Institutions, experience and performance: the effect of institutions, institutional distance and prior international experience on cross-border deal performance

Institutions, Experience and Performance:

The Effect of Institutions, Institutional

Distance and Prior International Experience

on Cross-Border Deal Performance

Master Thesis

MSc Business Studies, Strategy Track

University of Amsterdam, Amsterdam Business School August 15, 2014

Student: Yaroslava Belenko (5903041)

Supervisor: Bernardo Silveira Barbosa Correia Lima MSc Second Supervisor: Pepijn van Neerijnen

Word count: 9, 452

Abstract

Due to the mixed findings reported in the research identifying factors that explain acquisition

performance and the limitations of institutional theory implication in cross-border research this

paper contributes to the field by studying the influence of distinctive institutional factors on

acquisition performance. In addition, the study incorporates the learning theory in an attempt to

examine the moderation impact of experience on the institution – performance relationship.

More specifically, this study examines the effects of institutions and institutional distances on

performance and how this relationship is influenced by the parent company’s prior international

experience. The research is built on a sample of 591 international acquisitions by US based

firms. The findings of the empirical research show that institutions and institutional distances do

impact performance and under certain cases this relationship is moderated by prior

international experience.

Table of Contents

Institutions and Experience ... 11

Institutional Distance and Experience ... 13

Research Design... 15 Sample... 15 Dependent variable ... 16 Independent variables ... 17 Control Variables ... 18 Results ... 20 Discussion ... 32

Implications for the management... 35

Limitations and implications for future research ... 36

Conclusion ... 37

References ... 38

Appendix I ... 44

Introduction

Mergers and acquisitions (M&A) play an important role in today’s global market. The total value of acquisitions in 2013 reached $2.33 trillion USD (“Global Legal Advisory Mergers & Acquisitions Rankings 2013,” 2014). M&A formation is a complex process where numerous attributes need to be accounted for and the final decision is governed by a collective consideration of transaction costs, institutional and cultural variables (Brouthers, 2013). Ironically, despite the acknowledge fact of the high failure rate ranging between 50 to 60 percent (Cartwright & Cooper, 1993) the number of M&A deal announcements continues to grow from 30 thousand to 38 thousand worldwide between 2003-2013 (“M&A Activity: Number & Value of Announced Transactions,” 2014).

The cross-border M&A performance field is relatively new and even though a sufficient number of studies have been carried out, the analyses are fragmented and report inconsistent results. While some scholars find support that cross-border acquisitions result in value creation (Eun, Kolodny, & Scheraga, 1996; Vermeulen & Barkema, 2001), others argue that it destroys value (Datta & Puia, 1995; Moeller & Schlingemann, 2005). Therefore, when reviewing the research available King, Dalton, Daily, & Covin (2004) suggest that the further research in the field is of great value.

Cross-border deals have to conform with extra obstacles compared to the domestic ones. The study in cross-country investments has reported about the influence of national differences on strategic decisions (Davis, Desai, & Francis, 2000; Harzing, 2002) and even performance (Teerikangas & Very, 2006; Very et al., 1996). However, in more recent work Kostova et al. (2008) criticize the usage of traditional institutional theory and highlight the need for future studies to draw more distinctiveness in institutional factors. Researchers have also considered the

influence of the national distances between two parties on performance, however the reported results diverge. Some conclude that greater differences result in lower wealth creation (Datta & Puia, 1995), others state the opposite interpreting that while such deals lead to greater challenges it also creates greater opportunities to learn and explore, which eventually result in acquirers’ greater strategic flexibility (Vermeulen & Barkema, 2001).

Given that the existing research on success and failure factors of post-acquisition integration in cross-border deals is limited (Shimizu, Hitt, Vaidyanath, & Pisano, 2004) and the mixed empirical result in the existing work it is evident that further investigation of this topic is of great value. This paper contributes to the field by applying institutional theory in cross-border performance research to examine how institutions and institutional distances from the home country effect deal performance. Due to the need of further research regarding the outcomes of the unique institutional factors to identify the factors impacting acquisition performance (Kostova et al., 2008) distinctive institutional components are considered. This paper focuses on the effect of particular institutions in the divergent international environments. Additionally, the study addresses the issues raised in the existing research for a collective theoretical effort (Brouthers & Brouthers, 2000) by integrating learning and institutional theory in an attempt to bring clarity to the research on acquisition performance. The study incorporates prior international experience as a moderating variable to examine if it contributes to the interaction between institutions and performance.

This empirical study is grounded on a sample of 591 large (above $10 million USD) international deals completed by US based companies in the time period 1995-2004. The paper continues with the literature review section where a thorough analysis of the related literature in the field is carried out. It is followed by the hypotheses part containing propositions of the

current study and methodology. The results section presents the findings which are elaborated further in the discussion section after which managerial implications of this research are discussed. The paper ends with limitations of the current study and conclusion.

Literature Review

M&A deals have proven to be a complicated matter. Even at the stage of deal assessment a great number of attributes need to be taken into account: conformance with the regulations, assessing capital requirements, corporate and cultural integration, next to other potential risks and benefits of the deal. Researchers agree that amongst these criteria, special attention is given to the fit between the two companies (Datta & Puia, 1995; Jensen & Szulanski, 2004; Teerikangas & Very, 2006; Very et al., 1996; Weber, Shenkar, & Raveh, 1996), especially when the deals are cross-border (Angwin, 2001; Weber et al., 2011).

Even though the field of national differences in cross-border deals is researched extensively, there are still gaps to be addressed. For example, there persists a conflict in terminology choices. Teerikangas & Very (2006) examining culture–performance relationship, use the term “national culture” to describe the mindset of citizens in a country, their collective thinking and common beliefs. In entry modes research of the Chinese companies Chen, Yang, Hsu, & Wang (2009) embodied “formal institutions” to define government prescribed regulatory activities and “informal institutions” for the rules created and enforced by society. A number of other studies (Davis et al., 2000; Harzing, 2002; Huang & Sternquist, 2007) make use of “internal institutions” to describe interactions within a company and “external institutions” for other stakeholders involved. While these scholars incorporate cultural and institutional theories together and even though the two theories are not conflicting and share some fundamental

assumptions, the two views differ from one another (Mishler & Rose, 2001). Thus, the current research paper aims to disentangle culture from institutions with a special focus paid to institutions and performance relationship. The concept builds on the theoretical framework first developed by Richard Scott in 1995 and later revised and published in 2007.

