Zhen Yang 11093102
M&A
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Abstract
Outbound Chinese direct investment has now exceeded $100 billion a year (Rhodium Group in partnership with the Mercator Institute for China Studies (MERICS) of Berlin), and over the next five years these investments are expected to grow significantly, total foreign assets held by Chinese companies are expected to rise from around $6.4 trillion today to nearly $20 trillion by 2020. Chinese companies’ interest in cross-border acquisitions is growing, and there’s no end in sight. Whether their aim is to find new customers abroad or simply to gain greater leverage at home, many companies are now looking overseas for their next big opportunity. However, China and Western Markets (US/EU) have a large variance in their systems and regulations, Ignorance that variance would lead pitfalls in their M&A deals, that is why many of those deals are likely to fail or already failed. So how to make sure that your company isn’t among the casualties? Then it is necessary to study those cause-effect factors.
1. Introduction
1.1 M&A trend from East to West
In the recent years, cross-border acquisitions have become the dominant force of foreign expansion by Chinese companies. So far, roughly a quarter of that investment has been spent in outbound M&A transactions, according to recent PwC figures, although outbound M&A deals still represent a fraction of the total Chinese M&A market, according to an August report of the global consultancy. Of the 4,559 deals completed in the first six months of 2015, only 174 were outbound. In the first six months of 2015, $352 billion in M&A deals were completed, but only $27.2 billion of that went abroad. Enthusiasm is growing, however. Analysts say that the number of deals grew 17% compared to the same period in 2014, and total deal value rose 24%.
In Europe, Chinese investments have grown dramatically in the past seven years, from a value of €2 billion in 2009 to more than €14 billion in 2014. All told, China has invested more than €46 billion in Europe between 2000 and 2014, at least 90% in M&A deals, according to the Rhodium/MERICS report. Twenty-eight percent was invested in energy, and over 40% split roughly evenly between automotive, agriculture and food, real estate and industrial equipment.
State-owned Chinese enterprises led the first wave of deals as pioneers, mostly focusing on mining and resource assets in emerging market companies. “Now companies from industries as diverse as internet, automotive, insurance, chemicals, consumer electronics are all expanding outside of China,” (Joel Backaler, China Goes West, 2015)
Interest in outbound targets is growing equally among all kinds of Chinese companies—large enterprises, including state-owned enterprises (SOEs), large private companies and small and mid-sized companies (SMEs). When most of large firms finished their overseas IPO/M&A, where it is continuing momentum for outbound deals, which is now expanding downwards from SOEs and large Chinese companies to SMEs,” says Russell Brown, Managing Partner of Lehman Brown,
a Chinese accounting firm headquartered in Beijing. Most are “seeking to expand internationally, to reduce their single market dependency, and to exploit new growth opportunities.”
It has been agued that the cultural distance between countries of the acquirer and that of the acquired unit is an important determinant of the success of cross-border acquisitions (e.g., Hoefstede, 2001; Kogut & Singh, 1988; Very & Schweiger, 2001). Then we mainly focus on the cultural differences between nationals of the buyer firms and target firms. Hoefstede (1980) classified cultural distance four dimensions of national culture, i.e., uncertainty avoidance, power distance, individualism, and masculinity. Since other three factors except power distance are quite individual-oriented and have less effect among cross-boarder acquisitions, and there has been lots of researches about them, so in this study we would concentrate on the power distance, especially in the distance between East and West.
National cultural differences are often realized when individuals from different nations come together to implement post-acquisition integration (Shenkar, 2001). Meanwhile, conflicting findings about the effects of national cultural differences on post-acquisition performance are puzzling (Huang, Z., Zhu, H. S., & Brass, D. J. 2016). Alibaba used to ignore the sale of fake cigarettes, alcohol, and branded handbags by vendors on its marketplace sites, as well as the sale of restricted weapons and other forbidden items, which violated the regulation of US public firms, so Ma Jack had to do explaining to SEC, and face lawsuit risk and stock price fluctuation. Since the fake goods on Ali are generally made from lower quality components in an attempt to sell a cheap imitation of similar goods produced by brands consumers know and trust, then if consumers lose confidence in Alibaba, its business will be largely affected (Wong, 2015).
Buying abroad might make sense, but in execution lots can go wrong. It would be a great challenge for most companies to buy the right asset at the right time for the right price, handle the regulators of its industry in the right way and manage the integration with just the right touch, as many as four others flounder. Many studies have found that 50-80% of mergers fail to create synergy value, and a bad acquisition can cost largely. (Canina, L, Kim, J., & Ma, Q. 2010)
Six factors are the most common reasons for failure:
1. poor due diligence, 2. bad valuations,
3. over-estimates of cost savings synergies, 4. bad integration,
5. incompatible cultural values, 6. bad managerial incentive.
