Cultural diversity in the executive suite and international acquisition performance
Bram Fiselier S2226669
Supervisor: Dr. V. Purice Januari 2017
Master’s thesis University of Groningen Faculty of Economics and Business International Financial Management
MSc International Financial Management Faculty of Economics and Business
University of Groningen
MSc Business and Economics Department of Business Studies Uppsala University
Abstract
Many researchers tried to determine the performance effects of cross-border mergers and acquisitions, and what triggers this performance. This thesis contributes to this field of literature by investigating the role of cultural diversity within the executive board on acquisition performance. Where most studies focus on the announcement effects of cross-border acquisitions, this thesis focuses on the long-term effects, trying to capture the role of the executive board in the integration process after an acquisition becomes effective. Using a multivariate clustered regression on a sample of 120 cross-border acquisitions conducted by European firms between 2007 and 2012, this thesis investigates the influence of certain variables related to culture on long- term international acquisition performance. The results show that acquiring firms perform well in the long run after an international acquisition. No evidence was found for the impeding effect of cultural distance on this performance. The results show a positive effect of cultural board diversity on long-term acquisition performance. This effect increases as cultural distance increases.
Furthermore, having executives from the target country on the board is beneficial as cultural distance increases. Evidence is also found for a negative effect of board age on long-term performance. Limited evidence is found for a positive effect of openness of the target firm’s country to the world economy on this performance.
Keywords: International acquisitions, cultural distance, cultural diversity, executive boards, post- acquisition integration
1. Introduction ... 1
2. Theory ... 3
2.1 Mergers and acquisitions ... 3
Acquisition performance ... 5
2.2 International acquisitions ... 5
Opportunities ... 5
Challenges ... 6
International acquisition performance ... 9
2.3 Cultural board diversity ... 10
Positive effects ... 11
Negative effects ... 12
3. Data and Methodology ... 13
3.1 Data Collection ... 13
3.2 Variables ... 14
Independent variables ... 14
Control Variables ... 15
3.2 Methodology ... 19
4. Results ... 22
4.1 Multivariate clustered regression ... 22
5. Discussion... 26
5.1 Cultural distance ... 26
5.2 Cultural board diversity ... 28
Cultural board diversity and cultural distance ... 29
5.3 Executive board members from target country ... 29
6. Conclusion ... 30
6.1 Summary ... 30
6.2 Implications for practice ... 31
6.3 Limitations ... 31
Table of contents
1
1. Introduction
The number of mergers and acquisitions grew heavily over the last couple of decades. The majority of this rise is attributable to the growth in domestic acquisitions. The importance of cross- border acquisitions, however, is increasing. The share of cross-border acquisitions in the number of total acquisitions grew from 23% in 1997 to 45% in 2007. The value of all cross-border mergers and acquisition in 2014 combined was $3.4 trillion (Raice, 2015). To put this in perspective, only five countries worldwide, the United States, China, Japan, and Germany, had a GDP higher than the combined value of all worldwide conducted international mergers and acquisitions.
Mergers and acquisitions attracted much attention from scholars in the previous two decades. Previous research tried to identify the effects of mergers and acquisitions on firm performance. The results of these studies vary. Some studies report positive performance effects of mergers and acquisitions on firm performance (Healy et al., 1992; Wright et al., 2001), but most researchers found value destroying effects (King et al., 2004; Agrawal et al., 1992)
.
However, the case of international acquisitions seems to be different. Multiple scholars found positive performance effects of these acquisitions (Goergen and Renneboog, 2004; Chakrabarti et al., 2009;Gubbi et al., 2010). However, also in this case, some studies presented value-destroying effects (Datta and Puia, 1995). Thus, although it seems that cross-border acquisitions perform better than domestic ones, scholars do not seem able to reach consensus on the performance effects of these acquisitions, and what triggers this performance.
To create value in acquisitions, the combined firm should capture synergies (Larsson and Finkelstein, 1999). The more a company is able to capture these synergies, the more value it could create. If a company fails to capture these synergies, acquisitions will destroy value. To capture synergies, integrating the two entities in a proper way is important (Lemieux and Banks, 2007;
Lajoux, 2006). Thus, acquisition performance not only depends on proper due-diligence in the pre- acquisition phase but also on a sound post-acquisition strategy.
Several factors could complicate successful integration of entities. In the case of cross- border acquisitions, differences in national culture between the acquirer and the target could be of importance. Dealing with cultural differences is one of the challenges firms are facing in cross- border acquisitions. Cultural differences could affect international acquisition performance in several ways. They could increase the likelihood of conflicts between people from different cultures (Hofstede et al., 2010), lead to unsuccessful integration due to difficulties in knowledge
2 exchange (Lin and Germain, 1998), result in lower commitment and cooperation by the employees of the acquired firm (Very et al., 1996), lead to misunderstanding about assignments due to differences in administrative routines between cultures (Heiman et al., 2008; Heiman and Nickerson, 2004), and lead to more day-to-day operating conflicts (Jemison and Sitkin, 1986).
Therefore, one would expect cultural differences to have an impeding effect on acquisition performance. However, this might not be that evident. Cultural differences could provide some opportunities as well. For example, acquiring firms in culturally distant countries could provide the acquirer access to unique and potentially valuable capabilities (Chakrabarti et al., 2009), break rigidities and therefore enhance innovation and learning, and lead to a higher level of predisposition of managers in managing cultural differences (Goulet and Schweiger, 2006).
Another factor that could influence acquisition performance is board diversity. Board diversity attracted much attention from scholars in the last decade. Diversity is “any attribute that another person may use to detect individual differences” (Williams and O’Reilly, 1998, p.79).
Previous research on diversity primarily focused on differences in gender, age, ethnicity, tenure, educational and functional background (Millikens and Martins, 1996; Williams and O’Reilly, 1998). This thesis focuses on the cultural backgrounds of executives. Markets worldwide seem to get integrated more and more, and the number of firms operating internationally is growing. This trend is also visible within boards, which are getting increasingly international (Staples, 2007).