Institutions

Institutions take their beginning from norms and long-formed beliefs that are at the heart of society. A conventional opinion is that the main purpose of institutions is to serve as regulators that dictate rules applied in a given environment (Davis et al., 2000). Institutions define organizations and set limits for what is considered appropriate actions in a particular setting. For example, while public organizations are often allowed to collaborate, the strategic choices of private firms have to attain regulatory approval. However, it is important to acknowledge that institutions go beyond the traditional perception of forming a constraint and serve a dual purpose of supporting and encouraging social behavior (Scott, 2007). Whereas institutions are put in place to bring order to human activity, their power may be exploited to protect national companies and limit the entrance of foreign firms (Shimizu et al., 2004). A compliance with local institutions is important for entering firms because organizations need more than physical resources and technological know-how. Attaining social acceptance and legitimacy is vital for survival (Scott, 2007). “The neoinstitutional model essentially holds that organizational survival is determined by the extent of alignment with the institutional environment" (Kostova et al., 2008, p. 997). It is crucial for the firms entering international markets to comply with the institutional regulation of the host country. Organizations’ acceptability and, therefore, success depend on it (Xu & Shenkar, 2002). These conclusions only amplify the significance of the

institutional theory and draw attention to the criticality of its consideration in the cross-border research.

Institutional factors may take various forms: formal laws and regulations and informal, such as rules shaped by industry or society (Chen et al., 2009). Scott (2007) defines the three building blocks of institutional structure: “Institutions are comprised of regulative, normative and cultural-cognitive elements that, together with associated activities and resources, provide stability and meaning to social life” (p. 48). Following this definition, the regulative view constitutes of formal rule-setting, monitoring and sanctioning processes (Scott, 2007). These institutions are associated with constraint forming organizations. Such bodies exist to impose regulations, monitor conformity of others to them and impose sanctions for cases lacking discrepancy. Normative emphasizes values and norms applied in social life and cultural-cognitive consists of words, signs and gestures that form social cognition (Scott, 2007). Cultural-cognitive elements compose the nature of human reality and represent a key point of difference of neoinstitutionalism in the fields of sociology and organizational studies (Scott, 2007, p. 57). Even though the three pillars are related, each forms a distinguished foundation for legitimacy (Scott, 2007, p. 61). Regulatory controls highlight alignments with rules, whereas, normative view in contrast is more focused on moral base and at last, cultural-cognitive system conforms to common beliefs. Most of the institutional forms observed in practice are formed as a combination of these factors (Scott, 2007, p. 62). Even though it is possible to integrate the three views in a single complex model, Scott (2007) concludes that it is best to consider each element separately for further research (p.70).

When reviewing existing research in the cross-border field Shimizu et al. (2004) raise the question whether agency theory is the best suitable framework to examine the effect of

international governance in cross-border M&As and highlight that it is important for institutional theory to be embedded. Existing empirical work presents findings that institutions influence managerial decisions. For example, number of studies in the international business field have identified that host country institutional conditions influence firms’ entering choices (Davis et al., 2000; Harzing, 2002). In a similar research about companies’ entering mode choices in cross-border deals Brouthers & Brouthers (2000) hypothesize and find support that institutional variables help to predict organizations’ strategic decisions. Numerous additional scholars emphasize the criticality of cultural difference in post-merger performance and incorporate it in their research (Teerikangas & Very, 2006; Very et al., 1996; Weber et al., 2011). However, the results of the studies focusing on this relationship are miscellaneous. Where some argue that cross-border deals on average do not create value (Datta & Puia, 1995; Moeller & Schlingemann, 2005), others come to the conclusion that cross-border M&A is a source of new information and capabilities and therefore view it as an affirmative strategy for expansion (Eun et al., 1996; Vermeulen & Barkema, 2001). Shimizu et al. (2004) highlights that current research on success and failure factors of post-acquisition integration in cross-border deals is limited and suggest that further investigation of this matter is of great value. Additionally, Kostova et al. (2008) criticize the traditional institutional theory and highlight the need to draw more distinctiveness in institutional factors in future research. It is for these reasons this study aims to contribute to the acquisition performance research by focusing on specific institutional elements, namely regulatory and cultural-cognitive to examine how these impact cross-border M&A performance where diverse institutional setting apply.

Experience

Even though learning theory has been addressed by numerous scholars in the M&A field, the empirical studies show mixed results. The research by Haleblian & Finkelstein (1999) analyzed the influence of acquisition experience on acquisition performance focusing on 449 large (above $10 million USD) acquisitions completed from 1980-1992. At first, performance was measured in terms of abnormal returns. Later, to test for robustness a revenue-weighted difference between post- and pre- acquisition performance was used. Alike results were achieved by means of both methods, market- and accounting-based. Numerous propositions were made and the results showed significant support for the prediction that organizational acquisition experience negatively related to acquisition performance (Haleblian & Finkelstein, 1999). The authors explicate that these results are consistent with theories of inappropriate generalization. Firms that make dissimilar deals carry on negative consequences.

Ellis, Reus, Lamont, & Ranft (2011) examined the transfer effects in large acquisitions. The study focused on large (above $100 million USD) domestic acquisitions in the United States between 1995-1998. Performance was classified successful when positive change in returns on assets occurred in the time between three years following the acquisition and one year prior to the acquisition. Contradictory to the results of Haleblian & Finkelstein (1999), the study found supporting evidence to conclude that the transfer theory of learning positively affects performance in case of large related acquisitions (Ellis et al., 2011).

A research paper by Muehlfeld, Rao Sahib, & Van Witteloostuijn (2012) exploring organizational learning in the global newspaper industry, on the other hand, presented findings that the context of experience in general contributes to learning. Success and failure both devote to the learning experience. However, even though failures contribute to learning, at first it

reflects a negative effect on performance until it reaches the turning point (Muehlfeld et al., 2012). These results are in line with another conclusion by Haleblian & Finkelstein (1999) who found supporting results for the U-shaped relationship between acquisition experience and acquisition performance. Therefore, another input of this study is to contribute to the research examining learning and performance correlation by incorporate learning theory in the analyses.

