Effect of cross-border acquisitions on innovation intensity between emerging and developed countries and the moderating effect of cultural distance

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Effect of cross-border acquisitions on innovation

intensity between emerging and developed countries

and the moderating effect of cultural distance

Master thesis (final) Jelle Diks 11196033

Dr. Mashiho Mihalache (supervisor) Dr. Vittoria Scalera (second reader)

MSc. Business Administration – International management track Amsterdam Business School (University of Amsterdam)

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Jelle Diks 2 Statement of originality

This document is written by Student Jelle Diks who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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Jelle Diks 3

Abstract

This thesis investigates the impact cross-border acquisitions have on the innovation intensity for acquiring firms. Furthermore, the moderating effect of cultural distance is tested. The dataset contains 156 acquiring firms from Brazil, Russia, India, China, Indonesia, Mexico, and Turkey. The acquired firms are located in emerging markets and developed countries. All acquisitions are completed in 2009. Firstly, an event study is done to find the abnormal number of patents for the three years after the acquisition. Results show that, on average, the acquiring firms have three or four patents more each year than they would have when they did not acquire the foreign firm. This is due to the knowledge transfer from acquired firm to the acquiring firm. Furthermore, four regressions are run to test if this number is higher for acquired firms from developed countries or emerging countries. The findings suggest that acquiring firms from emerging markets have a higher increase in number of patents than acquired firms located in developed countries. This contradicts suggestions by previous researchers. Lastly, the moderating effect of cultural distance is tested. However, the regressions show contradicting results on this impact. Therefore, no conclusions on this effect can be drawn.

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4.2 Methodologies ... 27 4.2.1 Event study ... 27 4.2.2 Linear regression ... 30 4.2.3 Control variables ... 30 5. Findings ... 32 5.1 Event study ... 32 5.3 Limitations... 36 6. Discussion ... 37 7. Conclusion ... 38 7.1 Conclusive remarks ... 38 7.2 Recommendations ... 39 7.2.1 Managerial implications ... 39 7.2.2 Academic implications ... 39 References ... 41

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List of tables and figures

1. Figure 1 – Impact of gloabalization on trade of goods and services ... 7

2. Figure 2 – Reverse innovation ... 11

3. Figure 3 – Number and value of mergers and acquisitions over time ... 16

4. Table 1 – Descriptive statisics ... 26

5. Figure 4 – Conceptual model ... 27

6. Table 2 – Corrolation matrix ... 29

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1. Introduction

There are three main industrial revolutions that occurred in the history that had major impact on people, the environment and organisations. During the first industrial revolution, workers migrated from farm to factory in the industrializing countries and societies were transformed beyond recognition. In 1810, 84 percent of the work force was working in the agriculture sector compared to 3 percent of the population in manufacturing. This dramatically changed to 25 percent working in manufactory firms and 8 percent in agricultural sector by the year 1960. To accommodate to this new reality, the forms and practices of government, the organization of businesses, education and the way people lived changed (Blinder, 2006).

During the second industrial revolution the jobs shifted once again. Between 1960 and 2004 jobs moved away from manufacturing and toward the service sector. At first, the United States and other rich countries abominated rather than welcomed the loss of manufacturing jobs. However, jobs had been created far more rapidly in the service sector than jobs disappeared in manufacturing firms. In this period, the share of total jobs in the service sector increased around 20 points in the United States and Japan, and even 25 percent in France, Italy, and the United Kingdom according to the Organisation for Economic Cooperation and Development (OECD, 1998).

Today, we are in the midst of a third industrial revolution; the information age or technological revolution. Due to the phenomenon ‘globalization’ the world became more boundaryless. “Economic ‘globalization’ is a historical process, the result of human innovation and technological progress. It refers to the increasing integration of economies around the world, particularly through the movement of goods, services, and capital across borders. The term sometimes also refers to the movement of people (labor) and knowledge (technology) across international borders. There are also broader cultural, political, and environmental dimensions of globalization.” (IMF, 2008) The possibility of a cheap and easy flow of

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Jelle Diks 7 information around the globe led to a vastly expansion of the scope of tradable services as shown in figure 1. An important aspect that leads to a sustainable competitive advantage during this period is being innovative while using all knowledge flows. Throughout this technological revolution, researchers tried to investigate the impact of innovative changes on firm performance.

Figure 1 – Impact of globalization on trade in goods and services

Source: http://www.imf.org/external/np/exr/ib/2008/053008.htm

Innovation could be and is seen as an important solution to differentiate your product from competitors. Therefore, it is seen as a major instrument for growth strategies. By offering technological improved products a company can gain a strong market position (Krugman, 1980). It further helps to enter new markets and compete with local players.

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Jelle Diks 8 In the past, the developed countries have had the most influential inventions. To compete in the world, it became more common to expand internationally. The most cross-border mergers and acquisitions occurred between developed countries mutually at first. However, times have changed and European multinationals started doing business outside of the developed countries.

One reason for expanding to emerging markets is that the markets in less developed countries are increasing in revenues. For instance, emerging markets had an $30 trillion GDP after the financial crisis in the year 2008. Therefore, multinational corporations were interested in doing business here. This further helped the growth in emerging markets. Barney (1988) suggest that acquisitions create value when it adds valuable resources, physical, financial or human, that can be taken over by the acquiring firm.

The hardest challenge for the companies is to overcome the cultural “distance” (Ghemawat, 2001) when doing business abroad or engaging in mergers and acquisitions. Sustainable competitive advantages from acquired firms tend to be constrained by national cultures, which make them hard to duplicate by the acquiring firm.

The main purpose of mergers and acquisitions is to overcome the cultural problems and create a sustainable advantages compared to their competitors in the market place. It is suggested that tomorrow’s market place winners are the masters of knowledge management (Nonaka and Takeuchi, 1995; Arthur, 1996).

