M&A performance

Organizational performance may represent the ultimate outcome of management research (Richard et al., 2009; Greenwood & Miller, 2010). Most research assumes acquisitions improve performance, but acquisition performance is a multi-dimensional construct and selection of performance measures needs to be part of the initial research design and this requires a clear understanding of differences in performance measures (Cording et al., 2010; Richard et al., 2009). Both objective and subjective measures of performance contain errors (Wall et al., 2004), driving the need to compare multiple measures of performance to understand the aggregate impact of research variables on performance (King et al., 2004; Richard et al., 2009; Schoenberg, 2006). Table 5.1 shows a comparison of primary research measures that are developed more in the following paragraphs. After reviewing the primary financial performance measures used in acquisition research, possible alternative measures are discussed.

Unrealistic expectations?

In considering measures of acquisition performance, and consistent findings that acquisitions on average display no change in performance, it may be useful to step back and ask whether it is reasonable to expect acquisition performance to improve. Upfront, we are not disputing that variance in acquisition performance exists and we confirm that it remains an imperative for research to identify drivers of acquisition performance. Still, is it surprising that on average that acquisition performance is near zero?

If markets are competitive and acquisitions represent a means that firms adapt to maintain a fit with their environment, then improved competitiveness for an acquirer may only result in performance parity (cf. Derfus et al., 2008). Improved acquisition performance is also handicapped by the need for an acquirer to pay a premium to gain control of a target firm and its assets (Sirower, 1997; Wright, Renneboog, Simons & Scholes, 2006). An average premium of roughly 40 percent is consistently reported (Boone & Mulherin, 2007; Jensen, 1993; Laamanen, 2007). Higher premiums reduce the potential benefit to an acquirer from making an acquisition by sharing the benefits with a target firm (Roll, 1986; Sirower, 1997). Higher premiums increase the pressure on acquiring firm managers and this can lead to engaging in risker actions and cost reductions that are often counterproductive (Hitt et al., 2009). Meanwhile, competition does not remain idle and can take actions that degrade planned performance improvements (Porter, 1980; Sirower, 1997).

Continued use of acquisitions by firms, even if they do not improve performance on average, may still be rational if performance is maintained and a better fit with a firm’s environment contributes to its continued survival. Additionally, since target firms experience gains and resources can be expected to be put to more efficient uses, there are overall societal benefits from acquisitions (Abramovitz, 1986; Dutz, 1989). In summary, we recognize that there is variance in acquisition performance and that acquirers are likely able and should work to improve their performance. However, it is a consistent finding that “on average” acquisition performance is near zero (King et al., 2004), and we believe this is explainable. Next, we consider alternative performance measures, including innovation, and increased firm survival.

Alternative performance measures

Acquisitions also can display non-financial motives, and we discuss two that would still make the use of acquisitions rational or provide insights into resource transfer – innovative performance and firm survival.

Acquisition capability

The proceeding logic also suggests an important outcome from completing acquisitions is building a firm’s acquisition capability, or its ability to successfully conduct M&A. Managers face a continuous challenge of balancing between organic growth, leveraging networks and alliances to pursue growth, or growing through acquisitions (Capron & Mitchell, 2010). The challenge comes from the fact that managers are limited in their ability to perform multiple tasks at once, and the uncertainty about the future state of the firm and its environment. It also comes from poorly understanding how to evaluate existing resources. For example, different strategic needs and firm resources make available options for growth more or less desirable (Moatti, Ren, Anand, & Dussage, 2015). Penrose (1959) suggests these demands require matching the rate and direction of firm growth with available managerial capacity. In fact, Penrose (1959, p. 5) emphasized that managerial capacity was the key limiting factor to firm expansion because it affects the productivity of all a firm’s resources. Restated, during acquisitions, managers have to: 1) effectively guide growth, and 2) then oversee operations in a larger and more complex firm.

As a result, managers and their capacity to manage growth represent a constraint on acquisitive growth (Lamont et al., 2018), and this capacity to manage change forms the foundation for an acquisition capability. For example, more growth means that managers have to execute an increased number of administrative tasks, a greater diversity of actions, and develop better coordination mechanisms between employees. An advantage of acquisition over organic growth for Penrose (1959) was that firms were also able to buy the managerial capacity of a target along with its other resources. That is, acquisitions are an attractive way to quickly expand managerial capacity for the acquirer because the target possesses a range and quality of services that can be uniquely bundled, organized, and leveraged (Sirmon, Hitt, & Ireland, 2007) with its own managers that can better utilize an acquirer’s resources. For acquisitions, this implies they are more common when a firm’s environment is changing (e.g., Heeley et al., 2006; Lee & Lieberman, 2010; Zarzewska-Bielawska, 2012). Under circumstances of change and adaptation, managerial capacity is needed to quickly “match” and buffer an organization against changes in the external environment. For example, Penrose (1959, p. 128) notes that acquirers must have excess managerial capacity beyond what is required to run a combined firm, or that acquisitive growth is constrained.

