisons. The next comparisons assessed the fourth condition of mediation (Hom et al., 1995) and followed satisfaction of the ﬁrst three conditions of mediation (Baron & Kenny, 1986). First, correlation coefﬁcients showed that indicators of background diversity and organization-based diversity were signiﬁcantly correlated with ﬁrm performance indicators. Second, baseline structural model results showed that background diversity and organization-based diversity inﬂuenced the mediators in the hypothesized direction (the exception being that background diversity did not signiﬁcantly affect belief homogeneity). The third condition requires that both mediators inﬂuence ﬁrm performance in the predicted direction and, again, baseline structural model results show that this is the case (see Fig. 3). After these assessments, we examined two model comparisons to evaluate the fourth condition of mediation. Model 7 (see Table 2) speciﬁed a direct path from background diversity to ﬁnancial ﬁrm performance and was examined in a nested model comparison with the baseline structural model. This comparison yielded an insigniﬁcant chisquare difference relative to Model 5, the baseline model. This result supports acceptance of the more parsimonious baseline model and suggests that the effects of background diversity on ﬁnancial ﬁrm performance are completely mediated by belief richness. Finally, Model 8 was tested against the baseline model (see Table 2). Model 8 included a direct path from organization-based diversity to ﬁrm performance. This comparison assessed whether or not the effects of organizationbased diversity were mediated by the belief constructs. As before, the comparison of Model 8 and the baseline structural model (Model 5 in Table 2) produced an insigniﬁcant chi-square difference. This result suggests that the effect of organization-based diversity on ﬁnancial ﬁrm performance is fully mediated by belief homogeneity and belief richness. Results showing complete mediation indicate that the baseline model (Model 5 in Table 2) is the best ﬁtting model.

DISCUSSION The present study used upper echelons theory as a framework for generating hypotheses regarding the relationship between various components of TMT diversity and parent ﬁrm ﬁnancial performance following an acquisition. Until this

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test, the mediating role of TMT beliefs or cognitions within the acquisition process had not been substantiated. The ﬁrst phase of the analysis examined the operational measures used to assess our proposed latent diversity and belief constructs. Although past research assumed demographic proxies represent components of TMT diversity, our conﬁrmatory factor analysis provided a direct test of this assumption. Findings completely supported the convergent validity of our measures in that indicators were signiﬁcantly associated with their respective latent constructs. Moreover, results conﬁrm the discriminant validity of the two diversity constructs and the two belief constructs. These discriminant validity ﬁndings are important for illuminating the “black box” of TMT demography in three ways. First, the conﬁrmed presence of two constructs underlying classic measures of TMT demography suggests that future theory development be done using the latent constructs supported in this study instead of the classic proxies that loaded on these constructs. Much theorizing is still done using these classic proxies. Second, the discriminant validity of the two demographic diversity constructs indicates that the background diversity construct is not as broad as it was thought to be in past research (see Pelled, 1996; Williams & O’Reilly, 1998). For example, Pelled (1996) conjectures that organization tenure is part of background or task-based diversity but current ﬁndings on discriminant validity corroborate organization tenure as part of organization-based diversity. This distinction proves to be an important one given that current results show different effects emanating from background and organization-based diversity. Third, the discriminant validity of the two belief constructs supports our extrapolation of cognitive complexity to the team level of analysis in that ﬁndings conﬁrm two structural properties of beliefs for TMTs analogous to properties at the individual level. Moreover, results showing two underlying belief constructs encourage researchers to move beyond the single belief construct, belief homogeneity, which has been the focus on those rare occasions when TMT beliefs are operationalized (see Glick et al., 1993; Kilduff et al., 2000; Miller et al., 1998). Also, the discriminant validity of the two belief constructs has implications for extending research on mergers and acquisitions. Speciﬁcally, there are longstanding hypotheses about acquisition beliefs that are potentially testable in light of current results. TMTs with homogeneous acquisition beliefs are hypothesized to make poorer acquisition decisions relative to belief heterogeneous teams (Ginsberg, 1990). Ginsberg conjectures that homogeneous TMTs consider fewer interrelationships between parent and any target as well as assess fewer targets. He also proposes that a TMT with numerous beliefs, an idea analogous to the current notion of belief richness, may consider more targets and more effectively evaluate targets than TMTs with few beliefs. Future research can

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examine these propositions making use of the acquisition belief elicitation procedures used in the present study. The second phase of the analysis longitudinally examined alternative representations of relationships between TMT diversity and parent ﬁrm ﬁnancial performance following an acquisition. Covariance structure analysis provides support for the constellation of relationships underlying the baseline structural model shown in Fig. 1. The CFI of 0.98 reveals that our model accurately reproduced the observed covariances. This is an important ﬁnding because it provides a rare test of the premise that TMT diversity inﬂuences ﬁrm outcomes through a set of cognitive mediators possessed by a TMT. As such, this result supports theoretical propositions that TMT demographics affect organizational performance outcomes through top teams’ “cognitive bases” as suggested in the upper echelon theory originally developed by Hambrick & Mason (1984). This support has practical implications for appointing members to top management teams in that TMT demographics are highly visible and thus are potentially managed through stafﬁng. Precise implications of ﬁndings for stafﬁng TMTs are discussed below.

Structural Hypotheses Tests All but one of the six structural hypotheses were supported and are discussed below. Background diversity is not related to belief homogeneity, contrary to Hypothesis 1a, but it is positively associated with belief richness, supporting Hypothesis 2a. The hypothesized relationships between background diversity and TMT beliefs were based on the widespread proposition that background diversity is linked to the information or beliefs TMTs possess when making decisions (Williams & O’Reilly, 1998). Our approach to measuring TMTs beliefs is one plausible explanation for not conﬁrming Hypothesis 1a. We operationalized TMT beliefs into two separate constructs – belief homogeneity and belief richness – whereas past conceptual research used to anchor this hypothesis did not consider the dimensionality of TMT beliefs. It appears that the conceptual treatment of the relationship between TMT background diversity and TMT beliefs is based on an aggregate or global construct reﬂecting TMT beliefs whereas our predictions are based on considering more narrowly deﬁned characteristics of TMT beliefs. Our results challenge this broad conceptualization of TMT beliefs because the relationship between background diversity and TMT beliefs varies according to different dimensions of TMT beliefs – homogeneity verse richness. This conclusion is further supported by results from our conﬁrmatory factor analysis, particularly the test for the discriminant validity of belief homogeneity and belief richness. All told, the current results encourage future researchers to consider the

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dimensionality of beliefs when considering relationships between TMT diversity and TMT beliefs. Both Hypotheses 1b and 2b are supported in that organization-based diversity is negatively related to belief homogeneity and negatively related to belief richness. The negative relationship between organization-based diversity and belief homogeneity parallels past empirical results that show divergence in team tenure results in a lack of social integration deﬁned as the degree to which team members are psychologically linked to other members (O’Reilly, Caldwell & Barnett, 1989). This present ﬁnding thus provides additional support for the enduring notion that individuals entering an organization or group at different times have divergent beliefs about an organization and its goals (O’Reilly et al., 1993; Tsui, Egan & O’Reilly, 1992). This is a notion that is often conjectured but left untested because beliefs are rarely operationalized. Moreover, current results extend this notion to the content domain of acquisitions since assessed beliefs were TMT members’ beliefs about their parent company making an acquisition. Future research can explore the extent to which this same ﬁnding extends to the content domain of other types of strategic decisions such as divestitures or new product introductions. The negative relationship between organization-based diversity and belief richness is a unique ﬁnding in demography research because researchers seldom theorize about links between tenure diversity and the amount of information or beliefs available to executive teams (Williams & O’Reilly, 1998). These researchers instead focus on the demographic characteristic of background diversity when wanting to explain variation in TMT information or beliefs (see Jackson, 1992; Glick et al., 1993). This particular result however, encourages researchers to include tenure diversity as a predictor of the amount of information or beliefs TMTs possess when developing future demography theory. Moreover, ﬁndings corroborating Hypotheses 1b and 2b have implications for stafﬁng TMTs in that they imply belief homogeneity and belief richness can be managed through the highly visible characteristic of organizationbased demography. In particular, results suggest organization-based demography is the key to managing belief homogeneity since the relationship between background diversity and belief homogeneity was not supported. In particular, a high level of belief homogeneity can be avoided through stafﬁng TMTs with members possessing divergent organization tenure and team tenure. Any intent to manage belief homogeneity, however, must be balanced against organizationbased diversity’s negative effect on belief richness. Practitioners will want to consider minimizing tenure diversity in a TMT due to its negative effect on the richness of acquisition beliefs. TMTs making acquisition decisions, arguably the most technically complex (Jemison & Sitkin, 1986) and cognitively demanding (Duhaime & Schwenk, 1985; Zajac & Bazerman, 1991) decisions TMTs face,

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will want to maximize the information or beliefs they have available to make these decisions. Further, Hypotheses 3a and 3d are supported. Belief homogeneity is negatively related to ﬁnancial ﬁrm performance, and belief richness is positively associated with this criterion. The negative relationship from belief homogeneity is consistent with the notion of groupthink wherein similarities in group members lead to premature consensus on decision alternatives and negative outcomes from decisions (Janis, 1982). Applying groupthink speciﬁcally to acquisitions, the result suggests that homogeneity of acquisition beliefs may reduce the analysis of a target ﬁrm as well as scenarios for integrating it within the parent company. Further, this support of negative outcomes from belief homogeneity is a key ﬁnding in that the few studies assessing this link have produced scant results (see Glick et al., 1993; Kilduff et al., 2000). Perhaps the present ﬁnding is due to our assessing beliefs speciﬁc to acquisitions, a focused subset of TMTs’ broader set of beliefs that matches the content domain of the particular decision studied here – an acquisition. This focused approach to belief elicitation is advised by psychology research and stands in contrast to the more broadly focused operationalizations of TMT beliefs used in the few studies that have examined this same relationship (Glick et al., 1993; Kilduff et al., 2000). Researchers considering the inclusion of executive beliefs in future studies may want to implement this more focused approach to belief elicitation. Results conﬁrming Hypothesis 3d, the positive relationship between belief richness and ﬁnancial ﬁrm performance, have important implications for researchers investigating the information/decision making theoretical perspective of TMT demography. This perspective holds that demographically diverse individuals have a broader range of information or beliefs than homogeneous individuals and this greater information positively affects performance (Williams & O’Reilly, 1998). The current ﬁnding of a positive relationship between belief richness and performance empirically veriﬁes this basic proposition of the information perspective on demography theory, a rare direct test of this proposition. Future research can examine the extent to which this positive relationship holds for strategic decisions other than the acquisition decisions examined here. This result also extends the information/decision making perspective of TMT demography in two ways. First, the present study arguably assesses TMT information more directly through its operationalization of beliefs than is the case in previous empirical research where internal and external communication served as proxies for team information (see Ancona & Caldwell, 1992; Zenger & Lawrence, 1989). Future research can now explore the implicit assumption in past research – that volume of communication enhances TMT information – by using the belief richness construct and belief operationalizations described in the current study.

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Finally, we consider the implications of the conﬁrmed positive relationship between belief richness and performance in conjunction with the corroboration of two dimensions underlying classic TMT diversity measures. Considered together, these results potentially extend the information/decision making view of demography. To date, researchers generally proposed that diversity in any TMT demographic characteristic enhanced the information available to a team, thereby improving outcomes (Williams & O’Reilly, 1998). The implied conceptualization of TMT demographic diversity thus was a broad construct encompassing all classic measures of demography. We question this broad view of diversity by proposing and ﬁnding support for two distinct demographic diversity constructs; background diversity and organization-based diversity. Importantly, different effects emanated from the two diversity constructs with background diversity enhancing TMT information, operationalized here as belief richness, and organization-based diversity detracting from it. In summary, these collective ﬁndings encourage scholars to consider the dimensionality of TMT diversity when designing future studies anchored in the information/decision perspective of demography. Future research aimed at untangling the positive and negative effects of team diversity may also beneﬁt from explicitly recognizing diversity’s dimensionality as illustrated by the differences in effects that background diversity (positive) and organizationbased diversity (negative) had on belief richness.

Alternative Model Tests Alternative model tests show that relationships between TMT diversity constructs and ﬁnancial ﬁrm performance following an acquisition are completely mediated by the acquisition-related belief constructs. Speciﬁcally, results reveal that background diversity positively affects ﬁnancial ﬁrm performance through enriching the beliefs TMTs have to draw upon when making acquisition decisions. As such, ﬁndings are consistent with prior research that shows background diversity is associated positively with ﬁrm outcomes (see Eisenhardt & Schoonhoven, 1990; Hambrick, Cho & Chen, 1996; Wiersema & Bantel, 1992). Researchers have explained these positive results by conjecturing that TMTs high in background diversity are more creative (Daft & Lengel, 1986; Jackson, 1992) or better at problem solving (Jackson, 1992) than TMTs with little background diversity. Current ﬁndings extend these ideas by providing empirical veriﬁcation of a precise mechanism that may fuel creativity and problem solving – belief richness. In particular, our results show extensive background diversity to produce a rich set of numerous beliefs that TMTs have to draw on when considering an acquisition and further show that this rich set of beliefs facilitates positive acquisition

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outcomes. The implication is that background diversity potentially helps TMTs to be more creative or solve problems through adding more beliefs to their collective belief set. Moreover, the current ﬁndings also corroborate two mediational paths emanating from organization-based diversity. These ﬁndings reinforce Flatt’s (1996) conclusion that both positive and negative effects may emanate from organization-based diversity despite the bulk of empirical ﬁndings demonstrating negative effects on group functioning and performance (see Williams & O’Reilly, 1998, for a review). The dual effects emanating from organization-based diversity in this study may have been masked in prior research because generally only the direct effects of this kind of diversity on outcomes are examined. Perhaps negative effects of organization-based diversity were found because the default combining of negative and positive effects on outcomes may result in an overall negative effect. Further research is needed to examine how these dual effects combine to produce an overall effect on ﬁrm performance. Overall results from the alternative models tests have practical implications for forming top management teams since the TMT demographics studied are highly visible when stafﬁng top teams. In particular, current results support constructing a TMT with considerable background diversity in that this characteristic positively affected post-acquisition ﬁnancial performance through enhancing teams’ acquisition beliefs. The prescription for organization-based diversity is less clear since this kind of diversity produced both positive and negative indirect effects on ﬁnancial ﬁrm performance. Speciﬁcally, organization-based diversity reduced belief homogeneity which was good for performance but it also dampened the positive inﬂuence of belief richness on ﬁnancial ﬁrm performance. This negative effect emanating from organization-based diversity is a reminder that a TMT member can be reluctant to communicate beliefs when his or her tenure is different from that of other members. A TMT faced with divergent tenures thus may want to consider structured conﬂict techniques such as devil’s advocacy or dialectic inquiry in an attempt to surface beliefs and ameliorate the downside to organization-based diversity found in the current study.

Limitations Despite its contributions, this study has three limitations to consider. First, beliefs in the current study were elicited about acquisitions and this produces both a limitation and a strength in the ﬁndings. The limitation comes from social psychology research suggesting that these results are not necessarily generalizable to another content domain such as a different kind of strategic decision (e.g. new product

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introduction). However, the acquisition content of beliefs is a strength of the current study because it enhances the validity of elicited beliefs (Ajzen & Fishbein, 1980). On balance, the fact that 11,209 acquisitions valued at $908 billion U.S. dollars took place in 1997 alone suggests that, despite this limitation, current ﬁndings have far reaching implications. Second, the relatively small sample size may have distorted the parameter estimates of the SEM analysis. On the positive side, our use of the CFI corrects for underestimation of model ﬁt found for small sample sizes when using the normed ﬁt index (Bentler, 1990). Moreover, the sample size is in line with other studies at the top team level using non-archival data (Amason, 1996; Lumpkin & Dess, 1995; Miller, Burke & Glick, 1998; Sutcliffe, 1994). However, further research is needed to validate and extend current results to other samples. Third, the use of retrospective measures is an issue because TMT members’ beliefs were elicited after the acquisition considered in the study was made but before performance results from the acquisition were known. These measures were judged valid given empirical evidence suggesting that TMT beliefs are very stable (Ajzen & Fishbein, 1980) and highly resistant to change due to the emotional attachment team members have to them (Donaldson & Lorsch, 1983). Also, recent evidence suggests retrospective measures are not as serious a limitation as some authors suggest (Miller, Cardinal & Glick, 1997). Miller et al., list safeguards for researchers to follow to insure the integrity of their retrospective data and these were followed in the current study including: (1) reliable measures (see Table 1); (2) respondents asked about concrete events; and (3) appropriateness of retrospective reporting for the research question. In particular, the current study does not lend itself to a prospective design which would require researchers to collect data on beliefs from TMTs that might make acquisitions in the future. In conclusion, the upper echelon perspective applied in the current study suggests that TMT demographics do inﬂuence acquisition outcomes. In particular, the study revealed negative as well as positive effects of demographic diversity on ﬁrm performance. These negative effects are initial pieces of an acquisition decision making puzzle that, as more puzzle pieces are added, may begin to answer the question of “why” acquisitions continue to be a popular growth strategy when baseline probabililties imply a high likelihood of negative outcomes.

ACKNOWLEDGMENTS The authors thank the following scholars for their insightful comments on earlier versions of this manuscript: Michael Hitt, Michael Lubatkin, Bill Glick, Zeki Simsek, Stephen Bowden, Carol Jacobsen, Richard Gooding, and Jim Corner. We also acknowledge those scholars who gave the ﬁrst author feedback in the 2002

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“Cognition in the Rough” seminar at the Academy of Management meetings in Denver. These include Marlene Fiol, Lynn Isabella, and Kathleen Sutcliffe.

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APPENDIX Belief items: TMT members were asked to indicate which outcomes their ﬁrm might realize for each acquisition cause. Speciﬁcally, respondents were asked to list the number(s) of outcome(s) expected from each cause on the lines to the right of each cause. Instructions noted that improved proﬁtability and growth in sales were not included as outcomes because they are probably expected in all manufacturing acquisitions. Acquisition Causes 1. Acquisition’s marketing capabilities 2. Acquisition’s R&D capabilities 3. Skills of acquisition’s management 4. Acquisition’s proﬁtability 5. Acquisition’s market share 6. Acquisitions access to international markets 7. Acquisition’s access to raw materials 8. Acquisition’s manufacturing capabilities 9. Acquisition’s distribution channels 10. Acquisition’s product line(s) 11. Acquisition’s unique product technologies 12. Acquisition’s unique process technologies 13. Acquisition’s access to domestic markets 14. Acquisition’s revenue spread across many customers 15. Other – specify Note: Outcomes: 1 = Cost Savings; 2 = Better Product Differentiation; 3 = Increased Market Power; 4 = Lowered Cost of Debt/Capital; 5 = Reduced Cyclicality in Earnings; 6 = Other – specify.

TOP MANAGEMENT TEAM TURNOVER IN MERGERS & ACQUISITIONS Jeffrey A. Krug and Ruth V. Aguilera ABSTRACT This paper reviews the evolving literature on top management team effects in mergers and acquisitions (M&As). Existing research has focused on understanding why incumbent top managers depart at higher rates than normal following an acquisition and why high turnover rates have negative postacquisition performance effects. We explore two new areas of inquiry. First, we discuss the role of newly hired executives – executives hired after the acquisition. Our research indicates that executives who join target companies after an acquisition also depart more quickly than executives who join companies not previously involved in an acquisition. Acquisitions appear to create long-term instability in the target ﬁrm’s top management team – both incumbent and new-hire executives depart at higher rates than normal well into the future. Integration of the target ﬁrm often intensiﬁes instability within the target company’s top management team. This instability affects performance and leads to further integration efforts as the ﬁrm attempts to improve performance. These additional integration activities, in turn, lead to even higher subsequent executive turnover. Second, we examine the topic of director turnover and propose a theoretical framework for understanding the relationship between acquisitions and director retention. Future research that

Advances in Mergers and Acquisitions Advances in Mergers and Acquisitions, Volume 4, 121–149 Copyright © 2005 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1479-361X/doi:10.1016/S1479-361X(04)04005-0

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considers the role of directors as well as executives may lead to deeper insight into the nature of turnover and integration effects in mergers and acquisitions.

INTRODUCTION The importance and popularity of mergers and acquisitions as a means of achieving corporate growth and proﬁt objectives is well established. The merger wave of the 1980s is considered to be the fourth merger wave of the twentieth century (Golbe & White, 1988). Between 1980 and 1989, 36,622 U.S. ﬁrms were acquired, an average of 3,662 transactions each year (The Thompson Corporation, 2004). Rather than showing signs of slowing, however, merger activity intensiﬁed through the 1990s both in terms of value and number of deals. Between 1990 and 1999, 103,016 U.S. ﬁrms were acquired, an average of 10,302 transactions each year. This high level of M&A activity continues relatively unabated. Between January 2000 and July 2004, an additional 42,077 U.S. ﬁrms were acquired for a total value of $4.8 trillion, an average of $1.1 trillion each year. Given the U.S. gross domestic product of $11.0 trillion in 2003, the M&A market is generating transactions valued at about 10% of the U.S. economy (Bureau of Economic Analysis, 2004). Despite the popularity of M&As, the evidence is that acquisitions, on average, do not improve performance of the ﬁrms they acquire. In the most recent review of M&A literature, King, Dalton, Daily and Covin (2004) conducted a metaanalysis of 93 empirical studies of M&A performance. They found that stock values for both acquiring and target ﬁrms generally increase signiﬁcantly on the day of the acquisition announcement. This suggests that shareholders expect longterm synergy gains at the time of the announcement, even though one in four global acquisition announcements is later withdrawn because of conﬂicts arising during merger negotiations or because the acquiring ﬁrm uncovers organizational problems during the due diligence process (Aguilera, Dencker & Escandell, 2004). They also found that future measures of acquiring ﬁrm market returns and accounting returns (ROA, ROE, and ROS) are generally negative. This suggests that acquiring ﬁrms generally fail to realize expected synergy gains. There is also little evidence that greater degrees of strategic relatedness between merging ﬁrms lead to greater acquisition value or postacquisition performance (Barney, 1988; Lubatkin, 1987; Singh & Montgomery, 1987). Relatedness appears to be a desirable but insufﬁcient condition for creating value in the absence of effective integration (Capron & Pistre, 2002). Integration is viewed as a critical determinant of acquisition success regardless of the degree to which potential synergies exist (Cartwright & Cooper, 1996; Galpin & Herndon, 2000; Haspeslagh & Jemison, 1991; Hitt, Harrison & Ireland, 2001; Hubbard, 1999; Marks & Mirvis, 1998; Schweiger, 2002; Schweiger & Goulet, 2000).