This thesis investigates if acquiring companies benefit from cultural diversity within the executive board in the event of an international acquisition. Focusing on executive board’s characteristics allows for better prediction of organizational outcomes than by focusing on CEO's characteristics only (Hambrick et al., 1996). Many other studies focused on the role of the full board of directors instead of focusing on just the executive board. This thesis takes into consideration the executive board only, since they are responsible for implementing strategic decisions and day to day operations, and thus have a direct impact on post-acquisition integration, and therefore, performance (Fama and Jensen, 1983).
Cultural diversity within the executive board could have several benefits for organizations engaging in international acquisitions. For example, diversity results in higher absorptive capacity (Cohen and Levinthal, 1990), which is needed for a successful integration of the entities (Reus and Lamont, 2009), a culturally diverse board has access to a greater pool of task relevant knowledge, skills and abilities (Rivas, 2012), more cultural knowledge available, needed for international
3 success (Alon and Higgins, 2005), higher level of creativity and problem solving capabilities (Dutton and Duncan, 1987), are less subject to the domestic myopia concept (Barkema and Vermeulen, 1998), could generate trust among a firm’s product and geographic unit managers (Kim and Mauborgne, 1991), and increased socio-cognitively complexity, leading to a greater ability to cope with changing international market opportunities and handling conflicts and paradoxes related to acquiring internationally (Murtha et al., 1998).
This thesis focuses on cultural diversity within the executive boards of acquiring companies, and its effect on international acquisition performance. Short-term event studies are a common way to measure acquisition performance (Datta and Puia, 1995; Li, Li and Wang, 2016).
However, by doing so, only the performance implications around the announcement date of an acquisition are captured, which are subject to investor overreaction and do not provide insights in the long-term performance (De Bondt and Thaler, 1985). Since this thesis tries to shed light on the long-term effects of culturally diverse executive boards in the post-acquisition phase, this methodology is not appropriate. Therefore, a long-term event study is conducted using the ‘buy- and-hold abnormal return’ methodology. This methodology defines performance by measuring long-term investor experience. A multivariate clustered regression is used to investigate the effect of cultural board diversity, among other variables, on the long-term acquisition performance of a sample of 120 European acquirers.
This thesis is structured as follows. Section 2 discusses related literature and provides the hypotheses. Section 3 describes the data and methodology used. Section 4 reports the regression outcomes. Section 5 contains the discussion. Finally, section 6 presents concluding remarks.
2. Theory
This section provides an overview of the relevant literature related to international acquisitions and board diversity. This section will start off with an explanation on how companies can capture value in acquisitions, followed by an overview of the opportunities and challenges in international acquisitions. Finally, the potential role of cultural board diversity in international acquisitions will be explained.
2.1 Mergers and acquisitions
Many people think of mergers and acquisitions as two similar phenomena. However, there are some differences. In the case of an acquisition, one company takes a controlling ownership
4 interest in another company, which means that more than fifty percent of the voting rights should be acquired. It involves the purchase of assets or shares of the target firm by the acquiring firm, with the target firm continuing to exist as a subsidiary of the acquirer. In the case of a merger, two firms are combined into one firm, so one of the firms ceases to exist (DePamphilis, 2008).
Synergies
Firms can create value through acquisitions if synergies are present. If the combined company is able to be more profitable than the individual companies before the acquisition, synergies occur. According to Straub (2007), the value of an acquisition is equal to the value of the combined companies after the acquisition minus the values of both companies before the acquisition, the premium paid, and the expenses made in the acquisition process.
Haleblian et al. (2009) identified several ways in which synergies could arise. The first one is through higher market power. The idea behind this is that having fewer firms in an industry increases pricing power on firm-level. Therefore, it is easier for the combined firm to increase their prices, since it is bigger. The increase in size also improves a firm’s bargaining power with its suppliers. Larger firms can demand lower prices from their suppliers. Previous literature provides evidence for this hypothesis (Prager, 1992; Kim and Singal, 1993). Secondly, synergies could arise through economies of scale (McGuckin and Nguyen, 1995; Banker et al., 2003). In this case, marginal costs decrease as production volume increases. Bigger production volumes allow companies to use different, more cost-efficient production methods. Furthermore, firms could reduce the number of employees by combining overlapping departments into one single department which results in savings on salaries (Straub, 2007). Thirdly, through redeployment of assets and competency transfers acquisitions can generate economies of scope (Capron et al., 1998;
King et al, 2008). An acquisition may enlarge a company’s product line. In this case, product names, distribution channels, and customer bases can be used for multiple products, which could enable firms to more easily enter new markets and save costs through bundling strategies. Finally, synergies could arise through market discipline. This hypothesis states that acquisitions could create value by disciplining incompetent managers (Jensen, 1986; Jensen and Ruback, 1983).
Agrawal and Walkling (1994) showed that CEOs of acquired firms are often dismissed once the acquisition is completed.
The extent to which a company’s management is able to successfully integrate the acquired company into their existing operations and capture possible synergies is related to their absorptive
5 capacity (Reus and Lamont, 2009). Absorptive capacity is “the ability to recognize the value of new information, assimilate it, and apply it to commercial end” (Cohen and Levinthal, 1990, p.128). So, the higher the absorptive capacity of a company, the higher its capability to use the information and resources obtained by an acquisition and the more successful it will be in integrating the two separate entities. Scholars recognized the importance of a proper integration strategy (Lemieux and Banks, 2007; Lajoux, 2006). According to them, acquisition performance depends on a sound post-acquisition integration strategy as well, besides proper due-diligence of the target company prior to the acquisition. If the two entities are not integrated properly, a company will not be able to capture synergies and create value in an acquisition (Gates and Very, 2003).