The most important part of knowledge management is the process of knowledge transfer between business units. There can be an increase in knowledge transfer in international firms because foreign markets often provide access to new stimuli and ideas that can be used in other countries (Bartlett and Ghoshal, 1989). Transfer of knowledge can occur under a hierarchical mode of governance between two affiliates of one company or through a market transaction

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Jelle Diks 9 between independent firms. Furthermore, it occurs through alliances, joint ventures, licensing arrangements, and mergers and acquisitions (Borys and Jemison, 1990).

This thesis tries to investigate what the impact of cross-border acquisitions is on the innovativeness of firms. However, it is not clear where most influential innovative ideas come from today. At first, it travelled from developed countries to emerging markets and underdeveloped countries (Shan & Khan, 2016).. However, in recent years, a new phenomenon begun which is called reverse innovation. This means that emerging markets are starting to develop innovative products themselves as shown in figure 2 (Govundarajan & Ramamurti, 2011). Emerging markets no longer just borrow innovations from other countries, but further contribute to innovative ideas. However, reverse innovations still tend to appear rarely.

Reverse innovation shows that there is an innovative collaboration of firms from different continents. They adapt to new innovative ideas from firms abroad. Could this collaboration between the firms from different continents have further impact on the innovations intensity in the future for those firms? Once companies discussed different views on technology, it could give new insights and innovative ideas. Therefore, acquisition could have to potential to increase the innovativeness of the acquiring firm.

This thesis will further investigate what the implications of an cross-border acquisition is on the innovation intensity. This thesis specifically goes in depth on what the effect of cross-border acquisition of acquiring firms from emerging markets will be on the intensity of innovation. If this is recognized, it will be further investigated if there is a moderating effect of cultural distance on this relationship.

Therefore, the purpose of this thesis will be to answer the following three questions:  Do acquiring firms form emerging markets increase their innovation intensity after

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Jelle Diks 10  Is this effect higher when acquiring a firm located in a developed country or

emerging country?

 Is there a moderating effect of cultural distance on this relationship?

Those question will be answered throughout quantitative data analysis. The data for cross-border acquisitions, patents, cultural distance and firm financial figures are used. Firstly, the database Zephyr is used to look what cross-border acquisitions are made in 2009. This generated 156 acquisitions from acquiring firms located in Brazil, Russia, India, China, Indonesia, Mexico, or Turkey. All target firms are located in emerging markets or developing markets. To further test their innovation intensity, the number of patents between 2006 and 2015 are retrieved from Patentscope. All financial numbers are taken from DataStream. Lastly, the cultural distance information is provided by Geert Hofstede’s website.

After the gathering of data, the calculations can be started. To begin with, the numbers of patents itself does not give a clear view whether the innovation intensity increased due to the acquisition or because the innovation level of the whole world increased. Therefore, an event study helps to compare the innovation level of a single firm with the innovation intensity of the world. The number of patents of each acquiring firm will be compared with the number of patents of all firms together from the United States between 2006 and 2015. The abnormal change in number of patents is used as the dependent variable.

Then, a regression analysis will be done to look for the effect of the independent variable (dummy variable for target firms located in an emerging market or developing country), moderator variable, and control variables on the innovation level. Cultural distance is the moderator variable and the control variables are size of the firm, return on investment, research and development expenditure, sales growth, debt, and a dummy variable for the industry.

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Jelle Diks 11 Results show that innovation intensity increases the three years after the acquisition. The increase is higher when the acquired firm is located in an emerging country. The result does not show a clear statement of the effect of cultural distance as moderator, because the results of the different regressions are contradicting.

This thesis has a few academic and managerial implications. Due to the fact that the results are insignificant, it is hard to advice managers whether to acquire or not to acquire firms abroad. However, the positive abnormal number of patents after cross-border acquisitions should encourage managers to acquire firms internationally. The results enriches mainstream theories such as innovation, internalization, multinational enterprise management, and foreign direct investment spill overs.

The structure of this thesis will be the following: Next to this introduction, there will be a literature review. Followed by a theoretical framework with three hypothesis. The data gathering and methodologies will be explained in the next section. The findings are showed in chapter 5. Then a discussion will be hold ended by the conclusive remarks. The references are at the end of this paper.

Figure 2 - Reverse innovation

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2. Literature review

2.1 Globalization and semi-globalization

The world and its markets becomes increasingly integrated. Different scholars suggest that we are living in a globalized world. Borders to enter new markets are decreasing. Multinational enterprises (MNE’s) engage in cross-border markets to maximize their profit in a world of imperfect markets. This international business strategy has proven to be fruitful (Garret, 2000). With the help of firm specific advantages (FSAs), such as brand name, firms have an competitive advantage versus small local competitors. However, the integration of the markets are far from complete. This phenomenon of incomplete cross-border integration is referred as semi-globalization. It involves situations where barriers to enter new markets are high, but not high enough to stop MNEs to enter potentially profitable new markets (Ghemawat, 2003).

2.2 Entering new markets

There can be four reasons for firms to enter new markets: Natural resources seeking, markets seeking, efficiency seeking, and strategic asset seeking (Dunning, 1998).

Firstly, natural resources means physical resources such as minerals, an unskilled labour force which have lower costs. Furthermore, it includes knowledge type resources such as a skills and capabilities of workers in the specific country.

Market seeking includes the search of markets where there are new potential customers. Thirdly, an increase in efficiency can occur due to economies of scope and scale when entering a new market. Producing higher volumes of a single product reduces the fixed cost on each individual product. Economies of scope decreases the average total cost of a company’s production when a firm increases their product line.

