Copyright 2009 by Kelley School of Business, Indiana University. For reprints, call HBS Publishing at (800) 545-7685.     ...
524                                                                                        EXECUTIVE DIGESTThe method of p...
EXECUTIVE DIGEST                                                                                             525   Other f...
526                                                                                          EXECUTIVE DIGESTof the knowle...
EXECUTIVE DIGEST                                                                                            527knowledge t...
528                                                                                                            EXECUTIVE D...
EXECUTIVE DIGEST                                                                                                          ...
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M&A - common mistakes and dangers


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M&A - common mistakes and dangers

  1. 1. Copyright 2009 by Kelley School of Business, Indiana University. For reprints, call HBS Publishing at (800) 545-7685. BH 353 Business Horizons (2009) 52, 523—529 EXECUTIVE DIGEST Mergers and acquisitions: Overcoming pitfalls, building synergy, and creating value Michael A. Hitt a,*, David King b, Hema Krishnan c, Marianna Makri d, Mario Schijven e, Katsuhiko Shimizu f, Hong Zhu g a Mays Business School, Texas A&M University, 4113 TAMU, College Station, TX 77843-4113, U.S.A. b Marquette University c Xavier University d University of Miami e Texas A&M University f University of Texas at San Antonio g Chinese University of Hong Kong 1. Mergers and acquisitions: A closer acquisition capability based on organizational learn- look ing from the acquisitions and complementary sci- ence and technology for strategic renewal. Finally, Mergers and acquisitions (M&A) represent a popular we end with a discussion of the research on cross- strategy used by firms for many years, but the border mergers and acquisitions which have become success of this strategy has been limited. In fact, prominent in recent years. several reviews have shown that, on average, firms create little or no value by making acquisitions 2. Research on mergers and (Hitt, Harrison, & Ireland, 2001). While there acquisitions has been a significant amount of research on merg- ers and acquisitions, there appears to be little A representative review of the extant research on consensus as to the reasons for outcomes achieved mergers and acquisitions over the last 25 years from them (King, Dalton, Daily, & Covin, 2004). (89 articles) produced a list–—available from the Herein, we begin by reviewing some of the extant authors–—of the most common variables studied. research on mergers and acquisitions, identifying The top three research variables include: the key variables on which the studies have focused. Thereafter, we summarize some of the major work 1. The extent to which the acquisition increased the on a primary reason for failure–—paying too high a diversification of the acquiring firm/the related- premium–—and discuss why executives often delay ness of the acquiring firm (58% of the studies); too long the divestiture of poorly performing businesses that were acquired. Additionally, we 2. Firm size or the relative size of the acquired to examine research suggesting the importance of an the acquiring firm (52% of the studies); and * Corresponding author. 3. The acquisition experience of the acquiring firm E-mail address: (M.A. Hitt). (28% of the studies). 0007-6813/$ — see front matter # 2009 Kelley School of Business, Indiana University. All rights reserved. doi:10.1016/j.bushor.2009.06.008
  2. 2. 524 EXECUTIVE DIGESTThe method of payment for target firms appeared in (Laamanen, 2007). The justification for a premium18% of the studies, with more emphasis in research is the potential synergy that can be created in theafter 2004. merger of the two firms. A premium is paid to entice While there are logical arguments to suggest that the target firm shareholders to sell to the acquiringtarget firms with greater relatedness to an acquiring firm. However, the premium paid should not andfirm should produce higher performance, existing cannot be greater than the potential synergy if theresearch provides mixed evidence. The recent re- acquisition is to produce positive returns. Of course,search by Palich, Cardinal, and Miller (2000) sug- it is difficult to predict the value that can be createdgests a curvilinear relationship between relatedness by synergy, and it is often difficult to realize theand performance. Mixed results from prior research potential synergy because of the challenges ofcan be explained by the fact that few of the studies achieving integration (Sirower, 1997).examined nonlinear relationships. There are other reasons that acquiring firms The impact of firm size on acquisition perfor- pay large premiums. One such reason stems frommance likely results from the effectiveness of the agency factors when top executives engage inintegration process, with integration being more opportunistic behavior that provides them personaldifficult for larger acquisitions. Yet, the acquired gains (Trautwein, 1990). Because acquisitions in-firm must be large enough to have an impact on the crease the size of a firm, they often have a positiveacquiring firm’s performance (King, Slotegraaf, & effect on a top executive’s compensation and en-Kesner, 2008). While a complex relationship, re- hance his/her power. Furthermore, if the acquisi-search findings for firm size are more consistent tion diversifies the firm, it may also reduce that topthan for many of the other variables. executive’s employment risk. Because these are Acquisition experience has been the subject of personal gains that rarely produce positive returnsstudy for a number of years because of its assumed for the acquiring firm, acquisitions made for theseimportance. Yet, the more critical issue is likely to purposes are unlikely to be the amount learned from making an acquisition. Another reason for high premiums is executiveObviously, a firm with some experience should be hubris (Roll, 1986). In this context, hubris is exec-able to learn from additional acquisitions, but hav- utives’ overconfidence that they can achieve theing more experience does not ensure that greater synergy projected when the firm is acquired andlearning occurs. Early experiences can produce integrated. Yet, firms acquired where hubris is amore learning than later experiences but without major factor are unlikely to achieve the neededadequate absorptive capacity, early lessons may be synergy. As a result, firms may pay too high ageneralized to subsequent acquisitions to which premium and are unable to earn adequate returnsthey are not applicable. Thus, the relationship be- to compensate for the premium and also produce atween experience and learning is likely to be curvi- positive return (Hayward & Hambrick, 1997). Whenlinear but also even more complex (Haleblian & hubris is instrumental in the acquisition, it is notFinkelstein, 1999). While prior research and its uncommon for the CEO to do a less than adequateconclusions are useful, increased utilization of a job of due diligence or to ignore negative informa-common set of variables in M&A research could tion provided by the due diligence process (Hittminimize model under-specification and facilitate et al., 2001).achieving greater consensus on the drivers of acqui- However, Sirower (1997) downplays hubris as asition performance. This being the case, we still primary factor in paying too high a premium for aneed to learn more about the requirements for target. Rather, he suggests three alternative causesmaking successful acquisitions; toward that end, for overpayment: (1) unfamiliarity with critical el-we examine next some factors that contribute to ements of the acquisition strategy, (2) lack of ade-acquisition failure and success. quate knowledge of the target, and (3) unexpected problems that occur in the integration process. Overpayment may also result from decision biases;3. Acquisition premiums for example, Baker, Pan, and Wurgler (2009) found that the majority of acquisition announcements useWhile the acquisition premium has been identified a target firm’s 52-week trading high to determineas a significant variable (Krishnan, Hitt, & Park, acquisition premiums. Still, while an unsuccessful2007; Sirower, 1997), it has been examined in only acquisition may be due to a lack of capabilities ora minority of M&A studies. An acquisition premium is experience on the part of the executive, an assump-the price paid for a target firm that exceeds its pre- tion on the part of managers that they can make aacquisition market value. Over the past 20 years, deal work (hubris) likely plays a role in premiumthe average premium paid has been 40% - 50% overpayments.