In this paper we would stick to incompatible cultural values (power distance by Hoefstede), where specialists suggest to prevent the pitfalls since it is a risky business,” (Robert Sher, 2007). Chinese acquirers do not have easy time in developed markets, because most have to pay as much as a 33% premium over the market price to close a North American deal, due to regulatory complexity in China and unfamiliarity with western markets. (Backaler, J. 2014)
In the process of M&A, after announcement of M&A, the shareholders of bidding firms would experience an abnormal return during the post-announcement period. (Wang, Aug 2009) But not for long, most pitfalls occur during the post-acquisition period, bad integration would be main reason. The merger between Daimler and Chrysler resulted in a failure, and Daimler had to sell Chrysler out as a result to avoid further loss (Jeffrey, 2000). Then Bad integration might be attributed to cultural distance, especially for national cultural distance (power distance) in cross-boarder acquisition. Those differences are often used as indication for systems and regulations distances. Due to a high failure rate of mergers and acquisitions (Biggadike, 1979; Kitching, 1967; Mayer-Sommer, Sweeney &Walker, 2006; Meeks 1977; Schoenberg, 2006), then it would be beneficial for firm to understand those distances and avoid M&A pitfalls.
1.2 Pitfalls might Occur
“Post-acquisition legal and regulatory troubles can present huge challenges, particularly if the acquisition is in a mature market such as the United States. “One of the greatest stumbling blocks for Chinese companies doing business in the US occurs after an acquisition,” (William J. Carney, 2010). On the contrary, situations in China are rather different from US market. The reason might be that they have come of age in a market where such skepticism is sometimes warranted: in a 2015 poll by Charney Research, 35% of 2,293 C-suite executives working in China said their business had to pay bribes or give gifts in order to operate. Transparency International ranked the country 100th out of 175 in its 2014 Corruption
Perceptions Index, compared to 17th for the US or 14th for the UK.
Currently, most CN firms have to pay a 33% premium over the market price to close a North American deal (Backaler, 2014), which can be attributed to regulatory complexity in China and unfamiliarity with western markets. However, some companies are learning through experience. Lenovo and ChemChina, have both already begun to apply the lessons of past mistakes, “Each post-merger integration has gone smoother than earlier deals,” (Backalers, 2014)
If CN acquirers could cut off the stupid 20 or 30%, that number that’s published and in truth accurate would be very, very different,” (Sher, 2007). The odds/pitfalls might be particularly high for Chinese outbound companies. where recent report by A.T. Kearney, concluded that “most outbound deals have not created value because Chinese companies had to overpay or were not able to capture operational synergies”, then in the pursuit of expansion outside of China, many are failing to avoid the most common pitfalls (Wang, P. 2009).
In addition to ordinary risks, CN companies must face challenges of learning to do business in a foreign market not just as an exporter but as an active participant, where regulations are one potential pitfall. In the US, companies must comply with complex accounting standards, labor laws and environmental standards, or face serious penalties. “Noncompliance can leave the buyer with disastrous unexpected liabilities,” (William J. Carney, 2010), if the acquisition is towards wester, the acquirer must also comply with Western stereotypes that they don’t use to deal with.
2. Theory and hypothesis
2.1. Cross-border versus domestic acquisitions
It has been argued that few theoretical and empirical research on national cultural differences in cross-border mergers and acquisitions (M&As) (Datta & Puia, 1995; Weber, Shenkar, & Raveh, 1996), with most M&A studies focusing on differences in corporate culture in domestic deals (e.g., Buono & Bowditch, 1989; Chatterjee, Lubatkin, Schweiger, &
Weber, 1992; Datta, 1991). Those domestic M&A studies could never be applied to investigate cross-border M&A research,
since the cultural difficulties of cross-border acquisitions are as large as those of domestic ones (Shimizu, Hitt, Vaidyanath,
& Pisano, 2004; Very & Schweiger, 2001). In conclusion, those cultural distances are often larger in cross-border deals
(Very, Lubatkin, & Calori, 1996; Weber et al., 1996), assuming employees are more deeply embedded in their national
beforehand than in their corporate culture (Hofstede, Neuijen, Ohayv, & Sanders, 1990). Then studying national cultural differences in cross-border acquisitions is to yield meaningful findings for Chinese buyers.