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Jelle Diks 13 Lastly, strategic asset seeking can be divided in catching up, diversification and a research and development springboard. Catching up with competitors that already tapped into new markets who gaining high market shares. Firms do not want to lag behind. The diversification purpose means that the risk reduces for the company when selling your products in more markets. The new market can further act as an R&D springboard, because of all the technological knowledge that is available abroad. It is more easy to obtain technological knowledge from others then inventing yourself.

2.3 Entry mode

Once a MNE made the choice to enter new markets it has four different choices on how to enter the market. The most important decision is if they want to engage in a non-equity based entry mode or equity based. The entry mode choices is an important strategical decision. The entry mode choice results in different levels of control, commitment, and risk. This result is particularly significant when entering unstable or new markets (Dunning, 1980).

Non-equity modes can be divided in two different entry modes. Firstly, export is an option to enter new markets by selling your products to foreign countries. Secondly, a contractual agreement can be set up to enter new markets. This gives a company the right to operate under the name of the organization it has its agreement with. Both types of entry are not risky, because the MNE cannot lose money from selling products abroad without the necessity to invest.

Within equity based entry mode, there is the choice between a jointed venture and wholly owned subsidiary. In joint ventures a company cooperates with another firm while entering a new market. Whereby a wholly owned subsidiary means that you own the company. This gives the highest risk and required amount of investments. A wholly owned subsidiary can be a greenfield investment or an acquisition. A greenfield investment means a firm starts from

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Jelle Diks 14 scratch and builds the company itself. When acquiring another firm, you already have a starting point. The workers are already familiar with the culture and market. The MNE can learn from the acquired firm how they operate. This eventually leads to new knowledge for the acquiring firm (Pan and David, 2000).

2.4 Acquisitions

This thesis will mainly focus on acquisitions as entry mode due to the implications of an acquisition. Throughout acquisitions, the acquiring firms is in full charge. Therefore, the firm is able to use all knowledge of the workers and patents that the firm has.

Several studies investigated the impact of global diversification through cross-border acquisitions on firm value. Global diversification have both benefits and costs for the acquiring firm.

An important factor of the acquisition is that the combination of firms leads to synergies. Synergies means that both firms together create more value than each could achieve alone (Schweiger and Walsh, 1990). The synergy potential comes from both similarities and complementarities between the two companies; different products, market access, or know-how that fit with and enhance one another. When the benefits are based on complementarities, they are more likely to produce abnormal returns (Harrison et al., 2001).

Caves (1971) suggests that synergies stems from the value of information-based assets within the acquired firm. These assets lead to an increase in returns to scale and are difficult to duplicate by competitors. Global diversification is a mechanism for bringing buyers and sellers of knowledge together. Therefore, increasing value of the acquiring firm due to the intangible assets such as superior production skills, marketing skills, and management quality.

Furthermore, a cross-border acquisition leads to value creation by creating flexibility within the firm. The firm is more able to respond to changes in the relative prices and can

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Jelle Diks 15 benefit from differences in tax codes and other institutional differences. This is consistent with Stein’s (1997) ‘winner-picking’ theory. A firms that can diversify internationally chooses to produce in countries where costs are the lowest or demands are the highest. Furthermore, the multinational has the ability to exploit differences in tax systems across countries.

Lastly, a benefit can arise from investors’ diversification preferences. Corporations are able to diversify at a lower cost than individuals can because investors are willing to pay a premium for globally diversified firms (Denis et al., 2002).

Once the acquisition adds unique and valuable resources that can be leveraged into the target organisation, it will lead to the creation of value according to Barney (1988).

However, there are potential costs that comes with cross-border acquisitions. Globally diversified firms are more complex than domestic firms. Bodnar et al. (1999) argues that it becomes more difficult to monitor managerial decisions when the firm is more complex or globally diversified.

Furthermore, global diversification could lead to inefficient cross-subsidization of less profitable business units. Division managers exert influence to increase the number of assets under their control which, in some cases, leads to less profitable division being subsidized by more profitable departments (Scharfstein and Stein, 2000).

Despite the potential losses of acquisitions, the number and value of mergers and acquisitions increased over the past years as figure 3 shows. Therefore, this is an important topic for researchers. This thesis rather focusses on the value creation after acquisition instead of the cost cutting that arises from overlapping activities.

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Figure 3 – Number and value of mergers and acquisitions over time

Source: http://mebfaber.com/2013/12/03/where-have-all-the-mergers-gone/

2.5 Cultural distance

When acquiring a firm abroad, the MNE should consider the cultural distance between the two countries to improve the integration process. Ghemawat (2001) talks about four different aspect of “distance” that affect the firms. Cultural, administrative or political, geographical, and economic distance. Cultural and political together are the most influential factors.

The first aspect of distance is administrative or political distance and means to what degree the countries have a historical or trading relationships with each other. The trade volume is positively related between historical colonies and colonizers. Countries with low administrative distance tend to have trading arrangements, common currencies, and a political union. The European Union consists of a group of countries which tried to minimize the administrative distance and improved the trading mutually.

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Jelle Diks 17 Trading barriers further affect the political distance. Governments use tariffs, trade quotas, restrictions on foreign direct investments, and preferences for domestic competitors in form of subsidies to favour domestic firms against foreign competitors. It can function as protection to the fear that the country becomes dependent of foreign products. Farmers from Europe gain subsidies to provide food for the domestic population for instance.

Geographical distance further impacts distance between countries. Geographical distance has a dampening effect on investment flows and trade flows between countries. This distance covers both the physical distance as well as the infrastructure. Is the country accessible by train, plane, and boat? The delivery costs are positively related with the accessibility of different transport resources (Porter, 2007).

The third aspects of distance, economical, is the difference in the level of incomes and wealth. Wealth and trading activity is positively related between countries. People with higher levels of wealth are able to afford expensive luxury products where poor citizens are not. Therefore, an Italian brand such as Ferrari would have a higher demand in the United States than in Gambia for instance.