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Fig. 1. Top Management Team Turnover in Mergers & Acquisitions: A Conceptual Framework.

Corporate Governance Issues in Mergers & Acquisitions In this paper, we focus on the role of the target company’s top management team. We examine the existing literature and present the preliminary results of our research. Our objective is to give the reader an understanding of what has been done and where we believe the most productive future contributions to this evolving literature may be made. We examine the target ﬁrm’s top management team as a dependent variable (e.g. understanding the determinants of top management turnover) and as an independent variable (e.g. understanding the effect of top management turnover on postacquisition integration and performance). We adopt the framework in Fig. 1 as a basis for our discussion. Most of the literature has focused on the target company’s incumbent top management team. Despite anecdotal evidence and widespread acceptance in the media through the 1980s, Walsh (1988) was the ﬁrst to empirically test whether acquisitions led to higher executive turnover. Walsh is generally credited with stimulating much of the work that followed on incumbent top management team effects in mergers and acquisitions. In the ten-year period following his initial research, the literature generally focused on three primary questions: (1) Do target company executives depart at higher rates than normal following an acquisition? (2) If so, what are the determinants of this higher than normal executive turnover? (3) What are the performance effects of high executive turnover after an acquisition? This literature focused exclusively on the incumbent executive team. The literature generally concluded that the turnover effects of acquisitions disappear beyond the

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second or third year after the acquisition. That is, beyond the second or third year following the acquisition, executives in acquired ﬁrms are no more likely to depart than executives in ﬁrms that were not acquired two or three years prior. Our research indicates that this conclusion was erroneous. Mergers and acquisitions have effects that extend far beyond the incumbent top management team. Executives hired after the acquisition are also affected. Our ﬁndings indicate that the study of top management team effects may be an important avenue for helping us understand where and how value is created in M&As. Recent research on the long-term effects of acquisitions indicates that acquisitions have a signiﬁcant impact on executives hired after the acquisition (Krug, 2003a, b). Two important questions arise from these ﬁndings. First, if an executive has two job offers – one with a ﬁrm that was acquired several years before versus one with a ﬁrm that was not – will his or her daily responsibilities, work environment, and career prospects be any different? Second, if acquisitions have long-term effects on the target company’s top management team, how do these effects inﬂuence integration efforts, company strategy, human resources, and long-term performance? The following queries show promise for contributing to our understanding of the long-term top management team effects of M&As. Issues related to the target ﬁrm’s top management team: (1) Are executives who join companies after an acquisition more likely to depart than executives who join companies not previously involved in an acquisition? (2) If so, what are the determinants of this higher than normal turnover? (3) What is the relationship between incumbent top management team turnover and new-hire executive turnover? Issues related to the target ﬁrm’s board of directors: (1) What is the effect of acquisitions on the target ﬁrm’s board of directors? (2) What theoretical explanations predict director retention? (3) What are the theoretical linkages between board retention and integration effectiveness?

INCUMBENT TOP MANAGEMENT TEAM TURNOVER Level of Turnover after the Acquisition Table 1 summarizes the results of studies that measured rates of turnover among incumbent target company executives after an acquisition. No attempt was made to measure the effect of the acquisition on executives who joined the target company

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Table 1. Cumulative Top Management Turnover Rates Following Acquisition. Study

Walsh (1988) Acquired ﬁrms Non-acquired ﬁrms

Sample

Period

Year Following Acquisition 1

2

3

4

5

50 30

1975–1979 1975–1979

25.0 2.0

37.0 13.0

46.0 21.0

52.0 31.0

59.0 33.0

Walsh (1989) Acquired ﬁrms

102

1975–1979

26.1

38.6

48.9

54.9

61.1

Walsh and Ellwood (1991) Acquired ﬁrms Non-acquired ﬁrms

102 75

1975–1979 1975–1979

26.1 7.1

38.6 15.0

48.9 24.3

54.9 29.2

61.1 33.5

Hambrick and Cannella (1993) Acquired ﬁrms 97

1980–1984

27.0

45.0

55.0

67.0

Krishnan, Miller and Judge (1997) Acquired ﬁrms 146

1986–1988

Krug and Hegarty (1997) Acquired ﬁrms Non-acquired ﬁrms

1986–1988 1986–1988

21.2 8.1

40.5 16.3

59.9 23.6

68.4 31.6

Lubatkin, Schweiger and Weber (1999) Acquired ﬁrms 69 1985–1987

20.0

33.0

42.0

52.0

Average turnover rates Acquired ﬁrms Non-acquired ﬁrms

23.6 5.7

39.3 14.8

50.6 23.0

60.6 30.6

270 120

47.0 74.8 36.9

68.0 34.5

Note: Cumulative top management turnover rates calculated by dividing the number of executives employed at time of acquisition (incumbent top management team) leaving the ﬁrm through year being reported divided by the number of executives employed at time of acquisition.

after the acquisition. In all cases, cumulative rather than annual rates of turnover were reported. The objective was to understand the full effects of the acquisition on the acquired top management team and when those effects returned to normal. A signiﬁcant number of executives leave during the ﬁrst year after the acquisition, when an average of 24% of the top management team departs. This represents a postacquisition turnover rate almost three times higher than normal. By the end of the third year, more than one-half of the original top management team is gone. Sixty-eight percent are gone by the end of the ﬁfth year. A signiﬁcant portion of the incumbent executives who depart after the acquisition leaves involuntarily. Two studies interviewed a sample of target company executives to understand the nature of the executive’s departure decision (Krug & Hegarty, 2001; Krug & Nigh, 2001). One third of the executives who

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departed after the acquisition reported that they left voluntarily for reasons that had nothing to do with the acquisition, e.g. retirement, to take a better career opportunity, or family reasons. Another one-third reported that they were involuntarily terminated. The last one-third reported that they departed because they felt alienated from the new top management team or were made to feel that their participation in the new management team was no longer valued. In these cases, the company recorded the executive’s departure as voluntary. The nature of these executives’ turnover decisions, however, indicated that they would not have departed absent the acquisition. Despite the acquiring ﬁrm’s reporting these latter departures as voluntary, these ﬁndings suggest that acquisitions may have negative consequences for up to two-thirds of the target company’s top management team.

Situational Determinants of Incumbent Executive Turnover Merger Characteristics Early attempts to understand the causes of high postacquisition executive turnover in target ﬁrms focused on a variety of merger, industry, ﬁrm, and individual characteristics. Walsh (1989), for example, examined aspects of the merger negotiation process. His analysis included preacquisition interest in the target company, tender offer versus merger proposal, negotiations marked by numerous counteroffers, the amount of time required to negotiate the deal, buyer’s public assurance that it would retain target company management, hostile versus friendly negotiations, type of payment (i.e. cash or stock), and the premium paid for the target company. Only the hostility of merger negotiations explained high turnover rates in the ﬁrst year after the acquisition. When target executives opposed an acquisition, particularly in instances where an acquiring company bypassed the target company’s top management team and presented a tender offer directly to shareholders, they were less likely to stay once the acquisition took place. Other merger characteristics, however, generally did not explain why so many executives left soon after the acquisition. While hostile negotiations were the most signiﬁcant of the merger characteristics studied, it is noteworthy that hostile acquisitions represent an insigniﬁcant number – 5% of less – of all acquisitions transacted in any year (Krug & Nigh, 1998). Thus, merger characteristics appear to be a poor predictor of future target company turnover. Industry Characteristics The examination of industry differences has focused primarily on the issue of relatedness. Early research tested the hypothesis that acquiring ﬁrms were more likely to view target executives as dispensable when they acquired ﬁrms that

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operated in similar industries or product categories (Manne, 1965; Pitts, 1976). In unrelated acquisitions, acquiring ﬁrms have less knowledge of the ﬁrm they are acquiring and would, therefore, be favorably inclined toward retention of target company executives. Walsh (1988, 1989) tested the effect of relatedness using the ﬁve Federal Trade Commission categories (related = horizontal, vertical, product extension, and market extension; unrelated = conglomerate). He found no direct correlation between relatedness and turnover. Walsh’s (1989) analysis of merger characteristics, however, did ﬁnd indirect associations. When a target company was approached with a merger proposal by an unrelated acquiring ﬁrm after it had been subjected to signiﬁcant merger interest, its executives were more likely to leave four years after the merger. Walsh, however, suggested that his analysis of merger characteristics and industry relatedness, both which were based on the examination of intercorrelations, stopped short of adequately explaining the high level of turnover, especially during the ﬁrst two years after the acquisition. Hambrick and Cannella (1993) also tested the effect of relatedness. They used two judges who independently placed acquisitions into categories of relatedness using business descriptions of the merging ﬁrms. Their ﬁndings, however, were contrary to existing thought. Horizontal acquisitions, which resulted in the combination of ﬁrms operating in similar product categories, experienced low levels of turnover among target ﬁrm executives during the ﬁrst month after the acquisition. Unrelated acquisitions experienced higher target executive turnover rates. Relatedness was not associated with turnover beyond the ﬁrst month after the acquisition. The immediate loss of executives in unrelated target companies was counter to the expectation that acquiring ﬁrms would take steps to minimize turnover given that they had fewer managers with sufﬁcient industry knowledge to operate the unrelated target. Hambrick and Cannella (1993) argued that the lack of relatedness may generate greater cultural gaps that lead to communication problems and create incentives for executives to leave. The ﬁndings in both Walsh’s (1988, 1989) and Hambrick and Cannella’s (1993) research suggest that relatedness is nevertheless a weak direct predictor of turnover. A more promising avenue for understanding industry effects may be found in Krug and Nigh’s (1998) study of cross-border acquisitions. Using the concept of transnational integration developed by Kobrin (1991), they found that turnover in U.S. target companies was signiﬁcantly higher when the merging ﬁrms operated in a global industry. This effect began immediately after the acquisition and intensiﬁed through the sixth year following the acquisition, suggesting that global industry effects are immediate and long-term. Previous studies of industry relatedness focused on whether the acquiring ﬁrm had an adequate supply of managers with sufﬁcient industry knowledge to operate the acquired company after the acquisition. In contrast, Krug and Nigh (1998) focused on the desirability of

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retaining target company managers given industry structure. In global industries, companies beneﬁt by standardizing product designs, manufacturing processes, distribution channels, and marketing practices. Standardization lowers costs through scale effects and provides the ﬁrm leverage across a larger sales base. It also has two important human resource effects. First, local managers – that is target company managers – are less critical to the global ﬁrm’s integration efforts, since standardization reduces the need for local market knowledge. Second, the global ﬁrm’s existing managerial base becomes a critical resource for transferring the ﬁrm’s strategy abroad. In multi-domestic industries, in contrast, ﬁrms beneﬁt from local adaptation rather than standardization. Local managers become a more critical resource for helping the global ﬁrm adapt its product and processes to the local market. These ﬁndings suggest that managers’ ﬁrm- versus industry-speciﬁc knowledge may be more inﬂuential in enabling the acquiring ﬁrm to successfully transfer capabilities and integrate the target ﬁrm. Firm Characteristics Research on ﬁrm characteristics has concentrated primarily on target company performance prior to the acquisition and on the market for corporate control. Hambrick and Cannella (1993) found that poor accounting performance in target companies relative to the acquiring ﬁrm is associated with greater target company executive departures during the ﬁrst two years after the acquisition. Poor preacquisition stock performance is also associated with signiﬁcantly higher turnover when the target company is acquired by a corporate raider (Walsh & Kosnik, 1993). As we discuss later, Hambrick and Cannella (1993) suggested that poor preacquisition performance creates the perception of inferiority on the part of target company top management – they feel inferior and the acquiring company feels superior. These feelings of status, brought on by the target company’s poor performance prior to the acquisition, cause target company executives to depart more quickly. Acquiring ﬁrms may also be more inclined to replace target executives with their own when performance has been poor. The association between poor preacquisition performance and postacquisition turnover raises the question of whether poor performance is a primary motivating factor behind merger and acquisition activity. According to the market for corporate control, ﬁrms that perform below shareholder expectations become takeover targets. Outside ﬁrms may compete for control of underperforming ﬁrms, replacing perceived incompetent target ﬁrm executives immediately after the acquisition in an attempt to improve performance (Berle & Means, 1932; Fama, 1980; Fama & Jensen, 1983; Jensen & Meckling, 1976; Varian, 1988). In this type of acquisition, the termination of less than competent executives is a major objective of the acquisition (i.e. hubris). Theoretically, executives are motivated to pursue activities

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that promote their self-interest even at the expenses of shareholders. They tend to pursue projects that create the perception of competence, thereby enhancing their own opportunities for promotion and increased job security. If boards fail to address such behavior, then the market for corporate control becomes an important mechanism whereby outside ﬁrms may intervene by acquiring the poorly performing ﬁrm, replacing incompetent management, and improving performance. Studies of the market for corporate control, however, have found that few acquisitions are driven strictly by the desire to improve poor target ﬁrm performance (Walsh & Ellwood, 1991; Walsh & Kosnik, 1993). Nevertheless, companies that perform below their industry average do experience higher turnover rates after the acquisition, an indication that acquiring companies are less willing to retain executives when performance is poor. In practice, however, the average target company performs at or above industry standards before it is acquired. This suggests that most acquiring ﬁrms actively seek acquisition candidates that are either industry leaders or have some unique set of competences that are of value. The market for corporate control also assumes that executives entrench themselves by pursuing projects that maximize their tenure. Walsh and Kosnik (1993), however, found that target companies generally experience preacquisition turnover rates at or above turnover rates in comparable, non-acquired companies. This also implies that target companies are either good performers or willing to discipline themselves when performance falls short of expectations. Target companies are acquired for a variety of reasons (Ravenscraft, 1987; Trautwein, 1990; Walter & Barney, 1990). The inefﬁcient management hypothesis, however, while long accepted as a major incentive for acquisition activity in the media, has little theoretical support (Davis & Stout, 1992; Walsh & Ellwood, 1991). Krug and Hegarty (1997) found that the effect of ﬁrm characteristics is intensiﬁed in cross-border transactions. Cross-border acquisitions are associated with higher executive turnover in target companies compared to purely domestic acquisitions. Research on domestic acquisitions concluded that the most signiﬁcant turnover effects occur within three years after the acquisition. Beyond the third year, turnover rates rise at about the same rate as in non-acquired ﬁrms. In the case of cross-border acquisitions, turnover rates continue to rise at a higher rate than normal through the sixth year after the acquisition. This suggests that longerterm effects are present when the target is acquired by a foreign ﬁrm. In addition to the global industry effects already discussed, Krug and Nigh (1998) found that turnover rates are signiﬁcantly higher when the foreign acquirer has made previous acquisitions in the same country. Acquisition experience enables foreign ﬁrms to develop internal capabilities and experiences that can be leveraged in future acquisitions. As the foreign ﬁrm gains experience, it becomes less dependent on the target company for local knowledge. Consequently, foreign ﬁrms are more likely

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to use their own managers to integrate acquired ﬁrms when they have signiﬁcant acquisition experience. Individual and Top Management Team Characteristics Individual characteristics are an important determinant of organizational success. They affect how top management team members interact and inﬂuence both the quality of decision making and the efﬁciency with which decisions are implemented (Schweiger & Sandberg, 1989). Certain types of executives are more likely to depart more quickly than others. More senior managers, for example, tend to depart sooner after the acquisition. In Walsh’s (1988) study, 39% of the target company CEOs, presidents, and chairs left within ﬁve years after the acquisition. In contrast, a signiﬁcantly lower number (27%) of vice presidents, controllers, secretaries, and treasurers left during the same period. The loss of more senior executives has important organizational implications because it disrupts strategic projects and degrades leadership continuity (Schweiger, Ivancevich & Power, 1987). When the most senior executives depart, a leadership vacuum is created in the target company that must be ﬁlled by the acquirer. Executives from the acquiring ﬁrm, however, often lack the ﬁrm-speciﬁc knowledge needed to quickly step in and make informed strategic decisions. In many cases, however, replacing the most senior executives in the target company is viewed as having signiﬁcant symbolic value. It signals that the acquiring ﬁrm is in charge (Pfeffer, 1981). Krishnan, Miller and Judge (1997) examined the question of top management team complementarity, where complementarity referred to instances in which the merging top management teams had dissimilar or non-overlapping functional skills. They found that target company executives were more likely to depart when their functional backgrounds were similar to the backgrounds of acquiring ﬁrm executives. In these instances, executive skills were viewed as redundant in that they did not contribute to the acquiring ﬁrm’s existing knowledge base. The existence of overlapping skills creates opportunities to achieve greater cost efﬁciencies by eliminating redundant positions. In contrast, executives were most likely to be retained when they had complementary skills or unique sets of managerial competencies that added value to the acquiring ﬁrm’s knowledge base. In addition to these knowledge beneﬁts, the merging of top management teams with dissimilar individual characteristics and functional skills improves problem solving by increasing the diversity of solutions proffered (Haspeslagh & Jemison, 1991). Whereas the departure of older, more tenured executives might be viewed as non-efﬁcient insofar as they deprive the ﬁrm of experience and leadership stability, top management team complementarity might be viewed as efﬁcient in that it creates synergies in the decision making process.

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Individual values and beliefs are strongly embedded in culture. Cultural differences often lead to conﬂicts and miscommunications that exacerbate turnover after an acquisition (Lubatkin, Schweiger & Weber, 1999). They cause target company executives to leave voluntarily and motivate acquiring ﬁrms to replace executives with their own as a way of reducing integration problems. The effect of culture, however, is moderated by a variety of other ﬁrm characteristics. Krug and Nigh’s (1998) analysis of turnover in cross-border acquisitions, for example, showed that cultural effects are strongly inﬂuenced by other factors. The negative effect of culture is reduced when the foreign acquirer has signiﬁcant international experience operating in multiple countries. International experience helps the ﬁrm build cross-cultural sensitivities that mitigate communication problems. The negative effect of culture is also reduced when the foreign acquirer has signiﬁcant acquisition experience. This experience reduces integration problems that would otherwise be intensiﬁed by cultural differences.

Dispositional Determinants of Turnover Related Status and Removal of Autonomy Early studies focused on situational determinants (merger, ﬁrm, industry, and individual and top management team characteristics) to understand the nature of high executive turnover in target companies after an acquisition. The low predictive power of most situational characteristics, however, led researchers to examine dispositional characteristics such as executive perceptions of the merger process. While they did not directly measure perceptions, Hambrick and Cannella (1993) studied the concepts of relative status and autonomy removal. They found that executives were less likely to depart when they were granted greater status and autonomy in the newly merged company. They measured status using a dichotomous variable that identiﬁed instances where an executive’s job title indicated an increase in status. They acknowledged that this measure did not embody actual managerial responsibilities. It was, however, an expectation that executive perceptions were captured – albeit imperfectly – by the simple measure of titular status. Autonomy of target company executives was measured through surveys sent to security analysts and executives in the acquiring company. As with status, this measure did not directly measure executive perceptions but was thought to capture the nature of the executive’s level of autonomy after the acquisition. An individual executive’s feelings about his or her status and autonomy in the new ﬁrm had a direct bearing on his or her job satisfaction and ultimate decision on departure. In addition, executives were more likely to depart when other executives in the ﬁrm received greater status enhancements. Thus, acquiring companies that increase the status of

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one or more executives as a means of motivating them to stay may nevertheless ﬁnd these executives leaving if they grant greater status increases to other executives in the ﬁrm. Lubatkin et al. (1999) replicated these ﬁndings using actual perceptions of managers in ﬁrms acquired in friendly, related acquisitions. Perceptions of cultural differences and removal of autonomy were signiﬁcant in explaining more than 50% of the variance in turnover in the ﬁrst year after the acquisition. In the fourth year after the acquisition, removal of autonomy remained signiﬁcant. In a third study, Krug and Hegarty (2001) used surveys to analyze how executives’ perceptions of merger events determined whether they stayed or left after the acquisition. They found that executives’ perceptions of the merger announcement, interactions with executives in the acquiring ﬁrm after the merger, and executives’ perceptions of the long-term personal effects of the merger had a signiﬁcant impact on their decision to stay or leave. These perceptions could be used to accurately distinguish executives as stayers or leavers in 80% of the cases. When the sample was split into “stayers” and “leavers” based on whether they were “informed” or “uninformed,” Krug and Hegarty (2001) found that informed stayers had the most favorable impressions. The most informed leavers had the most negative perceptions. This suggests that good communications during the merger integration process is insufﬁcient for overcoming all executives’ initial negative perceptions of the merger. Consistent with upper echelons theory, executives are driven by a complex set of motives and often develop widely divergent interpretations of the same event. This makes it difﬁcult for researchers to make accurate predications about an executive’s behavior, even when methodology is based on perceptional measurements.

The Performance Consequences of Postacquisition Executive Turnover Three studies addressed the relationship between postacquisition executive turnover and performance. Each study drew similar conclusions: the loss of target company top managers after the acquisition has negative performance consequences and should be managed accordingly. Cannella and Hambrick (1993) looked at performance in 96 acquisitions between 1980 and 1984. Surveys were mailed to twelve expert informants, including six executives from each acquiring ﬁrm and six security analysts who specialized in the acquiring ﬁrm’s industry. Each informant rated the proﬁtability of the target ﬁrm at the time of the acquisition and four years after. Results indicated that high target company executive turnover rates after the acquisition were associated with lower performance. Performance was affected most when the most senior managers left. Giving higher status to one or more target company executives in the post-merger organization was associated

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with the greatest performance improvement. These results suggest that executives from the target ﬁrm are important resources, especially in terms of the experience they bring to the integration process. When target ﬁrms lose their top management base, organizational processes are broken and leadership discontinuity often leads to instability. Such resources are not easily replaced. Krishnan, Miller and Judge’s (1997) study found a positive relationship between top management team complementarity and performance. They used a sample of 147 acquisitions between 1986 and 1988 and measured performance as return on assets (ROA) averaged over a three-year period immediately following the acquisition. Dissimilar functional backgrounds provided complementary or synergycontributing skills that improved the integration process. In turn, executive turnover was lowest in complementary acquisitions, an indication that target company executives who had complementary skills were both easier to integrate into the new organization and provided the greatest contribution to the new company in terms of background experience and skills. Top management team complementarity was positively associated with both lower postacquisition executive turnover and higher postacquisition performance. Complementary skills are an indication of the individual executive’s potential value to the integration process. Bergh (2001) studied the association between target company executive retention and the probability that the target company would later be divested. He examined 104 of the largest U.S. publicly traded acquisitions between 1986 and 1992. Fifty percent of the target companies were divested within ﬁve years of the initial acquisition. Performance was measured as return on assets (ROA) for the acquiring ﬁrm during the years the target ﬁrm was retained. Target ﬁrms had the highest probability of eventual divestiture when the least senior executives were retained (i.e. executives other than the chairman, vice chairman, president, CEO, or COO). In addition, targets that retained executives with the longest organizational tenures were the least likely to be divested. These ﬁndings indicate that retaining executives with the longest organizational tenure decreases a target ﬁrm’s probability of divestiture. Consistent with the resource-based view of the ﬁrm, organizational tenure implies that the executive with greater ﬁrm-speciﬁc knowledge contributes to more effective integration of the target ﬁrm.