Cross-border acquisition is a complex process and in their theoretical review, Haleblian et al. (2009) suggest for future studies to contribute more focus to the post-acquisition stage. King et al. (2004) also argue that the existing empirical work in M&A has not clearly identified variables that impact acquisition performance which leaves room for future research. Delios & Beamish (1999) come to the conclusion that institutional context variables provide a valuable extension to the transaction cost theory in explaining firms’ strategic choices. Additionally, in their paper Brouthers & Brouthers (2000) suggest that interesting findings may arise from consideration of multiple theories at once. Therefore, the current study aims to contribute to the field of acquisition performance by examining distinct institutional factors and their effect on performance. Furthermore, this study contributes to the research of learning and performance by integrating learning and institutional theory to analyze how acquirers’ prior experience with non-domestic institutions influences cross-border acquisition performance. More specifically, this paper aims to answer the following research question:

Whether regulatory and cultural-cognitive institutions or the substantial differences of such

institutions between the home and the host countries in cross-border M&As impact the

acquisition performance and whether this relationship is moderated by prior cross-border

experience.

As the Bloomberg report indicated in the year 2013: the North American region completed 41% of all acquisitions with the United States as a leading acquirer with an outflow of $1.22 trillion USD (“Global Legal Advisory Mergers & Acquisitions Rankings 2013,” 2014). Because the US based firms are the most active in M&A and there is a large amount of data available, this study is focused on non-domestic acquisitions by American firms. The objective of this study is to investigate how institutions and institutional distances with the home country affect acquisition performance. Specifically, the analyses combines regulatory and cultural-cognitive institutional factors from 43 foreign countries to examine this relationship. In the process of addressing the research question this study is expanded by incorporating a moderating variable prior international experience to examine if it impacts the interaction between institutions and performance positively.

Hypotheses

Institutions and Experience

As measures for regulatory institutions property protection and labor market flexibility are examined and openness as an indicator for cultural-cognitive institutions. Following a study on intellectual property protection by Lee & Mansfield (1996), the results reveal that such regulations are bound to the overall legal system and serve as an indication of the general perception of property rights in the culture. Furthermore, the researchers find that greater volumes of foreign investments are reflected in countries where intellectual property protection appears to be higher (Lee & Mansfield, 1996). Property protection creates sense of security and safety for one’s belongings. Hence, stronger property rights in the host country are perceived positively by foreign investors. Based on the argument by Deardorff (1992) that property

protection rights have proven to lead to monopoly profits for those who take advantage of such regulations, it is anticipated that higher property protection positively associates with profits.

In his book “The wealth of nations” Adam Smith argues against labor market regulations in particular (Minowitz, 2004). Following his ideology, the invisible hand of open market determines the fair pay every worker deserves based on what he/she is “worth”. Such conditions appear to be favorable to businesses as it is in their right to negotiate the wages instead of being forced to pay a certain minimum amount. When a study by Blanchard & Giavazzi (2003) tested labor market deregulation with a macroeconomic model the results reveled that indeed eventually these conditions lead to lower wages. Hence, higher labor market flexibility supposedly is more attractive to businesses as it keeps the labor costs low which in turn enhances company performance.

Numerous studies come to conclude that cultural differences do matter in cross-border deals because culture is important in all aspects, including financial (Weber et al., 2011). In general, investors view higher degree of openness in a country positively. In their paper Sekkat & Veganzones-Varoudakis (2007) emphasize that in order for economies to be more appealing to foreign investors higher level of openness needs to be initiated. Because managers view openness as an attractive attribute in a foreign country it is interesting to explore whether the desirable higher scores positively relates to the acquisition performance. Given the review of the three institutions, the following hypothesis is proposed:

Hypothesis 1: There is a positive relationship between the host country institution and M&A

performance: higher property protection, labor market flexibility and openness contribute to

higher performance.

Scholars often argue that companies with previous M&A experience perform better than those without (Haleblian & Finkelstein, 1999). The study by Muehlfeld et al. (2012) finds that learning from successful experiences positively enhances future performance. Learning from failure also positively contributes to future performance, however, the pattern is U-shaped where after a turning point the chances for future success increase (Muehlfeld et al., 2012). Alongside, the research by Haleblian & Finkelstein (1999) on acquisition experience and acquisition performance displayed support for the U-shaped association supporting the proposition that eventually experience enhances performance. Another study by Ellis et al. (2011) examining large domestic acquisitions in America found a direct support for positive association of the transfer theory of learning and performance. Given the focus on firms which have completed two or more large acquisitions and following from the findings in prior literature it is anticipated that experience contributes to performance. Hence, a positive moderation of experience on performance is predicted at every level of institutional score. The following prediction is constructed:

Hypothesis 2: The acquirer’s prior international experience positively moderates the

relationship between property protection, labor market flexibility, openness and M&A

performance, in such a way that the relationship becomes more positive with experience.

Institutional Distance and Experience

The study by Weber et al. (1996) found that differences in national cultures between two parties predict attitude towards the deal and often are associated with stress, negative perception towards the deal and cooperation overall. Such differences generally form resistance to change which results in conflicts on a path to successful integration (Weber et al., 2011). The research by Angwin (2001) lead to analogous results with the author inferring further that national cultural

differences may convey important consequences for the post-acquisition phase and the deal in general. In line with this proposition research by Dikova, Sahib, & van Witteloostuijn (2009) came to conclude that deal complexity increases considerably when country specific regulatory institutions differ significantly. Typically, with greater degree of institutional differences a higher level of adaptation is required (Jensen & Szulanski, 2004). Other studies focused on the relationship between cultural distance and performance and reflected significant association. Weber et al. (2011) found that cultural differences form a critical obstacle for acquisition performance. Likewise, Datta & Puia (1995) reported results that cultural distance negatively affect shareholder wealth created. Based on this literature and results of a study by Kostova & Zaheer (1999), showing that acquirers adjust more easily in the environment where institutional laws are more closely related to their own, it is anticipated that institutional distance negatively relates to performance. Thus, it is hypothesized that higher institutional distance contributes negatively to the acquisition performance:

Hypothesis 3: There is a negative relationship between the distance of property protection, labor

market flexibility and openness of the parent’s and the target’s home nations and the M&A

performance; as the institutional distance increases performance decreases.