Cultural distance means that countries differ in their culture. Religious belief, race, social norms, and language are factors that differ between countries and are the reason why people interact differently with each other. The interaction further impact trading within the country. Therefore, MNEs have to keep in mind the differences and adapt to this phenomenon. Some cultural attributes are more easily to adapt to than others. Language for instance, is a factor which can be learned. Empirical research found that countries with similar language trade three times more than countries with different languages.

Other attributes are more deeply rooted in a country and cannot be copied. Social norms for instance are unspoken principles guiding individuals in their everyday choices and interactions. Furthermore, colour taste can be linked to cultural differences. People from the

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Jelle Diks 18 Netherlands feel like they belong together by wearing orange clothes during the world championship of football. Firms can adapt to this by selling orange shirts during certain periods. Culture prejudices also differ between countries. People highly value space in Japan. Therefore, they prefer automobiles and apartments to be small. Lastly, markets and industries as a whole are affected by culture. People from different regions prefer different food. Therefore, MNE should sell food products where the locals are familiar with and prefer in order to maintain market position. Citizens believing in Islam do not eat pork as an example (Sebenius, 2002).

2.6 Hofstede’s four dimensional framework

Hofstede (1983) made a four dimensional framework to look at the cultural distance between countries. Firstly, individualism versus collectivism (IDV) creates distance between people. Individualism refers to the preference in which individuals are expected to take care of themselves and their families. Where collectivism is defined as a situation where individuals act loyal to and tries to help members of a particular group.

Furthermore, there are differences between nations in their masculinity or femininity (MAS). Masculinity stands for the preference for achievement, heroism, assertiveness and material rewards for success. Femininity means that people try to cooperate, care for the weak and quality of life, and feminists are most likely to be modest.

The third factor is uncertainty avoidance (UAI). This is measured by the degree to which people feel comfortable with ambiguity and uncertainty.

The last cultural difference is power distance (PDI): the extent to which there is inequality between people and if people are feeling comfortable with this differences. High power distance means that people with lower status suffer from inequality. However, it is valued that there are differences in status (David, Pan and Au, 1997).

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2.7 Innovation

This section discusses the importance of innovation. Why should a firm focus on research and development when it brings a large amount of costs?

Starting with the different definition given by literature on innovation or innovativeness. The first definition that emerged is that innovation performance is related to the adoption of the newness and novelty of products or processes (Hollenstein, 1996).

The second concept refers to the speed of innovation. Speed can be interpreted in two different ways. Speed could relate to the lead time required for new products. In a world with shortened life cycles of products, the importance of capabilities to improve and replace products frequently increases. This definition leads to pressure on firms to introduce new products and doing it faster than competitors (Stalk, 1993). However, the second interpretation of speed is how early a firm adopts to new technology that emerged in the industry. Rogers (1993) suggested five categories for the speed of adoption: innovators, early adopters, early majority, late adopters, and laggards. The faster a company is capable to adopt to innovation, the higher the benefits and risks from the innovation.

The third definition of innovativeness is related to the consistency and continuity of companies. These firms are knowns as world-class product innovators and focus on the development of new products without ignoring other entry requirements for competition. Therefore, consistently introducing new products to the market (Subramanian and Nilakanta, 1996).

The last dimension is related to strategy and capabilities of firms to be an early market entrant in new or undiscovered markets. Firms further strive to create new market. This strategy comes with the principle of ‘first-mover advantages’ (Lieberman and Motgomery, 1988).

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Jelle Diks 20 Innovation can be further distinguished between product and process. However, this dividing line seems to be confusing. It is important to notice this difference as it both has different impact on business performance (Kraft, 1990).

Yamin et al. (1997) compared product innovation and process innovation. Results showed that process innovation is a stronger indicator for business performance in terms of liquidity, leverage, activity, and return on investment.

The ‘closeness’ of product and process innovation is stronger in the service sector than the manufacturing sector. This is particularly due to the relationship with customers which makes processes in services more transparent. This has impact on the overall quality of service perception by customers (Zeithaml et al., 1990).

Innovativeness showed a positive relationship with business performance by previous empirical studies. Deshpande et al. (1993) indicated that innovation intensity is positively related to relative profitability, size, market share, growth rate.

Dwyer and Mellor (1993) indicated that a technical offensive strategy led to the highest percentage of successful new products and achieved the highest level of performance. Performance measured by meeting the performance objectives, profitability of the new product projects and the perceived overall success.

Baldwin and Johnson (1996) further showed that there is a positive relationship of innovativeness and performance in terms of market share gain and return on investment.

Lastly, Subramanian and Nilakanta (1996) compared the different impact of number of innovations versus time of innovation adoption on business performance in terms of effectiveness and efficiency. Both innovation proxies showed a positively significant relationship with efficiency. Time of innovation adoption has a positive impact on effectiveness.

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3. Theoretical framework

3.1 Effect of acquisitions on innovation intensity

Today, knowledge is seen as the most critical resource to create a sustainable competitive advantage. It is increasingly difficult to attain and sustain knowledge as a competitive advantage. Firms who have gained a competitive edge over their competitors, have done so through the recombination of knowledge. It is suggested that tomorrow’s market place winners are the masters of knowledge management (Nonaka and Takeuchi, 1995; Arthur, 1996). This increase the incentive to improve the innovation intensity.

The most important part of knowledge management is the process of knowledge transfer between business units. There can be an increase in knowledge transfer in international firms because foreign markets often provide access to new stimuli and ideas that can be used in the home country (Bartlett and Ghoshal, 1989). Transfer of knowledge can occur under a hierarchical mode of governance between two affiliates of one company or through a market transaction between independent firms. Furthermore, it occurs through alliances, joint ventures, licensing arrangements, and mergers and acquisitions (Borys and Jemison, 1990).