NEW-HIRE TOP MANAGEMENT TEAM TURNOVER Level of Turnover after the Acquisition Three conclusions from the existing work on target company incumbent top management turnover following an acquisition can be drawn: (1) the greatest

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executive turnover occurs during the ﬁrst year after the acquisition; (2) turnover rates generally return to normal within three years after the acquisition; and (3) high executive turnover rates are associated with poor target company performance. Despite the insight offered by existing studies, several issues remain. First, the primary insight offered by existing studies is in explaining the high turnover that occurs in the ﬁrst year after the acquisition. These studies, however, have had less success explaining turnover beyond year one. Additionally, many ﬁndings have been contradictory. Hambrick and Cannella (1993), for example, found that reduced autonomy and status are associated with higher turnover in the second year after the acquisition. This relationship, however, reverses itself by year four, when reduced autonomy and status are associated with lower turnover. Lubatkin et al. (1999) also found, consistent with Hambrick and Cannella (1993), that lower autonomy in year two is associated with higher turnover. This relationship, however, remained positive in year four rather than reversing itself as in Hambrick and Cannella’s analysis. These problems raise a number of questions. First, are the effects of acquisitions limited to executives in the acquired top management team? Or, do acquisitions also impact executives who join the ﬁrm after the acquisition (new-hire executives)? If total executive turnover equals incumbent plus new-hire turnover, then perhaps the inability of studies to fully explain turnover beyond the ﬁrst year post-acquisition, as well as the contradictory ﬁndings of existing studies, can be explained by these studies focusing solely on incumbent executives. Second, if new-hires are also affected by the acquisition, then do turnover rates really return to normal? Third, what is the relationship between incumbent and new-hire turnover? In order to better understand the long-term effects of acquisitions, Krug (2003b) analyzed rates, patterns, and the timing of executive turnover among 12,080 executives in 473 target and non-acquired ﬁrms over a ﬁfteen-year period. He analyzed data using a repeated measures longitudinal design that controlled for violations in homoscedastic error assumptions. He found no signiﬁcant differences in turnover rates between merged and non-merged ﬁrms during the ﬁve years leading up to the acquisition or point of observation. This suggested that there was no reason to believe that turnover rates between the two groups would have differed in the future had the target ﬁrms not been acquired. Nevertheless, during the nineyear period following the acquisition, the merged ﬁrms experienced average annual turnover rates of 9%, two times higher than turnover rates in the non-acquired ﬁrms. These ﬁndings indicate that the conclusions of studies that the turnover effects of acquisitions disappear beyond the second or third year after the acquisition are erroneous. Acquisitions appear to create leadership instability in target companies that continues for at least nine years after the acquisition. Executives who join targets after the acquisition also appear to leave more quickly than executives who

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join ﬁrms not previously involved in an acquisition. This suggests that much of the conﬂicting results of studies that only examined incumbent executive turnover might be explained by turnover among new-hire executives. Acquisitions create conditions that lead to high turnover rates among both groups. Studies that separate the turnover effects of these two groups may ﬁnd more robust explanations of the effects of acquisitions.

The Relationship between Incumbent and New-Hire Executive Turnover Drawing on the concept of managerial discretion (Barnard, 1938; Finkelstein & Hambrick, 1990; Hambrick & Abrahamson, 1995; Hambrick & Finkelstein, 1987), Krug and Michael (2004) analyzed the relationship between incumbent and new-hire executive turnover. Using a longitudinal repeated measures model, they examined the careers of more than 4,000 incumbent and new-hire executives in 89 merged and 90 non-merged ﬁrms over a ﬁfteen-year period surrounding the acquisition. Consistent with the literature, they found that incumbent executives departed at abnormally high rates after the acquisition. In addition, they found that executives who joined target ﬁrms after the acquisition also departed at higher rates than executives who joined ﬁrms not involved in an acquisition. Newhire executives who joined the target ﬁrm one year after the acquisition were already departing at higher rates than normal one year later. New-hire turnover continued to occur at a higher rate than normal through the ninth year. Further, newhire turnover was signiﬁcantly higher when it was preceded by high incumbent executive turnover. Firms with the highest rates of turnover among incumbent executives immediately following the acquisition had the highest rates of turnover among new-hire executives several years later. Based on their framework of managerial discretion, Krug and Michael (2004) argued that acquisitions create uncertainty among executives regarding their managerial discretion. Many incumbent executives depart immediately after the acquisition because the merger creates uncertainty surrounding their decisionmaking rights in the ﬁrm. Existing psychological contracts are broken when executives must deal with new managers and directors who have different interpretations of the terms and conditions of previously made psychological contracts (Hambrick & Finkelstein, 1987; Herman, 1981; Mizruchi, 1983). After the acquisition, executives suffer uncertainty regarding the extent of their new discretion. Managerial discretion is created by psychological contracts that depend on the identities of the individuals making them. Instead of negotiating new contracts with new managers and directors in the acquiring ﬁrm, many incumbent executives choose to exit.

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Many new-hire executives face the same uncertainty regarding their managerial discretion, especially in the face of high incumbent executive turnover. When incumbent executives feel uncertainty regarding their managerial discretion, they have greater difﬁculty delegating decision-making rights to executives who join the ﬁrm after the acquisition. As a result, new-hire executives are more likely to feel greater uncertainty regarding the boundaries of their own discretion compared to executives who join ﬁrms not subjected to acquisition. When incumbent executives depart, this situation is aggravated. The new-hire executive must now renegotiate his decision-making rights with a new executive, one who may have a different understanding of the previously negotiated psychological contract. Acquisitions create uncertainty for all target executives who must renegotiate psychological contracts with new superiors. This uncertainty creates long-term instability in the target ﬁrm and causes high turnover rates well into the future.

TURNOVER AMONG THE TARGET FIRM’S BOARD OF DIRECTORS Little research has been conducted on the turnover behavior of the main governance body (board of directors) of the acquired ﬁrm. The few studies touching on director turnover focused on turnover of the CEO or chair using agency theory arguments (e.g. Walsh & Ellwood, 1991; Walsh & Seward, 1990). We respond to the research oversight pointed out by Walsh and Kosnik (1993, p. 692) more than a decade ago and discuss the patterns and consequences of target ﬁrms’ director turnover. An understanding of director turnover is fundamental to the success of acquisitions, given the directors’ potential decision-making role in the newly merged ﬁrm. Since acquiring ﬁrms are generally unable or unwilling to retain all target directors, we inquire into the factors that affect the likelihood that target company directors will be retained. The role and importance of individual directors and the board of directors as a whole has been an area of extensive debate in the corporate governance literature (Johnson, Daily & Ellstrand, 1996). Class hegemony theory, for example, describes the director’s role as one of perpetuating class power and the ruling elite (Useem, 1984). In contrast, managerial hegemony theory views directors as passive actors with little power (Mace, 1986). Increasing empirical evidence indicates that directors are of strategic importance in the ﬁrm’s value creation process (Golden & Zajac, 2001; Westphal, 1999). Westphal and Frederickson (2001) teased out board effects on ﬁrm strategy from what previously had been considered to be executive effects. Other studies demonstrated direct board effects on ﬁrm strategic outcomes (Ruigrok, Peck & Keller, 2002) and how board demographics and processes affect

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IPOs (Filatotchev & Bishop, 2002), entrepreneurship patterns (Zahra, 1996), CEO succession (Ocasio, 1994), and acquisition strategies (Davis, Diekmann & Tinsley, 1994). In sum, the literature indicates that, as a corporate governance entity, the board of directors has direct effects on ﬁrm strategy and value creation. In the context of M&A negotiations, the target ﬁrm’s board of directors is critical because it is the body that engages in merger negotiations in the case of friendly acquisitions or that is superseded in the case of hostile takeovers. In addition, “maintaining continuity of board membership is often important in meeting the long-term objectives of the combined forces,” unless the ﬁrm is signiﬁcantly smaller than the acquiring ﬁrm (DePamphilis, 2001, p. 242). This is particularly true when the target operates as a subsidiary of the acquirer. As Bergh (2001) rightly questioned for executives, we ask a similar question regarding directors. Given that the newly merged ﬁrm is unable to retain all acquired directors, which directors should be retained and which should be let go? The retention of key human capital is one of the factors leading to successful implementation of an acquisition strategy (Haspeslagh & Jemison, 1991; Porter, 1987). We develop a theoretical framework of director turnover in acquired ﬁrms by examining directors’ functions from three theoretical perspectives. We conﬁne our discussion to outsider directors – those with no executive responsibilities in the ﬁrm. For the study of insider directors’ turnover postacquisition, we refer to the TMT turnover studies already discussed. Agency theory is traditionally used to explain the conﬂict of interests between shareholders and the ﬁduciaries of their interests – the directors. We argue, however, that this single-focused approach is insufﬁcient to understand director turnover in the context of acquisitions because directors fulﬁll multiple functions. We propose a framework that builds on agency theory but also examines the endogenous functions of directors through the resource-based view of the ﬁrm and directors’ organizational boundary spanning functions through the social capital perspective. These three distinct theoretical perspectives allow us to analyze directors’ functions as ﬁduciaries of shareholder interests in the acquired ﬁrm, both as critical human capital contributing to the knowledge base of the acquiring ﬁrm and as social capital or resource linkages between the acquiring ﬁrm and external stakeholders. Whereas human capital ﬁlls the gaps in the principle agent dyad, social capital is the contextual complement to human capital (Burt, 2003, p. 150). Consequently, we argue that acquired director turnover is not only explained by classic agency arguments such as director dependence relative to the top management team of the acquired ﬁrm but also by factors such as asset speciﬁcity, asset complementarity, and directors’ boundary-spanning relations with other organizations. These multiple factors have interactive effects.

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The Monitoring Function Amidst corporate scandals, the board of directors faces increasing pressure from various stakeholders and the institutional environment for increased accountability (Luoma & Goodstein, 1999). This pressure resonates well with the agency argument that directors are the ﬁduciaries of shareholder interests. The argument is built on the premise of management’s potential self-serving behavior and the information asymmetry between management and shareholders (Arrow, 1985). The separation between ownership and management, particularly with diffuse ownership structures, may lead managers to act in their self-interest. These actions may not coincide with the interests of shareholders (Fama, 1980). One function of the board of directors is to behave as the ultimate internal monitoring mechanism to reduce such self-serving behavior (Fama & Jensen, 1983). This monitoring function is commonly recognized by the public and regarded as the most “orthodox” function of the board of directors as a governance entity. As the main internal monitoring mechanism, the board of directors provides a lower-cost means of replacing underperforming top managers relative to market takeovers (Fama, 1980). Directors, however, may fail to monitor management effectively and may themselves need to be monitored. If so, the outside takeover market serves as a court of last resort, where not only inefﬁcient management but also the ultimate internal control mechanism – the board of directors – will be culled. From an agency perspective, Walsh and Kosnik (1993) argue that if corporate takeovers are indeed motivated by the desire to increase performance by eliminating management inefﬁciencies, then postacquisition restructuring decisions need to address both director and management deﬁciencies in the acquired ﬁrm. Walsh and Kosnik (1993) suggest that turnover among directors of the acquired ﬁrm will be higher than the company’s historical turnover rate and the rate of ﬁrms not engaged in acquisitions. Ineffective monitoring is possible either because directors lack adequate information needed to supervise management activities or because the board of directors is subservient to the CEO, top management team, or both. Since it is difﬁcult to ascertain any information asymmetry a priori, we focus on the case of director dependence. Directors are said to be dependent on top management when their personal, professional, and/or economic relationships with top management unduly inﬂuence the effectiveness of their monitoring. CEOs, for example, can signiﬁcantly inﬂuence directors’ interests and decision-making (Johnson et al., 1996). This is expected or anticipated and may even be considered a part of their job. It is a matter of degree and the directors’ response. Some managers use any means available to pressure directors to their advantage. Directors are sometimes viewed simply as “rubber-stampers” serving top management interests (Pfeffer, 1981).

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In sum, from an agency perspective, it is more likely that directors can effectively carry out their monitoring function when they are independent of undue inﬂuence from other directors, the CEO, or other top management members. Conversely, we expect that directors are more likely to monitor the TMT ineffectively when they are unduly attached to the top management of the acquired ﬁrm. As a result of the acquisition, they, in turn, are more likely to leave.

The Knowledge Contribution and Capability Building Function The agency argument is built on the presumed conﬂict of interest between shareholders and management. Despite its dominance in the corporate governance literature, shareholders may not always be subject to conﬂicts of interests with managers and directors. This is particularly the case when directors or managers are altruistic or are also shareholders (Aguilera & Jackson, 2003; Davis, Schoorman & Donaldson, 1997). In these cases, the monitoring function assigned to directors may not be more important than other director functions such as those of knowledge contribution and capability building. Ideally, it is to be hoped that each director will contribute to all three functions, albeit to varying degrees. Drawing on the resource-based view of the ﬁrm, we identify two director functions: knowledge contribution and capability building. First, it is broadly accepted within the content approach of the resource-based view that ﬁrm competitive advantage and value creation are based on the possession and service of ﬁrm-speciﬁc, costly-to-imitate resources (Barney, 1991; Mahoney & Pandian, 1992). Directors are critical human capital and contribute specialized knowledge and expertise to the ﬁrm. Director knowledge and expertise are speciﬁc to the ﬁrm when they are embedded in directors’ experience. In particular, tenured directors develop as the ﬁrm grows and accumulate knowledge about the ﬁrm and its environment over time. Such knowledge is difﬁcult to replicate. If directors have valuable specialized knowledge or expertise, we argue that they also have a knowledge contribution function. While the knowledge contribution function relates to the ﬁrm-speciﬁc, inimitable characteristics of director knowledge and expertise, the capability building function refers to a director’s role in the dynamic process of accumulating organizational capabilities. Firms not only require a collection of resources for value creation, but they must also engage in processes of deploying and developing resources, e.g. coordination, integration, reconﬁguration, and the transformation of existing internal and external resources (Teece, Pisano & Shuen, 1997). As the environment changes, the ﬁrm must generate new knowledge and renovate its resource base to maintain competitiveness. Therefore, the director’s process of

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accumulating ﬁrm-speciﬁc resources matters as well. Not only the stock of existing knowledge in a ﬁrm but also effective development and deployment of resources and capabilities over time are sources of competitive advantage and value creation (Eisenhardt & Martin, 2000). As part of the ﬁrm’s strategic leadership, directors have important functions in setting strategic direction, bringing together internal and external resources, and solving various problems on a sustained basis in the capability building processes. Speciﬁcally, directors have a say in the resource allocation process for strategic investments. When directors are associated with the development of critical ﬁrm capabilities such as innovation and technology, then they have a key capability building function. Such functions are particularly valuable for a ﬁrm in competitive, technology-intensive industries and in today’s knowledge economy in general. These two functions are related to the “resource role” and “service role” of directors as described by Johnson et al. (1996). From resource dependency theory (Pfeffer & Salancik, 1978), directors have an important resource seeking role in the sense of securing access to certain critical resources such as ﬁnancial capital or legal advice. This helps reduce uncertainty from the ﬁrm’s interdependence with the environment (Dalton, Daily, Johnson & Ellstrand, 1999). These roles derive fundamentally from directors’ leverage within the ﬁrm as well as the ﬁrm’s interdependent relationship with other ﬁrms. Therefore, the “resource role” is power-based. The resource-based view of directors, however, emphasizes the value creation aspect of directors as critical human capital of a ﬁrm. Both resource functions of directors in our discussion are efﬁciency-based. Directors with these two functions should help the ﬁrm gain and sustain competitive advantage. This follows directly from the basic proposition within the resource-based view of the ﬁrm, that internal resources and capabilities that are valuable, rare, insubstitutable and inimitable are critical to a ﬁrm’s competitive advantage (Barney, 1991; Conner, 1991; Peteraf, 1993). In addition, our discussion explicitly distinguishes between the static and dynamic director functions. The resource dependency perspective is silent on this issue. We propose that how well directors fulﬁll the knowledge contribution and capability building functions will inﬂuence director turnover in acquisitions. First, acquisitions are motivated not only by proﬁt-seeking goals but also by assetseeking goals. Teece (1988) pointed out that, under certain circumstances, acquisition is the only means of obtaining certain valuable assets. If directors embody or are closely associated with the development of ﬁrm-speciﬁc knowledge in the target that is sought by the acquiring ﬁrm, then these directors will most likely be retained. Even when the acquisition is not motivated solely by asset-seeking incentives, directors with ﬁrm-speciﬁc knowledge that is potentially valuable to the acquiring ﬁrm have a better chance of retention than those who lack such knowledge.

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This dynamic capabilities view focuses on a ﬁrm’s capabilities as a source of competitive advantage. Capabilities involve purposeful and collective activities by which resources are assembled in integrated clusters spanning individuals and groups so that they enable distinctive activities to be performed. Capabilities are characterized by their degree of coherence or the degree to which one element reinforces or complements others (Teece, Rumelt, Dosi & Winter, 1994). In this sense, capabilities are highly “combinatorial” and involve complementarities among multiple resources and routines. One of Sony’s capabilities, for example, is based on its core competence of miniaturization, the maintenance and enhancement of which must be supported by complementary capabilities in manufacturing (Prahalad & Hamel, 1990). Following the acquisition, the acquiring ﬁrm should reconﬁgure complementary resources and capabilities. For example, top scientists equipped with expertise and knowledge in the acquired ﬁrm may no longer be needed either because the acquiring ﬁrm possesses similar expertise on its board or because the ﬁrm is in the process of shifting its strategic orientation, e.g. from a focus on basic research to applied research or development. Such a redeﬁnition in the value of complementary knowledge and expertise means that these directors are less likely to contribute to the whole ﬁrm’s capability. They may even be detrimental to the acquiring ﬁrm’s capability accumulation in case of cacophony between directors and others in the acquiring ﬁrm. If directors’ abilities do not complement the acquiring board or top management team, they are more likely to depart. Such complementarity is important for top management team members of the acquiring and acquired ﬁrms. While the asset speciﬁcity of director knowledge relates to the value of individual director knowledge and expertise to the acquiring ﬁrm, complementarity relates to whether director knowledge and abilities are compatible with the rest of the acquiring ﬁrm for its capability building. These two are distinct concepts, though equally important in determining the likelihood of acquired director turnover.

Interaction between the Agency and Resource-Based Arguments Our claim that directors exercise multiple functions within the board adds complexity to the prediction of acquired director turnover, since we must examine the interactive effects of these different functions. From an agency perspective, director dependence is more likely to lead to ineffective monitoring and be associated with director turnover. This may, however, not always be consistent with the resource-based view argument. When acquired directors possess critical knowledge contribution and capability building functions, their asset speciﬁcity and complementarity increase the probability of their retention. Suppose, for

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example, that a scientist is a director in a biotech ﬁrm that has professional attachment to the ﬁrm’s top management team but also possesses substitutable expertise. His or her retention following the acquisition depends on two factors: (1) whether his or her attachment to top management has had negative performance effects; and (2) whether his or her speciﬁc expertise remains an important asset to and complements the existing asset base of the acquiring ﬁrm. If these two factors operate in different directions when the acquisition takes place, one will weaken the effect of the other on director turnover. When the director is attached to the top management team of the acquired ﬁrm but his knowledge remains valuable or complementary, the acquired director is less likely to depart.

The Social Capital Function The social capital perspective is an excellent complement to the agency and resource-based views because it stresses different organizational issues and dynamics. While the agency perspective focuses on the function of directors in aligning incentives of management and shareholders and the resource-based view emphasizes the endogenous directors’ function in knowledge contribution and capability building, the social capital perspective focuses on the social context of the ﬁrms mediated by its directors (Burt, 2003; Coleman, 1990; Lin, 2001; White, 1981). Social capital is deﬁned as “the sum of the resources, actual or virtual, that accrue to an individual or group by virtue of possessing a durable network of more or less institutionalized relationships of mutual acquaintance and recognition” (Bourdieu & Wacquant, 1992, p. 119). From this perspective, directors bring social capital to the ﬁrm through their personal inter-organizational relations as well as through their overall location in the social structure of their networks. The social capital perspective conceptualizes actors as part of a broader social structure. In line with this view, directors do not operate in isolation within the ﬁrm. Instead, they are embedded in a broader social context beyond the ﬁrm. They span organizational boundaries creating an advantage for lowering the risk of cooperation and increasing the value of information and resource transfer (Granovetter, 1985). In this respect, directors hold a pivotal function in building and maintaining a ﬁrm’s social capital. They serve as key linkages between the focal ﬁrm and peer organizations, suppliers, customers, government and other stakeholders. Such inter-organizational relationships are critical to the ﬁrm’s competitive advantage and value creation. Although directors possess internal bonding relationships with other directors on the board, their external bridging relationships are particularly important in our analysis of director’s social capital and acquired director’s likelihood of turnover

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(Adler & Kwon, 2002). We now focus on the directors’ function of boundary spanning relationships that was originally discussed in the management literature by Barnard (1938) and Mintzberg (1978) in describing the role of senior managers. Directors’ social capital stems from boundary spanning relationships beyond their ﬁrm and industry. This director function may be fulﬁlled, for example, by serving on several boards or having a functional background in other ﬁrms. We analyze directors’ social capital along two main dimensions: relational and structural. The relational aspect refers to the characteristics of directors’ social relations and the resources gained from these relationships. One of the most important features of social relations is closure. Closure refers to the permeability of social relations and their density in preserving and maintaining resources. It will determine how much information and resources are gained from these relationships as well as what type of information and resources are transferred to the ﬁrm. Coleman (1990) stresses the importance of network closure as a distinctive advantage in social capital. He states that closure – as opposed to open networks – preserves and enhances trust, norms, authority and sanctions, thereby ensuring that network resources are mobilized through social relations. Moreover, because of its role in facilitating trust and norms among social actors, closed networks also confer competitive advantage by lowering the risk of cooperation in exchanging information and resources (Burt, 1993). Social capital research also shows that closed social relations can serve as mechanisms for effective communications and obtaining ﬁne-grained information. In acquisitions, acquired directors may bring with them closed networks that are valuable in helping the acquiring ﬁrm integrate the target company. Directors in closed inter-organizational networks can potentially contribute more social capital to the acquiring ﬁrm than directors in open social networks. Therefore, we expect that directors with closed networks will have a greater ability to secure social capital by virtue of their membership in such social networks and will be less likely to leave than directors with open networks. Second, the structural dimension of social capital concerns the location of a focal actor in a social network and the director’s utility in allowing information to ﬂow from one social circle to another. Particularly important within this social structure is what Burt deﬁned as structural holes or the separation between non-redundant contacts predominant in sparse networks (1992). As Lin (2001) states, “Locations that link nodes and their occupants to information and other resources unlikely to be accessible otherwise constitute valuable capital for the occupants of these ‘structural hole’ positions, and at other locations and for other occupants accessing them” (p. 22). In their boundary spanning function, directors develop social capital by building interpersonal bridges between disconnected parts of markets and organizations where it is valuable to do so. Directors’ social structure deﬁnes

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their opportunities for brokering the ﬂow of information across organizations as well as controlling resources. Burt (1992) demonstrated that sparse networks are especially beneﬁcial because each contact serves as a bridge to non-redundant information. Thus, directors whose networks span holes across organizations are more likely to increase the value to the ﬁrm of cooperation with outsiders and consequently their own value within the ﬁrm. Directors’ advantages accrue to those whose networks are sparse or rich in structural holes (Burt, 2003). In the context of acquired directors, those located in sparse networks will be able to add more value to the acquiring ﬁrm because these resources are difﬁcult to access and tend to be attached to actors.