  3. 3. EXECUTIVE DIGEST 525 Other factors can also influence premiums paid. the company announced that the AOL assets wouldFor example, relationships between individuals in be spun off from the parent firm.the two firms may lead to higher premiums, espe- While important, there has been a dearth ofcially if those relationships are board interlocks research on divestitures of acquired businesses(Haunschild, 1994). Of course, multiple bidders (Brauer, 2006). A decision to divest an acquiredfor a particular target also drive up the premiums business is essentially reversing a major strategicpaid for an acquisition. These cases have been decision made earlier, often by the same executive.termed the winner’s curse, whereby the acquirer Therefore, the divestiture decision is influenced bywith the winning bid often overestimates a target various psychological and organizational factorsfirm’s value (Coff, 2002). (Shimizu & Hitt, 2004). Yet, because of the high Most of the research suggests that paying high rate of failure associated with acquisitions, eventu-premiums is likely to result in negative performance al divestiture of acquired businesses is not uncom-of the firm, due to an inability to earn adequate mon. For example, Kaplan and Weisbach (1992)returns beyond the premiums paid (Datta, found that 44% of the acquisitions they studied wereNarayanan, & Pinches, 1992). A large premium eventually divested. Acquired firms are likely to beplaces a major burden on managers of the acquiring divested when the acquired unit is performing poor-firm to recoup those costs and extract sufficient ly, but also when organizational inertia to maintainsynergies from the merged firm. Research suggests the acquisition is low, when the business unit isthat about 70% of acquiring firms fail to deliver the smaller, and when the acquired firm is young andnecessary results to recoup the premium payment small. Also, when parent firms have divestiture(Sirower, 1997). Because managers in the acquiring experience, they are more likely to divest acquiredfirm face tremendous pressure, they are likely to businesses (Shimizu & Hitt, 2005).take additional actions in attempt to garner positive Oftentimes, executives escalate their commit-returns. For example, they frequently engage in ment to the prior decisions and try to avoid divestingrestructuring processes to consolidate assets and the business (Shimizu, 2007). However, when thesell off others that are considered redundant acquiring firm’s overall performance is strong and it(Cascio, Young, & Morris, 1997). This restructuring has higher slack, executives are often more willingaction basically results in operational synergy, but it to divest poorly performing acquired businessesis often inadequate to recoup the high costs of the (Hayward & Shimizu, 2006). Certainly, acquiredacquisition because of large premiums. Under such businesses that are performing poorly are moreconditions, managers then often engage in more likely to be divested when there is a change inrisky actions designed to reduce costs and increase the CEO and when more independent directorscash flows from the acquisition. For example, a are added to the board. Thus, there are a numbercommon action is large-scale workforce reductions of non-business factors that contribute to making(Krishnan et al., 2007). Unfortunately, employee decisions to divest businesses that have not pro-turnover erodes the human capital in firms, reduces duced the synergy and positive returns predictedthe performance of the acquiring firm (Cording, when they were acquired.Christman, & King, 2008), and harms the long-termvalue of the acquired firm’s assets. 5. Acquisition capability development4. Divestiture of acquired businesses There are at least two important types of learning in acquisitions. Drawing from success or failure expe-When acquisitions are unsuccessful, it may be wise riences, firms can learn to (1) select better futureto divest a business rather than continue to suffer targets, and (2) improve their integration processeslosses from that acquired business. For example, for future acquisitions. We referred to this type ofafter several years of experiencing losses, Daimler- learning earlier. In this section, we also examineChrysler divested the Chrysler assets, even though it learning from the target firm, especially after it ishad to do so at a significant loss from what it acquired.originally paid to acquire Chrysler. Some argue that While relatedness between the target and acquir-DaimlerChrysler should have sold Chrysler much ing firms is important, research has shown thatsooner to avoid suffering those losses, as it may synergy is created largely by complementary capa-have been able to obtain a higher price for the bilities. Complementary capabilities are differentChrysler assets. In fact, Time Warner also suffered abilities which fit or work well together. Althoughcriticism for several years suggesting the need to the integration of complementary capabilities is andivest AOL, even if it had to do so at a loss. Recently, important criterion for success in acquisitions, much