2.2. The cultural difficulties of cross-border acquisitions
National cultural distance can be defined as the extent to which the shared norms and values in one country differ from those in another (cf. Hofstede, 2001; Kogut & Singh, 1988; Morosini et al., 1998). There has been three research streams that can explain why and how a large national cultural distance affects cross-border acquisitions.
First, international management research has indicated that firms from culturally diversified countries have different organizational practices (Child, Faulkner, & Pitkethly, 2001; Kogut & Singh, 1988), such as management and strategic decision making styles (Ralston, Gustafson, Mainiero, & Umstot, 1993; Schneider & De Meyer, 1991), conflict resolution strategies (Cushman & King, 1985), human-resource management practices (Ngo, Turban, Lau, & Lui, 1998; Schuler, 1998), and codes of ethics (Langlois & Schlegelmilch, 1990) etc. In general, the larger the national cultural distance between the acquirer and the acquired unit, the more diversified and incompatible their practices are (Kogut & Singh, 1988),
and the more complicated their transfer (Geringer, Beamish, & daCosta, 1989). That makes acquisitions in culturally distant countries more costly to execute (Kogut & Singh, 1988).
Second, organizational theorists such as Buono and Bowditch (1989) have argued that employees are often deeply embedded in their own culture that the inter-firm contact resulting from an acquisition leads to misunderstandings, and to misattributions of motives and intentions, which boosts smooth interactions between people from different national cultures (Olie, 1996). The problematic interactions that result cause negative feelings among the workforces involved, such as uncertainty, confusion, helplessness, stress, discomfort, and hostility (Elsass & Veiga, 1994; Hofstede, 2001; Olie, 1996). These feelings can be subsumed under the term ‘acculturative stress’, which is the disruptive tension that is cognized by the members of a culture when they are required to interact with another (Very et al., 1996). In general, the larger the cultural differences between the acquirer and the target unit, the greater the amount of acculturative stress among their workforces (Berry, 1980; Very et al., 1996). Such stress has been argued by studies, which is to decrease the commitment, loyalty, cooperation, satisfaction, and productivity of employees (Buono & Bowditch, 1989; Very et al., 1996), to increase conflict potential and to hinder agreement over management issues (Olie, 1996), and to result in communication breakdowns, resistance to parent-company directives, and management underperformance (Neal, 1998).
Third, The human-resource management (HRM) literature has argued that acquiring firms often try to resolve or avoid the above problems by replacing the acquired unit’s management with their own executives/teams (Hambrick & Cannella, 1993). In other cases, managers do not await their replacement and leave on their own account (Krug & Nigh, 2001). Overseas acquisitions often lead to a destruction of human resources, which is a destruction of financial resources as a result (Hofstede, 2001).
Hypothesis. Since the power distance in national cultural distance moderates cross-border acquisition performance, so
cultural distance has a negative impact on overseas acquisition performance. As hypothesized, we think that these findings of study can be explained by the fact that the power distance between east and west countries leads to bad post-acquisition performance (cf. Datta, 1991; Very et al., 1997).
3. Methodology
3.1. Data collection and sources
Data for this study were traced from PwC CN and Thomson One, some data from PwC CN are confidential. The Chinese public firms (SOE and SME) with more than 500 employees and with at least one foreign subsidiary were selected.
104 cross-border acquisitions by CN firms were retrieved. As the recent 10 years are the peak season that Chinese buyers went abroad, so we drew our analyses acquisitions made from 2006 to 2016. During 2014-2016, Chinese economy has been slowing down, many Chinese rich business owners turn to invest abroad, so cross-boarder M&A has reach high levels in recent years. As a result, the sampling pool consists 104 firms and 125 M&A deals in 2006-2016.
3.2. Variables
According to previous statistical studies on the effect of national cultural differences among foreign acquisition performance, we measure national cultural distance through the Kogut and Singh (1988) index. This index is based on the differences in country scores on each of Hofstede’s (1980) four dimensions of national culture, i.e., uncertainty avoidance, power distance, individualism, and masculinity.
These differences use to be corrected for differences in the variance of each dimension and then arithmetically averaged, but in this research we take power distance as dominant variable and count for 100% for the cultural distance. Since other three factors in Hoefstede’s cultural criteria are mostly individual-oriented, except for power distance. And that is what we
are going to research about the distance between systems and regulations in east and west. Algebraically: where CDj is the cultural distance between country j (EU/US) and the China, Iij is country j’s score on the i-th cultural dimension, IiN is the score of the China on this dimension, and Vi is the variance of the score of the dimension.