Interaction of Social Capital Arguments with Agency and Resource-Based Arguments Under agency theory, we proposed that director dependence on top management will lead to higher turnover because the director’s monitoring function within the acquired ﬁrm will be adversely affected. The social capital perspective suggests that directors contribute social capital to the acquiring ﬁrm through their organizational boundary spanning function, particularly in the case of those with a closed and sparse social network. Therefore, the social capital brought to the acquiring ﬁrm by directors through their external linkages may dilute the impact of direct dependence on turnover. We expect that the positive relationship between director dependence and director turnover will not be as strong as when a director does not have a closed and sparse social network or does not possess any competitive advantage over other directors as an efﬁcient boundary-spanner. Finally, according to the resource-based view, asset speciﬁcity and complementarity of director knowledge and expertise lead to lower acquired director turnover. It is reasonable to expect that directors with knowledge or expertise speciﬁc to the acquired ﬁrm and potentially valuable to the acquiring ﬁrm, or abilities complementary to those of the board or top management of the acquiring ﬁrm, will have a better chance of retention if they have also maintained a close and sparse social network.

CONCLUSION Our objective in this paper was to provide the reader with a better understanding of the theoretical and empirical literature that has examined the issue of top management turnover in target companies following acquisition. One conclusion

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from our examination is that studies have focused too narrowly on the target company’s incumbent top management team. Our own research indicates that executives who join target companies after the acquisition experience high turnover rates up to nine years after the acquisition. This suggests that acquisitions create long-term leadership instability in acquired ﬁrms. Conﬂicting ﬁndings in studies that focused on incumbent executive turnover might be explained by the fact that they did not consider the possibility that acquisitions also impacted executives who joined the target ﬁrm several years after the acquisition. Acquisitions appear to create long periods of instability in the target company’s top management team that begins with a high level of departures among incumbent executives immediately following the acquisition and continues with high levels of turnover among executives who join the target ﬁrm after the acquisition. These ﬁndings have both practical and theoretical considerations. Executives with job choices may ﬁnd the nature and dynamics of different job opportunities to be signiﬁcantly different depending on the ﬁrm’s past acquisition activities. Firms previously involved in an acquisition may provide less job security and a more dynamic, rapidly changing environment as the ﬁrm pursues restructuring activities and attempts to improve performance. From a theoretical point-of-view, future research that considers these long-term effects may be more successful in providing better explanations for the high failure rates of acquisitions. We also proposed a theoretical framework for understanding the nature of target company director turnover following acquisition. Little research has yet been done in this area. We believe the best insight into merger integration effects will be found in future research that considers the role of each of these three agents – directors, incumbent executives, and new-hire executives – in managing target ﬁrms over the long-term.

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ACQUISITION AS A MECHANISM OF MARKET EVOLUTION: AN EVOLUTIONARY PERSPECTIVE ON HOW ACQUISITION CREATES VALUE Annetta Fortune INTRODUCTION Merger and acquisition activity generates a substantial amount of discussion within business circles among academics, analysts, and the media. Even though research and experience demonstrates that many mergers and acquisitions fall short of the intended goal of creating shareholder value, mergers and acquisitions still persist in the marketplace. The purpose of this discussion is to suggest that a potential explanation for this dilemma can be found by applying the resource-based rationale of acquisition within an evolutionary framework of business dynamics. Business dynamics relates to the study of how business and ﬁrms change in the face of constraints. The lens of business dynamics emphasizes the role of acquisition as a vehicle of change. An evolutionary perspective highlights the impact of change over time and across levels of analysis, which suggests that we consider the cumulative impact of acquisition at multiple levels of analysis. Resource-based thinking provides a focal point for our discussion of change, ﬁrm level resources and capabilities, which illustrates the adaptive and selective impact of acquisition activity. The assumption of an evolutionary approach to acquisition from the perspective of ﬁrm level resources and capabilities establishes

Advances in Mergers and Acquisitions Advances in Mergers and Acquisitions, Volume 4, 151–162 Copyright © 2005 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1479-361X/doi:10.1016/S1479-361X(04)04006-2

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the foundation for a discussion of the adaptive and selective implications of acquisition across multiple levels of analysis. The presence of adaptive and selective implications occurring across multiple levels of analysis suggests that acquisition represents a mechanism of market evolution, which provides a potential explanation for the persistence of acquisition in light of a frequent inability to increase shareholder value at the ﬁrm level. The contemporary state and recent history of the telecommunications industry makes this an ideal industry context to address the role of acquisition in business dynamics. Addressing the recent acquisition activity within the telecommunications industry from a resource-based perspective within an evolutionary framework highlights the adaptive use of acquisition to maintain competitiveness, as well as the capacity of acquisition to behave as a selective force that shapes the nature of the industry landscape. In particular, acquisition activity within the telecommunications industry represents a salient example of the contribution of acquisition activity to the evolution of an industry even in the absence of increased shareholder value.

BACKGROUND The Evolutionary Perspective of Business Dynamics Historically, the study of organizational change centers on the debate between organizational adaptation (Cyert & March, 1963; Levitt & March, 1988) and environmental selection (Hannan & Freeman, 1977, 1989). The organization adaptation perspective on change proposes that organizations are ﬂexible and have the ability to change, or adapt, to their environments by altering routines or practices (Cyert & March, 1963; Levitt & March, 1988). Alternatively, the environmental selection perspective proposes that environmental forces drive change in the business landscape through the selection of organizations given that organizations are inert actors in the process of organizational change (Hannan & Freeman, 1977, 1989). The initial attempts at reconciling the competing camps purport that these perspectives are actually complementary (Singh, House & Tucker, 1986) and interdependent (Levinthal, 1991). However, evolutionary theory (Aldrich, 1999) advances and expands on the relationship between these two perspectives by incorporating the tenets of the adaptation and selection perspectives within a more powerful and generic theory of organizational evolution. Evolutionary theory encompasses both the adaptation and selection perspectives by acknowledging the intentionality and the indeterminacy of change at the organizational level. Evolutionary theory purports that organizational evolution represents the aggregate effect of variation, selection, retention, struggle, and

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transformation, which occur across multiple levels of analysis (Aldrich, 1999). The emphasis on transformation acknowledges the presence of adaptation by recognizing the intentionality of ﬁrm action in the presence of indeterminacy. Highlighting the role of indeterminacy acknowledges the presence of selection given that this indeterminacy results from the inability of the ﬁrm to control, or foresee, the outcomes of change as a result of external forces. Furthermore, evolutionary theory emphasizes the presence of evolutionary forces across multiple levels of analysis, which integrates the ﬁrm level emphasis of adaptation with the environmental emphasis of selection into one framework. Hence, evolutionary theory provides a foundation for construing acquisition as a mechanism of market evolution based on the adaptive and selective implications of acquisition that occur across multiple levels of analysis.

The Resource-Based View of Acquisition Taken together, the resource-based view and the capabilities perspective establish the value and importance of ﬁrm speciﬁc resources and capabilities. The resourcebased view emphasizes the importance of unique, ﬁrm speciﬁc resources as contributors to competitive advantage (Barney, 1991; Penrose, 1959; Wernerfelt, 1984). The capabilities perspective (Richardson, 1972; Teece, Pisano & Shuen, 1997) extends a thread within resource-based thinking that dates back to the work of Penrose (1959) by adopting a focus on organizational processes and activities as contributors to competitive advantage. These perspectives also emphasize that path dependence and embeddedness are the key operative characteristics in the value, and resulting ability, of ﬁrm resources and capabilities to yield competitive advantage. The resource-based rationale for acquisition follows from the value and key characteristics of ﬁrm resources and capabilities. The ability of ﬁrm speciﬁc resources and capabilities to contribute to competitive advantage makes them desirable. However, the path dependent and embedded nature of organizational resources and capabilities yields the conditions of market failure, which complicate obtaining these desired capabilities. Hence, the conditions of market failure necessitate acquisition as a vehicle to access the resources and capabilities resident in another ﬁrm. The conditions of market failure arise due to the inability to separately identify and value a discrete asset apart from the context in which the asset resides. The path dependent and embedded nature of organizational resources and capabilities hampers the isolation and valuation of these ﬁrm speciﬁc characteristics apart from the context of the ﬁrm, which creates the conditions of market failure.

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This situation is especially relevant for those resources and capabilities that are most likely to yield a competitive advantage as a result of the casual ambiguity and social complexity involved (Barney, 1991). As a result of the conditions of market failure that envelop organizational resources and capabilities, the discrete purchase of valuable organizational capabilities becomes exceedingly difﬁcult. As a consequence of the difﬁculty associated with discrete purchase, the acquisition of an entire entity represents an important mode of access to obtain the value resident in the resources and capabilities of another ﬁrm.

ACQUISITION AS A MECHANISM OF MARKET EVOLUTION Acquisition and Adaptation An existing stream of literature within strategy empirically demonstrates the use of acquisition as a mode of access to the resources and capabilities resident within another ﬁrm (Capron, Dussauge & Mitchell, 1998; Capron & Mitchell, 1998; Granstrand & Sjolander, 1990). In particular, acquisition represents a tool for overcoming the internal inertial forces resulting from the constraints of existing routines (Capron & Mitchell, 1998; Capron, Mitchell & Swaminathan, 2001; Zollo & Singh, 2004), which contributes to the revitalization of the acquiring ﬁrm (Vermeulen & Barkema, 2001). Firms use acquisition both to build on an existing set of capabilities and to establish new sets of capabilities; however, ﬁrms tend to use acquisition to build on existing capabilities more frequently than ﬁrms use acquisition to establish new capabilities (Karim & Mitchell, 2000). The use of acquisition as a vehicle to obtain organizational resources and capabilities possesses importance within the study of business dynamics because acquisition represents a way for businesses to change in the face of constraints. The capacity of acquisition to act as a vehicle for resource reconﬁguration establishes the adaptive nature of acquisition from the standpoint of the ﬁrm and intra-ﬁrm levels of analysis given that adaptation represents a change in response to the environment (Levinthal, 1994). Acquisition is adaptive from the perspective of resources and capabilities because the acquisition of an entity preserves the context in which ﬁrm speciﬁc characteristics reside. The preservation of the ﬁrm context then in turn provides a preservation of the resources and capabilities embedded within the ﬁrm. Therefore, acquisition exempliﬁes a mechanism of adaptation at the intra-ﬁrm level, which maintains the existence of ﬁrm level resources and capabilities, albeit within another entity.

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Acquisition also demonstrates adaptive implications at the ﬁrm level from the perspectives of both the target and the acquirer. In particular, the bilateral nature of resource reconﬁguration in acquisition (Capron & Mitchell, 1998) indicates that the potential beneﬁts of acquisition extend to the target ﬁrm in addition to the acquiring ﬁrm. Hence, the use of acquisition as an adaptive response at the resource and capability level generates adaptive results at the ﬁrm level where the unit character of the target survives and the acquirer transforms itself. Similarly, the population or industry level of analysis also reﬂects the adaptive implications of acquisition. Given that the population or industry represents an aggregation of the member ﬁrms and their inherent resources and capabilities, the adaptive actions at the ﬁrm and resource level impact the composition and characteristics of the population and industry. Hence, the use of acquisition as a means of change also creates change at the population and industry level by impacting the constituencies that make up the whole. The adaptive implications of acquisition at the population or industry level would imply that the reconﬁguration and recombination of resources and capabilities at lower levels of analysis would foster the continued existence and success of the industry or population as the environment changes. Hence, the use of acquisition as a means of change contributes to the discussion of acquisition as a mechanism of market evolution given the adaptive implications of acquisition across the intra-ﬁrm, ﬁrm, population, and industry levels of analysis.

Acquisition and Selection A consideration of the impact of acquisition activity on an aggregate scale reveals that acquisition also acts as a force of environmental selection. Selection occurs as market, competitive, institutional, or other environmental forces select, or selectively eliminate, certain variations within the landscape (Aldrich, 1999). An examination of the options facing struggling ﬁrms highlights the capacity of acquisition to selectively eliminate certain resources and capabilities. Speciﬁcally, a struggling ﬁrm is a ﬁrm that lacks viability as an independent entity. Since struggling ﬁrms are no longer viable as independent entities, they generally face one of two possible outcomes: acquisition or dissolution. Acquisition acts as a force of selective elimination from a resource-based perspective given that the dissolution of an un-acquired struggling ﬁrm destroys ﬁrm speciﬁc resources and capabilities. Granted dissolution releases human and capital resources held within the ﬁrm to be used elsewhere in the business environment, but dissolution eliminates those resources and capabilities that are idiosyncratically embedded within the context of the ﬁrm, by destroying the ﬁrm as a coherent whole (Mitchell, 1994). Hence,

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acquisition acts as a mechanism that actually de-selects the ﬁrm speciﬁc resources and capabilities of struggling ﬁrms that are not acquired. On the other side of the coin, acquisition acts as a force that selects certain resources and capabilities to be retained within the business landscape. Acquisition preserves some degree of the idiosyncratic ﬁrm speciﬁc characteristics following a resource-based perspective of acquisition, as well as resource-based empirical ﬁndings regarding acquisition. Given that the resources and capabilities of a target ﬁrm continue to survive in the business landscape to some extent, acquisition acts as a vehicle that fosters the maintenance of particular resources and capabilities within the business landscape. Hence, acquisition acts as a selective force through the selection of certain resources and capabilities, and the selective elimination of others. As a result of the embeddedness of ﬁrm resources and capabilities within a ﬁrm, the selective implications of acquisition at the resource and capability level create similar results at the ﬁrm level. The embeddedness of resources and capabilities within the context of a speciﬁc ﬁrm contributes to their value by augmenting casual ambiguity, social complexity, as well as rarity (Barney, 1991). The depth of this embeddedness also transfers resource and capability level implications up to the ﬁrm level. Speciﬁcally, the selective implications of acquisitions at the resource and capability level create similar implications at the ﬁrm level because the embeddedness of resources and capabilities joins the fate of the ﬁrm to the fate of its resources and capabilities. The selective implications of acquisition also exist at the population and industry levels of analysis. Since the existing member ﬁrms characterize the population or industry as a result of consistent selection criteria (Aldrich, 1999), the selective implications of acquisition at the population and industry levels reﬂect the cumulative impact of the selection via acquisition that occurs at the ﬁrm and resource level. Furthermore, the cumulative impact of this acquisition activity can also result in the selection and selectively elimination groups or populations of ﬁrms over time. Hence, at the population and industry levels of analysis acquisition represents a concerted selective force that shapes the nature of industries and populations through the cumulative impact on ﬁrms and groups of ﬁrms.

A CASE EXAMPLE: THE TELECOMMUNICATIONS INDUSTRY The deregulation and liberalization of the telecommunications industry that began in the 1980s transformed the landscape of this industry from one of stability with few opportunities for acquisition, to one in ﬂux with a high incidence of

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acquisition activity (Le Blanc & Shelanski, 2002). By the 1990s acquisitions in the telecommunications industry represented a salient feature of the industry, and garnered substantial attention in the business press. From 1990 to 1995, the telecommunications industry led all U.S. industries in acquisition activity with deals totaling approximately $110 billion (Capron & Mitchell, 1997). The acquisition fever continued through the end of the 1990s into the new millennium as more than 20 acquisitions with a total deal value exceeding $20 billion occurred from 1996–2001 (Le Blanc & Shelanski, 2002). The high incidence of acquisition activity and the escalating deal values demonstrate the relevance of acquisition as a force shaping the telecommunications industry. The combination of deregulation, globalization, and technological advances within the telecommunications industry yielded a competitive environment that has ﬁrms racing to stake out market share. Speciﬁcally, the competitive environment within telecommunications provides strong incentives for ﬁrms to offer multiservice, worldwide solutions (Goldman, Gotts & Piaskoski, 2003; Le Blanc & Shelanski, 2002). Acquisition represents a key strategic tool in a ﬁrm’s efforts to obtain the requisite resources and capabilities since acquisition provides a faster means of entry as opposed to in-house or collaborative development of resources and capabilities (Mitchell, Shaver & Yeung, 1994). Within the telecommunications industry in particular, acquisitions provide a means of expanding networks and services (Capron & Mitchell, 1997), as well as a means of capturing innovativeness, while avoiding the substantial capital investment and time required to construct and implement these resources and capabilities (Goldman et al., 2003). The use of acquisition as a means to expand service and innovative capabilities within telecommunications reveals that the telecommunication industry represents a context where the resource-based rationale for acquisition applies. Furthermore, the use of acquisition as a means to obtain the resources and capabilities within other ﬁrms also demonstrates that acquisition represents an adaptive response for ﬁrms striving to enhance performance and survival within a changing industry environment. Given the degree of upheaval and uncertainty created by technological advances and deregulation within the telecommunications industry, the persistence in acquisition activity represents the efforts of ﬁrms to adapt and survive by scrambling to transform and augment resources and capabilities. Prior to the deregulation of the telecommunications industry, the regulations represented the most salient environmental force affecting industry participants. In the era of deregulation, acquisition activity emerged as an important environmental force in the re-shaping of the telecommunications industry. Whereas deregulation attempted to create a competitive environment populated by many viable competitors, acquisition activity represents a consolidating environmental force that is contracting the numbers of industry participants and potential

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competitors (Villano, 2004). In acting as a consolidating force, acquisition shapes the nature and conﬁguration of resources, capabilities, and ﬁrms present within the industry landscape through the selection and selective elimination of features. The consolidation of the Regional Bell Operating Companies (RBOC’s) following the Telecommunications Reform Act of 1996 exempliﬁes the selection of a certain resource and capability conﬁgurations through acquisition. The breakup of AT&T resulted in the creation of seven RBOC’s (Ameritech, Bell Atlantic, Bell South, Nynex, Paciﬁc Telesis, Southwestern Bell, and U.S. West). The Telecommunications Reform Act of 1996 furthered deregulation and permitted acquisition activity among the RBOC’s, which yielded the current landscape of four RBOC’s or Incumbent Local Exchange Carriers (ILEC’s): SBC Communications, Verizon, Qwest Communications, and BellSouth. (Sheldon, 2001). Hence, acquisition served as the force that shaped the nature of the RBOC/ILEC space in the absence of the environmental force of regulatory control. Even when considering non-traditional telecommunications ﬁrms, acquisition represents a force that selectively favors certain resource and capability conﬁgurations. These non-traditional telecommunications ﬁrms provide service solutions to niche markets created by technological advances, which diverge from the space occupied by the RBOC’s/ILEC’s and their intended competition, the Competitive Local Exchange Companies (CLEC’s). Firms providing specialty services (such as global mobility solutions and managed IP network services) continue to prosper through an industry downturn after the acquisition of ﬁrms possessing strong yet related resources and capabilities, which enhanced and deepened the resources and capabilities of the acquirer (Johnson, 2003). Hence, among non-traditional telecommunications ﬁrms, focus and depth appear to represent the favored conﬁguration selected and maintained by the forces of acquisition as indicated by the post-acquisition survival and continued success of these ﬁrms. The selective elimination of resources, capabilities, and ﬁrms by acquisition is evident by the plethora of struggling, yet non-acquired, telecommunications ﬁrms including CLEC’s, ISP’s, cable companies, long-haul and ﬁber network wholesalers, and long distance providers (Goldman et al., 2003). The de-selection of the resources and capabilities embedded within these ﬁrms is particularly salient given the unabated pace of acquisition activity within the industry. The high incidence of acquisition provides numerous opportunities for the valuable resources and capabilities of target ﬁrms to be maintained within the environment. However, in the case of struggling ﬁrms, acquisition represents one of the last chances for survival. By passing over the resources and capabilities of a struggling ﬁrm, acquisition seals the fate of ﬁrms that lack viability as independent entities

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by leaving these ﬁrms to their demise, which removes the ﬁrm, as well as its ﬁrm speciﬁc resources and capabilities, from the landscape.

ACQUISITION AND MARKET EVOLUTION: DELINEATING ADAPTATION AND SELECTION The discussion of acquisition as a mechanism of market evolution provides the opportunity to engage resource-based thinking within a comprehensive discussion of business dynamics. Based on evolutionary theory, a comprehensive discussion of business dynamics or organizational change incorporates multiple levels of analysis and encompasses both the adaptation and selection perspectives on organizational change. Drawing from a resource-based perspective on acquisition, a focus on organizational resources and capabilities creates a crosswalk for tracing the adaptive and selective impact of acquisition across multiple levels of analysis, which enables this discussion to address business dynamics in a comprehensive manner. Furthermore, the ripple effect of acquisition across multiple levels of analysis demonstrates that acquisition has all of the faculties of a mechanism of market evolution. Within the telecommunications industry, acquisition represents a salient force that is actively shaping the landscape of the industry. Acquisition represents an adaptive tool that incumbents repeatedly employ as a means to reconﬁgure their resources and capabilities in an effort to improve performance and survival chances. Acquisition also represents an environmental force that entered the void created by deregulation, and that now shapes the nature of the industry in the absence of the regulatory regime. Hence, the context of the telecommunications industry illustrates the contemporaneous existence of acquisition as a means of both adaptation and selection. The treatment of acquisition as a mechanism of market evolution within the telecommunications industry also provides an opportunity to advance the discussion of business dynamics by addressing two factors that delineate the role of acquisition as adaptation from the role of acquisition as selection. First, the focal level of analysis distinguishes the adaptive implications of acquisition from the selective implications. At lower levels of analysis (i.e. the ﬁrm or intra-ﬁrm levels), acquisition is an indeterminant action undertaken by ﬁrms in an effort to improve performance and survival, which represents an attempt at adaptation (Levinthal, 1994). However, at higher levels of analysis (i.e. environmental, population, or industry levels), acquisition represents a force that selects and selectively eliminations features from the landscape, which often drives the members of a population toward a certain conﬁguration (Aldrich, 1999).