Acquisition performance
Companies engage in acquisitions to capture potential synergies. Many scholars found, however, that despite the synergy potential, acquisitions in general diminish value. Some studies reported positive performance effects of acquisitions (Healy et al., 1992; Wright et al., 2002), but most studies show adverse effects of acquisitions (King et al., 2004; Agrawal et al., 1992). Thus, although acquisitions are a popular way of expanding businesses and enabling growth, it seems that firms have difficulties reaping the benefits of these acquisitions. Therefore, many scholars tried to find out what triggers acquisition performance. These studies, however, do not provide any prerequisites that aid the estimation of acquisition performance (Straub, 2007). The different conclusions of the studies on acquisition performance show that acquisitions are complex events, involving the interaction of a vast number of variables.
2.2 International acquisitions
International acquisitions provide a different set of opportunities and challenges than domestic acquisitions. In this subsection, the various opportunities offered in such acquisitions is explained, followed by the challenges acquiring firms face.
Opportunities
Firstly, firms can get access to lucrative markets or expand their current product market through international acquisitions. Entering markets in foreign countries is often difficult for companies because of multiple entry barriers. Examples of these are regulations that discourage foreign firms from entering the market, or the lack of relationships with suppliers and distributors
6 in foreign countries (Hitt and Pisano, 2003). Acquiring companies in these markets could help firms overcome these barriers. In this way, international acquisitions could provide companies access to foreign markets that are difficult to access in other ways. Entering foreign markets provides an opportunity for firms to expand the market for their current products. This provides economies of scale and lowers marginal costs. As a result, international acquisitions enable firms to grow faster and enhance their profitability.
Secondly, international acquisitions are a form of geographical diversification. When firms operate internationally, they spread their risks over multiple countries and markets, which results in firms being less reliant on one single market. Furthermore, the fluctuating revenue flows due to different economic conditions in various markets will be outbalanced by international diversification.
Thirdly, international acquisitions offer companies opportunities to gain new knowledge and capabilities (Barkema and Vermeulen, 1998; Very and Schweiger, 2001). Societal and corporate cultures differ across countries, which offers firms opportunities to learn about new capabilities and managerial practices from the acquired companies. For example, firms can exchange knowledge of operational methods, know-how, and feedback regarding products and procedures (Javidan et al., 2005). Furthermore, international acquisitions could provide firms access to new resources. Many companies do not have all the resources necessary to implement certain strategies, especially when it concerns entering markets in foreign countries. MNEs could use international expansion as a springboard to acquire strategic resources and reduce their institutional and market constraints at home and thereby, reduce the latecomer disadvantage (Luo and Tung, 2007). In an increasingly global and competitive market, firms need unique and valuable resources to gain a sustainable competitive advantage (Barney, 1991). By looking outside country borders, the variety of new and valuable resources firms could use to expand their existing resource base will be bigger. Therefore, international acquisitions could help firms to develop a unique and hard to imitate resource base, composed of existing resources combined with foreign acquired resources, which will give them an advantage over their competitors (Makino et al., 2002).
Challenges
Besides the opportunities international acquisitions offer, firms engaging in these type of acquisitions also face certain challenges.
7 When a company wants to acquire another company, targets have to be identified and valued. The valuation of potential targets is a complex process in every acquisition (Hitt et al., 2001). In international acquisitions, this process is even more complicated (Angwin, 2001).
Companies need to overcome the problems related to different accounting standards and practices and fluctuations in the foreign exchange rates in valuing foreign targets. One of the most challenging parts in valuing acquisition targets is assigning a value to intangible assets. This process is complex in domestic acquisitions, but even more so in international acquisitions. For example, understanding of the educational system in a country and skills and capabilities of the workforce may be required in valuing intangible assets. Furthermore, a firm’s reputation should be valued, which is harder in unfamiliar markets. Lastly, to appropriately value a company, critical environmental conditions should be assessed. It could, for example, be useful to identify the governmental regulations applicable to the firm (Hitt and Pisano, 2003).
Cultural differences
The most interesting challenges concerning this thesis are the challenges regarding the differences in culture between the acquirer’s and the target’s countries. “Culture consists of the unwritten rules of the social game. It is the collective programming of the mind that distinguishes the members of one group or category of people from others” (Hofstede et al., 2010, p.6). Hofstede et al. (2010) identified six dimensions of national culture. These six dimensions are individualism, power distance, masculinity, uncertainty avoidance, long-term orientation, and indulgence.
Appendix C provides an overview of the dimensions. These dimensions can be used to calculate the cultural distance between two countries1. The cultural distance reflects the level of cultural differences between groups, or between countries. The higher the cultural distance between two countries, the more these countries differ in relation to the cultural dimensions.
Several scholars recognized the importance of cultural distance matters in international business(Hofstede et al., 2010; Trompenaars and Hampden-Turner, 1998; House et al., 2004), and thus, in international acquisitions as well. For example, cultural differences could complicate the integration process in international acquisitions. As mentioned before, integrating issues are an important part of the acquisition process and could be of major importance in determining the success or failure of an acquisition (Lemieux and Banks, 2007; Gates and Very, 2003; Lajoux,
1 The data and methodology section provides a common method of calculating this distance
8 2006). The integration problem in international acquisitions is referred to as double-layered acculturation, the process in which a group adopts cultural characteristics of another group (Barkema et al., 1996). Double-layered acculturation is necessary for international acquisitions because of the different cultures represented in the acquiring and target firms. The literature provides several ways in which these cultural differences hinder a successful integration. Firstly, differences in languages could have disintegrative effects in international acquisitions (Piekkari et al., 2005). Secondly, there should be a certain ‘organizational fit’ when successfully integrating two companies. Datta (1991) showed that differences in leadership styles could result in the unsuccessful integration of two companies. This issue is likely to be higher in international acquisitions since leadership styles differ between cultures and countries (Van de Vliert, 2006).
Thirdly, cultural differences could hinder the exchange of knowledge, which is crucial in successful integration, due to poor communication between managers from culturally different countries(Lin and Germain, 1998; De Long and Fahey, 2000; Sales and Mirvis, 1984).