During acquisitions, two organisations may complement each other in different functions and parts of the organisation. According to the model of Jemison (1988), the objective of acquisitions is to improve the competitive position by transferring complementary strategic capabilities. Capabilities such as the use of tacit and explicit knowledge which are originated by one of the two organisations. This does not mean that the transfer of capabilities entails a ‘perfect’ replication for the acquiring firm. However, it leads to a transformation and exploitation of knowledge that will be combined with the existing capabilities (Zahra and George, 2002). It further helps with the development of knowledge, capabilities, and complex interaction between the business units. Capron, Dussauge, and Mitchell (1998) provided

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Jelle Diks 22 evidence that merging firms gained improved technical innovation capabilities, manufacturing know-how and managerial capabilities.

Therefore, one reason for an acquisition is to gain knowledge of the acquired firm and transfer that knowledge within the firm (Bresman, Birkinshaw and Nobel, 1999). This serve as a basis to improve innovative capabilities and competitiveness which creates superior value (Barney, 1991).

Due to the previous research, the following hypotheses is formulated:

H1 Cross-border acquisitions increase the innovation intensity for the acquiring firm

3.2 Developed versus developing countries

The purpose of this thesis is to look for differences between acquiring a firm from a developed country or a firm from an emerging market with respect to the knowledge transfer and innovation intensity.

Almeida and Phene (2004) state in their paper that there are two variables that affect the transfer of knowledge; the internal multination company’s network and external host country network. One potential source of value creation for MNCs can be external learning form host country locations. Originally, host country regions were seen as markets or as sources of cheap labour. This changed to seeing host countries as potential source of new knowledge (Dunning, 1994). Nelson (1993) and Westney (1993) suggest that specific technological trajectories are developed by the dynamic interaction of political, economic, and educational systems. This means that subsidiaries and acquired firms in technologically advanced regions have access to specific knowledge which can be gained by the MNC as a whole. For instance, Almeida (1996) showed that subsidiaries in the United States heavily rely upon the technology of local companies in their knowledge building. In the biotechnology industry there are European firms that make equity investments in American biotechnology firms with high levels of patent

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Jelle Diks 23 activity to source country-specific knowledge. The opportunity is greater when the knowledge resources in the network is higher (Gulati, 2000). This result in better innovatory performance. Therefore it is likely to gain more knowledge from firms in developed countries. As a result, the second hypothesis is formulated as the following:

H2 The increase in innovation intensity is higher when the acquired firm is from a developed country compared to an acquired company from emerging markets

3.3 Moderating role of cultural distance

Important part of the knowledge-transfer is the integration process of the acquiring and acquired firm. According to Zander and Kogut (1995), organisations exploit resources more efficiently internally than would be possible through external markets. A range of barriers has been uncovered in the capability to transfer knowledge. ‘first, the level of social integration between the acquiring and the acquired firms and, second, the recipient organisation's potential capacity to absorb capabilities from the other unit will mediate the effect of national cultural differences on the interfirm capability transfer.’ (Björkman, Stahl, and Vaara, 2007, p. 646). The aim is to establish a shared set of values and objectives across business units, providing them a shared identity. The multinational corporation is more likely to exchange complementary knowledge needed to pursue their shared vision. The higher the cultural distance, the harder it will be to create a shared vision (Nahapiet and Ghoshal, 1998).

This leads to the third hypothesis:

H3 Cultural distance negatively mediates the relationship between cross-border acquisitions and innovation intensity

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4. Data and methodologies

4.1 Data

This thesis uses several different databases. Firstly, Zephyr is used to find all acquisitions in the sample period. Furthermore, Patentscope is used to gather the number of patents of the acquiring firms. Then, the firm characteristics are retrieved from DataStream. Lastly, Geert Hofstede’s website is used for the cultural distance between the countries of acquiring and acquired firm.

The next paragraphs describes what specific data is gathered followed by their descriptive statistics. Furthermore, the two different methodologies used in this study will be explained. The second methodology uses control variables, which are explained in the last sub-paragraph. This data will eventually be used to test the hypotheses.

4.1.1 Data gathering and description

The data of all acquisitions will be gathered from Zephyr. The sample period for these acquisitions is the year 2009. The requirements of the acquiring firm is that it has to come from an emerging market. This thesis uses Brazil, Russia, India, China, Indonesia, Mexico, and Turkey as emerging markets for the acquiring firms. This study will only focus on full takeovers, due to the guaranteed consolidation (Bris and Cabolis 2008). Moreover, the corporate governance do not differ significantly if you control country characteristics after the acquisition (Doidge, Karolyi, and Stulz, 2007).

This generated 156 cross-border acquisition. 82 of these acquisitions were made by acquiring firms from India. Where Indonesia only had two acquiring firms. Brazil, Russia, China, Mexico, and Turkey lie in the middle with the number of acquisitions. All acquired firms come from either an emerging country or a developed country. A region dummy variable is made. This variable is 0 when the acquired firms is located in an emerging country and 1 when

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Jelle Diks 25 operating in a developed country. This dataset does not include acquired firms from underdeveloped countries. There simply were no acquired firms from those countries during this period. The most common country of an acquired firm is the United States (39). Other countries of acquired firms variate from Kazakhstan to South Africa.

For innovation intensity we use the number of patents a firm has after an acquisition. This data will be gathered from Patentscope. It is necessary for the study to know the number of patents three years before and six years after the acquisition. This means that patents between 2006-2015 are gathered. The three years after the acquisition will be used in the regression analysis. It takes time to convert the newly acquired knowledge in new innovative products and it takes time for the patents to be granted. This means that this study needs the data of the control variables for the years 2010 till 2012. Patents are used as a proxy of innovation intensity because it is the output of all the research and development effort (Watanabe, Tsuji and Griffy-Brown, 2001).