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When focusing on acquisition as it relates to the lower levels of analysis within the telecommunications industry, the use of acquisition to transform and reconﬁgure ﬁrm level resources and capabilities demonstrates the use of acquisition as adaptation at the ﬁrm and intra-ﬁrm levels. On the other hand, when focusing on populations of telecommunication ﬁrms or the telecommunications industry as a whole, acquisition represents a predominate force driving consolidation and reshaping the nature of the industry in the era of deregulation, which illustrates the capacity of acquisition to function as an environmental level force. Acquisition became an important adaptive response at the ﬁrm level, as well as an important selective force at the environmental level, when deregulation eliminated the key environmental force shaping telecommunications and created a competitive condition for industry participants. Second, the determination of the adaptive and selective implications of acquisition also hinges on the time horizon under consideration. Given the indeterminacy of outcomes in the evolution of the market (Aldrich, 1999), in the short term only the adaptive implications of acquisition are palpable. The outcomes of environmental forces only become palpable over the long term with the capacity to employ hindsight. For example, I mentioned in an earlier section that acquisition favored depth and focus in the resources and capabilities of non-traditional telecommunications ﬁrms; however, this selective implication of acquisition only became evident after the passage of time allowed the retrospective examination of the fate of these ﬁrms. Hence, even though acquisition represents a force of market evolution via concurrent adaptive and selective implications, the identiﬁcation of these implications is temporal with adaptive implications revealed in the short term and selective implications revealed over the long term.

CONCLUSION An evolutionary perspective highlights the role of adaptive and selective forces that operate across multiple levels of analysis in the evolution of the market. A discussion of the adaptive and selective implications of acquisitions demonstrates the capacity of acquisition to function as a mechanism of market evolution. Establishing acquisition as a mechanism of market evolution is valuable because this perspective highlights the multilevel and temporal aspects involved in evaluating the impact of acquisition activity. The existence of multilevel and temporal implications of acquisition provides an opportunity to reconcile the continued persistence of acquisition activity given the inability of acquisitions to create shareholder value at the ﬁrm level. First,

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acquisition may be creating value at other levels of analysis, which may not be reﬂected at the ﬁrm level of analysis. Speciﬁcally, the value created by acquisition may reside at a level of analysis above that of the ﬁrm. Second, the value created by acquisition may become evident over the long term as market evolution unfolds. Hence, the critique of acquisition based on the destruction of shareholder value, as in AOL-Time Warner, Vodafone-Mannesmann, and WorldCom-MCI (Hammonds, 2002) within telecommunications, should be revisited with the perspective of acquisition as a mechanism of market evolution whose value may reside at a different level of analysis, and may become more evident over time.

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Levinthal, D. A. (1994). Surviving Schumpeterian environments: An evolutionary perspective. In: J. A. C. Baum & J. V. Singh (Eds), Evolutionary Dynamics of Organizations. New York: Oxford University Press. Levitt, B., & March, J. G. (1988). Organizational learning. In: W. R. Scott (Ed.), Annual Review of Sociology (Vol. 14). Palo Alto, CA: Annual Reviews. Mitchell, W. (1994). The dynamics of evolving markets: The effects of business sales and age on dissolutions and divestitures. Administrative Science Quarterly, 39, 575–602. Mitchell, W., Shaver, M., & Yeung, B. (1994). Foreign entrant survival and foreign market share: Canadian companies’ experience in United States medical sector markets. Strategic Management Journal, 15, 555–567. Penrose, E. T. (1959). The theory of the growth of the ﬁrm. Wiley: New York. Richardson, G. B. (1972). The organisation of industry. The Economic Journal, 82, 883–896. Sheldon, T. (2001). RBOCs (Regional Bell Operating Companies). Accessed from www. Linktionary.com, Summer 2004. Singh, J., House, R. J., & Tucker, D. J. (1986). Organizational change and organizational mortality. Administrative Science Quarterly, 31, 587–611. Teece, D. J., Pisano, G., & Shuen, A. (1997). Dynamic capabilities and strategic management. Strategic Management Journal, 18(7), 509–533. Vermeulen, F., & Barkema, H. (2001). Learning through acquisition. Academy of Management Journal, 44(3), 457–476. Villano, M. (2004). Consolidation changes carrier market for VARs: Wave of telecom mergers could shrink industry. Computer Reseller News, p. 31. Wernerfelt, B. (1984). A resource-based view of the ﬁrm. Strategic Management Journal, 5, 171–180. Zollo, M., & Singh, H. (2004). Deliberate learning in corporate acquisitions: Post acquisition strategies and integration capability in U.S. bank mergers. Strategic Management Journal, (forthcoming, December 2004).

M&A STRATEGIES IN MATURE AND DECLINING INDUSTRIES: THEORETICAL PERSPECTIVES AND IMPLICATIONS Jaideep Anand ABSTRACT Firms in mature or declining industries are faced with the challenge of redeploying their excess resources to new applications, and M&A strategies can be an important component of this effort. I consider two ways in which excess resources are applied to more attractive business opportunities through M&A, and I analyze these strategies through the lenses of industrial organization economics, resource-based view, evolutionary perspective and agency theory. In the redeployment strategy, ﬁrms seek attractive opportunities in related industries, using acquisitions to ﬁll any resource deﬁciencies. In the consolidation strategy, ﬁrms combine with their competitors within the same industry. The resulting larger pool of resources provides greater opportunities for disposing off their under-utilized resources through the market, while enhancing their proﬁtability. Either way, excess resources can ﬁnd new applications, within the ﬁrm in the former strategy and through the market in the latter. I also discuss some implications for future research and practice.

Advances in Mergers and Acquisitions Advances in Mergers and Acquisitions, Volume 4, 163–179 Copyright © 2005 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1479-361X/doi:10.1016/S1479-361X(04)04007-4

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It is popular in strategy literature to take a “rosy view of time” in which industries and markets forever expand (Ghemawat & Nalebuff, 1990, p. 167). Yet, mature and even declining industries are common in the industrial landscape. With rapid changes in technologies, regulations and markets, and increasing international sourcing and competition, a large number of industrial sectors do not provide natural growth opportunities (Harrigan & Porter, 1983). The most fundamental readjustment challenge for ﬁrms in such industries is to redeploy their resources and capital to more attractive opportunities elsewhere. Mergers and acquisitions (M&A) can help in pursuing such ﬁrm objectives by providing the framework for a sound strategy as well as a basis for ﬁrm growth. M&A are often used to pursue growth objectives of the ﬁrm. By providing the opportunity to assimilate a running business, M&A transactions provide a mechanism for enhancing the scale and scope of the ﬁrm without the delay and uncertainty inherent in building a new business from scratch (Dierickx & Cool, 1989). In growing industries, managers may still be able to choose between investing in new capacity through organic growth and investing in existing capacity through M&A (Anand & Delios, 2002). However in mature or declining industries, the option of investing in new capacity through organic growth is not realistic since it can exacerbate the problems from excess capacity and price competition (Bower, 2001). Therefore, M&A are a particularly important tool in such industries. What kinds of M&A strategies can be used in mature or declining business environments? In this chapter I describe two such strategies with potential for value creation: redeployment and consolidation. Redeployment-oriented M&A strategies involve an attempt to redeploy the resources of the ﬁrm into new and more attractive markets by combining them with the complementary resources of the acquired ﬁrm. Consolidation oriented M&A strategies involve combinations of ﬁrms with overlapping resources, which facilitates a reduction in excess capacity and reduces the number of competitors in a shrinking market. In determining the appropriateness and potential outcomes of these strategies, it is useful to draw upon several theoretical perspectives including industrial organization (Scherer & Ross, 1990), resource based view (Wernerfelt, 1984), evolutionary theory (Nelson & Winter, 1982) as well as agency theory (Jensen & Meckling, 1976), and their respective applications to M&A (Capron, Dussauge & Mitchell, 1998; Dial & Murphy, 1995; Dutz, 1989). Each of these perspectives is based on a distinct set of assumptions and address different issues. Collectively, they yield important insights for academics as well as practicing managers. I begin by brieﬂy describing the redeployment and consolidation based M&A strategies. Then I review and develop the insights from different theoretical perspectives for these strategies. Finally, I discuss some implications for research and practice.

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M&A STRATEGIES: REDEPLOYMENT AND CONSOLIDATION A ﬁrm can pursue a number of strategic choices in order to achieve growth through M&A. Purchase of unrelated businesses can certainly help meet growth objectives, but may entail ﬁnancial, strategic or organizational costs (Haspeslagh & Jemison, 1991; Singh & Montgomery, 1987). But if the goal of the endeavor is to achieve growth while also ensuring good returns to shareholders, the options are much more limited (Sirower, 1997). M&A can potentially serve as a mechanism for new resource acquisition and for achieving meaningful organizational change and value creation particularly when there is a market failure in resource markets, scope economies or opportunity for transferring capabilities (Capron, Dussauge & Mitchell, 1998). Shifts in demand due to changes in technology, market tastes, regaulations or other exogenous changes create mature or declining industries. These changes may be in the form of changes in technological regimes (e.g. Majumdar’s (1981) study on pocket calculators), changes in consumer tastes and habits (e.g. Miles’ (1982) study of the tobacco industry), or changes in the availability of inputs or regulations (e.g. Fligstein’s (1990) study of the responses to antitrust legislation) or other shocks (e.g. Meyer’s (1982) study of the responses of hospitals to a doctor’s strike). The excess corporate resources left in the wake of such exogenous shifts in market demands need to be reallocated to the next best possible economic use. M&A can help facilitate such a reallocation of resources, thus unlocking signiﬁcant economic value. I classify such value creating strategies under redeployment and consolidation. Redeployment Under this category, I include strategies designed to redeploy resources within the ﬁrm to alternative and more attractive opportunities. For example, a tobacco ﬁrm with developed expertise in marketing, branding and distribution of consumer products uses these capabilities to achieve success in non-tobacco markets, or a defense contractor with technologies developed during the cold war now assists government agencies in database management. But such internal redeployment is challenging since ﬁrms often lack some of the ingredients for success required in new markets (Anand & Singh, 1997). Reallocation to the next best possible use of corporate resources is only achieved by combining them with new resources to meet demand in new and attractive markets. In this case, acquisitions are used to gain access to the new resources required, ﬁll gaps in resource requirements,

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and obtain complementary downstream resources required to enter new markets (Teece, 1987). Consequently, these M&A often involve target ﬁrms that provide a brand, distribution, or other resources required to compete in the new market that are not otherwise available to the focal ﬁrms operating in the mature or declining industry. In such acquisitions the focal ﬁrm must “redeploy” its other existing resources (e.g. technology, human resources) to serve the growing opportunity in the new market rather than being constrained by its lack of growth.

Consolidation An alternative to the redeployment strategy described above is for the ﬁrm to combine with other similar ﬁrms in the same mature industry. In this case, such horizontal acquisitions can be followed by divestitures, retirement of excess capacity, asset sales, plant closings and employee layoffs, to achieve consolidation and disposal of excess resources. Thus, this M&A strategy helps achieve “consolidation” in the industry, and helps achieve economic value in a manner quite distinct from the “redeployment” approach, when these excess resources are reallocated to their next best use by the purchasers of these resources. Therefore, reallocation of excess resources is achieved through the market interface, i.e. these resources ﬁnd application to their next best use after being traded rather than within the ﬁrm. For example, the ﬁrm may divest business units, sell assets, close plants, layoff employees, and license its technology, all as a part of exchanging its tangible and intangible resources for ﬁnancial assets. The proceeds from such disposal of resources can be captured by the shareholders of the ﬁrm, who can then reinvest them in other, more attractive investment opportunities (Dial & Murphy, 1995). Meanwhile, the ﬁrm also grows by achieving a larger position in the existing industry. Such horizontal deals also reduce the number of competitors, allowing for greater proﬁtability and potential collusion (Scherer & Ross, 1990). I now turn to examining the implications of various theoretical perspectives on both these kinds of strategies. This will enable us to compare the conditions under which these strategies may be appropriate, their outcomes and their relative advantages and disadvantages.

THEORETICAL PERSPECTIVES Theoretical perspectives begin with different assumptions and address outcomes at different levels of analysis. Industrial organization economics addresses issues at the industry level and often focuses on social welfare outcomes. The resource-based

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view and evolutionary theory are ﬁrm level perspectives that take into account ﬁrm capabilities and help discriminate among potential strategies. Agency and related theories make certain assumptions at the individual/managerial level and posit a relationship between individual motives and ﬁrm strategies. All these perspectives are examined here, with a focus on how they help understand M&A strategies in mature or declining industries.

Industrial Organization Economics The perspective from industrial organization economics (IO) provides the opportunity to understand the interaction between ﬁrm strategies and market structure. Fundamentally, the market structure and the nature of competition in the focal and related industries are of critical importance to this ﬁeld of study. Because the unit of analysis is the industry, the implications of this perspective are much easier to deﬁne for consolidation strategy where M&A activity involves ﬁrms within the same industry rather than in redeployment strategy where ﬁrms from different industries are involved. The IO perspective is generally limited to market power and cost efﬁciency as motives and outcomes for M&A, while other potential issues are ignored. Market power is deﬁned as the ability of a market participant or group of participants to control the price, quantity, or nature of the products sold – thereby generating extra-normal proﬁts. Generally speaking, there are three models explaining how mergers and acquisitions increase market power. The oligopoly model suggests that in horizontal acquisitions, market power results in gains to the market participant through revenue-side effects which arise from greater opportunities for collusion. The dominant-ﬁrm model argues that prices in an industry rise consequent to horizontal acquisition by a dominant ﬁrm. Third, in the multi-point competition framework, mergers are seen as a means to reduce the intensity of rivalry by increasing the number of contacts with other multi-point competitors. The three models illustrate different ways to increase market power, but even the simplest Cournot models of competition predict that when the number of competitors in a market declines, proﬁtability is enhanced due to greater market power and potential collusion among competitors. Consequently, horizontal M&A as a part of the consolidation strategy are likely to increase proﬁtability. At the same time, it is also possible that such M&A activity increase efﬁciency due to scale economies or other related mechanisms (Williamson, 1968). But a long-standing issue in IO and public policy is how to discriminate between efﬁciency and market power as potential sources of value creation for ﬁrms (Pautler, 2003). Yet, declining

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or even mature industries offer unique sources of efﬁciency enhancement through M&A that may not exist in growing industries. Hence, these contexts deserve special consideration (Coate & Kleit, 1991). Diminished demand in mature or declining industries can create overcapacity leading to diminished proﬁtability, and it becomes desirable that the least efﬁcient and presumably older capacity is retired quickly. Such a decline in proﬁtability can be reversed, under certain circumstances, through acquisitions of ﬁrms competing in the same market (Dutz, 1989). Consequently, M&A can help in the disposal of excess resources through a process of consolidation (Bowman & Singh, 1993). Consolidation is accomplished through elimination of redundancies and achievement of minimum-efﬁcient scale or scale economies in general. Such gains are most likely in industries characterized by negative shifts in demand, technological obsolescence, regulatory changes or simply an over-optimistic growth forecast (Williamson, 1968). Consolidation M&A can facilitate rationalization and permit ﬁrms to reorganize into more efﬁcient conﬁgurations. Such a strategy can help “to combine, specialize or lengthen production runs, minimize duplication or otherwise improve quality of a product or service” (Dutz, 1989, p. 12). Plant-level and multi-plant economies follow from the disposition and rationalization of redundant assets, attainment of minimum-efﬁcient scale, the use of more specialized or cost-effective technologies, and spreading the ﬁxed costs over larger sales volumes. Economies of scale represent a speciﬁc and common source of ﬁrm efﬁciency when the unit cost of producing a product decreases with output. Productionlinked scale economies may be achieved in the areas of purchasing or inventory management in the case of a merger of ﬁrms using common raw materials or components. In addition, scale economies may be present in other functional areas of a business such as advertising, distribution, service networks, and research and development. In declining or mature businesses, scale economies can be an important issue if ﬁrms are operating below the minimum-efﬁcient scale or if there is signiﬁcant idle capacity. Consolidation M&A can help reverse these problems. The IO perspective also yields important insights for the build versus buy decision. When contemplating a build versus buy decision within a given industry, an important consideration is the impact of the investment decision on market concentration of the industry. Acquiring an existing ﬁrm takes a potential competitor out of the market and provides the potential for collusive synergy through increased market power. On the contrary, internal development requires a ﬁrm to reach a minimum-efﬁcient scale, which might add substantial capacity to an industry and result in over-capacity. The impact on market concentration is especially important in mature/declining industries where additional capacity can lead to competitive responses and price competition. Thus, the IO perspective

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posits that consolidation M&A would potentially lead to increased market power as well as efﬁciency gains. Both these kinds of gains are related to the ability of ﬁrms to use consolidation to ease capital and resources out of the industry so that they can be invested elsewhere. The redeployment M&A strategy involves ﬁrms from different industries or markets, so the implications of the IO perspective are less direct. But two important insights from this perspective involve multi-point competition and scope economies. Multi-point competition involves several ﬁrms that compete in multiple markets, thus, leading to opportunities for collusion in these multiple settings (Karnani & Wernerfelt, 1985). Such a scenario enables ﬁrms to compete less vigorously leading to “mutual forbearnce” (Gimeno, 1999), for example, because of the threat of retaliation by competitors in other markets. But it must be recognized that such a result may only hold when there are signiﬁcant asymmetries between the cost structures or competitive positions of ﬁrms (Bernheim & Whinston, 1990). In the case of a redeployment strategy, if multiple ﬁrms from industry A acquire ﬁrms in industry B and attempt to redeploy their resources for growth in industry B, it can result in multi-point competition among these ﬁrms. A second implication of this perspective for redeployment M&A strategies involves economies of scope (Panzar & Willig, 1981). Such economies result from sub-additive cost structures of two different but related activities, i.e. when the cost of joint production of two goods by a multi-product ﬁrm is less than the combined costs of production of these goods by two single-product ﬁrms. For example, if ﬁrms are able to enter a new business by redeploying some of their capacity in an existing business, it can lead to potential gains from scope economies. Economies of scope can arise if the shared factor of production is imperfectly divisible, such that manufacturing a subset of goods leaves excess capacity in some stage of production. This type of ﬁxed factor is subject to economies of scale, but in the event that demand for the end-product limits the level of production, joint utilization of the factor in the production of other goods would result in scope economies. These gains are similar to gains from sharing resources across ﬁrm activities and are described in the next section on the resource-based view of the ﬁrm.

Resource-Based View Unlike in economics and IO, the perspective in management theories like RBV is more focused on the ﬁrm level rather than industry level issues. The resourcebased perspective proposes that the ﬁrm is best analyzed as a bundle of its resources (Barney, 1991; Penrose, 1959; Wernerfelt, 1984). The core of the resource-based view holds that ﬁrms seek to accumulate stocks of heterogeneous, non-imitable

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assets (Barney, 1991; Dierickx & Cool, 1989) which serve to drive performance and create competitive advantage through the generation of rents (Conner, 1991). These resources are “sticky” in the sense that they are intertwined within the ﬁrm and are accumulated as a result of path-dependent actions taken over time (Barney, 1991; Dierickx & Cool, 1989). Fungible resources can be applied to new endeavors within the ﬁrm or concentrated on a narrower range of existing endeavors. This perspective offers two ways in which a ﬁrm can realign itself to changing markets. First, ﬁrms can adapt to new conditions by redeploying their existing resources to serve new markets (Capron et al., 1998; Penrose, 1959). The extent to which existing resources may be redeployed in new uses depends on the underlying “fungibility” and tradability of these resources. Thus, fungibility is an attribute of a resource that facilitates its application to different organizational and market settings. An argument can be made that ﬁrms rich in fungible resources should be able to survive industry transformations by changing the product markets they serve. The implication for corporate evolution and survival is that if some resources are truly fungible across lines of business, then ﬁrms possessing these resources should not be constrained by the life of their individual businesses (Anand & Singh, 1997; Eisenhardt & Helfat, 2001). Firms with such assets can redeploy such resources to growing businesses and survive in the long run. When these resources are less tradable, the argument for redeployment becomes even stronger since they cannot be traded in discrete factor markets (Dierickx & Cool, 1989). Second, a ﬁrm can adapt to new market conditions by changing its bundle of resources. Since critical resources are seldom bought and sold in discrete market exchanges (Capron, Dussauge & Mitchell, 1998; Teece, 1982), M&A offer an opportunity for ﬁrms to change their resource bundles by combining resources from different ﬁrms (Wernerfelt, 1984). When ﬁrms face strong inertial forces internally due to the difﬁculty of developing new capabilities internally (Barney, 1991), acquisitions can help them to keep pace with the environment by modifying the mix of their capabilities. Capron, Dussauge and Mitchell deﬁne resource redeployment in M&A as “the use by a target or acquiring business of the other businesses’ resources, which may involve physical transfer of resources to new locations or sharing of resources without physical transfer” (1998, p. 631). Often such redeployment involves intangible assets which can have public good properties and can help generate new revenue streams (Itami, 1987). Complementarity in the resource endowments of merging ﬁrms can create opportunities for recombination and redeployment of resources, which can help the ﬁrm weaken the internal inertial pressures. Such recombination can represent Schumpeterian innovations in creation of new combinations of resources from the existing and acquired stocks (Galunic & Rodan, 1998). Therefore, opportunities for redeployment are affected by the overlap between resources required to compete in

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a new market and the resources possessed by the ﬁrm. The shortcomings in resource requirements have to be acquired from the outside when internal development is difﬁcult or time-consuming (Dierickx & Cool, 1989). Acquisitions help ﬁrms to reconﬁgure themselves to support growth and change their mix of products and markets (Bowman & Singh, 1993). In order for redeployment within the ﬁrm to work, these resources need to be non-tradable as well as fungible. If the ﬁrm’s resources are context-speciﬁc (Galunic & Rodan, 1998) rather than fungible, consolidation might be the superior strategy. But if some important resources and capabilities of the ﬁrm are fungible, and can be applied to new uses, redeployment strategy may offer an attractive option. If some of the resources are fungible, and others are not, as may happen frequently, the ﬁrm may use M&A to obtain some new resources that can combine with the existing fungible resources. For example, if the brand that the ﬁrm possesses is fungible, but its distribution system is context speciﬁc, the ﬁrm can expand by acquiring another ﬁrm with a distribution system in another context and then selling its brand through the new distribution system. Often obtaining the distribution system through means other than ownership (e.g. for a fee) is not an option due to transactional challenges in such arrangements (Teece, 1987). Thus, serving alternative product markets may necessitate the addition of complementary resources, which in this case, are often procured through acquisitions. Acquisitions undertaken for access to complementary resources involve ﬁrms with different and non-overlapping resources. These differences in the resources of the acquired and acquiring ﬁrms create greater opportunities for post-acquisition resource transfers (Harrison, Hitt, Hoskisson & Ireland, 1991). The public good nature of many of the resources involved can also lead to spillovers across businesses within the ﬁrm (Itami, 1987). The collective implication of these arguments and results is that ﬁrm resource endowments and their attributes of fungibility and tradability provide important determinants of the ﬁrm’s M&A strategy.