Besides the issues arising because of differences in culture in the integration phase of acquisitions, some long-term post-integration issues could arise as well (Reuer and Koza, 2000).
The literature provides some examples of these issues. Firstly, tensions could arise because of differences in culture, resulting in lower commitment and cooperation by the employees of the acquired firm (Very et al., 1996). Secondly, different administrative routines in various cultures result in difficulties regarding the transfer of managerial skills between companies. Thirdly, limited understanding between culturally different parties leads to misunderstandings about assignments (Heiman et al., 2008; Heiman and Nickerson, 2004)
.
Fourthly, the increased likelihood of target company executives leaving the company in international acquisitions and its impeding effect on the learning effects, since valuable knowledge could be embedded in those executives (Li, Li and Wang, 2016; Hofstede et al., 2010). Finally, day-to-day operating conflicts arise in the case of many cultural differences (Jemison and Sitkin, 1986).Thus, cultural differences seem to affect the performance of an acquisition. Another challenge companies have to face beside coping with cultural differences is the so-called liability of foreignness. When a corporation wants to operate outside its home country, it will face unavoidable costs that firms operating in their home market would not (Zaheer and Mosakowski, 1997). These costs occur due to coordination difficulties, lack of knowledge about local markets, and lack of relationships in critical networks along with cultural differences (Hitt and Pisano,
9 2003). Because of the extra costs related to operating in foreign markets, foreign firms have a certain competitive disadvantage compared to firms operating solely their local domestic market (Miller and Parkhe, 2002).
International acquisition performance
As mentioned in the previous section, the international aspect adds even more complexity to the already complex event of an acquisition, providing several opportunities and challenges.
Scholars tried to shed light on the performance implications of cross-border acquisitions. For example, Goergen and Renneboog (2004), Chakrabarti et al. (2009) and Gubbi et al. (2010) found positive performance effects of cross-border acquisitions, while Datta and Puia (1995) found negative effects. Some scholars also remain inconclusive (Datta et al., 1992). Thus, although it seems that cross-border acquisitions result in better firm performance than domestic ones, scholars do not seem able to reach consensus on the performance effects of these acquisitions.
In investigating the performance effects of cross-border acquisitions, many scholars highlighted the effect of cultural differences on acquisition performance. Taking into account the possible effects of cultural differences on the integration process of an international acquisition, as presented in the previous subsection, it seems evident that differences in culture will have an impeding effect on acquisition performance (Datta and Puia, 1995; Morosini et al., 1998).
However, this might not be as obvious as it seems. Chakrabarti et al. (2009), argued against this negative relationship. They provided evidence for a positive effect of cultural distance, as measured using the dimensions identified by Hofstede et al. (2010), on acquisition performance.
Firstly, they state that culturally distant acquisitions could provide acquirers with a competitive advantage by offering them access to unique and valuable capabilities. Secondly, from an organizational learning perspective, culturally distant acquisitions could positively affect innovation and learning by breaking rigidities. Finally, managers are more disposed to managing cultural differences and pay attention to national cultural factors, which improves acquisition performance (Goulet and Schweiger, 2006).
Besides these post-deal mechanisms that could enhance international acquisition performance, a pre-deal factor could be taken into account as well. In the case of an international acquisition, it is more likely that the awareness of cultural differences, and the difficulties coming with them, result in a stricter selection process. The acquiring firms will only go through with deals
10 characterized by a high cultural distance between acquirer and target country if the acquisition has substantial economic potential (Aguilera et al., 2004; Nahata et al., 2014).
In conclusion, previous research has shown that cultural differences potentially could provide synergies in acquisitions through capability transfer, resource sharing, and learning.
However, cultural differences result in certain challenges as well. For example, these differences could lead to conflicts or hinder the exchange of knowledge in acquisitions. This could result in an unsuccessful integration of the two entities. Therefore, the first hypothesis is as follows:
H1: Cultural distance has a negative effect on the acquiring firm’s performance after an international acquisition
2.3 Cultural board diversity
Besides focusing on the cultural differences on country level and their impact on acquisition performance, this thesis takes into account firm level variables as well. One of these variables is the cultural diversity within the executive board of the acquiring company. Focusing on executive board’s characteristics allows for a better prediction of organizational outcomes than by focusing on CEO's characteristics only (Hambrick et al., 1996). Many other studies focused on the role of the full board of directors instead of focusing on the executive board only. The reason this thesis focuses on the executive board only is that the boards of directors are responsible for monitoring and influencing strategy only, not for implementing these strategies or day-to-day operations. The latter is the responsibility of the executive board (Fama and Jensen, 1983). In the case of international acquisitions, this means the executive board is responsible for the decisions and operations related to integrating the entities.
Diversity has been a hot topic in the literature over the past couple of decades. According to Williams and O’Reilly (1998, p.79), diversity is “any attribute that another person may use to detect individual differences”. Previous research on diversity primarily focused on differences in gender, age, ethnicity, tenure, educational and functional background (Milliken and Martins, 1996;
Williams and O’Reilly, 1998). Scholars highlighted the effect of board diversity on a firm’s strategy or performance. For example, Chen et al. (2016) showed that a gender diversity within boards affects the acquisitive behavior of a firm, Herrmann and Datta (2005) highlighted the effect of shorter tenure and lower age of managers on a firm’s internationalization, and Hutzchenreuter and Horstkotte (2013) showed that firms with experienced boards perform better in acquisitions.
11 Some studies also addressed international diversity within boards. Oxelheim and Randøy (2003) showed that within European companies, the presence Anglo-Americans directors has a positive effect on its stock price and Masulis et al. (2012) found that foreign directors could add value when a firm is highly dependent on a foreign product market. However, there have also been studies finding a negative (Murray, 1989) or no significant relation between board diversity and firm performance (Michel and Hambrick, 1992). The question is, how diversity within boards could create value for companies, especially in the case of international acquisitions. The next subsections will provide an overview of the positive effects of cultural diversity on acquisition performance, as well as the possible negative implications.