There is a large difference in number of patents between the acquiring firms in the sample period. The average number of patents for all firms combined is 27,93 with a maximum of 1907 patents as shown in table 1. The standard deviation is relatively large with 106,85.

The third database is DataStream, which provided the firm characteristics. These numbers are used as control variables which will be further explained in paragraph 4.2.3.

The moderating variable is cultural distance and is measured by Kogut & Singh’s (1988) CD-index. Geert Hofstede’s website provides the data for the cultural distance between the countries of the acquired and acquiring firm. The CD-index takes Hofstede’s four dimensional framework into account and calculates the distance with the following formula:

𝐶𝐷𝑖 = ∑{(𝐼𝑦 − 𝐼𝑥)^2 / 𝑉𝑖 }/ 4

4

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Jelle Diks 26 The average cultural distance between the countries of the acquired and acquiring firm is 1,95. The lowest cultural distance (0,11) is between Russia and Ukraine. Where the cultural distance between Russia and Austria is the highest (6,39).

Table 2 shows the correlation matrix between the variables. It shows that the dummy variable for region of the acquired firm is positively related with cultural distance. This can be explained with the fact that it is more likely that the cultural distance is high when the acquiring and acquired firms are from different regions (emerging country versus developed country).

Furthermore, the dummy variable is negatively related with capital expenditures. This means that firms from emerging markets that are acquiring firms from emerging markets are relatively spending more on capital compared to firms from developed countries.

Table 1 Descriptive statistics

Variable N Mean Min. Max. Std. dev.

Abnormal patents 468 3,54 -313,34 904,10 52,49 Size 445 267257553,80 40673 13945777000 1090488086,44 Debt 444 0,32 0 1,29 ,21 Sales growth 431 1,43 -.93 396,70 19,44 Capital expenditures 440 ,07 0 ,51 ,07 Return on investments 442 0,04 -,90 ,73 ,11

Research and development 128 0,03 0 ,59 ,08

Industry 468 5,26 1 11 2,55

Cultural distance 414 1,95 ,11 6,39 1,67

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4.2 Methodologies

The main point of this thesis is to test the following model: Figure 4 – Conceptual model

To test this model, an event study and linear regressions will be done. The last sub-paragraph explains the different control variables used in the linear regression.

4.2.1 Event study

As previously mentioned, this thesis will start with an event study. An event study is a useful tool to determine if an event, the acquisitions in this case, has an effect on innovation intensity. Number of patents will be used as an proxy for innovation intensity. The purpose of this event study is to determine the normal and abnormal number of patents in the years 2010, 2011, and 2012 for the acquiring firms.

Firstly, the databases of patents and acquisition had to be combined. These number of patents are compared to the number of patent in the United Stated for the same years. Then, the normal number of patents can be calculated. The normal number of patents stands for the expected patents for a company in the future when the event would not have happened. The patents can be determined by a linear regression. In this regression the number of patents from the acquiring firms are compared to the benchmark in the years before the event. In this case, the benchmark is the number of patents in the United States. A correlation coefficient is

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Jelle Diks 28 calculated (the Beta), which determines the impact of the benchmark on the number of patents in the situation that the acquisition did not happen.

Eventually, this gives the following formula, which estimates the normal performance for each company:

Number of patents

a,t

= α + βnumber of patents

b,t

+ ε

t

a = acquiring firms, t = year, and b = patents in the United States

The Alpha is a constant factor. Beta is the sensitivity of the company’s number of patents in the United States. If the β is 1,5 for a firm, it means that if the patents in the US increases by 1%, the number of patents will increase by 1,5% . The Epsilon stands for the error term. This is a number, which cannot be explained in the formula itself.

For this study, the completion year of the acquisition is used as a reference point. The normal number of patents is calculated for the 3 years after the acquisition (2010-2012). For the estimation formula there is chosen to regress the patents of the acquiring firm for seven years. Starting 6 years before the completion of the acquisition until the year of the acquisition [-6 – 0].

This generated the normal number of patents for the acquiring firms. Eventually, this study needs the abnormal number of patents. This is calculated by the realized number of patents minus the normal number of patents for each firm. This can be formulated as the following:

Abnormal number of patents

a

= Realized number of patents

a

− Normal

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Table 2 Correlation Matrix

Variable Patents Size Debt Sales growth Capital

expenditures Return on investments Research and development Cultural distance Region dummy Patents ₁ Size _-,006 ₁ Debt _-,018 _-,105* ₁ Sales growth _-,003 _-.013 _-,079 ₁ Capital expenditure ,048 -.029 .211** -,023 1 Return on investments ,017 .018 -.451** _-.025 _,151** ₁ Research and development -,030 -,114 -,163 -,174 -,153 -,104 1 Cultural distance ,020 -,063 -,083 -,035 ,077 ,119* -,032 1 Region dummy -,073 -,011 -,070 ,026 -,137** -,049 ,150 -,346** 1

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Jelle Diks 30 4.2.2 Linear regression

As previously mentioned, a linear regression is a helpful tool to explain a dependent variable by independent variables. In this study, innovation intensity (number of patents) is the dependent variable. The question is whether the number of patents is effected by the acquisition. Therefore, a dummy variable for the acquisition is the independent variable. This dummy variable is 1 when the acquired firm is from a developed country and 0 when it is located in an emerging markets. 122 of the acquired firms are based in developed markets and 44 in emerging countries.

Cultural distance is the moderating variable in this regression. Four different regressions are calculated. First, a regression of the control variables on the dependent variable is done. Followed by a regression with the control variables and the moderator variable. In the third regression, the independent is included. The last regression is plus the multiplication of the dependent variable and independent variable.