Evolutionary Theory Relative to the resource-based view, the evolutionary theory paints a less optimistic picture of ﬁrms adapting to serve new markets in response to exogenous changes.1 While the resource-based view emphasizes the potential for resource fungibility, evolutionary theory reveals the limitations in fungibility of rent-generating assets (Cohen & Levinthal, 1990; Nelson & Winter, 1982). Consequently, this perspective helps explain why redeployment of ﬁrms’ assets into new contexts and markets often does not produce good ﬁnancial outcomes (Anand & Singh, 1997).

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For example, managers may not ﬁnd it possible to ﬁnd uses for otherwise fungible resources beyond closely related domains (Cyert & March, 1963; Nelson & Winter, 1982), and opportunities for new learning and innovation are bound by the ﬁrm’s previous experience and existing technological base. Similarly, Cohen and Levinthal (1990) argue that the capacity of an organization to assimilate external knowledge is constrained by its prior state of knowledge, which they labeled “absorptive capacity.” More broadly, evolutionary theory emphasizes the context-speciﬁc and industry -speciﬁc nature of the ﬁrm’s routines and resources (Levinthal, 1991; Nelson & Winter, 1982). In the absence of a suitable context, a ﬁrm’s resources may suffer from erosion in their value, and the receiving unit may not be able to retain the routines. Such issues create problems in assimilating new resources in redeployment M&A. Stocks of resources can be redeployed internally only under appropriate organizational conditions, i.e. when there are few institutional or cultural barriers to prevent mobility of resources to new uses. Oliver (1997) has noted that a ﬁrm’s historical, political and cultural context, along with psychological costs associated with change, can constrain resource redeployment. It is important to note that many of the organizational problems of internal redeployment are less likely to occur in consolidation-oriented acquisitions. Therefore, redeployment of these resources through the market is more effective when recombination requires separation of the resource from its organizational context. Issues of bounded rationality, absorptive capacity and the compatibility of organizational routines are likely to be less acute in acquisitions involving similar ﬁrms with overlapping businesses. Thus, while the resource-based perspective provides the rationale for the redeployment strategy, the evolutionary theory provides boundary conditions for these arguments to be relevant. When the conditions for successful redeployment are not fulﬁlled, consolidation oriented M&A may be the superior choice.

Agency Theory Agency theory focuses on the divergence of interests of shareholders and managers (Jensen & Meckling, 1976), which could take the form of shirking, excess executive compensation and pursuit of goals that do not maximize the shareholders’ wealth.2 One such goal is excess diversiﬁcation, especially via acquisitions. In the absence of signiﬁcant ownership stakes, managers can pursue acquisition strategies that do not maximize the value of the ﬁrm. Acquisitions may be undertaken to pursue managerial goals that do not converge with a ﬁrm’s proﬁt maximization objective, while ignoring efﬁciency consequences of these investments.

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For example, managers may acquire other ﬁrms to reduce their individual risk and maximize their personal wealth at the cost of shareholders’ interests. There are several reasons why managers may seek such acquisitions. First, they reduce risk, which beneﬁts them without necessarily beneﬁting the shareholders as the shareholders can diversify their investments independently. Second, acquisitions might increase the value of managers’ human capital, for example, top management compensation is often tied to the size of the ﬁrm and their span of control (Rosen, 1982). Third, such ventures might relieve the boredom of management and provide the challenges and satisfaction of building empires (Hayward & Hambrick, 1997). This is in contrast to the organizational unpleasantness that accompanies consolidation oriented activities. In declining or mature industries, such agency problems can be particularly severe (Dial & Murphy, 1995). These industries are generally not appropriate for managers to pursue their individual goals,3 who are therefore more likely to seek opportunities outside of their mature/declining contexts (Jensen, 1986). Other things being equal, the effect of agency forces is to push managers toward a preference for strategies that sustain and grow the size of the organization and reduce its risk. Consequently, ﬁrms are ceteris paribus more likely to adopt redeployment strategies when agency assumes greater importance. These forces more commonly prevail when the industry is in maturity or decline.

Summary While each of the above perspectives makes different assumptions and provides a different emphasis, they all have important implications for redeployment and consolidation M&A strategies in mature and declining industries. Some key implications from each perspective are summarized in Table 1. The IO perspective deals much more with consolidation strategies than with redeployment, though it provides some implications for both. This perspective provides a more speciﬁc rationale for value creation in consolidation M&A through an increase in market power, collusion opportunities and scale economies but a less speciﬁc rationale for value creation in redeployment M&A through multi-market collusion and scope economies. In the context of M&A in mature and declining industries, the resource-based view, on the other hand, primarily emphasizes the gains from redeployment when corporate resources are fungible. Fungible resources provide the basis for moving into new attractive markets over time, thus, causing ﬁrms to outlive their markets. The evolutionary and agency theories, however, caution against too much faith in redeployment strategies, though for different reasons. The evolutionary theory suggests the context- and industry-

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Table 1. Implications of Theoretical Perspectives for M&A Strategies. Theoretical Perspective

Redeployment M&A

Consolidation M&A

Industrial organization

Potential for scope economies Collusion through multi-point competition

Potential for scale economies Market power is achievable subject to antitrust challenges Permits reduction in excess capacity

Resource-based view

Internal redeployment of excess, fungible, non-trade-able corporate resources Combination with acquired resources facilitates entry into new markets

Disposal of less fungible excess resources through markets

Evolutionary theory

Stickiness of capabilities can lead to core rigidities Context-speciﬁc routines can be a problem

Helps dispose resources by breaking them down Embedded resources and context-speciﬁc routines are not a problem

Agency and hubris

Often preferred by managers, particularly when there is poor alignment with shareholder interests Emphasizes growth over proﬁts

Target shareholders appropriate most gains

Avoids painful retrenchment decisions

Acquirer should have superior management and integration capabilities

It is facilitated by appropriate alignment of shareholder and managerial interests Can be used to replace inefﬁcient management in target ﬁrms

speciﬁc nature of business routines in which ﬁrms’ capabilities are embodied. Agency theory shifts the focus to managerial motives, which may be biased towards redeployment when there is poor alignment with shareholder goals. In summary, the resource-based view provides the most direct and strongest argument for redeployment M&A while other perspectives provide a less positive picture of this strategy.

IMPLICATIONS The four theoretical perspectives described above provide important insights into the M&A strategies used by ﬁrms in mature or declining industries. This empirical context also provides an interesting and fertile domain to develop and

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test some implications of these theories. Some interesting research questions and implications are described brieﬂy in this section. In comparing the redeployment and consolidation strategy, the main efﬁciency focused argument for the former resides in the resource-based view. Speciﬁcally, this argument originates in the notions of fungibility and non-tradability of ﬁrms’ resources and capabilities. While the argument for internal redeployment of ﬁrm resources has been made strongly in the literature (Capron, 1999; Eisenhardt & Helfat, 2001; Galunic & Rodan, 1998), the empirical results are mixed at best (Anand, 2004; Anand & Singh, 1997; Capron, 1999). Further studies should attempt to make more direct comparisons between internal redeployment and disposal of excess resources through the market. So far the evidence seems to indicate that at least in terms of ﬁnancial performance, ﬁrms are better off shrinking with the declining market or not attempting to grow new businesses in mature markets. Perhaps these results indicate that some of the assumptions behind the argument for redeployment including non-tradeability, fungibility and conditions related to modularity are rarely met in the real world. These empirical results also conﬁrm that ﬁrms on average are not good at learning new businesses due to inertia, as directly follows from evolutionary theory. The empirical context of M&A in mature and declining industries also has the potential for enhancing our understanding of evolutionary processes, speciﬁcally how routines are unlearned or retained in ﬁrms attempting to accumulate capabilities to enter new businesses. Evidence from related literature in alliances and joint ventures (Zhao, Anand & Mitchell, 2004) shows that previous experience of ﬁrms can sometimes serve as an obstacle in the form of a “competency trap” (Leonard-Barton, 1992), and some other times serve as absorptive capacity (Cohen & Levinthal, 1990). Ironically, the former effect is more dominant when an incremental strategy for implanting new capabilities is followed because it permits the routines to survive. When a more radical approach is taken, there is a better chance that transformation can occur. It is possible that ﬁrms adopting redeployment M&A strategies would be better off making larger transactions earlier in the process. This is in contrast to the more conventional approach of taking an incremental approach by making small acquisitions ﬁrst, followed by attempts to assimilate new capabilities, and only then making more substantial acquisitions. This is an interesting research question with implications for both theory and practice, and one that can be tested in the context of mature or declining industries by comparing outcomes of different ﬁrm strategies. As noted earlier in the paper, the IO perspective is also extremely pertinent in this context, particularly for understanding consolidation M&A. But the salience of this perspective in understanding M&A strategies suggests that industry conditions, particularly growth/decline rates are important to take into account

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while analyzing the choice or outcomes of these strategies. The consideration of industry growth/decline can shed light on the motives of the strategies being pursued and the choice between M&A and organic growth (Anand & Delios, 2002). In terms of outcomes, previous research has often tried to separate out the gains due to market power from gains due to efﬁciency (e.g. Eckbo, 1983) in consolidation M&A, but because of methodological and measurement complexities, this question has not been resolved (Pautler, 2003). Since there is some evidence for both market power and efﬁciency outcomes in consolidation M&A, perhaps it would be more interesting to discriminate between situations where one source dominates the other. The rate of growth or decline can be such an important contingency to consider (Coate & Kleit, 1991). Furthermore, because some potential M&A deals are blocked due to antitrust regulations, there may be a selection effect in the deals that are actually observed. It would be interesting to observe if taking into account this source of endogeneity effects any empirical conclusions. The agency-based hypotheses link the separation of ownership and control to ﬁrm strategy and performance. But these studies often reveal weak and complex relationships and have collectively led to inconsistent, and at times conﬂicting, results (e.g. Baruch & Lev, 1981; Lane, Canella & Lubatkin, 1998). Since declining industries represent a more stark trade-off between managerial and shareholder goals, it may be appropriate to focus on such contexts to test and develop hypotheses related to agency motivations. Further, future research should also take into account the interaction between agency and capability characteristics of ﬁrms to seek more insights into whether these variables collectively inﬂuence ﬁrm behavior and performance (Anand, 2004). There are two speciﬁc research questions that emerge from the earlier discussions in this chapter. One, if ﬁrm resources can be applied to new applications proﬁtably, why should ﬁrms wait for their current industry to mature or decline before attempting redeployment? This question is particularly salient when ﬁrm resources are intangible with public good characteristics. Agency theory suggests that such redeployment is actually not proﬁtable, and only serves the managerial interests. Another argument is that ﬁrms search for new solutions only when their performance falls below their “aspiration level” (Cyert & March, 1963). Therefore, lack of growth in their industries, forces these ﬁrms to seek new and more risky opportunities outside these industries. Both these arguments may be complementary, but the critical feature of the agency explanation is that redeployment to new applications is not proﬁtable or value enhancing for the ﬁrm. Future studies may be able to explicitly focus on this question. A second research question that lies at the intersection of resource or capability based perspectives and agency theory has to do with the characteristics that

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determine whether a ﬁrm will be a target or acquirer in consolidation. The acquiring ﬁrm management obtains control of the combined ﬁrm and is responsible for the following integration, while the target ﬁrm shareholders appropriate most of the wealth created (Anand & Singh, 1997). The resource based perspective suggests that the ﬁrm with superior management and integration capabilities should play the role of the acquirer (Mitchell & Shaver, 2003). Agency theory suggests that ﬁrms with greater alignment of shareholder and managerial interests seek better shareholder returns, so are more amenable to be acquired. Future empirical studies can help sort among these explanations. In this chapter, redeployment and consolidation M&A were for the most part treated as independent strategies that a ﬁrm could choose between. But it should be noted that it may be appropriate to adopt one strategy and then switch to the other. Since consolidation is a ﬁnite process, and often ends when the number of competitors becomes small, some ﬁrms might ﬁnd it more appropriate to pursue consolidation initially. Having achieved some scale and size in the industry and enhanced their proﬁtability, they can then pursue further growth through redeployment into other businesses. However, ﬁrms switching between these strategies should be wary of inappropriately applying their previous experience in one kind of M&A strategy to the other (Haleblian & Finkelstein, 1999).

NOTES 1. Ecological models (e.g. Hennart & Freeman, 1989) provide the extreme argument in this regard. These models emphasize the inability of ﬁrms to change due to inertia. 2. Related theories focus on managerial hubris (Roll, 1986) or the salience of nonﬁnancial goals (Hayward & Hambrick, 1997). 3. Though these industries may provide signiﬁcant value creation opportunities for shareholders (Dial & Murphy, 1995).

ACKNOWLEDGMENTS The author is grateful to Michael Leiblein and Brandon Macko for comments on an earlier draft.

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IN THE MARKET FOR FIRMS, HOW SHOULD A FIRM BE SOLD? Ilgaz Arikan INTRODUCTION In the strategic management literature, two mechanisms have been proposed to explain how managers generate economic rents: resource selection, and capability building. Resource selection is a Ricardian perspective where the productivity of resources are heterogeneously distributed among ﬁrms (Peteraf, 1993; Wernerfelt, 1984), and managers outsmart the factor markets by selecting resources based on their future values (Barney, 1986). The alternative Schumpeterian perspective is capability building, a mechanism that depends on deployment of resources to affect a desired end (Amit & Shoemaker, 1993; Mahoney, 1995). While capability building requires that managers develop a capacity to manage ﬁrm speciﬁc tangible and intangible processes, the resource selection mechanism demands managers to accurately assess expectations about the future value of resources. One argument is that when resources are selected, economic rents are created before the ﬁrm acquires resources, and after if the ﬁrm develops capabilities based on ﬁrm speciﬁc processes. The distinctions between these two mechanisms have important theoretical, empirical and practical implications (Makadok, 2001). The criticism of this perspective is that if economic rents are embedded on a resource, then ﬁrms would try to pick resources with embedded economic rents and the prices would be bid up, dissipating all above normal returns. The question then becomes under what conditions will these two mechanisms be preferred to each other? And why are some ﬁrms better at picking resources? Some empirical and practical cases Advances in Mergers and Acquisitions Advances in Mergers and Acquisitions, Volume 4, 181–208 © 2005 Published by Elsevier Ltd. ISSN: 1479-361X/doi:10.1016/S1479-361X(04)04008-6

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display characteristics of one mechanism dominating over the other. For example, in the market for ﬁrms, merger and acquisition activities require managers to value tangible and intangible assets of targets (Hitt et al., 2001a). On the other hand, research and development ﬁrms might ﬁnd it more advantageous to develop capabilities internally (Hitt et al., 2001a, b). Firms have been characterized as a bundle of linked and idiosyncratic resources and resource conversion activities (Rumelt, 1987). When a ﬁrm is sold, its new owners have a right to its future cash ﬂows. Therefore, the dynamics of competition on product and resource markets by ﬁrms (Wernerfelt, 1984), and the ability of ﬁrms to generate and appropriate rents is fully applicable to the market for ﬁrms, where ﬁrms are exchanged through various market mechanisms. I argue that for private ﬁrms an IPO is an auction, and an M&A is a negotiation; where, one unit of a ﬁrm’s stock of equity represents a future cash ﬂow opportunity, and a numeraire resource (Arikan, 2003). In this paper, I focus on one question: what determines the choice of selling a ﬁrm? More speciﬁcally, in the market for ﬁrms, how does one decide which market mechanism is optimal? Firms are sold in two ways: using auctions with bidding, or using negotiations with bargaining. Posted prices in spot markets are not applicable in the market for ﬁrms since no ﬁrm has ever declared a value for itself and as if in a perfectly competitive homogenous product market, no buyer has purchased it. The concern in a market for ﬁrms is the determinants of the discrete choice: how should one sell its ﬁrm to maximize utility from the transaction? This utility might be the highest sales revenue or highest degree of controlling rights, etc. No matter what the individual utility function might be, I assume that the owner/manager will maximize his returns from the transaction given a set of factors. While it is well established that ﬁrms should acquire rare, inimitable and valuable resources from factor markets to gain competitive advantages, the mechanisms by which ﬁrms acquire these resources have received little attention. In this paper, I study the factors that affect ﬁrms’ decisions to prefer one market mechanism to another. The discrete choice between choosing to auction off a company through an IPO or to negotiate its sale as a privately held target rests on ﬁve factors: bargaining power, resource value, market thickness, risk propensity and search costs (Arikan, 2002, 2003).

DECISION TO GO PUBLIC To be safe from agency and managerial hubris challenges in large and established ﬁrms (Field & Karpoff, 2002); I use a sample of entrepreneurial ﬁrms, all private ﬁrms which make the decision to sell their ﬁrms either in an initial public offering

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or in the acquisition block. The IPO decision has been discussed in the context of market-timing and life-cycle theories (Arikan, 2003). Life-cycle theories suggest that entrepreneurs will seek additional ﬁnancing via IPO to facilitate growth (Chemmanur & Fulghieri, 1999; Zingales, 1995). On the other hand, owners might decide to time the market and sell equity via IPO when: (i) there are other similar ﬁrms’ competing in the market for capital; (ii) there is information asymmetry between the insiders and the market participants that would lead to higher valuation of the stock offering (Lucas & McDonald, 1990); and (iii) they wish to signal growth opportunities that would require additional sources of funding (Schultz, 2000). Besides rational explanations it might also be argued that an entrepreneur will try to hold on to his venture due to concerns of “letting go,” or delineation of control (Pagano & Roell, 1998; Pagano et al., 1998). In these cases I assume entrepreneurs who might have non-ﬁnancial reasons that are driven by semirational considerations will be inclined to sell their shares after public market valuations have reached optimal levels (Ritter & Welch, 2002). In IPO markets, various mechanism designs allow ﬁrms to choose the optimal offering method. There are two dominant designs in the IPO markets and both are considered to be an auction (Benveniste & Busaba, 1997; Welch, 1992). Whether a ﬁrm chooses the bookbuilding method or a ﬁxed price (European) auction affects the potential revenues from the sale of the ﬁrm but the end result remains the same: the entrepreneur still has a higher degree of control in the daily operations of the ﬁrm. On the contrary, once the ﬁrm is sold off in an acquisition, control and cash ﬂow rights pass on to the acquirer, hence control is delegated to the new owner. In the bookbuilding method the seller ﬁles a prospectus with the securities authorities, and makes the information about the ﬁrm public through a series of reports of both a ﬁnancial and strategic nature. The main constituents are the large institutional investors, banks, and syndicate members. The ﬁxed price method does not involve the syndicate and the information is released to the public in other forms of communication, allowing for all interested parties to be involved without ﬁrst soliciting investor interest. The lure of this method is in creation of information cascades hence causing a bidding frenzy (Welch, 1992). In both forms of IPO markets, the goal is designing an information delivery mechanism about the ﬁrm’s assets, prospects and performance. The ﬁxed-price IPOs use initial investors’ valuations to signal the strength of the issued shares, hence the later investors very closely watch the initial stock price and the early investor valuations. For all IPOs, the true value of the stock is known by all investors after the auction. However in the beginning each investor only knows his true value and reservation value with certainty. Hence during the auction bidders receive signals from the market about the value of the shares and

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those bidders who overestimate the true value of the stock and “overshoot” are subject to winners’ curse. To increase the demand and create a bidding frenzy for the offering, the ﬁrm opens the auction at an undervalued point (underpricing). Investors who realize great proﬁt potential enter bidding and a positive cascade is formed. While an initial underpricing might be healthy and proﬁtable, too low of a price might cause a negative cascade, where bidders demand less of an “unattractive” offering (Benveniste & Busaba, 1997). The bookbuilding method, on the contrary, starts off at the aggregate market valuation that better reﬂects the syndicate members’ separate valuations. Through non-binding demand schedules, investors help determine a true value for the issue. It is in their best interest to bid their true values so that they get a higher allocation at this target price. Both mechanisms will sell the ﬁrm to the public but will generate potentially different revenues to its initial stakeholders. Bookbuilding generates higher expected proceeds, and provides an opportunity to sell additional shares at full price after the IPO, but exposes the issuer to a greater risk. On the other hand, the ﬁxed price offerings guarantee the issuer a certain level of proceeds, but at a lower level when compared to bookbuilding (Benveniste & Busaba, 1997). Neither strategy dominates, since the issuer acts on behalf of the entrepreneur, whose choice may be inﬂuenced in the ﬁrst place by future ﬁnancing concerns, considerable costs of the IPO, and the market trends that are highly cyclical (Lowry & Schwert, 2002; Ritter & Welch, 2002).