Even though the model has its limitations (Shenkar, 2001), we consider the Kogut and Singh index to be the best measure for national cultural distance, since the scores on Hofstede’s dimensions are accessible for a large number of countries and many studies have confirmed their validity (e.g., Van Oudenhoven, 2001; for an overview of earlier replications, see
Sfndergaard, 1994), indicaitng that they can reliably be used to determine the cultural distance between countries.
We used OLS regression analysis with regular standard errors to estimate our models, as Cook- Weisberg tests indicated that they are not subject to heteroskedasticity. We estimated them with STATA MP 14.
3.3. Control variables
Regard to controlling for other factors that would influence the performance of foreign acquisitionsas well, Firstly, we control for the acquirer’s level of host- country experience, since acquirers with host-country experience are likely to perform better in managing local acquisitions (Li, 1995). We estimated this measure by scoring respondents whether their firm had been active in the country of the acquisition before through (1) licensing, (2) exports, (3) sales subsidiaries, (4) manufacturing or service sub- sidiaries, or (5) other means. We scored them in scale1 to 4 to the first four experience types, because the amount of interaction with locals, and hence the contribution to the acquirer’s local knowledge base, variation across them (Johanson & Vahlne, 1977). In few cases, acquirers had ‘excess’ experiences with the country of the
acquisition. The value we assigned to these experiences depends on the description of the samples. The measurement of host-country experience is the sum of the values assigned to the different experience types. Secondly, as experienced acquirers may have more skills to effectively form cross-border acquisitions (Padmanabhan & Cho, 1999), then we control for the acquirer’s level of cross-border acquisition experience as indicated by respondents on scale of 7. Thirdly, large acquisitions are more important to acquirers and thus generally receive more attention and support to ensure good result
(Ravenscraft & Scherer, 1987), so we control for the relative sizes of the acquisition (in terms of the number of employees
engaged in) as indicated by respondents on a 7-point scale. Fourthly, related acquisitions have a larger potential for economies of scale/ scope to create synergies (Datta, 1991), then firms making acquisitions in unrelated industries often lack the product/industry-specific knowledge required to successfully operate in such industries (Li, 1995), and we control for the relatedness of the acquisition as indicated by respondents on a 7-point scale. Fifthly, we have a dummy variable that we coded 1 for partial acquisitions, as they may perform worse than full ones due to conflicts between the partners about the strategy and management of the venture (Hennart, Kim, & Zeng, 1998). At last, acquisitions should perform better if the growth rate of the demand for their products is high if economic conditions are favorable (Hennart et al., 1998), controlling for the demand growth and economic conditions faced by the target unit during the first two years after the acquisition with indication on two 7-point scales.
3.4. Prospective common method bias
As the dependent variable (acquisition performance), one of the key independent variables (the planned level of post-acquisition integration), and controls are based on data provided by a single individual firm, and they might be affected by common method bias.
However, this is unlikely to irritate, as (1) the variables measuring acquisition performance and those measuring the planned level of post-acquisition integration are dissimilar in content, (2) these constructs are measured through a large number of sample, (3) top managers are familiar with them, and (4) the variables included in our models are a mix of
cognitive and explicit measures (Brouthers, Brouthers, & Werner, 2003). Rather, we performed a one-factor test of common method bias on our seven truly cognitive variables, which resulted in three factors, with acquisition performance, demand growth, and economic conditions having high loadings on the first (explaining 35% of the total variance), relative acquisition size and acquisition relatedness having loading highly on the second (20%), and the planned level of post-acquisition integration and acquisition experience mainly loading on the third (18%). So common method bias is not going to be a problem.
3.5 Method
We used OLS regression analysis with regular standard errors to estimate our models, as Cook- Weisberg tests indicated that they are not subject to heteroskedasticity. We estimated them with STATA MP 14.
4. Results
Table 1 shows the descriptive statistics and correlation matrix of the variables. The correlation between the independent
variables is generally low to moderate, except for that between demand growth and economic conditions (r = 0.46). However, the variance inflation factors of our models were all below 2, which is much lower than Hair et al.’s (1998)
threshold value of 10, indicating that our results do not suffer from multicollinearity.
Regression model 1 in Table 2 shows that national cultural distance does have a significant impact on cross-border acquisition performance in terms of our assumption. This is in line with our hypothesis, that depending on the level of post-acquisition integration, national cultural distance may have negative impact on acquisition performance. The model also argues that power distance negatively affects cross- border acquisition performance ( p < 0.01), indicating that foreign acquisitions generally perform poorly when they are cultural0diversified (cf. Very et al., 1997).