As a result, an acquirer’s managerial capacity is critical to acquisition success, but it can grow over time (Lamont et al., 2018). Although integration is required to improve acquisition performance (Capron, 1999; Capron & Mitchell, 1998; Penrose, 1959; Zaheer, Castaner, & Souder, 2011), when managed effectively, the integration process blends combining firms with different histories into a coherent functioning entity (Graebner et al., 2017; Marks & Mirvis, 1998, 2001). Acquisition integration is partly a planned, but mostly an emergent process that reconciles mismatches in demands, people, practices, structures, and systems (Garnsey, Stam, & Heffernan, 2006; Graebner et al., 2017; Nicholls-Nixon, 2005). For example, acquisitions evolve over time and early decisions can influence later outcomes in unexpected ways (Graebner, 2004; Graebner et al., 2017).

Managers have a dominant influence on new employee socialization, or they are an inherent part of the process of shifting task, social knowledge and organizational behaviors (Bauer & Green, 1998; Tan & Mahoney, 2007; Weeks & Galunic, 2003). For example, Ibarra (1999) describes role adaptation as involving a process of observing role models, experimenting, and receiving feedback. In this process, managers likely serve as role models and contribute to employees adopting a new organizational identity. This learning goes beyond facts to acting in accordance with social customs (Brown & Duguid, 2001), as managers need to devote considerable time to take into account the emotions, identifications, and justice perceptions of the people involved (Ellis, Reus & Lamont, 2009; Graebner et al., 2017; Vuori & Huy, 2015). A focus on the “softer-side” of the integration process rather than “harder-side” operational efficiencies is managerially difficult, as it is a more ambiguous process. However, this is particularly important given that a large component of knowledge resides in the routines and heads of people who can walk out of the door (Argote, 2013; Grant, 1996). This capability builds through tacit experience from managing acquisitions.

While unexpected organizational change, such as an acquisition, disrupts middle manager sensemaking (Balogun & Johnson, 2004), the disruption will remain lower for managers that have experience working together and are familiar with acquisition integration (Penrose, 1959). In the process of managing an acquisition and its integration, managers learn how to build, bundle, and leverage a combined firms’ other resources more effectively and transfer that knowledge to newly hired managers. As a result, successful integration of target firm managers will expand management capacity in a combined firm and enhance a firm’s acquisition capability (Lamont et al., 2018). For example, planning and execution grows management capacity by giving managers that are both old and new to a firm experience working together (Penrose, 1955). To the extent integration is successful, it will generate management capacity by increasing the number of managers with experience working together that have a common identity (Moldaschl & Fischer, 2004; Penrose, 1959).

A generative aspect of acquisitions on management capacity begins to explain Lockett and colleagues (2011) observation that acquisitive growth can increase organic growth. Prior experience from having gone through an acquisition previously can provide an advantage by lowering anxiety of what to expect. In other words, there is a positive relationship between task repetition and performance (Finkelstein & Haleblian, 2002). For retained target managers and employees, this will also provide empathy for the experience of target firm employees in a subsequent acquisition. As result, firm experience with associated integration and restructuring from acquisitions enables better decisions in future acquisitions (Barkema & Schijven, 2008). Overall, acquisitions increase the diversity of personnel, resources, and experience of an acquirer that managed effectively can build an acquirer’s capability and reputation for performing acquisitions (c.f., Secher & Horley, 2018).

The previous logic on acquisition experience suggests that top and middle managers can benefit from experience in the selection of targets and planning an approach to integration. However, research generally examines firm level experience, and middle manager experience may help with implementing strategic decisions that were made by top managers (Denis et al., 2009). The need for experience across the levels of an organization likely addresses long-standing observations to avoid acquisitions that exceed an acquirer’s managerial capacity (Kitching, 1967). Additionally, implementation often requires additional planning as a common organization for combining organizations is formed (Stensaker et al., 2008), and this requires middle manager involvement. For example, part of Cisco’s acquisition strategy is to leverage relationships between managers at different levels and pairing acquired employees with a Cisco mentor (Mayer & Kenney, 2004). Still, relying on prior ties risks managers ignoring other targets with more potential (Rogan & Sorenson, 2014). Meanwhile, research typically only examines acquisition experience as a simple count of a firm’s acquisitions without considering the managers involved or the applied learning mechanisms. Research focused on how acquisition capabilities form and what are the more important factors of such a capability is needed.

Summary and outlook

Change outcomes are arguably the focal point in organization research, and much M&A performance research focuses on this crossroad. However, the complexity of combining two firms reflects that performance is a multi-faceted concept. In other words, there are different ways to gauge acquisition outcomes, each with its own strengths and weaknesses, suggesting the need to use multiple measures of M&A performance. Without the ability to compare measures within and across research, only limited insights are possible on what motives and performance outcomes relate to one another. As a result, research needs to clarify the conditions where the resources invested in M&A are put productively to use.