DECISION TO BE ACQUIRED Many management scholars have used the language of auctions to describe the bidding process in mergers and acquisitions for a good reason. In M&A activities ﬁrms strategically bid to acquire their targets and moreover, the U.S. competition authorities use auction models to investigate the antitrust implications of the proposed mergers (Baker, 1997). However, there is one very crucial element in acquisitions that distinguishes M&A from auctions (IPOs): the ultimate decision to select the acquirer rests solely on the seller in an acquisition. In other words, in an IPO the seller does not care who buys the issues, but in an M&A, the identity of the buyer is of outmost importance. This is probably the main reason why negotiations fail or take longer periods of time compared to a straightforward auction. Technically, acquisitions involve bilateral or multilateral negotiations (Krishna & Serrano, 1996; Thomas & Wilson, 2002). The outcome of negotiations with four or less bargaining parties yield higher revenues for the seller compared to ﬁrst price auctions, and when the number of bargaining parties is higher than four there are no statistical differences in revenues

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from a seller’s perspective (Thomas & Wilson, 2002). Two aspects of acquisitions are seminal in my analysis: ﬁrst, in a negotiation the outcome is not certain; and second, the value of the target is not for certain before the negotiation. However, an auction is a game and every game has a solution (Roth, 1995). The IPO outcomes have more certainty both for the outcome, and the value. Parties can reach a number of Pareto optimal outcomes based on their utilities (Nash, 1950). The decision to sell or not depends on a number of factors. For example in the case of management buyouts, managerial and shareholder alignment becomes an issue (Seth & Easterwood, 1993), and in the decision to IPO or not, management and a small number of shareholder interests may not be aligned (Alchian & Demsetz, 1972). Furthermore, an initial partial equity stake in a ﬁrm has a binding effect on the bidders, where such a toehold biases bidding strategies for acquirers who tend to overbid. While such overbidding is an optimal rational strategy, it often leads to an inefﬁcient outcome and increases the winners’ curse for a nontoe holder (Burkart, 1995; Hirshleifer & Titman, 1990). A high degree of toehold, which might decrease potential entrants to be serious contenders, decreases the price of the target ﬁrm. When the situation is reversed, and few large equity stake holders exceed their valuation, ex post acquisition proﬁts are descreased (Bulow et al., 1999). Empirical evidence suggests that markets for buying and selling companies are reasonably competitive, and an acquirer pays approximately the discounted present value of the target ﬁrm. If any, all above normal returns go to stockholders of the acquired ﬁrms (Porter, 1980). Firms can only generate above normal returns if the cost of resources to implement product market strategies is signiﬁcantly less than their economic value (Barney, 1986). This requires ﬁrms to exploit competitive imperfections in factor markets. In other words, valuation of a target ﬁrm requires heterogeneous expectations about its future cash ﬂow. There is an important difference between bidding a premium and overbidding. If the bidder overestimates the value of the ﬁrm after the acquisition when incorporating the ex post synergistic gains, he/she will be subject to winner’s curse. Two problems need to be addressed: valuation error and managerial hubris (Arikan, 2003). Valuation error arguments are due to erroneous heterogeneous expectations about the future proﬁtability of a bundle of resources. This was also evident in my interviews with some of the ﬁrms that have repeat acquisitions, which were considerable in number compared to managers who have repeat IPO experience. In these interviews the dominant one line almost every interviewee provided was that “they learned how to bid.” In fact since markets are assumed to be at least semi-strong efﬁcient, we can argue that irrational bidders would be selected out of the market and would go bankrupt.

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The hubris arguments are strongly related to all markets (product, ﬁnancial and labor) being strong-form efﬁcient (Roll, 1986). In takeover markets the task at hand is easier since there is an initial starting point to make a judgment. However in a market for all privately held targets, strong information asymmetries exist due to the existence of private information among targets’ insiders. Econometrically this poses a challenge since we can only observe the right hand side tail of the distribution where the acquisition has taken place with all overvalued targets. Therefore the hubris arguments do not apply since bidders do not have full information before the negotiation, but the information is received asymmetrically throughout the due diligence phase. The valuation error and managerial hubris arguments are not necessarily mutually exclusive. If one could ask an acquirer “what he is buying,” some will say they are acquiring control rights over assets which are a concern for future division of ex post surplus; whereas control rights of stock is a more immediate concern about current cash ﬂows (Hart, 1988; Zingales, 1995). If a bundle of resources have immediate and easily foreseeable returns to potential bidders, the seller is more likely to sell the bundle in the form of an asset sale, since the replacement value for these resources will be competitively priced. If, however, these resources represented unique returns to some, and few bidders realized this potential, the acquirer would most probably seek ex post division, to make sure that the full potential is realized.

EFFICIENCY IN MARKET MECHANISMS The extent to which a seller’s expected revenues are maximized given informational constraints in the environment, is the efﬁciency of the market. Therefore, when we are studying which market mechanism is going to generate rents for the entrepreneur more efﬁciently, it is important to consider several criteria that affect pricing of issues. From the auction literature, we know how different auction forms affect expected revenues both theoretically (Milgrom & Weber, 1982) and empirically (Holt, 1995). In practice, the efﬁciency of market design has been a central concern in the auctioning of treasury bills, securities, telecommunication licenses. In the case of entrepreneurial ﬁrms, the principle features are similar to established ﬁnancial markets, with one important difference: the ﬁrm is better informed than the market (Myers & Majluf, 1984). In a competitive IPO market, the stocks are priced such that the investors break even and the entrepreneurs decide whether to sell or not. If they think this price is fair, they sell, but if the anticipated price is not achieved, the underpricing implies a market failure, and investment opportunities are wasted (Giammarino & Lewis, 1989).

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In this context, two issues are at the center of efﬁciency arguments: underpricing, and undersubscription. In a bargaining setting, where the bookbuilding method provides a negotiation market during the roadshow, the entrepreneur and the institutional investors try to determine a demand schedule. The efﬁciency of this process is often criticized for intentional underpricing, and for the information asymmetries between the ﬁrm and the underwriters (Sherman & Titman, 2001). Compared to the bookbuilding negotiations, the posted price mechanism ﬁxed-price contracts) with nonbinding communication maximizes the seller’s expected revenue given informational constraints. If the entrepreneur selects among the potential investors who announce higher reservation prices, and restricts allocations, he/she can eliminate underreporting in the ﬁrst stage of bookbuilding negotiations (Spatt & Srivastava, 1991). This mechanism would be a second price auction where the potential bidders would report their true values. In the case of initial underpricing, the early investors would appropriate the rents, and in the posted price with communication, the entrepreneur would generate and appropriate the rents (if any). In the case of underpricing, the secondary markets would be the fair market. The role of the underwriters in these types of markets can be characterized as intermediaries for ex post Pareto-inefﬁcient agreements, who try to expand the pie in an incomplete information setting. The number of shares sold is higher in bookbuilding than in a posted price IPO. In this context, the entrepreneurial ﬁrm may be vulnerable to undersubscription, selling far less if the set reservation price is high, or leaving money on the table if the price is set too low (Ritter & Welch, 2002). The bookbuilding allows the underwriter to choose the bidders, whereas the posted price auction does not provide such a mechanism.1

FACTORS THAT INFLUENCE THE DECISIONS Based on auction and negotiation theory in economics and ﬁnance literatures, I identiﬁed ﬁve factors: bargaining power of the parties, resource’s value to each bidder, the market thickness for both the demand and the supply side, risk taking propensity of the parties, and the existence of search costs (Arikan, 2002, 2003). I argue that two conditions are necessary for generation of rents in the market for ﬁrms. First, if a buyer is to generate rents, the productive capabilities of the good itself are a necessary condition. Second, the mechanism by which these resources are acquired are also a necessary condition since all economic rents could easily be wiped away if, for example a bidder overbids his true value, or the seller selects a suboptimal mechanism to complete the transaction.

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Bargaining power is an advantage that one of the parties possesses and can utilize to extract a better outcome (Schelling, 1956). Most often information is the key bargaining power and these determine the direction of the negotiation. Whichever party “knows” more will deﬁnitely has a higher bargaining power, which relates to the information asymmetries. Most important result of information economics is that bargaining under asymmetric information results in ex post trade inefﬁciencies (Coase, 1960); where as the ideal situation is the symmetric case which leads to an efﬁcient result. In the context of entrepreneurial ﬁrms, the entrepreneur “knows” more than the investor, hence if the information asymmetries continue this will lead to misjudgments in valuation. On the other hand, actions to decrease information asymmetries are costly and will discount the future utilities. For example to decrease the information asymmetries search is conducted, during the bargaining process parties exchange information but both are time consuming (Tirole, 1988). As parties negotiate and release information to reduce the asymmetries, rents are dissipated during the process. Hence if an entrepreneur negotiates while he has bargaining power, he in essence lets go of his excess proﬁts and wastes a valuable opportunity to extract the highest amount of rents. Entrepreneurial ﬁrms gain bargaining power as they gain expertise and experience, accumulate assets and if they hold a patent. Formation of alliances and joint ventures especially in the biotech industry, increase a ﬁrm’s bargaining power. Firms that have formed alliances are more likely to negotiate a deal with their alliance partners. However, this does not mean that an entrepreneurial ﬁrm will always chose to be acquired. If the ﬁrm’s goal is to generate capital, hence sell a minority equity stake, an IPO may be more feasible. In this case, ﬁrms that have formed alliances will have a higher propensity to IPO than ﬁrms that have not formed alliances (Stuart et al., 1999). H1. Increase in bargaining power increases the likelihood of choosing M&A over IPO. Resource value is a value judgment for what a resource might be worth in an exchange for all potentially interested parties. All resources will therefore have private and common values attached to it. After the auction for a pure common value resource, a market value is established and is known by all parties bidding. During a common value auction all bidders receive signals related to the value of this resource but interpret them in unique ways given their heterogeneous expectations about the future productivity of the item. For example although the value of a plot of land might be unknown before the auction, it will be well established after the auction, so the differences in valuation depends on the experts’ judgment. On the other hand in a private value auction, each bidder knows the value of the item to him, and has a probabilistic information on the values of the item to other bidders

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(Kagel et al., 1987). The concept private value component of resources is akin to the discussion of heterogeneous expectations about a resource’s rent potential in product markets (Barney, 1986). Rent potential for sellers and buyers will be affected by the heterogeneity in expectations regarding the gains from trade and I argue that exchange mechanism will moderate this process. H2. Increase in private value increases the likelihood of choosing IPO over M&A. Market thickness is the number of buyers and sellers in a market. Two aspects of this factor are crucial for the M&A vs. IPO market decision maker. First, he should decide whether to encourage or discourage entry into bidding, and second whether he can endogenously select the bidders by considering the identity of the bidders. In an auction for a common value product, the seller is better of limiting entry into bidding since higher number of bidders will drive the outcome to perfectly competitive levels, and conversely for a private value resource, he is better of with higher number of bidders (Kagel, 1995). Also, if bidders are bidding for a resource are “experts” or are within the same industry, this means they are going to be repeatedly bidding for the similar resources and compete against their fellow experts. Consider Monet’s famous “Water lilies” painting. There are three complete paintings painted in 1903, 1906, and one between 1916 and 1923. All three also have numerous color sketches (almost exact replicas). Although bidding for such a painting is almost entirely a pure value auction to a na¨ıve bidder, for the same resource, the experts will have correlated values, hence the private value component would decline and they would be subject to winners’ curse (Kagel & Levin, 1986). H3. Increase in market thickness increases the likelihood of choosing IPO over M&A. Risk propensity can be associated with the willingness to carry debt and the degree at which an owner/manager retains ownership in the venture. Two categories have been established in the literature: risk aversion and risk neutrality of entrepreneurs (Kihlstrom & Laffont, 1979). From a seller’s perspective, the concern is whether the market mechanisms to govern the exchange will have equivalent payoffs. If either mechanism is assumed to yield the same outcome, we would expect the seller to be completely indifferent. From a buyer’s perspective, the same concern also holds and more importantly, releases information about the sellers’ propensity for risk because the buyer is in a position to observe the debt and ownership levels before the auction or negotiation. Risk averse managers would carry low levels of debt, and we would expect them to maximize expected utilities; whereas risk neutral managers would carry higher debt levels and would maximize

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expected proﬁts from the sale, conforming to revenue equivalence theorem (Riley & Samuelson, 1981; Vickrey, 1961). H4. Increase in risk aversion increases the likelihood of choosing IPO over M&A. Search costs arise due to information asymmetries that exist between buyers and sellers. These costs are especially high for privately held ﬁrms since they tend to release less information about their assets and prospects into the market. Switching costs are likely to arise due to search costs. For example during an M&A negotiation, costs of switching between buyers-sellers and information gathering are going to be high. The M&A blocks are far from being a perfectly competitive Walrasian market where spot transactions govern and buyers’ search strategies are interdependent (Rothschild, 1973). In these markets prices would reﬂect all relevant information about the resource and competition would drive the proﬁts to zero. Hypothetically if the M&A markets displayed zero search cost conditions, then delaying the bargaining and not reaching a settlement would be costly (Arrow & Debreu, 1954). Industry insiders on the other hand will have better information about the privately held ﬁrms compared to industry outsiders. Although rents would be low for such industry experts, they have a higher incentive to stay in the market and enter a transaction (Salop & Stiglitz, 1977). In markets intermediaries also act to lower search costs. For example in the market for ﬁrms for privately held ﬁrms, investment banks and underwriters would decrease search costs and also ﬁnd a “match,” in the case of IPOs, their reputation would be correlated to both short and long term performance of offerings (Brav & Gompers, 1996; Michaely & Shaw, 1994). H5. Increase in search costs increases the likelihood of choosing IPO over M&A.

EMPIRICAL ANALYSIS Empirical Design In this paper an entrepreneur makes an endogenous decision to sell his ﬁrm using either an M&A or IPO. Therefore his decision tree will start after the point of sale decision and the decision to not sell, or sell in debt markets hence liquidation is not an option. At one particular moment in time, his decision will be effected by the above described ﬁve factors. Once the ﬁrm is put on the market for sale, the deal is executed or not. If it is executed, two forms are chosen in each of the two

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options: in the M&A decision, the ﬁrm can either sell assets or stocks; in the IPO decision, the ﬁrm can pursue bookbuilding or ﬁxed-price offering. These decisions are discrete choices and not necessarily continuous, error terms are heteroscedastic, and the dependent variable is the choice which is not normally distributed. More importantly, econometrically I decompose a single decision and minimize cross alternative substitution where the error terms are not independently correlated.

Description of the Dataset I constructed a panel dataset containing information on initial public offerings of private ﬁrms and mergers and acquisitions of private targets, across time, and industry using three different databases. The sample excludes leveraged recapitalization, one-time dividends, preferred stock or debt securities sales, privatizations, equity buybacks, and seasoned equity offerings. For the initial public offerings, I used SDC’s Global New Issues Database maintained by the SDC Thompson Financial Securities. The data from this source covers private companies that issued common stocks between 1980 and 2000 in the U.S. From SDC, I obtained the M&A data from Mergers & Acquisitions Database for U.S. targets, with private sellers (targets). I checked all entries to make sure that the deal is actually consummated, and not pulled back. The domestic U.S. targets sample covers ﬁrms between 1980 and 2000. I separated the M&A dataset into two samples: stock sale and asset sale samples. Stock sales constitutes when (i) there is a combination of businesses, (ii) the end result is the change in ownership of 100% of equity, and (iii) the acquisition results in a change in ownership over the majority interest (over 50%). Asset sale refers to the types of divestitures where the focal ﬁrm sells off portion of its assets and/or divisions.

Variables In this section I will present the dependent and independent variables and describe the empirical model used to test the hypothesized relationships between the mechanism choice and the 5 factors identiﬁed (see a more detailed discussion of the variables in Arikan, 2003). The dependent variables are identiﬁed for each decision level. MECHANISM is a dichotomized variable which takes the value of one when the choice is an IPO and zero when the choice is an M&A. First-level of market mechanisms lead into four second-level choices. TYPE is a categorical variable with four values representing each second-level choice (bookbuilding, ﬁxed price, asset sale, and stock sale).

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Independent variables are as follows. Return on assets (ROA) is used as a proxy for the bargaining power of the target. Private ﬁrm with higher ROA will be at a better bargaining potion and can demand higher price to release ownership rights to the buyer. Moreover, high ROA signals that the assets invested in the business are already generating revenue. On the other hand, low (or negative) ROA could suggest one of the following: (i) the assets are not used in their most productive uses; (ii) there are managerial problems which affect revenue negatively; (iii) the ﬁrm is in need of expansion and the only route is to sell ownership rights to generate needed capital; and (iv) low ROA is due to an extraordinary charge that is not a systematic problem yet might force the sale of ownership rights. Search costs in an industry will be lower if there are intermediaries that produce valuable information about the industry participants and lower the search costs for the parties who are looking for trading partners. Venture capital ﬁrms can be classiﬁed as serving two roles in the ﬁnancial markets: (i) lend capital to entrepreneurial ﬁrms; and (ii) decrease the information asymmetry and lower search costs for the industry participants in the sector that they are interested in. Hence, a dichotomous variable of VC-Involvement in the industry of the target ﬁrm is used to proxy search costs. VC-IND is a dichotomous variable that takes the value of one if SDC classiﬁes it as one where VCs actively participate in. The intuition is such that if there are VCs actively participating by ﬁnding out the best entrepreneurial projects in an industry then the search costs in that industry is diminished for the other participants as well. Resource value as discussed before refers to the private versus common value associated with the private ﬁrm. It is very hard to ﬁnd a resource that has pure common or private value associated with it. However we can make some generalizations as follows. High technology industries tend to have products and patents that have higher private values as opposed to common values. As discussed above, higher private values are associated with increased probability of having auctions rather than negotiation. For instance, Maksimovic and Pichler show that IPOs are more likely in the case of high-tech ﬁrms (2001). As the number of different contexts that the patent is applicable to increases, the more likely that it has private value than common. I capture this by creating a dichotomous variable, HI-TECH, that is equal to one if the industry is classiﬁed as hi-tech by SDC, and zero otherwise. Hence, ﬁrms are categorized as high tech versus low tech using classiﬁcations provided by the SDC. High tech industries would be biotechnology, chemicals, communications, computers, defense, electronics, medical, and pharmaceuticals. Another variable used for resource value is a continuous variable, which is a modiﬁed Tobin’s q (Lindenberg & Ross, 1981; Tobin, 1969). Tobin’s q is calculated as a ratio of market value of all assets of the ﬁrms divided by the

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replacement value of those assets (which is proxied by book value of total assets). Especially the valuation of intangible assets correlates with private values and involves heterogeneous expectation of market participants (Cockburn & Griliches, 1988).2 For instance, we can apply this logic to the valuation of small ﬁrms in high-tech industries (Himmelberg & Petersen, 1994; Megna & Klock, 1993). This measure can easily be computed if the ﬁrm is publicly traded. However, this study uses privately held ﬁrms, where there is no stock price determined by the stock market. It should be noted that, even if the ﬁrm is privately held, the capital structure can encompass both debt and equity. Therefore the task was to ﬁnd a reasonable proxy for the market value of equity for these ﬁrms. Depending on the availability of data in SDC, I calculated the market value of equity using the offer price and the number of shares offered to impute the Proxy for Tobin’s q for the privately held ﬁrms. This measure would be a proxy for heterogeneous expectations, prior to being sold through and IPO or an M&A, regarding ﬁrm’s growth and the existing bundle of assets. Risk propensity is measured by the ratio of debt over total assets, DEBT/ASSET. Debt is the riskiest source for ﬁnancing because of the bankruptcy threat if the interest payments are not made on time and fully to the debt holders (Myers & Majluf, 1984). It would be consistent to expect that risk-averse managers would choose to maintain lower debt ratios compared to the industry norm. As discussed above, participants’ risk propensity impacts the dynamics and the outcome of auctions and negotiations. McAfee and Reny (1992) offer a detailed and welldeveloped discussion on risk neutrality and correlated private infor: (i) uncertainty in outcomes (Roth, 1995); (ii) renegotiations always possible; and (iii) negotiations are extensive preparation, costly, laborious (Hitt et al., 2001b). Market thickness is measured by the number of ﬁrms in the same industry classiﬁed by the primary two-digit SIC code of the privately held ﬁrm. As the market thickness increases the competition between the market participant increases. However, market mechanisms differ in terms of their efﬁciency and the increasing market thickness. Auction mechanism would be more efﬁcient and less costly if the number of potentially interested parties increases. On the other hand, negotiating with an increasing number of interested parties would be inefﬁcient and costly. Financial economics have looked extensively into the IPO related issues and offer very interesting variables that have impact on the decision to pursue IPO. I identiﬁed following variables as the control variables for this study.3 I control for industry wide effects on capital structure and used the average leverage ratio for ﬁrms in the same industry, IND DEBT/ASSET, to proxy the normal debt level (Harris & Raviv, 1990). As discussed in various studies in ﬁnancial economics,

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industry characteristics might predispose ﬁrms in that industry for one particular market mechanism. If the market-to-book value of equity is high then the likelihood of observing IPOs is higher (Pagano et al., 1998). Conversely, low levels of marketto-book ratio of equity predispose the industry for takeovers (Brau et al., 2001). This empirical regularity is controlled by the industry level market-to-book value of equity, IND MKT/BOOK. A stream of studies looks at the IPO decision within the context of market timing concerns (Choe et al., 1993; Lucas & McDonald, 1990). IPOs are expected to happen when the managers believe that their ﬁrm is overvalued or there is not any close substitute offerings by other ﬁrms (offering the same risk-return dynamic). It could also be such that entrepreneurs take time to adjust their expectations conditional on the recent market conditions, which is observed as a lag (Ritter & Welch, 2002). It has also been widely discussed that IPOs have hot or cold markets such that the offerings tend to happen in clusters (e.g. Lowry & Schwert, 2002). To proxy for the market cycle, I use the one-year lagged return on the S&P500 and NASDAQ, SP500 and NASDAQ, and the ratio of lagged volume of public offerings over acquisitions, IPO/MA, to establish the hot versus cold markets. I also included the industry’s Tobin’s q, IND TobinsQ as an additional control for the expectations regarding the industry-wide growth potential. Econometric Model4 When an entrepreneur decides to sell his/her company, he is faced with a series of single decisions among two or more alternatives. Each of these alternatives is mutually exclusive and is unordered. In other words, the focus of this empirical study is the decision after the entrepreneur decides to sell, and when he sells, he/she can either sell to another ﬁrm through negotiations, or he/she can auction off the ﬁrm to a number of public investors. Hence, I use a modiﬁed unordered conditional logit model. By relaxing the homoscedasticity assumption, I group the alternatives into subgroups with their variance differing across and maintain the independence of irrelevant alternatives assumptions (IIA) within the groups. This slight modiﬁcation of the stochastic speciﬁcation in the original conditional logit model deﬁnes a nested logit model (Greene, 1997). In order to construct the nested logit model, I start with auction vs. negotiation alternatives and divide into asset or stock sale, bookbuilding or ﬁxed-price offering subgroups. The entrepreneur ﬁrst makes the choice among the alternatives, and then makes speciﬁc choices within the subgroup set. The data consists of observations on the attributes of the choices (variables for explaining mechanisms in the second level) and attributes of the choice sets (attributes of markets in the ﬁrst level). I

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then estimate the nested logit using a full information maximum likelihood method. Since I am using a large sample that accommodates the parameters, the sequential approach was not used. The choices discussed in this paper are discrete and not continuous, the error terms are heteroscedastic, and the dependent variable (the choice) is not normally distributed. I assume that the decision makers choose the alternative from which they derive the highest utility; therefore I use the random utility maximization (RUM) model. The RUM outcome probabilities are based on utility difference only, and since the models normalize the utilities, the scales need not to be identiﬁed.