In accordance with the argumentation for Hypothesis 2 where it is anticipated experience contributes to performance and given the proposition above that low institutional distance positively affects acquisition performance a positive moderation of experience on performance is predicted at all scores of institutional distance. This effect is especially anticipated when institutional distance scores are low because such conditions decrease deal complexity (Dikova et al., 2009) making adaptation easier (Kostova & Zaheer, 1999) and, thus, more likely to lead to

learning from success which enhances performance (Muehlfeld et al., 2012). Given this, the following hypothesis is formed:

Hypothesis 4: The acquirer’s prior international experience positively moderates the

relationship between the distance of property protection, labor market flexibility and openness of

the parent’s and the target’s home nations and the M&A performance; the negative relationship

weakens with experience.

Research Design

The data sample consists of foreign deals performed by American firms in the period between January 1995 and January 2005. It is comprised of large acquisitions with the asset value of above $10 million USD. Large deals are more likely to convey noticeable impact on market valuations (Chatterjee & Lubatkin, 1990; Haleblian & Finkelstein, 1999). Each acquirer in the data set operates within the manufacturing industry and is traded on one of the major stock exchanges. The sample contains 722 “foreign” deals executed in 43 countries around the globe other than the USA. The deals are “completed”, meaning the bidding firm has gone beyond the public announcement phase and already offered cash or securities and with a “majority stake” where the ownership of the bidding firm exceeds 50 percent.

Records for dates of announcement, acquisition experience and control variables were derived from Securities Data Company (SDC), a division of Thomson Financial. The database collects information through such sources as U. S. Securities and Exchange Commission (SEC), official news releases and tracks changes for variety of industries (Schilling, 2009). SDC provides information regarding global financial activity including thorough information on joint

ventures and merger and acquisition deals (“SDC Platinum | Thomson Reuters,” n.d.). Furthermore, one of the biggest advantages of this database is that it allows distinguishing between “completed” versus “pending” deals (Schilling, 2009).

Following the SDC data collection the deal information was matched to data in COMPUSTAT. The COMPUSTAT database provides financial, statistical and market information about companies throughout the world. From the data collected 516 deals were matched to firms registered in COMPUSTAT using the “acquirer CUSIP”. Additionally, 76 deals were matched using “acquirer immediate parent CUSIP”. From the deal sample, 130 were eliminated due to various reasons such as inability to match with the data in COMPUSTAT using the methods described above.Therefore, the final sample resulted in 591 deals.

Dependent variable

In order to measure performance an event study was used. It measures the impact of the deal announcement on the value of the firm in terms of abnormal returns. Such method presumes market efficiency in which security prices reflect market reactions to the information publically available and rapidly adjust upon new information releases. This study followed the steps of conventional event study methodology as presented by Haleblian & Finkelstein (1999). In short, an event study concerns the market reactions around the public announcement stage.

Acquisition Performance

To calculate expected return a market model was used. This model assumes a stable linear relation between the market return and the firm’s return. Abnormal returns are calculated as the difference between the observed return and the predicted return. Mathematically, the impact of the event is express as follows:

𝑒𝑒 = 𝑅𝑅𝑖𝑖𝑖𝑖− (𝛼𝛼𝑖𝑖+ 𝛽𝛽𝑖𝑖𝑅𝑅𝑚𝑚𝑖𝑖),

where R_it is return on stock i at the moment t; R_mt the market returns for the time t; α_i is a constant and β_i is the beta of stock i (Haleblian & Finkelstein, 1999). Here, α and β are calculated during an arbitrary estimation window. This study tested multiple event windows of one, two, three, four, and six days prior to and following the acquisition announcement. However, a one day window prior to and following the event yield the greatest results.

The data regarding market returns was collected from the Center for Research in Securities Pricing (CRSP). Finally, the analysis of Cumulative Abnormal Returns was performed with EVENTUS software by matching the previously constructed input file with company CUSIP and the event date.

Independent variables

Institutions

Data regarding institutional regulations for the countries in the sample was collected through two sources, namely: Global Competition Review (GCR) and World Competitiveness Yearbook (WCY) for year 2004 and 2005 respectively. The data from the GCR report is rated on a scale from one to seven, where one is a low score (rights poorly defined) and seven is associated with a high score (rights clearly defined and protected) (see Table 6 in Appendix I for full description). The WCY report rates data on the scale from 0 (regulations set by centralized negotiation) to 10 (regulations up to each individual company). Because the variables are scored on a diverse likert scale each is standardized (z-score). As the final step, a factor analysis is performed where variables with the highest factor loading are grouped into three factors, namely: Property protection, labor market flexibility and openness. Each factor contained three variables

(in the following order), scores for five of them are used from the GCR report: property right protection, intellectual property protection, judicial independence, hiring & firing practices, wage

determination. The rest is extracted from the WCY report: labor regulations, international experience, national culture, and attitudes toward globalization.

Distance

In this study distance is the number that represents the difference in the institutional scores between the home (USA) and host country. Distance is calculated as the average number of distances in each variable forming a factor. The formula for the distance variable included the z-score of the USA subtracted from the z-z-score (as explained above) of the foreign country for each of the three variables in a factor and then divided by the average of three.

Experience

In the sample, companies with one cross-border deal or less are considered as lacking international experience. Prior international experience is measured with a dummy variable. Zero stands for no prior international experience, i.e. the company has completed only one cross-border M&A prior to or during the sampling period. One indicates the presence of prior international experience and stands for at least two international deals complete by a single firm.

Control Variables

There are number of additional variables which were not considered yet but may have an impact on market-based deal performance. Therefore, their effects need to be controlled for. This research makes use of control variables implemented primarily by Haleblian & Finkelstein (1999) in previous studies in acquisition performance.

Acquirer-to-target relatedness

Because firms may see greater potential for synergies of targets related to the parent such acquisitions may be considered more valuable than unrelated ones (Haleblian & Finkelstein, 1999). Ellis et al. (2011) found supporting results that the positive relationship between the

acquirer to target relatedness and performance holds true in case of large acquisitions. Thus, it is highly likely that organizations choose related acquisitions over unrelated. Relatedness is measured following the Haleblian & Finkelstein (1999) study with the 4-digit industry SIC code for the six largest lines of business (in sales) for both parent and the target. An acquirer and target were classified as “related” (one) if they shared at least one 4-digit SIC code. Otherwise the deals were classified as “unrelated” (zero).