  4. 4. 526 EXECUTIVE DIGESTof the knowledge underlying these capabilities is mance, regardless of whether it is positive or nega-tacit. Furthermore, the true value to an acquiring tive. If the performance is strong, the routines usedfirm can only be captured if the valuable capabilities seemingly work; if the performance is poor, however,in the acquired firm are fully integrated into and they must be reevaluated and perhaps changed.absorbed by the acquiring firm. This requires that A third mechanism for learning is that of observ-the acquiring firm learn the new and valuable knowl- ing, and learning from, others. This is often referrededge stocks held by the acquired firm. If the acquir- to as vicarious learning (Miner & Haunschild, 1995).ing firm is able to learn and absorb the knowledge, Such learning tends to be more exploratory than thethereby integrating it with its own knowledge mere exploitation of their current knowledge stocksstocks, it can create new and possibly even more gained from prior experience. It also often occursvaluable capabilities. Thus, the learning that occurs through board interlocks and the acquisition expe-in the acquisition process and the integration there- rience of the firms on which their board membersafter is crucial to its success (Hitt et al., 2001). In serve (Haunschild & Beckman, 1998). The bottomfact, some firms have had significant success in line is that firms can learn from acquisitions, andmaking acquisitions, and this success can be at least probably must do so in order to gain the greatestpartially attributed to their ability to learn from the value from them.acquired firms and to absorb and integrate the newknowledge in order to build new capabilities. Twoexamples of such companies are Cisco Systems and 6. Technological learning inGeneral Electric. acquisitions While at a coarse-grained level, a positive linearrelationship has been argued to exist between Innovation has become an increasingly importantacquisition experience and performance (Barkema, source of value creation in many industries. TheBell, & Pennings, 1996; Barkema & Schijven, 2008a, importance of innovation has been heightened by2008b). At the same time, others have noted that rapid technological change and growing knowledgethe relationship is likely curvilinear (Haleblian & intensity in industries. Because of these factors,Finkelstein, 1999; Zollo & Reuer, in press). The innovation must come faster and there is a higherdifferences in results of studies examining the rela- need for novel solutions, especially in high-technol-tionships suggest that other factors are likely in- ogy industries. Thus, firms have turned to mergersvolved. While experience suggests learning, it is a and acquisitions as an alternative strategy for ob-coarse-grained proxy for it. And, there are many taining the knowledge necessary to create innova-factors that likely affect the firm’s ability to learn as tions with the speed needed and the noveltyit gains experience. necessary to either maintain a competitive advan- Organizational learning in acquisitions is highly tage or to build a new one (King et al., 2008; Makri,complex. First, there is the opportunity to transfer Hitt, & Lane, in press; Uhlenbruck, Hitt, &experience into situations where it does not apply. Semadeni, 2006). While some research suggests thatFor example, transferring acquisition routines from acquisitions may produce a reduction in innovationone industry to another may not be effective. Es- output over time (Hitt, Hoskisson, Johnson, &sentially, the firm must learn to adapt the knowl- Moesel, 1996), if a target with complementary ca-edge gained to the context in which it is applied pabilities is selected, acquisitions have the oppor-(Finkelstein & Haleblian, 2002). Certainly, when the tunity to develop novel knowledge and to enhanceorganizations are too homogeneous, very little the innovative output of an acquiring firm.learning can occur. Thus, heterogeneity or differ- A key element in the positive effect of acquis-ences between the firms is necessary for firms to itions on innovation is the knowledge relatednessacquire new knowledge (Hayward, 2002). Alterna- between the acquiring and acquired firms and, oftively, the firm must have adequate absorptive ca- course, the ability to integrate the knowledgepacity in order to learn the knowledge, so there into the acquiring firm (Cloodt, Hagedoorn, &must be some homogeneous elements that allow it Van Kranenburg, 2006). Makri et al. (in press) exam-to learn and integrate the new knowledge. ined the knowledge relatedness between acquiring Firms can institute processes by which they delib- and acquired firms in high-technology industries.erately learn. For example, Haleblian, Kim, and Their study emphasizes the importance of knowl-Rajagopalan (2006) argue that learning can be en- edge complementarities between targets and ac-hanced through an active process of evaluating per- quirers, and suggests that firms in high-technologyformance feedback from recent acquisitions. Of industries have a higher likelihood of achievingcourse, managers must then analyze the acquisitions novel inventions if they can identify and acquireto understand the factors leading to the perfor- businesses that have scientific and technological