RESULTS Table 1 provides the descriptive statistics for the variables used in this study. There are signiﬁcant correlations between multiple variables which will be of concern when running the discrete choice models. It is not very meaningful to draw conclusions based on the correlations presented because of nonlinear relationships among variables as well as expected differences among sub-groups based on different mechanisms. Table 2 presents the ﬁrst set of models. First empirical model is a multinomial logistic regression (Greene, 2003), with the base case of ﬁxed-price mechanism (IPO type). I present this model for two reasons: (i) provide robustness check; and (ii) test for the IIA assumptions to check whether the end-nodes are correlated within branches. If this is the case, then it is econometrically as well as theoretically justiﬁed to use the nested logit speciﬁcation (Greene, 2003). There are two models presented. Model 1 has the explanatory variables suggested in this study, and industry’s market-to-book of equity ratio as the only control. The results of this speciﬁcation are consistent with the predictions and the overall model has statistically signiﬁcant explanatory power. One unit increase in the Proxy for Tobin’s q increases the likelihood of choosing ﬁxed-price IPO mechanism as opposed to M&A mechanisms. On the other hand, as expected, one unit increase in the ROA increases the likelihood of choosing M&A mechanisms over ﬁxedprice IPO mechanisms. If the focal ﬁrm is in a high-tech industry the odds of choosing IPO mechanisms increases over the M&A mechanisms. Both VC IND and the number of ﬁrms in the two-digit SIC industry do not follow the expected relationships, since one unit increase in both of the variables decreases the odds of choosing ﬁxed-price IPO mechanism over the other three mechanisms. Model 2 includes the control variables and utilizes the multinomial logistic regression. The inclusion of the control variables did not change the results reported

196

Table 1. Descriptive Statistics. Variables

5

6

7

−0.18*** −0.39*** −0.16*** 0.20*** −0.15*** −0.16***

0.92*** 0.43*** 0.01 −0.43*** −0.12*** −0.04***

1 0.51*** 0.03*** −0.37*** −0.11*** −0.012***

1 0.04*** −0.63*** 0.0009 0.05***

−0.03*

0.02***

0.03***

0.06***

0.06***

0.01

−0.03**

0.01

0.05***

0.08***

0.06***

−0.001

−0.04

−0.03**

−0.13***

−0.11***

−0.10***

0.007

0.25

0.01*

−0.03

−0.05***

−0.19***

−0.05***

−0.03***

0.04***

1.06

0.005

0.07

0.0001

0.02***

0.06***

0.04***

Mean

1

2

3

4

14520 951 2771 14520 14520

1.23 −18.59 0.81 0.58 2.81

1 0.06*** −0.26*** −0.01** 0.01

1 −0.07*** 0.11*** −0.08***

1 0.2*** −0.04***

1 −0.12***

14520 14520 14520 14520 14493 14493

1.18 683.08 0.45 0.00 0.17 0.21

0.013 0.02** 0.05*** −0.004 0.002 0.012

−0.07*** −0.11*** 0.01 0.10*** −0.05* −0.025

−0.03*** −0.13*** −0.14*** 0.15*** −0.04*** −0.04***

14493

0.19

0.01

0.01

14493

0.21

0.01

14493

0.20

14493 14445

1

0.008

ILGAZ ARIKAN

1. Proxy for Tobin’s q 2. ROA 3. Debt/assets 4. Hi-Tech industry 5. Industry market/book value of equity 6. Industry Tobin’s q 7. Number of ﬁrms in industry 8. VC industry 9. Industry debt/equity 10. 1-year lagged S&P index return 11. 1-year lagged Nasdaq index return 12. 1-year lagged S&P index return for 1st decile 13. 1-year lagged Nasdaq index return for 1st decile 14. 1-year lagged S&P index return for 10th decile 15. 1-year lagged Nasdaq index return for 10th decile 16. 1-year lagged total value of IPOs over M&As

N

1. Proxy for Tobin’s q 2. ROA 3. Debt/assets 4. Hi-Tech industry 5. Industry market/book value of equity 6. Industry Tobin’s q 7. Number of ﬁrms in industry 8. VC industry 9. Industry debt/equity 10. 1-year lagged S&P index return 11. 1-year lagged Nasdaq index return 12. 1-year lagged S&P index return for 1st decile 13. 1-year lagged Nasdaq index return for 1st decile 14. 1-year lagged S&P index return for 10th decile 15. 1-year lagged Nasdaq index return for 10th decile 16. 1-year lagged total value of IPOs over M&As

8

9

10

11

12

13

14

1 −0.02*** 0.01 0.04***

1 0.007 −0.04***

1 0.77***

1

0.03***

−0.11***

0.28***

0.60***

1

0.03***

−0.11***

0.23***

0.62***

0.98***

1

0.008

−0.0003

0.99***

0.79***

0.34***

0.29***

1

0.04***

−0.02***

0.76***

0.98***

0.45***

0.49***

0.77***

0.05***

−0.08***

−0.05***

0.12***

0.52***

0.52***

−0.02***

15

16

In the Market for Firms, How Should a Firm be Sold?

Variables

1 0.04***

1

∗ Signiﬁcant

at the 10% level. at the 5% level. ∗∗∗ Signiﬁcant at the 1% level. ∗∗ Signiﬁcant

197

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ILGAZ ARIKAN

Table 2. Multinomial Logistic Regression. Base Case is the Choice for Fixed-Price IPO Mechanism. Model Comparisons

1 Coeff.

Fixed vs. Bookbuilding Proxy for Tobin’s q ROA Debt/assets H-Tech Industry M/B of equity Industry Tobin’s q # Of ﬁrms VC industry Industry debt/equity 1-yr Lagged S&P rtrn 1-yr Lagged Nasdaq rtrn IPO/M&A (total value) Constant Fixed vs. Asset Proxy for Tobin’s q ROA Debt/assets H-Tech Industry M/B of equity Industry Tobin’s q # Of ﬁrms VC industry Industry debt/equity 1-yr lagged S&P rtrn 1-yr lagged Nasdaq rtrn IPO/M&A (total value) Constant Fixed vs. Stock Proxy for Tobin’s q ROA Debt/assets H-Tech Industry M/B of equity Industry Tobin’s q # Of ﬁrms VC industry Industry debt/equity 1-yr Lagged S&P rtrn 1-yr Lagged Nasdaq rtrn

2 z

0.539 0.002 −0.187 −0.705 −0.278

3.57*** 1.30 0.56 2.35** 2.86***

−0.001 −1.274

1.82* 5.73***

0.875 −0.004 −2.080 2.125 −0.573

6.16*** 3.14*** 5.26*** 9.36*** 5.17***

−0.001 −1.541

2.36** 6.74***

0.884 −0.004 −0.598 0.642 −0.455

6.22*** 2.65*** 1.74* 2.84*** 4.06***

−0.002 −1.296

4.93*** 5.62***

Coeff.

z

1.632 0.002 0.831 −0.195 0.247 −0.423 0.000 0.040 0.308 −1.011 0.753 −0.323 −4.219

6.09*** 1.13 2.54** 0.60 0.81 0.71 0.00 0.12 0.31 0.84 1.39 1.80* 5.50***

1.955 −0.004 −1.033 3.008 0.492 −1.344 0.000 −0.412 0.520 −1.050 1.452 −0.768 −4.225

7.27*** 2.93*** 2.50** 10.53*** 1.62 2.21** 0.79 1.43 0.69 0.80 2.02** 3.90*** 5.93***

1.963 −0.004 0.107 1.346 0.476 −1.347 −0.001 −0.303 −0.271 −1.294 1.869

7.30*** 2.54** 0.30 5.05*** 1.58 2.20** 3.53*** 1.02 0.36 0.97 2.72***

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Table 2. (Continued ) Model Comparisons

1

2

Coeff.

z

IPO/M&A (total value) Constant

0.188 −4.453

N Log likelihood Wald test Prob > ␹2 Pseudo R2 Small-Hsiao Tests of IIA Assumption+

1597 −1086.956 2253.910 0.000 0.509 Omitted 2 3 4

Hausman Tests of IIA Assumption+

Coeff.

Omitted 2 3 4

␹2 87.05*** 115.94*** 95.90*** ␹2 28.232*** −89.61 106.542***

z 1.47 6.33***

1569 −997.800 1739.670 0.000 0.466 Omitted 2 3 4 Omitted 2 3 4

␹2 17.46 43.05*** 30.48*** ␹2 −53.116 27.977 0.058

Note: Ho: Odds (Outcome J vs. Outcome K) are independent of other alternatives. The number of ﬁrms in target’s industry is based on 2 digit SIC codes. Absolute value of z statistics are reported. ∗ Signiﬁcant at 10%. ∗∗ Signiﬁcant at 5%. ∗∗∗ Signiﬁcant at 1%.

in the ﬁrst model drastically. Interestingly, one-year lagged returns on S&P500 index and NASDAQ index have opposite effects. One unit increase in the one-year lagged return to the S&P500 index decrease the odds of choosing ﬁxed-price IPO mechanism over the M&A mechanisms. On the other hand, one unit increase in the one-year lagged return to the Nasdaq index increases the odds of choosing the ﬁxed-price IPO mechanism over the M&A mechanisms. This result is consistent with the IPO listing we see with NASDAQ stock exchange as opposed to other stock exchanges (e.g. NYSE, AMEX). Also this result would be consistent with the empirical regularities found in the empirical M&A studies in ﬁnancial economics. M&A activity is also concentrated across time and stock is a common method of payment. If the target ﬁrm intends to put itself up for sale via M&A it might be a better time when the public buyers’ stock is doing well. There are two types of tests presented in Table 2 for the veriﬁcation of the IIA Assumption: Small-Hsiao tests and Hausman tests. The null hypothesis for both of these tests is such that the Odds (Outcome J vs. Outcome K) are independent of

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ILGAZ ARIKAN

other alternatives. The results of the test reject the null hypothesis and suggest that there is statistically signiﬁcant correlation within branches (among nodes). Nested logit speciﬁcation allows for the correlation to exist within branches and corrects for it (Greene, 2003). The log-likelihood maximization is an iterative process where the initial values for the parameters are obtained from the conditional logistic regression (which also assumes that IIA Assumption holds). Table 3 presents the results of nested logit speciﬁcations. The base case for comparison is the bookbuilding IPO mechanism. The ﬁrst model presents the covariates discussed in this paper with the addition of industry’s market-to-book of equity ratio as the only control. The results are mainly the same as the results presented in the ﬁrst model in Table 1 but the magnitudes and the standard errors are corrected for heteroscedasticity. As expected, one unit increase in the proxy for Tobin’s q increases the odds of choosing ﬁxed-price IPO mechanism over M&A mechanisms. If the ﬁrm is in an industry where there is VC interest then the odds of choosing ﬁxed-price IPO mechanism over the M&A mechanisms decreases. This might be counterintuitive at ﬁrst glance, but it is consistent with the theoretical discussion that was provided. VC participation in an industry decreases search costs which also diminishes the costs of ﬁnding potential partners and the threat of holdup in the context of negotiations. The number of ﬁrms in the two-digit SIC industry of the focal ﬁrm is signiﬁcant yet with the opposite sign than predicted in the discussion of market thickness. One unit increase in the number of ﬁrms in the two-digit SIC industry of the focal ﬁrm decreases the odds of choosing ﬁxed-price IPO mechanism over the M&A mechanisms. However both the magnitude and the signiﬁcance of these coefﬁcients are diminished once the industry level controls are included. This effect is due to the fact that the controls uses number of ﬁrms in the two-digit SIC industry in the denominator. Risk propensity measure of DEBT/ASSET also yields mixed results. One unit increase in the DEBT/ASSET ratio of the focal ﬁrms increases the odds of choosing ﬁxed-price IPO mechanism over the stock-sale M&A mechanism. Conversely, as predicted, one unit increase in the DEBT/ASSET ratio of the focal ﬁrms decreases the odds of choosing ﬁxed-price IPO mechanism over the asset-sale M&A mechanism. Model 2 presents the nested logit results with al of the controls included to the ﬁrst model (Table 3). Interestingly the signiﬁcance of lagged index returns for S&P500 and NASDAQ goes away. Meanwhile, one unit increase in the Tobin’s q of the two-digit SIC increases the odds of choosing ﬁxed-price IPO mechanism over the stock-sale M&A mechanism. These results might be indicative of market timing mechanisms that differ across various market mechanisms, and might be an interesting venue of further research to shed light into these nuances.

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Table 3. Nested Logit. Base Case is the Choice for Fixed-Price IPO Mechanism. Model Variable × Mechanism Type

1 Coeff.

Tobin’s q × Book Asset Stock

2 z

Coeff.

z

6.342 5.186 5.243

3.59*** 3.74*** 3.77***

4.682 3.707 3.784

2.54** 2.78*** 2.84***

VC Industry × Book Asset Stock

−6.691 −6.039 −5.998

3.14*** 3.22*** 3.08***

−3.515 −3.951 −2.933

2.27** 2.63*** −1.64

Hi-Tech Industry × Book Asset Stock

−3.744 5.655 −7.602

2.26** 2.52** 2.55**

−2.266 6.167 −4.935

1.94* 3.51*** 2.32**

Number of ﬁrms in industry × Book Asset Stock

−0.01 −0.006 −0.01

2.81*** 2.03** 3.23***

−0.003 0.00 −0.005

2.11** −0.21 2.52**

−10.899 −18.504 −3.701

2.00** 4.07*** −0.66

−2.165 −16.689 9.277

−1.21 3.28*** 1.86*

0.016 0.002 0.015

2.11** −0.25 1.92*

0.01 −0.005 0.012

2.13** −0.7 1.79*

0.264

−0.44

−1.195 1.985 −5.66

−1.42 −1.03 2.32**

1.646

−1.05

−2.992 4.954 −11.624

−1.43 −1.17 2.41**

−0.927

−0.79

0.027 −5.63 7.495

−0.02 −1.57 1.73*

−6.065

1.81*

Debt/assets × Book Asset Stock ROA × Book Asset Stock Industry market/book value of equity × Book Asset Stock Industry debt/equity × Book Asset Stock Industry Tobin’s q × Book Asset Stock 1-year lagged S&P index return × Book

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ILGAZ ARIKAN

Table 3. (Continued ) Model Variable × Mechanism Type

1

2

Coeff. Asset Stock

0.885

1-year lagged Nasdaq index return × Book Asset Stock Type dummy (Ipo = 1, M&A = 0) Constant (IV for IPO) Constant (IV for M&A) LR test of homoskedasticity (IV = 1) ␹2 Observations Number of groups Log likelihood

−0.35 13.803 −5.934 12.123

z −0.34

−0.23 4.17*** 2.44** 2.71***

Coeff.

z

−2.38 −7.103

−0.44 −1.17

1.223 −0.496 2.332

−0.87 −0.17 −0.75

14.999 17.043 −2.735

68.2*** 6008 1502 −913.37***

3.05*** 2.27** 2.46**

79.91*** 6008 1502 −895.16***

Note: Absolute value of z statistics in parentheses. ∗ Signiﬁcant at 10%. ∗∗ Signiﬁcant at 5%. ∗∗∗ Signiﬁcant at 1%.

DISCUSSION AND CONCLUSION In the market for ﬁrms what is the best way to sell a ﬁrm? Most commonly used theories in strategy have focused on the governance mechanisms and the type of ﬁrms and resources one needs to buy, and organize the ﬁrm to extract rents efﬁciently, but do not address this question directly. For example in transaction cost economics, the focus is on markets versus hierarchies (and later on the hybrid forms in between), and the unit of analysis is the contract. In resource based view our focus is on the actual resource which delivers above normal performance, hence a manager’s concern is either picking or developing the resource. In this paper the focus is on HOW one buys these resources, ﬁrms, or products in markets. Hence, I decompose the market component and look at the market mechanisms that govern the exchanges. In this paper I study the discrete choice of selling a ﬁrm in the market for ﬁrms using the U.S. manufacturing sector ﬁrms between 1980 and 2000. All the ﬁrms used in the study are privately held ﬁrms across many industries within the manufacturing sector who have either consummated an IPO or an M&A.

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There are three main mechanisms that govern an exchange in markets: auctions, negotiations, and spot transactions. In the context of entrepreneurial ﬁrm sales, spot markets are not applicable since a value is not yet established. Hence either through an auction or a negotiation, parties will try to reveal a value and willingness to buy. When an entrepreneur sells his ﬁrm, his choices at that particular moment in time are mutually exclusive and each of these choices has very different outcomes. I argue that the optimal choice is inﬂuences by ﬁve factors that have direct implications for rent appropriation process: bargaining power, market thickness, resource value, risk propensity, and search costs. I ﬁnd that all else being equal, entrepreneurial ﬁrms with high bargaining power are more likely to choose M&As, ﬁrms that represent high private values (e.g. in high-tech industries) are more likely to be sold through IPOs, as the market thickness increases, the likelihood of entrepreneurial ﬁrms being sold through M&A decreases. However, this ﬁnding is reversed for ﬁrms with higher private values. For ﬁrms with high debt ratios, the likelihood of M&A increases compared to IPOs. I ﬁnd that as venture capital activity in the focal industry increases, the likelihood of M&As increases. Based on these empirical ﬁndings, I further investigated my hypotheses using a small sample randomly chosen ﬁrms in various industries, venture capitalists, and investment banks. Interviewees were asked how they decided on a particular market mechanism, and how they gave advice to or inﬂuenced their clients. They were speciﬁcally asked to demonstrate how they determined the ﬁve factors I have identiﬁed. During these interviews I found that some ﬁrms displayed very strong biases towards one market mechanism over the other without giving much consideration to their bargaining situation, competitive position in the market, risk structure, search costs, or information asymmetries. There might be several reasons for these misjudgments. First, these misjudgments might be due to inexperience of the decision makers. Most entrepreneurs are not repeat entrepreneurs and they do not take advantage of learning by doing. So in some cases, they misjudge their informational advantages (or disadvantages), as well as the timing of their actions (Chemmanur & Fulghieri, 1999). Second, the misjudgments about their competitive positions might be due to overconﬁdence in one’s abilities, which raises the issues regarding biases in decision making. After the IPO, we used the cash ﬂow to expand the business, and did very well. But, we waited too long to sell the ﬁrm. If we had sold it earlier, the buyers would have an incentive to compete. When Company B approached to buy us out, we hired a consultant. He said the offer was too low, and pushed us to seek an alliance partner. Now, why should we have done that I still do not understand. All we needed was to decide whether we should have done an IPO or be acquired.

Third, managers might be “following the herd,” and doing what same industry players choose to do without giving enough consideration to their own unique

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positions (Bernardo & Welch, 2001; Bikhchandani et al., 1998; Brandenburger & Polak, 1996). This is especially interesting since the reason is the opposite of overconﬁdence; although managers have superior information about their ﬁrms and their own prospects, they signiﬁcantly discount their signals. There are several reasons why this discount might take place. First, decision makers might be trying to limit potential losses by applying generic strategies. Second, decision makers might be listening to ’advice’ of consultants which might specialize in one mechanism. We started and then sold eight companies so far. In all but one we thought of doing an IPO. I mean we have a good thing going with acquisitions. We are good in negotiating with buyers. IPO would only be a distraction, it would be a waste of time and money. Suppose we did an IPO. What then? Why would I want to check the stock price of my company everyday to see how I am doing?

Fourth, decision makers might be misjudging their positions due to emotional reasons, which is difﬁcult to frame in a rational decision making heuristic. We did not want to be acquired before realizing all the potential of the ﬁrm. When you put your life in to a company, selling it to some stranger is the last thing on your mind. I sold my ﬁrst house 30 years ago after living in it for four years, and I still go and visit it from time to time. It is an emotional thing. Imagine now selling your company you built from scratch with your hands. Selling to some other ﬁrm could only be the last option.

Finally, ﬁrms’ success and survival might be linked to entrepreneur’s tenure (Eisenhardt & Schoonhoven, 1990). Their criteria for success Maybe when you are young you can take risks. Not me . . . I will retire in Florida after I sell it to Company X. Money in the bank is sweeter.

There are several future extensions. First, this paper utilizes a large panel dataset across industries and years covering all U.S. manufacturing sector. While this dataset allows me to make generalizations, I have sacriﬁced depth and a more ﬁnely focused investigation. If such an industry-speciﬁc study were undertaken, it would be possible to reﬁne the variables. However, the purpose of the sector wide dataset use was to give a more sustainable and robust coverage of the ﬁve decision factors without going into details. Therefore a natural extension of this research is an industry-speciﬁc study. Furthermore, evident from the interviews revealed very interesting biases and misjudgments by the decision makers as well as the consultants to the decision makers. A study of biases in decision making for this discrete choice would be most interesting. Also, ﬁrms are not entirely stand-alone decision makers and they exist in a network of peer ﬁrms, investment banks, and venture capitalists. Each of these constituents gives “advice” to the decision maker and inﬂuences the decision. Their effect and inﬂuence deserves investigation.

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Finally, while this paper answers “how” ﬁrms choose to sell, it does not address “why” they sell. Entrepreneurs put together a bundle of resources to realize the full potential of a venture and before they can further develop their optimal output, they require additional resources. In such cases entrepreneurial ﬁrms would choose auctions (IPOs) to realize full value, and would choose to negotiate the sale through an M&A if they did not have enough resources, could not acquire these resources, or were not positioned to develop them internally. This line of reasoning requires development of a new set of factors that will inﬂuence the decisions why entrepreneurs would sell their ﬁrms.

NOTES 1. The Dutch auction IPO, although it is very early to generalize, addresses these shortcomings: by building the demand schedule before the auction it aims to eliminate severe underpricing and undersubscription, and by the distribution of shares, tries to prevent informed investors from gaining windfall proﬁts and large orders. 2. Main reason for that is the lack of efﬁcient secondary markets for such assets where economic actors can determine the second-best value (and the associated price) via transacting. 3. Industry membership is also relevant because of the regulatory environment or industry concentration level. Therefore I used industry dummy variables to control for industry speciﬁc effects. However, in various models where industry dummies were included the iterations did not converge due to multicollinearity and ﬂatness of the log-likelihood function. Instead, the control variables capture the time effects as well as industry ﬁxed effects because they are measured by industry × year. 4. Details of the econometric models will be made available upon request from the author.

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