Relative acquisition size

Previous studies found the ratio of target to acquirer size to positively relate to acquirer abnormal returns, and in turn acquisition size to proportionally associate with gains (Haleblian & Finkelstein, 1999). For this reason it is decided to control for this affect to avoid bias results. The variable is measured as the ratio of target assets to acquirer assets.

Percentage of deal paid in cash

Existing studies suggests that the payment method is important to consider when studying acquisition performance. In general, cash offers are completed faster in comparison to stock payments and often send a signal that the firm is undervalued if the bidder chooses such type of payment (Haleblian & Finkelstein, 1999). Scholars point out that cash payments generate significantly higher returns than stock financed deals (Hayward, 2002). In this study the value of the percentage paid in cash for each deal is indicated and zero is used for missing values and stock financed acquisitions.

Acquirer slack

Research indicated that there are numerous potential impacts of slack on an acquisition. The findings reveal that with greater amount of slack resources less financing is required, while financing is less costly and slack is even directly associated with acquisition success (Haleblian

& Finkelstein, 1999). The measure for acquirer slack is calculated as the average debt-to-equity ratio. Afterwards the scores are Winsorized by a value of 0.1 to replace extreme values.

Year affect

The year of acquisition is a set of the dummy variables ranging from 1996 to 2004. One stands for the particular year and zero for all other years. The dummies are used in every estimation equation but are not displayed in the result tables to avoid cluttering. In most of the models the dummies are not significant; however, removing them affecting the results.

Industry and country performance

Two additional variables, industry performance and country performance prove to bring significant contribution to the results and therefore are important to be considered. Industry performance is calculated as the return on assets (ROA) for the industry of the acquired country in the year of acquisition completion. These are later Winsorized by a fraction of 0.1 to replace extreme values. Country economic performance is measured as the level of gross domestic product (GDP) per capita of the host countryfor the year of acquisition announcement in USD.

Results

In the sample a large number of observations occur in the European region (see Table 1). These outcomes are not of a surprise since Europe forms the second most attractive target market for acquisitions after the US with 28% of the total number of completed acquisitions in the same year (“Global Legal Advisory Mergers & Acquisitions Rankings 2013,” 2014). The total sample of 722 deals is dominated by two countries reoccurring frequently, namely Canada with 118 observations and United Kingdom 202 observations, which clearly indicates preferred markets for American investments. These results are can be explained by the fact that all three countries share the English language and such eliminates the communication barrier due to translation.

Also, in general the countries share some similarities historically, however, US and Canada are more alike in comparison to US verses UK. Geographically Canada is a neighboring country to the US and the two share a long standing relationship along with the Free Trade Agreement which makes it easier (without tariffs) to exchange goods across borders.

Table 1 US target nations by number of deals between 1995-2004

Target nation Number of deals Target nation Number of deals Target nation Number of deals

United Kingdom

202 Argentina 9 Greece 2

Canada 118 Ireland-Rep 9 India 2

Germany 64 Norway 9 Malaysia 2

France 46 Spain 9 Thailand 2

Australia 33 South Korea 8 Venezuela 2

Netherlands 29 Belgium 7 El Salvador 1

Sweden 24 Hong Kong 6 Luxembourg 1

Israel 18 Puerto Rico 6 New Zealand 1

Japan 15 South Africa 5 Pakistan 1

Switzerland 13 Finland 4 Panama 1

Brazil 12 Taiwan 4 Philippines 1

Italy 12 Chile 3 Poland 1

Denmark 11 Singapore 3 Russian

Federation 1 Mexico 11 Czech Republic 2 China 10 Egypt 2

Besides the geographical disadvantage between the US and UK there is also an institutional distance. Even though the US and the UK historically have similar ideological goals, historical differences in the political structure form a constraint to the policy transfer. In contrast, American and Canadian political systems are similar, which contributed to a smoother adaptation of similar regulations between the countries (Dolowitz & Marsh, 1996). Ferner, Almond, & Colling (2005) use an example of the differences in labor diversity policies between US and Britain which as the authors explain is due to the fact that the countries of the European Union

have to comply with the Union’s regulations as well as of their own country. Lasprogata, King, & Pillay (2004) present related findings concluding that if one would graph the employee privacy rights for the three countries on an axis, ultimately the US and the UK are the two extremes with Canada in between. And finally, the study by McCallum (1995) comes to the conclusion that the US and Canada are very similar in culture, language and institutions. This is in line with the sample data collected for this study. The scores for all three institutional factors of Canada have very little, if any, variation of those in US, whereas the UK scores fluctuate more, especially in labor market flexibility. Therefore, it was decided to eliminate Canadian deals to prevent bias results.

Table 2 presents descriptive statistics and correlations for the variables used in this research. As the mean statistics show, the sample is dominated by institutions with higher property protection and lower labor market flexibility and openness. The acquirer-to-target relatedness indicates that 68 percent of the deals share the same SIC industry code. This supports the estimation that companies feel more comfortable investing in similar industries (Haleblian & Finkelstein, 1999). For the deals in the sample, companies on average companies were purchased with 43 percent cash. The positive coefficient between the percentage of cash paid and the acquisition performance suggests that the returns to the bidding firm are higher with a greater percentage of the acquisition price paid in cash, which is consistent with conclusions of prior studies (Hayward, 2002). The positive and highly significant coefficient between acquirer slack and acquisition performance indicates that higher level of slack resources is positively associated with performance in the sample. As expected all institutional variables are correlated to one another. It is worth to note that the descriptive statistics revealed positive correlation for some institutions and country GDP.