Positive effects
Previous literature provides a number of arguments for a positive relationship between cultural board diversity and international acquisition performance. First off all, in a group composed of people from different backgrounds, the available knowledge and expertise are more differentiated. This leads to a higher absorptive capacity (Cohen and Levinthal, 1990), a greater level of innovation and creativity in solving problems (Rivas, 2012; Dutton and Duncan, 1987), and access to a greater pool of task-relevant knowledge, skills, and abilities. Secondly, Alon and Higgins (2005) argue that besides a CEO’s IQ and emotional intelligence (EQ), the role of cultural intelligence (CQ) is crucial to international success. Even the most intelligent managers are likely to fail in international markets if they cannot understand and adapt to different cultures. This concept could be extended to the whole executive board. The more cultural diversity within a board, the more cultural knowledge will be available, and the higher the likelihood of international success. Thirdly, diverse boards are less susceptible to ‘group thinking’ (Bantel and Jackson, 1989;
Jackson, 1992) and the concept of domestic myopia (Barkema and Vermeulen, 1998).
Furthermore, diverse boards are more ‘socio-cognitive’ complex (Jackson, 1992; Wiersema and Bantel, 1992). Socio-cognitively complex boards may be better able to cope with changing international market opportunities and handle the conflicts and paradoxes inherent to acquiring internationally (Murtha et al., 1998). Lastly, internationally diverse boards can generate trust among firms’ product and geographic unit managers by showing that the executive board takes their interests into account when allocating resources (Kim and Mauborgne, 1991).
12 Negative effects
Besides the positive influence of cultural board diversity, some scholars present negative arguments as well. For example, Chen and Macmillan (1992) argued that diversity might reduce the speed of firms in acting and responding to certain situations, which could hurt performance in complex events such as international acquisitions, where quick responses are needed. Furthermore, O’Reilly et al. (1989) showed that diversity could result in a lower rate of integration within groups, which could hurt performance. Thus, while board diversity could have positive performance implications, it might also be a double-edged sword, and result in lower performance.
Thus, although some scholars are presenting adverse effects of cultural diversity, the arguments presented by most scholars point towards a positive effect of cultural diversity on acquisition performance. Therefore, the second hypothesis in this thesis is as follows:
H2a: Cultural diversity within the executive board has a positive effect on the acquiring firm’s performance after an international acquisition
As explained before, cultural differences between the acquirer and the target could increase the complexity of an acquisition. Culturally diverse boards are more likely to possess a higher level of creativity, knowledge, and problem-solving ability, as mentioned above. Therefore, firms acquiring a target from a culturally distant country could reap more benefits from having a culturally diverse board. This leads to the following hypothesis:
H2b: The effect of having a culturally diverse executive board is higher in acquisitions characterized by a high cultural distance between acquirer and target
Besides the increased level of cultural diversity, having internationals on the board could also help the acquiring company overcome the so-called ‘liability of foreignness’ problem. As mentioned before, companies operating abroad face unavoidable costs that firms operating in their home market would not (Zaheer and Mosakowski, 1997). Reasons for this is the lack of knowledge of foreign markets, the lack of relationships in critical networks, and language difficulties.
According to Tihanyi et al. (2000), international networks are essential for firms operating internationally. Therefore, having members from the target firm’s country on the board could provide companies with knowledge of the target country’s market and could grant them access to
13 foreign networks. Furthermore, it could help the acquirer overcome the difficulties related to differences in languages (Piekkari, 2005). This leads to the following hypothesis:
H3a: Having members from the target firm’s country on the executive board has a positive effect on acquiring firm’s performance after an international acquisition
As with cultural diversity, the effect of having members from the target country on the board is likely to be greater in the case of a high cultural distance. Reasons for this is that firms acquiring a culturally distant target are less likely to have the necessary connections in that country.
Furthermore, difficulties due to different languages could arise. Therefore, having someone on the board from the target country, who is likely to have connections in his home country and speaks the language, could be more beneficial for these firms. This leads to the following hypotheses:
H3b: The effect of having members from the target firm’s country on the executive board is higher in acquisitions characterized by a high cultural distance between acquirer and target
3. Data and Methodology
This section describes the data and methodology used to test the hypotheses. This section will start off with describing the data collection and sources, followed by an explanation of the variables employed in the regressions, and lastly, an overview of the methodology is provided.
3.1 Data Collection
Acquisition data is gathered using the mergers and acquisition database Zephyr, developed by Bureau van Dijk. The sample consists of full acquisitions only, that is, when the acquirer buys 100 percent of the target shares. By doing so, only the acquisitions where the acquirer obtains complete control over the target without any influence of other shareholders are considered.
Furthermore, the sample includes only acquisitions with a deal value greater than 100 million euros. By including acquisitions with high deal value only, it is more likely that firms’ top executive managers will be involved in the deal. This allows for a clearer view on the role of executive board cultural diversity on acquisition performance.
The sample consists of acquisitions by firms headquartered in one of the countries of the European Union. All acquisitions in the sample are cross-border acquisitions. This means that the
14 target is headquartered in another country than the acquirer. Targets located in so-called tax havens (e.g. Cayman Islands) are excluded from the sample since firms mostly expand to these countries for a more favorable tax arrangement, not for value creation through operational means.
Furthermore, firms in the sample should not have engaged in other acquisitions within three years before or after an acquisition, to prevent having overlapping events in the sample.
The initial sample consisted of 671 acquisitions. However, most of the acquirers in this sample engaged in multiple acquisitions throughout the years. After removing these, and removing firms acquiring firms in tax-havens, with unavailable data, and outliers, a sample of 120 acquisitions, conducted between 2007 and 2012, remained. Appendix A provides an overview of all the acquiring and target countries represented in the sample. Data regarding the composition and characteristics of the executive board and its directors is hand-picked by going through the annual reports of the acquiring firms and complemented with data from additional sources (e.g.