  5. 5. EXECUTIVE DIGEST 527knowledge that is complementary to their own. The entering foreign markets, compared to using jointstudy found that the effects of knowledge comple- ventures or Greenfield ventures (Isobe, Makino, &mentarities are strongest when both science and Montgomery, 2000). Some have argued that cross-technology complementarities are combined; the border acquisitions actually reduce the transactionintegration of the two enhances innovation quality costs involved in entering new markets (Brouthers &and novelty. Brouthers, 2000). The synergistic relationship between science and While cross-border acquisitions may reduce cer-technology is based partly on the role of science tain types of costs, they still must overcome theknowledge in the innovation process. Science knowl- costs associated with the liability of foreignness inedge provides the base for the technological knowl- the host country; this includes knowledge about theedge which is normally more focused on providing different culture, area regulations, and the perva-solutions to problems (application). Thus, science sive business norms of the location. Acquisitions helpenables a better understanding of a problem at to overcome this liability because the acquired firmhand whereas technology helps to resolve those should have the local knowledge needed, assumingproblems. Oftentimes, combining science knowledge that the acquiring firm can capture this knowledgefrom two firms can help to produce more novel in making the acquisition (Eden & Miller, 2004).innovations, while combining technological knowl- More recently, scholars have used institutionaledge often leads to more incremental innovations. theory to help understand how country institutionsHowever, the combination of scientific and techno- affect firms’ choice of market entry and the perfor-logical complementarities in acquisitions is quite mance outcomes of different modes of entrycomplex and challenging. In general, if the acquiring (Brouthers, 2002; Xu & Shenkar, 2002). Researchand acquired firms possess similar knowledge stocks, by Zhu, Hitt, Eden, and Tihanyi (2009) found thatthe resulting innovations are likely to be incremental. acquiring firms are likely to create more value whenCertainly, it is helpful to have some similar knowledge the firms acquired are based in countries with lowerstocks in order for the acquiring firm to absorb other risks. In particular, firms are better able to achievecomplementary knowledge stocks. Thus, managers synergy when the institutions of the host country areof firms must manage effectively the breadth and more similar to the institutions in the acquiringdepth of their own scientific and technological firm’s home country. Clearly, however, firms basedknowledge, but also find ways to incorporate new in developed countries that acquire firms in emerg-knowledge in order to survive over the long term. ing market countries commonly transfer knowledgeThere are biases toward incremental innovations, stocks to the firms in the host country. This is likelypartly because they provide short-term returns and to benefit more the firm in the host country than theare less risky (Hoskisson, Hitt, Johnson, & Grossman, acquiring firm, unless the newly acquired firm can2002). Yet, firms must seek the more novel and be effectively integrated into the acquiring firmcomplementary knowledge stocks in order to create (Kostova & Zaheer, 1999). The acquiring firm is moreunique knowledge that leads to novel products willing to transfer these knowledge stocks becauseand services over time. Another possible form of they have acquired the firm’s assets and thus controlcomplementarity is combining different geographic the use of this knowledge, whereas the firm is lessoperations (Kim & Finkelstein, 2009); as such, we likely to do so in international joint ventures wherediscuss cross-border M&A next. they have lower control over how that knowledge is used and where it is applied. Obviously, integration is a critical element and is more complex and7. Cross-border mergers and challenging when the institutions differ greatly be-acquisitions tween the home and host countries (Chakrabarti, Jayaraman, & Mukherjee, 