Table 2 Descriptive Statistics

Means, Standard Deviations and Correlations for variables in the study (N= 591)

Variable Mean S.D. 1 2 3 4 5 6 7 8 9 10 11 12 13

1 Acquisition performance

.01 .08 2 Property protection

.66 .71 .05 3 Labor market flexibility

-.10 .90 -.07 .18** 4 Openness

-.12 .74 -.08 .26** .21** 5 Property protection

distance .64 1.42 .00 -.89** -.14** -.24** 6 Labor market flexibility

distance 2.71 2.50 .08 -.11** -.96** -.21** .10* 7 Openness distance .83 .89 -.05 -.26** -.23** .10* .09* .30** 8 Prior international experience .72 .45 -.02 -.04 -.06 .00 .04 .07 .02 9 Acquisition-to-target relatedness .68 .47 .00 .03 -.02 -.01 -.02 .01 .00 .00 10 Relative acquisition size

.55 8.72 -.11* .03 .04 -.01 -.02 -.04 -.04 -.08 -.06 11 Percentage of deal paid in

cash 43.36 47.13 .08* .08 .02 -.09* -.04 .00 -.05 .09* .03 -.04 12 Acquirer slack 1.07 1.51 .12** .09* .07 .01 -.06 -.05 -.01 .02 .02 .05 .00 13 Industry performance .17 .16 -.01 -.01 -.04 .04 .01 .06 .00 .15** .07 -.14** .06 -.26** 14 Country performance 23797.62 9018.81 -.03 .69** .02 .09* -.59** .06 -.02 -.04 .02 .00 .06 -.01 .07 *p < .05 **p < .01 23

Countries with higher property protection and openness institutions have better GDP per capita levels. And the property protection distance from the US score is correlated negatively with country performance. Overall, even though the multicollinearity analysis for some coefficients is significant, most of them are well below the cut-off point of 0.7 indicating no major multicollinearity issues amongst the variables. The country performance coefficient is highly correlated to property protection (positive) and property protection distance (negative) variables. These results indicate that countries with higher property protection enforcement perform better and the greater this level deviates from the score of the US, higher is its negative effect on performance. Even though the correlation coefficients are high and significant the variables are retained for further analysis since the coefficients are below the suggested 0.7 cut-off threshold.

To analyze the cross-sectional data ordinary least squares (OLS) regression tests are performed. Such method helps to track the relationship between the variables and produces solutions that can be interpreted. Results for control variables and Hypotheses 1 and 2 are summarized in Table 3 and for the distance Hypotheses 3 and 4 in Table 4. In the tables, the reported R-squares may appear relatively low, however, this is a typical result in studies where abnormal returns are used as a dependent variable (Haleblian & Finkelstein, 1999). Throughout all models the constant term was not significant; this indicates a lack of a statistically significant relationship between the independent and dependent variables. Model 1 (see Table 3) represents analyses of the control variables. Here, there are two highly significant coefficients that determine performance. Relative acquisition size negatively relates to acquisition performance which is contrary to the findings by Haleblian & Finkelstein (1999). This indicates that larger target company assets negatively affect acquisition performance. The acquirer’s slack resources in the analysis appear to positively relate to acquisition performance.

Hypothesis 1 predicted a positive relationship between institutions and performance. The results with partial support for the predictions are reported in Model 2. There is a positive relation of property protection but, however, a negative relation of labor market flexibility and openness to performance. This means that higher property protection contributes to greater acquisitions performance as was previously theorized and in line with findings in prior research about such rights leading to monopoly profits (Deardorff, 1992). The findings about higher labor market flexibility negatively affecting performance of the acquisition are surprising. This is possibly due to the fact that in the sample at the high end of the labor flexibility market there were countries like Finland and Denmark where high social standards apply. Even though no minimum wage is enforced by the government, companies are required to reimburse their workers with a minimum wage negotiated with the labor unions which are typically powerful. A possible alternative explanation for the negative labor market flexibility effect is the argument by Cahuc & Postel-Vinay (2002) that firms carry high costs of hiring due to the deregulation of labor laws. High openness also showed a negative effect to acquisition performance. A study by Stulz & Williamson (2003) reveal interesting findings that not all countries open to globalization offer protective regulations towards foreign investors. For example, while creditor rights may positively relate to openness shareholder rights may have a negative relationship.

Hypothesis 2 argued that prior international experience positively moderates the relationship between institutions and performance. The results of Model 3 present partial support with two interaction terms having significant coefficients. The insignificant coefficient for prior international experience shows no observable relationship with profitability.

Table 3

Acquisition performance

Variable Model 1 Model 2 Model 3

Controls only Institutions Institutions

and Experience Constant 18.85 26.11 -61.19 (181.28) (188.59) (208.31) Acquisition-to-target relatedness -.13 -2.83 -1.74 (74.09) (73.54) (73.42) Relative acquisition size -9.97*** -9.85*** -10.37***

(3.83) (3.78) (3.79)

Percentage of deal paid in cash 1.04 .83 .96

(0.72) (0.72) (0.72) Slack resources 65.74*** 61.70** 59.00** (24.26) (24.2) (24.29) Industry performance 189.52 241.66 0.03 (220.59) (219.09) (220.96) Country performance .00 -.01 -.01 (0.) (0.01) (0.01) Property protection 138.85* 314.69** (74.97) (124.45) Labor market flexibility -69.29* -134.52*

(39.04) (80.83)

Openness -111.63** -275.05***

(49.76) (93.61)

Prior international experience 106.52

(121.48) Prior international experience ×

property protection

-224.69* (124.31) Prior international experience ×

labor market flexibility

74.79

(92.21) Prior international experience ×

openness 225.55** (109.08) N 542 537 537 R-square 0.068 0.089 0.103 Adjusted R-square 0.041 0.057 0.065 *p < .10 **p < .05 and ***p < .01

Unstandardized coefficients reported; standard errors are in parentheses. All coefficients and standard errors are multiplied by 10000. Dummy variables for each year are omitted.

For the interaction variable, in case of no prior international experience a one unit increase in standardized score of property right protection yields a change in abnormal returns of the acquisition equal to 3.1 percent. On the other hand, contradictory to the hypothesis prior international experience diminishes this effect by 2.2 percent of the acquisition’s abnormal returns (holding other variables constant). These results are in line with the findings by Haleblian & Finkelstein (1999) who elucidate that such outcome is a consequence of an inappropriate generalization. With experience firms accumulate heterogeneous knowledge and are more likely to make a generalization error when choosing to initiate a new deal (Zollo & Winter, 2002). Further, the results indicate that one unit increase (one standard deviation above the mean) in labor market flexibility decreases performance by 1.3 percent. The interaction term prior international experience × labor market flexibility is not significant which indicates that the experience in this case is unimportant and has no significant effect on performance or on the relationship between labor market flexibility and performance. The increase of openness by one standard deviation above the mean results in a 2.8 percent decrease in abnormal returns. However when a company was exposed to international acquisitions, one unit increase in openness outweighs this decrease in abnormal returns by 2.3 percent. These results are in line with the predictions and the theory of learning where experience contributes to performance (Muehlfeld et al., 2012). According to the theory, new acquisitions unavoidably involve new knowledge which broadens a company’s knowledge (Vermeulen & Barkema, 2001). In order to better see the influence of experience the statistically significant interaction terms are graphically represented in Figure 1 and Figure 2.