Bloomberg and Thomson Reuters). Firm-specific performance data and characteristics are extracted from the Orbis database of Bureau van Dijk. Lastly, country-specific variables such as import, export, and GDP per capita are extracted from the Worldbank database, and data on bilateral trade flows between the target and the acquirer country is extracted from the STAN Bilateral trade database of the OECD.
3.2 Variables
Independent variables
The first independent variable in this thesis is the cultural distance between the acquirer country and the target country. The higher the cultural distance between the target and acquirer, the more cultural differences exist, and the harder it is to create value in acquisitions. Kogut and Singh (1988) developed a measure calculating the cultural distance between two countries based on the six cultural dimensions identified by Hofstede et al. (2010). This measure is widely used in the finance literature. The cultural distance between two countries is defined using the following formula:
𝐶𝐷𝑘𝑙 = ∑6𝑝=1(𝐼𝑝𝑘− 𝐼𝑝𝑙)/𝑉𝑝
6 (1)
15 Where CDkl is the cultural distance between acquirer country k and target country l, Ipk is acquirer country k’s score on the pth cultural dimension, Ipl is target country’s l’s score on the pth cultural dimension, and Vp is the variance of the score of dimension p.
The second independent variable used is executive board cultural diversity. The more cultural clusters represented in an executive board, the more culturally diverse this board is, and the more likely it will be that the acquisition will create value. The cultural clusters used in this study are derived from the GLOBE-study (House, 2004). This study grouped a large number of countries into several clusters, based on the cultural characteristics of these countries. The degree of cultural diversity on the board in the year before the acquisition is measured using the Blau- index (Blau, 1977; Harrison and Klein, 2007). The Blau-index calculates the level of diversity using the following formula:
𝐷𝐼𝑉𝑖 = 1 − ∑ (𝑥𝑚𝑖 𝑛𝑖 )
𝑝 2 𝑖=1
(2)
Where DIVi is the cultural diversity within the executive board of firm i, p is the total number of cultural clusters represented in the board, xmi is the number of members from cultural cluster m in the executive board of firm i, ni is the total number of members in the executive board of firm i. The scores of the index reach from 0 (completely homogeneous) to 1 (complete heterogeneous).
Lastly, a variable measuring the percentage of executive board members from the target company’s country is included. These executives could help the acquiring company overcome the liability of foreignness and therefore boost long-term acquisition performance. This variable is calculated by dividing the number of members of the executive board from the target company’s country by the total number of members in the executive board.
Control Variables
The analysis includes a set of board-specific control variables. Firstly, the average age of the board members is included in the regressions as a commonly used indicator of experience.
(Oxelheim et al., 2013). Older managers are likely to be more experienced in the field of acquisitions, and this could affect the acquisition-performance relationship (Cannella and Hambrick, 1993; Krishnan et al., 1997). However, older managers, compared to younger ones, are
16 less likely to come up with creative and innovative strategies and, in general, are less flexible (Rivas, 2012).
Secondly, a variable controlling for board size will be included. The level of heterogeneity of the board may be influenced by the size of the board. The influence of a single person might be reduced in larger boards (Amason and Sapienza, 1997; Haleblian and Finkelstein, 1993). This could affect the relationship between board diversity and acquisition performance.
Some firm-specific control variables are included as well. A variable controlling for firm age will be included by taking the natural logarithm of a firm’s age. Older firms may be more experienced in international acquisitions, which might affect the acquisition-performance relationship. For example, Fowler and Schmidt (1989) showed that post-acquisition financial performance was higher for older firms. A control variable for firm size is included as well.
Moeller et al. (2004) found that small acquisitions by small acquirers resulted in increased performance, whereas large acquisitions by large acquirers led to losses. Conversely, Healy et al.
(1992) found that large acquisitions normally resulted in positive post-acquisition performance.
Thus, firm size is likely to affect acquisition performance in important ways, although further research is needed to find out how exactly. To control for firm size, a variable measuring the natural logarithm of the acquiring firm’s total assets by the end of the year prior to the acquisition is used, a common way to measure firm size in the finance literature.
Besides the control variables on firm level, some country specific control variables are also included in the analysis. These control variables ensure that the results are not driven by trade or GDP differences between countries, instead of culture. Firstly, a variable controlling for the economic differences between the countries is included. Economic differences between two countries might affect the performance of an acquisition (Chakrabarti et al., 2009). To measure these differences, the difference in GDP per capita of these countries is measured, which is often associated with major socio-economic differences between countries. The economic disparity of the two nations is calculated as follows:
𝐸𝐷𝑘𝑙 = 𝐺𝐷𝑃𝑘− 𝐺𝐷𝑃𝑙 𝐺𝐷𝑃𝑘+ 𝐺𝐷𝑃𝑙
(3)
Where EDkl is economic disparity between acquirer country k and target country l, GDPk
is the GDP per capita of acquirer country k in the year prior to the acquisition, and GDPl is the
17 GDP per capita of target country l in the year prior to the acquisition. Secondly, a variable measuring the openness of the target to the world economy is added to the analysis. The openness of a country to the global economy could have an impact on acquisition performance. It could make managing the newly acquired business easier, and the new business division’s profits can be employed more efficiently (Chakrabarti et al., 2009). The openness of a target’s firm country to international firms is calculated as follows:
𝑂𝑝𝑒𝑛𝑛𝑒𝑠𝑠𝑙= 𝐼𝑚𝑝𝑜𝑟𝑡𝑙+ 𝐸𝑥𝑝𝑜𝑟𝑡𝑙 𝐺𝐷𝑃𝑙
(4)
Where Opennessl is the openness of target country l to the world economy, Importl is the total import of target country l in the year prior to the acquisition, Exportl is the total export of target country l in the year prior to the acquisition, and GDPl is the GDP of target country l in the year prior to the acquisition. Thirdly, a variable is included that controls for economic synergies between the acquiring and target country. This variable is calculated by taking the natural logarithm of the sum of the target nation’s export to, and import from the acquiring firm’s country (Chakrabarti et al., 2009):
𝐵𝑖𝑙𝑎𝑡𝑒𝑟𝑎𝑙𝑘𝑙 = 𝑙𝑛 (𝐸𝑥𝑝𝑜𝑟𝑡𝑙𝑘 + 𝐼𝑚𝑝𝑜𝑟𝑡𝑙𝑘) (5) Where Bilateralkl displays the economic synergies between acquirer country k and target country l, Exportlk is the export of target nation l to acquirer nation k, and Importlk is the import of target nation l from acquirer nation k. Lastly, a variable is added controlling for the geographic distance between the acquirer country k and the target country l. Frankel and Romer (1999) showed that geographic distance between countries affects international trade. The variable is defined by taking the natural logarithm of the distance between the capital cities of acquirer country k and target country l. Data of distances between the capital cities is gathered using the ‘Distance between Capital Cities Data’ dataset of Kristian Gleditsch.