2009).In waves of mergers and acquisitions during the late1990s and early 2000s, the number of cross-borderacquisitions has increased greatly (Shimizu, Hitt, 8. ConclusionsVaidyanath, & Pisano, 2004). These acquisitionsare often made for similar reasons as domestic Mergers and acquisitions have long been a popularacquisitions, but they also broaden the reach of strategy, and are increasingly common in manyfirms and allow them to effectively enter and/or industries. This strategy has been employed by bothenrich their competitive position within interna- large and small firms, and by established and newertional markets (Brakman, Garita, Garretsen, & firms. While at one time M&A was largely a strategyMarrewijk, 2008). Much of the prior research has used by U.S. and Western European firms, it hasexamined cross-border acquisitions as a means of become much more common in other regions of the
  6. 6. 528 EXECUTIVE DIGESTworld, and especially in acquisitions that cross coun- Cloodt, M., Hagedoorn, J., & Van Kranenburg, H. (2006). Mergerstry borders. While popular with many executives, it and acquisitions: Their effect on the innovative performance of companies in high-tech industries. Research Policy, 35(5),is a highly complex strategy and one that is fraught 642—668.with risk. In fact, even though the strategy has been Coff, R. (2002). Human capital, shared expertise, and the likeli-employed for several years and studied by countless hood of impasse in corporate acquisitions. Journal of Man-scholars, a large number of acquisitions fail to agement, 28(1), 107—128.produce the results promised. Cording, M., Christman, P., & King, D. (2008). Reducing causal ambiguity in acquisition integration: Intermediate goals as Herein, we have explored some of the reasons mediators of integration decisions and acquisition perfor-why acquisitions fail and have suggested ways for mance. Academy of Management Journal, 51(4), 744—767.firms to increase the probability of acquisition suc- Datta, D. K., Narayanan, V. K., & Pinches, G. E. (1992). Factorscess. Certainly, firms must make careful selections influencing wealth creation from mergers and acquisitions: A meta analysis. Strategic Management Journal, 13(1), 67—84.of their acquisition targets and try not to pay too Eden, L., & Miller, S. (2004). Distance matters: Liability ofhigh a premium; if they select the wrong firm or the foreignness, institutional distance, and ownership strategy.premium paid is too large, the likelihood of failure is In Hitt, M. A., & Cheng, J. (Eds.), Advances in internationalhigh. Yet, if firms search for and identify targets that management. (Vol. 16, pp.187—221). New York: Elsevier.have complementary capabilities and put in place Finkelstein, S., & Haleblian, J. (2002). Understanding acquisitionmechanisms that enrich their learning from the performance: The role of transfer effects. Organization Science, 13(1), 36—47.acquired firm, they are more likely to build new Haleblian, J., & Finkelstein, S. (1999). The influence of organi-capabilities and enhance their own competitive zational acquisition experience on acquisition performance:position in the market. In sum, mergers and acquis- A behavioral learning perspective. Administrative Scienceitions can sometimes be a highly effective and Quarterly, 44(1), 29—56.successful strategy, but this strategy must be very Haleblian, J., Kim, J., & Rajagopalan, N. (2006). The influence of acquisition experience and performance on acquisition be-carefully designed and implemented. havior: Evidence from the U.S. commercial banking industry. Academy of Management Journal, 49(2), 357—370. Haunschild, P. R. (1994). How much is that company worth? Interorganizational relationships, uncertainty, and acquisitionReferences premiums. Administrative Science Quarterly, 39(3), 391—411. Haunschild, P. R., & Beckman, C. M. (1998). When do interlocksBaker, M., Pan, X., & Wurgler, J. (2009). The psychology of matter? Alternate sources of information and interlock influ- pricing in mergers and acquisitions (Working Paper). Avail- ence. Administrative Science Quarterly, 43(4), 815—844. able at Hayward, M. L. A. (2002). When do firms learn from their acqui- id=1364152 sition experience? Evidence from 1990-1995. Strategic Man-Barkema, H. G., Bell, J. H. J., & Pennings, J. M. (1996). Foreign agement Journal, 23(1), 21—39. entry, cultural barriers, and learning. Strategic Management Hayward, M. L. A., & Hambrick, D. C. (1997). Explaining the Journal, 17(2), 151—166. premiums paid for large acquisitions: Evidence of CEO hubris.Barkema, H. G., & Schijven, M. (2008a). How do firms learn to Administrative Science Quarterly, 42(1), 103—127. make acquisitions? A review of past research and an agenda for Hayward, M. L. A., & Shimizu, K. (2006). De-commitment to losing the future. 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