4.2.3 Control variables

Control variables have to be used to prevent incorrect results. Innovation intensity is not only affected by the acquisition. It is likely that the transfer of knowledge has impact due to previous research. However, innovation intensity is also impacted by other variables. Therefore, control variables should be included in the regression for a more complete view on how the number of patents is affected.

This study uses seven different control variables which explain parts of the variation in number of patents:

 Capital expenditures as a percentage of total assets

 Leverage is total liabilities divided by total assets noted in percentages  Sales growth is the percentage of growth in sales

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Jelle Diks 31  Firm size is the total assets of a firm and has to be multiplied by 1,000 to get the

actual number

 Return on investment is net income divided by total assets  Research & development as a percentage of total assets

 Industry is a number between 1 and 11 where each number stands for the Global

Industry Classification Standard (GICS) where it operates in

The average Capital expenditure is 7,19%. On average the percentage of debt is 31,64. Some firms do not have debt, where other firms have more debt than total assets. A debt ratio of 1,29 means that they made so much losses that all the private equity is lost and the firm ended up with a negative equity.

Sales growth variates from a decrease of 93% in sales to a growth of 396,70 times their sales of the previous year. On average the sales growth is 142,81% which is relatively large. The size of firms have high variation with a standard deviation of 1090488086,44.

The return on investments is on average 3,87% in this sample. The lowest ROI is minus 89,63% and the highest is 72,57%. Most data for research and development expenses is missing. However, firms spend on average 2,7% of their total assets on R&D.

The different industries are: energy, materials, industrials, consumer discretionary, consumer staples, health care, financials, information technology, telecommunication services, utilities, and real estate. Most firms in this dataset are active in the information technology sector. Only six firms are active in utilities or real estate.

With all those variables, the linear regressions can be formulated as the following:

Abnormal number patents

𝑎

=𝛼 + kRegion acquired firm+ kCultural

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5. Findings

In this section the results of the event study will be discussed and the regressions are run to test the different hypotheses. This section is ended by the limitations of this study. Interesting is whether the results are in line with existing literature.

5.1 Event study

The purpose of the event study is to calculate the abnormal number of patents for the three years after the acquisition. If this number is positive it means that the acquisition led to a higher level of innovation intensity. According to Shan & Khan (2016) innovation intensity can be increased due to the transfer of knowledge after the acquisition. However, the acquisition has costs and thus this money cannot be spend on innovative projects (Grimpe, 2007). These two theories contradict each other therefor the effect of cross border acquisition can be both positive or negative.

H1 Cross-border acquisitions increase the innovation intensity for the acquiring firm Results show that on average the abnormal number of patents is 3,54 (table 1). This means that acquisitions have a positive effect on the innovation intensity. In the three years after the acquisition the firms have on average between three or four patents more than they would have when they did not acquire the foreign firm. This confirms Shan & Khan’s (2016) ideas that acquiring a firm increases the level of innovation intensity due to the transferred knowledge. The results are not significant.

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5.2 Linear regression

Table 3 shows the results of the linear regressions. Most important numbers are the Betas. This numbers means in what proportion the variables have impact on the innovation intensity. Furthermore, the t statistic measures the reliability. The higher the t value the more significant the Beta is.

H2 The increase in innovation intensity is higher when the acquired firm is from a developed country compared to an acquired company from emerging markets

Table 3 contains the four regressions. The first regression only includes the control variables. The second regression contains the moderating variable. The third regression contain the region dummy variable. The Beta of this variable is -0,083. This means that there is a lower increase in innovation intensity if the acquired firm is located in a developed country. According to Gulati (2000), the acquiring firms has a higher opportunity of an increase in innovation intensity when the knowledge recourses of the network of the acquired firm is higher. Developed countries have more knowledge resources in their network than firms in emerging markets. However, the results do not confirm this theory.

In the fourth regression, the Beta of the dummy variable is -1,056. The problem of the regression analysis is that all result are insignificant. Therefore, it is hard to draw strong statements about the hypothesis.

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H3 Cultural distance negatively mediates the relationship between cross-border acquisitions and innovation intensity

Regressions two, three, and four include cultural distance. After the acquisition the acquired firm tries to establish a shared set of values and objectives across business units, providing them a shared identity. The multinational corporation is more likely to exchange complementary knowledge to pursue their shared vision. The higher the cultural distance, the harder it will be to create a shared vision (Nahapiet and Ghoshal, 1998). This means that higher cultural distance would lead to lower knowledge transfer.

In the first two regressions with cultural distance, the Beta is positive. However, the sign is negative in the last regression. The last regression includes the variables region acquired firm multiplied by cultural distance. It is hard to draw conclusions upon the three regressions because they are contradicting each other. Further research is needed to find out if there is and what the mediating effect of cultural distance is.

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Table 3 Regression analysis

Variable Control variables + moderator variable + independent variable + interaction effect Constant 7,528 (6,563) 6,950 (6,771) 7,029 (8,681) 9,907 (9,465) Size -1,740 E-9 (,000) -1,450 E-9 (,000) -1,473 E-9 (,000) -2,053 E-9 (,000) Debt -16,327 (11,881) -17,360 (12,249) -17,383 (12,416) -17,119 (12,447) Sales growth 1,603 (5,787) 1,730 (5,823) 1,743 (5,920) 2,354 (5,986) Capital expenditures -8,009 (33,425) -7,045 (33,674) -7,231 (36,138) -13,776 (37,196) Return on investments -15,771 (22,687) -15,991 (22,802) -15,995 (22,925) -16,453 (22,982) Research and development -8,786

(21,824) -7,912 (22,046) -7,884 (22,246) -7,009 (22,323) Industry -,048 (,727) -,111 (,749) -,111 (,753) -,126 (,755) Cultural distance ,589 (1,574) ,594 (1,622) -4,322 (2,686) Region dummy -,083 (5,656) -1,056 (7,893) Cultural distance * region

dummy

2,542 (3,293)

Adjusted R2 _(%) _2,7 _2,8 _2,8 _3,4

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Jelle Diks 36

5.3 Limitations

The most important limitation of this study is the fact that a proxy is used for innovation intensity. It is impossible during this thesis to prove that the number of patents equal the innovation intensity. Furthermore, the number of patents is not very precise. It takes time to apply for a patent and time before the patent is granted. Therefore, it is hard to specify in which year the innovation intensity increased or decreased.