The Figure 1A shows that with international experience the acquisition performance is more consistent across all values of property protection, below as well as above the mean.

For companies without experience, acquisition performance is lower at property protection below the mean and higher than of those with experience when property protection scores are above the mean. Figure 1B represents the marginal effect of international experience from the results displayed in Figure 1A. The graph shows that the effect of international experience on performance is stronger at positive property protection scores when the institutional score is below the mean. Prior international experience negatively affects performance when property protection is above the mean.

Figure 2A depicts a graphical representation of the interaction term prior international experience × openness. With international experience acquisition returns are more consistent and are slightly above zero on average across all scores of openness. Having no international experience positively affects performance at openness below the mean and negatively when openness is above the mean. Figure 2B represents the marginal effect of international experience on the relationship between openness and acquisition performance. The graph displays that the

Figure 1 A Property protection and performance withe experience as moderator

B Conditional marginal effect of prior international experience on property protection and performance relationship

effect of experience is stronger the more openness deviates from the mean. International experience at lower openness affects performance negatively and positively at high openness.

Hypothesis 3 predicted that greater institutional distance from the home country is negatively relate to acquisition performance. Model 4 (see Table 4) displays partially supportive results. As the distance for openness increases it negatively affects performance, which is in line with the predictions. These results suggest that the greater deviation of openness from the home (USA) scores, the higher is the negative affect on the acquisition performance. However, the findings regarding labor market flexibility are contradictory to what was hypothesized. The results reveal that as labor market flexibility distance increases it positively affects performance, meaning that greater deviation of labor market flexibility from the home (USA) institutions leads to better acquisition performance. These results may be explained by the fact that the M&A decisions are well planned with all costs and benefits weighted, companies hire lawyers and bankers to assess the opportunities and threats.

Figure 2 A Openness and performance withe experience as moderator

B Conditional marginal effect of prior international experience on openness and performance relationship

Table 4

Acquisition performance

Variable Model 4 Model 5

Institutional distance Institutional distance

and Experience

Constant _{-31.89 1.15}

(220.54) (220.31) Acquisition-to-target relatedness _{7.12 10.31}

(73.61) (73.8)

Target-to-acquisition relative size _{-9.83*** -9.87***}

(3.78) (3.8)

Percentage of deal paid in cash _{1.00 1.09}

(0.71) (0.72) Slack resources _{63.68*** 61.37**} (24.11) (24.27) Industry performance _{183.17 240.65} (218.64) (221.06) Country performance _{.00 .00} (0.01) (0.01)

Property protection distance _{6.74 -17.72}

(31.35) (66.67)

Labor market flexibility distance _{37.49*** 84.13***}

(14.17) (30.58)

Openness distance _{-107.06** -194.63**}

(42.62) (83.61)

Prior international experience _-46.18 (125.07) Prior international experience ×

property protection distance 27.47 (67.97) Prior international experience ×

labor market flexibility distance -57.40* (34.45) Prior international experience ×

openness distance 112.30 (97.33) N 537 537 R-square 0.088 0.096 Adjusted R-square 0.057 0.058 *p < .10 **p < .05 and ***p < .01

Unstandardized coefficients reported; standard errors are in parentheses. All coefficients and standard errors are multiplied by 10000. Dummy variables for each year are omitted.

Teerikangas & Very (2006) propose that cross-border deals achieve higher levels of synergy than domestic M&As because foreign companies are more aware of cultural differences as oppose to domestic firms. The authors conclude that cultural differences impact the choice for synergy strategies which in turn reflects on performance (Teerikangas & Very, 2006).

Hypothesis 4 projected that prior international experience moderates the relationship between institutional distance from the home to host country and performance; i.e. the negative effect of higher distance on performance diminishes with experience. The premise of this hypothesis is not supported. The results in Model 5 demonstrate that the coefficients for openness distance and labor market flexibility are significant, while the prior international experience variable did not show substantial influence on the dependent variable performance. Higher institutional distance from home (USA) to the host country in labor market flexibility positively reflects on performance increasing it by a slight margin of 0.8 percent. The interaction term prior international experience × labor market flexibility distance diminishes acquisition performance by a marginal change of 0.6 percent. The openness distance coefficient indicates that a one unit increase in the variable results in 1.9 percent decrease in performance. Nevertheless, the interaction variable prior international experience × openness distance is not statistically significant. Figure 3A and 3B offer a graphical representation of the prior international experience effect on the relationship between labor market flexibility distance and M&A performance. In Figure 3A it is shown that performance of companies with prior international experience is more stable as oppose to those without across all values of labor market flexibility distance. The Figure 3B illustrates that when institutional distance is low, experience conveys a positive effect, however, as the distance increases the effect becomes more negative. These results are in line with earlier studies emphasizing inappropriate generalization

error as a result of rich investment experience (Haleblian & Finkelstein, 1999; Zollo & Winter, 2002). The results of all analyses with significant coefficients are summarized in Table 5.

Figure 1

Discussion

This study examined the effect of institutions and institutional distance on acquisition performance in cross-border deals and whether prior international experience positively contributes to this relationship. By doing so it was intended to integrate two theories, institutional and cross-border in one. Because national institutions are often country specific and serve as constraining measures it creates a certain span of what qualifies under “appropriate” activities. These measures influence organizations’ choices for mode of entry (Xia, Boal, & Delios, 2009), strategy (Brouthers & Brouthers, 2000) and survival (Delios & Beamish, 2001). Even though a considerable amount of literature is focused on the post M&A phase, the results are largely inconsistent. While some scholars argue that cross-border acquisitions lead to the shareholder

A Labor market flexibility distance and performance withe experience as moderator B Conditional marginal effect of prior international experience on labor market

flexibility distance and performance relationship

value distraction (Datta & Puia, 1995), others view it positively and come to a conclusion that M&A is the only way to develop and learn which eventually leads to fruitful results (Eun et al., 1996; Hayward, 2002). Therefore, another objective of this study was to contribute to the literature of deal performance by identifying a set of variables impacting performance. Finally, the study expanded further the research in cross-border performance by integrating the learning theory to examine whether prior international experience moderate the interaction between institutions and performance.