Table 1 provides descriptive statistics and a correlation matrix of the independent variables and control variables. The correlation table and additional tests show no signs of multicollinearity issues in the sample.
18 Table 1 Descriptive statistics and correlation matrix of independent and control variables Panel a: Descriptive statistics Independent variablesMeanSt. dev. MinMaxMedian CD1.3671.1300.1956.6711.502 CDIV0.2100.23800.7200 % from TC0.08120.16000.8570 Boardage 50.994.07039.406451.402 Boardsize6.3253.3462146 Firmsize15.331.9179.37219.9515.238 Firmage3.3921.51205.8353.401 Openness49.3047.21322.52432.928.182 ED0.1240.364-0.4020.934-0.030 Bilateral17.021.75611.1419.3417.699 GD8.5330.6616.0389.6918.688 Panel b: Correlation matrix CDs. CDIV%_TCBoardage BoardsizeFirmsizeFirmageOpenness ED d BilateralGD CD1.000 CDIV0.1341.000 % from TC-0.1320.1751.000 Boardage -0.193-0.174-0.0911.000 Boardsize0.1910.3250.163-0.1191.000 Firmsize0.160-0.063-0.0390.2010.2311.000 Firmage0.096-0.027-0.1070.1850.0530.1871.000 Openness0.2970.018-0.103-0.125-0.047-0.133-0.0911.000 ED0.4960.244-0.209-0.2090.1030.1550.0400.2481.000 Bilateral-0.468-0.1000.0890.167-0.102-0.0400.149-0.449-0.6121.000 GD0.0260.1120.0900.062-0.009-0.0550.127-0.2810.0750.0501.000
19 3.2 Methodology
One of the most common ways of measuring acquisition performance is by conducting a short-term event study (Datta and Puia, 1995; Li, Li and Wang, 2016). However, by doing so, only the performance effects around the announcement date of an acquisition are captured.
Furthermore, research has shown that investors tend to overreact on the announcement of certain events (De Bondt and Thaler, 1985). Thus, the performance measured in a short-term event study does not always reflect underlying firm performance reliably and does not predict future performance. This thesis focuses on the long-term performance of the acquirer after an international acquisition and the influence of cultural board diversity on this performance. By focusing on the long-term, it becomes clear if the acquiring company was able to integrate the two entities properly and capture the possible synergies. A methodology commonly used in the finance and business literature to capture the long-term performance is the ‘buy-and-hold abnormal returns’ (BHAR) methodology (Barber and Lyon, 1997). This methodology focuses on the long- term stock returns of a company after a certain event to precisely measure investor experience. In this thesis, the BHAR-methodology as used by Chakrabarti et al. (2009) will be closely followed in testing the hypotheses. The methodology utilized in this thesis distinguishes itself from the methodology used by Chakrabarti et al. (2009) by including firm-level variables as well, where Chakrabarti et al. (2009) highlight the role of country-level variables on long-term stock performance only. The used methodology indicates the excess return over the market portfolio an investor would generate if he bought the shares of the acquiring company in the month of the acquisition, and hold them for 36 months. The BHAR over a 36 months’ time window is calculated by compounding the monthly returns of the acquiring firm’s stock and the monthly returns of the market index of this firm’s country and subtracting the return on the market from the return on the acquiring firm’s stock. So, the BHAR methodology measures the total return from a buy-and-hold strategy in which a share of the acquiring company is purchased at the end of the month the acquisition became effective, and held for a three-year period.
The BHAR-methodology is standard in measuring long-term stock performance after certain events like acquisitions because it ‘precisely measures investor experience’ (Barber and Lyon, 1997). Furthermore, since it does not measure performance in the announcement period, it is less subject to investor overreaction. However, Mitchell and Stafford (2000) criticize the independence assumption of multi-year abnormal returns of the event-firms in this methodology.
20 They propose an alternative measure which accounts for the dependence of event-firm abnormal returns, namely the calendar-time portfolio returns (CTAR) measure. However, in this thesis, a multi-country sample is being used which reduces the likelihood of cross-sectional dependence.
Furthermore, by using year- and firm fixed effects, cross-sectional dependence is partially accounted for (Chakrabarti et al., 2009). Besides that, the CTAR measure does not lend itself for measuring the impact of certain variables, like cultural distance and international board diversity, on long-term stock performance.
A common problem in cross-country performance analysis of acquisitions is the possible presence of some country-level variables that are hard to control for. To minimize this problem, a clustered regression with robust standard errors is used in this thesis. By doing so, it accounts for clustering within the acquirer countries. Furthermore, target country fixed-effects are used. In this way, there is being controlled for certain characteristics of the target countries, which is of particular importance in this thesis since the majority of the target companies in this sample is headquartered in one country, namely, the United States of America. Besides using target country fixed-effects, year fixed-effects are used as well. Year fixed-effects are needed to control for time- related factors. In this thesis, these time-related factors would be mostly related to the financial crisis the world suffered in the period from 2007 to 2009.