Furthermore, the R2 is a number which stands for the degree which the independent, control, and mediating variables explain the dependent variable. Throughout the regressions the R2 is increasing. However, this number is still relatively low. This means there should be more variables that explain the variation in innovation intensity.

Besides adding more variable to the regression, the problem of a low R2 arises from the number of patents. Some firms did not have any patents at the ten year sample period. Other firms only a few versus firms with more than 100 patents in one year. The high variation made it hard for the variables to explain what led to the number of patents.

The last problem arises from reverse causality. The purpose of this thesis is to test whether an acquisition has effect on the innovation intensity of the acquiring firm. However, it is also possible that a higher innovation intensity gives incentives to acquire other firms. When a firm has innovative competitive advantages over other firms, it can choose to exploit these advantages abroad. It is hard to test what way the variables affect each other and therefore will not be further discussed or investigated in this paper. However, keep in mind that there is a possibility that the results are biased.

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Jelle Diks 37

6. Discussion

As previously mentioned, there are some limitations in this study. An important issue is the significance of the results. Most results are insignificant. The significance is the likelihood that the result occurred randomly or that they can be attributable to specific variables. Therefore, insignificant results of the sample are not representative for the whole population.

It is difficult to improve the statistical significance. Increasing the sample size improve the significance in most cases.. This makes the sample more representative for the whole population. Furthermore, There can be a missing variable that explains the relationship of cross-border acquisitions and innovation intensity which is not included in the regressions.

This means that further research is necessary to resolve the question where innovative ideas come from and how to improve innovation intensity. With the help of more significant results, better conclusions can be drawn on the impact of cross-border acquisitions on innovativeness.

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7. Conclusion

7.1 Conclusive remarks

The main purpose of this paper is to answer the question whether an acquisition has impact on the innovation intensity of the acquiring firm, moderated by cultural distance. This is followed by a set of hypothesis which test if there is correlation between the region of the acquired firm and the innovation intensity. The number of patents is used as a proxy for innovation intensity. The dataset consist of acquiring firms from emerging markets during 2009. An event study and linear regressions are used to give statistical conformation of the hypothesis.

Not all results are in line with the hypothesis and previous studies. The event study showed that there is a positive abnormal number of patents in the three years after the acquisition. On average the number of patents increase between three or four for the acquiring firm. This confirms Shan & Khan’s (2016) ideas that acquiring a firm increases the level of innovation intensity due to the transferred knowledge.

The third and fourth regression showed that the increase in number of patents is higher when the acquired firm is located in an emerging country. According to Gulati (2000), the acquiring firms has a higher opportunity of an increase in innovation intensity when the knowledge recourses of the network of the acquired firm is higher. Developed countries have more knowledge resources in their network than firms in emerging markets. However, this theory is not confirmed by the regression.

After the acquisition, the acquiring firm tries to establish a shared set of values and objectives across business units, providing them a shared identity. The multinational corporation is more likely to exchange complementary knowledge needed to pursue their shared vision. The higher the cultural distance, the harder it will be to create a shared vision (Nahapiet and Ghoshal, 1998). This means that higher cultural distance would lead to lower knowledge

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Jelle Diks 39 transfer. In the first two regressions the Betas are positive and in the last it is negative. It is hard to draw conclusions upon the three regressions because they are contradicting each other.

The most important issue of the results is that they are insignificant. Therefore, it is hard to draw strong conclusions.

7.2 Recommendations

The recommendations are divided in managerial and academic implications. What do the results mean for managers? How can managers improve innovation intensity in their firm. Furthermore, what do the results mean for further research? Is it possible to use the conceptual framework from this thesis in further research?

7.2.1 Managerial implications

This paper could have a few implications for firms which considers to acquire firms abroad. If a firm from an emerging market wants to increase their innovation intensity it is recommended to acquire firms across borders. More specific, a firm that is located in a emerging country.

This study did not show a conclusive result of the impact of cultural distance on the relationship between cross-border acquisition and innovation intensity. Therefore, no recommendations can be made to acquire firms with high or low cultural distance.

7.2.2 Academic implications

This paper did only investigate the impact of cross-border acquisitions for acquiring firms from emerging countries and acquired firms located in developed or emerging countries. Researches could adapt on the impact that acquired firm from underdeveloped countries could have on the innovation intensity. Furthermore, what is the impact of cross-border acquisition when the acquiring firm is located in a developed or underdeveloped country?

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Jelle Diks 40 The abnormal number of patents after a cross-border acquisition is positive in this study. However, results are insignificant. This could be improved by taken more years in consideration. This thesis only focused on acquisition in 2009. Furthermore, it could have been better to focus on one sector instead of eleven. For example, the technological sector. This gives a better comparison because the number of patents of firms operating in the same industry are more similar. The technological sector did only have 60 cross-border acquisitions in 2009 which is too low to draw conclusions from.

The moderating effect of cultural distance is investigated by this study. However, results of the different regressions are contradicting. Therefore, further research can investigate whether there is a negative or positive moderating role of cultural distance on the relationship of acquisitions and innovation intensity.

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Effect of cross-border acquisitions on innovation intensity between emerging and developed countries and the moderating effect of cultural distance