In order to test our hypothesis thoroughly, model 2 adds the interaction effect of cultural distance and the level of post-acquisition integration. This effect is significantly negative at the 5% level, implying the negative impact of cultural distance on cross-border acquisition performance, with cultural distance weakens performance (cf. Very et al., 1997). What’s more, negative effect on cross-border acquisition performance is stronger when national cultural differences are
large. An F-test showed that adding the interaction effect results in a significant increase in explanatory power ( p < 0.05), indicating that model 2 better explains cross-border acquisition performance than model 1.
With respect to the control variables, Table 2 shows significantly positive effects on foreign acquisition performance of host-country experience as expected, relative acquisition size, acquisition relatedness, demand growth, and economic conditions. We also find that partial acquisitions perform worse than full ones, indicating that having an equity partner is a disadvantage for CN firms making acquisitions abroad. In addition, acquisitions made by experienced foreign acquirers do not outperform those made by inexperienced ones, presumably acquiring firms tend to misapply the old knowledge/experience gained from previous acquisitions (Finkelstein & Haleblian, 2002).
5. Conclusions, implications, limitations, and suggestions
In this paper we try to reconcile the mixed empirical findings regarding the effect of differences in national culture (PD) on the performance of west acquisitions. In line with our hypothesis, we find that the planned level of poor post-acquisition integration caused by national cultural distance, where cultural distance has a negative impact on acquisition performance at high levels of national cultural distance.
A limitation of our study is that it ignores differences in corporate culture. As such differences are also important in cross-border acquisitions (Very & Schweiger, 2001), we recommend future studies to include the concept of ‘corporate cultural distance’ into our analysis as well, such as the organizational culture instruments such as Hofstede et al.’s (1990), where perhaps firms with compliance on western regulation/system would perform better than their domestic rivals.
The scientific implications of these findings are two- fold. First, it is insufficient to consider the extent of differences in national culture between an acquirer and an acquired unit in isolation when examining how these differences affect the performance of cross-border acquisitions. In order to accurately assess or predict this effect, scholars need to simultaneously consider the level of post-acquisition integration planned by the acquirer. Second, cultural differences are not necessarily harmful, as has often been argued in the literature, but also provide benefits in the form of unique organizational resources
(Morosini et al., 1998). However, acquired units can only benefit from the resources of their acquirers if they have
sufficient autonomy to use only those that are compatible with their own. This finding is in line with and adds to previous resource-based M&A research which has argued and found that differences between acquirers and acquired units are not necessarily detrimental, but can also have positive effects (e.g., Harrison, Hitt, Hoskisson, & Ireland, 1991; Vermeulen &
Barkema, 2001).
The main managerial contribution of our study is that management teams of acquiring firms should not unilaterally impose their countries’ culture (bribery/ fake) and practices upon an acquired unit if they want less disadvantage from the cultural differences existing between the two entities. They should rather try to maintain these differences by granting the acquired unit a considerable level of autonomy in compliance with their national culture, so that it can select those practices of the acquirer that it considers to be attractive and useful. If granting the acquired unit a considerable level of autonomy is not an
option for some centralized firms, the acquirer’s management should try to minimize the harmful impact of national cultural differences by clearly communicating to the acquired unit’s workforce why integration is beneficial, so as to minimize the risk of cultural conflicts. Many M&A studies have emphasized the importance of communication in post-acquisition operations (e.g., Child et al., 2001; Haspe- slagh & Jemison, 1991; Schweiger & DeNisi, 1991; Very & Schweiger, 2001), since the human side of an acquisition is at least as important as its strategic side (Very et al., 1997). Other ways in which acquirers can reduce culture-related integration problems by organizing intercultural workshops so that employees of the two entities become familiar with each other, operational managers of the acquirer should frequently consult with the acquired units, and hiring local human-resource consultants (Very & Schweiger, 2001).
The main limitations of our paper are our variables. First, since we only have data on the acquisitions’ initial performance, we cannot determine much further about the effect of national cultural distance on their long-term performance. This requires further screening on sample firms in a few years’ time. Second, the Kogut and Singh (1988) index questions that the cultural distance between countries is constant over time and that there are no intra-country variations in culture, among others (Shenkar, 2001). We therefore recommend future studies to run our tests with another cultural distance measures based on either more recent cultural frameworks (e.g., Schwartz, 1994) or managerial perceptions (cf. Very et al., 1997). Third, our post-acquisition variable measures the planned level of firm value and stock price. However, post M&A plans always change over time. Future research could examine the accumulative effect of the realized integration on acquisition performance, possibly by gaining more accurate data from long term (cf. Very et al., 1997; Weber et al., 1996).
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