Table 5 Summary of results

Hypothesis Expected relationship

to performance

Results

H1 Property protection

₊

Labor market flexibility

₊

Openness

₊

H2 Prior international experience ×

property protection

+

-224.69* (experience effect is positive at low property protection and negative at high property protection)

Prior international experience ×

openness

+

225.55** (experience effect is negative at low openness and positive at high openness)

H3 Labor market flexibility distance

_{_}

Openness distance

_{_}

H4 Prior international experience ×

labor market flexibility distance

+

-57.40* (experience effect is positive at low labor market flexibility distance and negative at high labor market flexibility distance)

*p< 0.1 **p < .05 ***p < .01

Unstandardized coefficients reported; standard errors are in parentheses. All coefficients and standard errors are multiplied by 10000.

The theory was built on the institutional framework developed by (Scott, 2007). Eventually three institutional factors were considered, namely property protection, labor market flexibility and openness. The sample contained US based firms who completed at least one large

(above $10 million USD) international deal in the period between January 1995 and January 2005. Firms with two or more international deals were coded as having had prior international experience. Results of the study reveal that institutions do have an impact on performance but not always in the expected course. While high property protection as hypothesized positively contributes to performance, high labor market flexibility and openness affect acquisition performance negatively. A possible justification of this relationship is the argumentation that relaxed regulations convey overlooked costs. Having no government obligation to offer fixed contracts employers carry high costs of hiring (Cahuc & Postel-Vinay, 2002). Similar findings are presented by Stulz & Williamson (2003) who found that high openness may be accompanied with a great deal of creditor right enforcement but very low shareholders rights. Experience proved to have a significant moderation effect in two interactions out of three. The findings are in line with the forecast that institutions do affect performance and experience does have an effect on this relationship. However, the course of the effect diverges for diverse institutions. In case of property protection, having prior international experience did not result in higher profits. International experience proved to have a strong positive effect on performance at property protection scores below the mean and negative at property protection above the mean. These results are in line with a theory of inappropriate generalization. Zollo & Winter (2002) explain that experience increases chances of making a generalization error due to diversity of knowledge attained. For openness, the acquisition returns of companies with prior international experience are more consistent and are slightly above zero on average across all scores. The effect of experience is stronger the more openness deviates from the mean with a negative effect on performance at lower openness and a positive effect at high openness scores.

The findings for institutional distance variables are also partially in line with the proposed hypotheses. Property protection distance did not prove to have a statistically significant influence on M&A performance. Contrary to the expectations, increase in labor market flexibility distance institutions from the home market (USA) showed a low but significant coefficient positively related to performance. The results indicated that companies are capable to overcome institutional contrast by carefully assessing conditions (Dikova et al., 2009). The outcome for openness distance, however, was in line with the premise. Increase in openness distance lead to a negative impact on acquisition performance. Adding the experience moderator variable to the model resulted in only one significant interaction. Prior international experience affected acquisition performance positively at low labor market flexibility distance from the home country (USA) and negative at high institutional distance. These findings again are consistent with the inappropriate generalization theory where having a relevant experience positively reflects on performance (Ellis et al., 2011), however, dealing with numerous and very diverse experiences undermines performance (Zollo & Winter, 2002).

Implications for the management

Skeptics may put the significance of institutional factors under question and argue that other aspects of the cross-border deals are of greater importance. Undoubtedly payment methods and ownership stake are crucial to take into account. Nevertheless, the results of this study showed that the magnitude of the impact of institutions and institutional differences on organizational performance is significant and therefore important for consideration in managerial decisions. What is more important, the anticipated direction of the effect does not always hold true. For instance, labor market flexibility and openness revealed negative relationship to acquisition

performance. Additionally, experience does not necessarily guarantee desired performance. Managers should not rely blindly on experience as its impact is not necessarily positive.

Limitations and implications for future research

There are several limitations to this study that need to be discussed. First, the factors used for measuring institutional variables were initially human rated. Such measuring technic may have caused a bias. Second, the study used an even study approach to measure acquisition abnormal returns. While this method is useful, it does not take into account the impact of the information leakage before the official public announcement is made. Therefore, this research will benefit from implication of additional methods measuring performance, for example ROA. And third, the sample used was dominated by deals in the United Kingdom. Even though the institutional characteristics deviate from those in the United States, these deals accounted to 1/3 of the total sample.

This study took into consideration only a little fraction of all institutional aspects and it would be beneficial to expand this research by considering a wider variety of such variables. Consideration of differentiated institutions may be accompanied with a choice of different industries as this study focused purely on the manufacturing sector. It is of a great benefit if the future research will address institutional distance between subsequent acquisitions of each parent to explore how the investing behavior changes with experience and whether it impacts performance. That is to integrate behavioral learning theory with institutional theory and to examine its influence on acquisition performance. The sample used in the this study was not large enough to address this question. A set of 70 observations conveyed no significant results. And finally, future studies could focus on inspecting a more dynamic process by examining how companies adopt to institutional difference over time.

Conclusion

The objective of this study was to investigate if institutions and institutional distances influence deal performance and whether experience moderates this relationship. Institutions were measured in terms of three variables, property protection, labor market flexibility and openness. Findings of the study showed only partially support for the hypotheses. In general, institutions and institutional distance do matter and bare an impact on performance, while experience does moderate this relationship, however, the direction of the interaction is contingent. The results demonstrate that high property protection is positively related to performance while labor market flexibility and openness negatively. The moderator experience proved to negatively impact this relationship at high property protection and positively at high values of openness. For institutional distance from acquirer to target nation analysis only two variables proved a statistically significant effect on performance, labor market flexibility distance with marginal but positive effect and openness distance with negative effect. Experience proved to positively moderate the labor market flexibility distance and performance interaction only when the distance is low and negatively when the distance is high. These findings suggest that institutional characteristics are necessary for managers to consider in cross-border deals and relying on experience does not always result in a positive outcome.

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