To test the hypotheses, six different models are used. The first hypothesis of this thesis is concerned with the effect of cultural distance between acquirer and target country on long-term acquisition performance. A negative effect is expected. To test if this hypothesis is true, the following regression model is used:
𝐵𝐻𝐴𝑅36𝑖 = 𝛼 + 𝛽1 ∗ 𝐶𝐷𝑘𝑙 + 𝛽2 ∗ 𝐵𝑜𝑎𝑟𝑑𝑎𝑔𝑒𝑖+ 𝛽3 ∗ 𝐵𝑜𝑎𝑟𝑑𝑠𝑖𝑧𝑒𝑖 + 𝛽4 ∗ 𝐹𝑖𝑟𝑚𝑠𝑖𝑧𝑒𝑖+ 𝛽5 ∗ 𝐹𝑖𝑟𝑚𝑎𝑔𝑒𝑖+ 𝛽6 ∗ 𝑂𝑝𝑒𝑛𝑛𝑒𝑠𝑠𝑙 + 𝛽7 ∗ 𝐸𝐷𝑘𝑙 + 𝛽8 ∗ 𝐵𝑖𝑙𝑎𝑡𝑒𝑟𝑎𝑙𝑘𝑙+ 𝛽9 ∗ 𝐺𝐷𝑘𝑙+ 𝐹𝐸𝑡𝑐+ 𝛾𝑡+ 𝜀𝑖
(6)
Where BHAR36i is the cumulative 36 month buy-and-hold abnormal return of acquirer firm i, CDkl is the cultural distance between acquirer country k and target country l, Boardagei is the average age of the executive board of acquirer company i, Boardsizei is the size of the executive board of company i, Firmsizei is the natural logarithm of acquirer firm i’s total assets, Firmagei is the natural logarithm of acquirer firm i’s age, Opennessl is the openness of target country l to the world economy, EDkl is economic disparity between acquirer country k and target country l,
21 Bilateralkl displays the economic synergies between acquirer country k and target country l, GDkl
is the natural logarithm of the geographic distance between acquirer country k and target country l, FEtc are the target-country fixed-effects, and 𝛾𝑡 are the year fixed-effects.
To test whether cultural diversity within the executive board of the acquiring company has a positive effect on long-term acquisition performance, as stated in hypothesis 2a, a variable for cultural diversity is added to the regression:
𝐵𝐻𝐴𝑅36𝑖 = 𝛼 + 𝛽1 ∗ 𝐶𝐷𝑘𝑙 + 𝛽2 ∗ 𝐶𝐷𝐼𝑉𝑖+ 𝛽3 ∗ 𝐵𝑜𝑎𝑟𝑑𝑎𝑔𝑒𝑖
+ 𝛽4 ∗ 𝐵𝑜𝑎𝑟𝑑𝑠𝑖𝑧𝑒𝑖+ 𝛽5 ∗ 𝐹𝑖𝑟𝑚𝑠𝑖𝑧𝑒𝑖 + 𝛽6 ∗ 𝐹𝑖𝑟𝑚𝑎𝑔𝑒𝑖 + 𝛽7 ∗ 𝑂𝑝𝑒𝑛𝑛𝑒𝑠𝑠𝑙+ 𝛽8 ∗ 𝐸𝐷𝑘𝑙 + 𝛽9 ∗ 𝐵𝑖𝑙𝑎𝑡𝑒𝑟𝑎𝑙𝑘𝑙 + 𝛽10 ∗ 𝐺𝐷𝑘𝑙+ 𝐹𝐸𝑡𝑐+ 𝛾𝑡+ 𝜀𝑖
(7)
Where CDIVi is the cultural diversity within the executive board of acquiring company i.
In the third model, an interaction term is added to see if the positive effect of cultural diversity increases as the cultural distance between the acquirer and the target country increases, as stated in hypothesis 2b. This leads to the following regression model:
𝐵𝐻𝐴𝑅36𝑖 = 𝛼 + 𝛽1 ∗ 𝐶𝐷𝑘𝑙 + 𝛽2 ∗ 𝐶𝐷𝐼𝑉𝑖+ 𝛽3 ∗ 𝐶𝐷𝑑𝑢𝑚𝑚𝑦 + 𝛽4 ∗ 𝐶𝐷𝐼𝑉𝑖∗ 𝐶𝐷𝑑𝑢𝑚𝑚𝑦 + 𝛽5 ∗ 𝐵𝑜𝑎𝑟𝑑𝑎𝑔𝑒𝑖
+ 𝛽6 ∗ 𝐵𝑜𝑎𝑟𝑑𝑠𝑖𝑧𝑒𝑖+ 𝛽7 ∗ 𝐹𝑖𝑟𝑚𝑠𝑖𝑧𝑒𝑖+ 𝛽8 ∗ 𝐹𝑖𝑟𝑚𝑎𝑔𝑒𝑖 + 𝛽9 ∗ 𝑂𝑝𝑒𝑛𝑛𝑒𝑠𝑠𝑙+ 𝛽10 ∗ 𝐸𝐷𝑘𝑙 + 𝛽11 ∗ 𝐵𝑖𝑙𝑎𝑡𝑒𝑟𝑎𝑙𝑘𝑙 + 𝛽12 ∗ 𝐺𝐷𝑘𝑙+ 𝐹𝐸𝑡𝑐+ 𝛾𝑡+ 𝜀𝑖
(8)
Where CDdummy is a dummy variable which takes value 1 for the acquisitions in the top quarter regarding cultural distance, and value 0 for the other acquisitions in the sample. In the fourth model, the cultural diversity variable is replaced by a variable measuring the percentage of board members from the target country. As stated in hypothesis 3a, executives from the target country could help the acquiring firm overcome their liability of foreignness. Thus it is expected to have a positive influence. This leads to the following regression model:
