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Probability of target executives retention after M&A transactions

in the USA.

Master Thesis Final Version

University of Amsterdam

MSc Business Economics, Finance track Michal Ciolek

Student number: 10397515 Thesis Supervisor: J.E. Ligterink

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Statement of Originality

This document is written by Student Michal Ciolek who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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Acknowledgements:

I would like to thank my family who supported me through the process of writing the thesis. That has been an interesting and valuable journey.

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Abstract:

This thesis explores the subject of management turnover in the firms that were acquired. The traditional view of market for corporate control predicts that acquired firm‟s executives depart after a transaction. However, the strategic management view recognizes target management as a valuable resource that may enhance competitive advantage of an acquirer. The thesis investigates why some top executives of acquired companies are retained by the acquirers whereas other executives leave. Characteristics of transactions, firms involved and target management are used in a probit model to explain the probability of target‟s executives retention. The study is based on a sample of 100, large transactions of mergers and acquisitions that occurred in the years 2002 – 2010 in the USA. The contribution of the master thesis lies in developing the empirical evidence on the top management turnover after a completion of mergers and acquisitions. The thesis provides supportive evidence that executives of relatively large target firms comparing to acquiring firms, have significantly high chances of being retained after a completion of a transaction. The findings are in line with the strategic management view.

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Content

1. Introduction ... 6

2. Literature overview ... 9

2.1 Management turnover in the M&A transactions ... 9

2.2 Agency theory... 10

2.3 Strategic management view ... 11

2.4 Specific context of target executives retention ... 12

2.4.1 Industry – relatedness ... 13

2.4.2 Target relative size ... 14

2.4.3 Target executives pre-acquisition performance ... 14

3. Hypothesis and methodology ... 16

3.1 Hypotheses ... 16

3.2 Control variables ... 19

3.3 Model ... 20

4. Data and descriptive statistics ... 21

5. Results ... 28

6. Robustness check ... 31

7. Conclusion ... 32

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1. Introduction

This thesis explores the subject of the management turnover around mergers and acquisitions in the USA. The top executives have a significant impact on company‟s strategic decisions thus

the topic has been interesting for scholars and business practitioners for long time. There are various contexts in which management turnover can be studied. This thesis investigates

the management turnover of acquired firms after a merger or an acquisition are completed. The context of M&As is chosen due to two major reasons. First, the transactions lead to unusually high frequency of management departure. The top executives of acquired firms tend to depart much quicker than their colleagues due to regular reasons such as retirement or better job offers. In the first year after a transaction, around 25% of top executives of acquired companies leave. The average turnover rate for a similar group of executives fluctuates around 8 – 10 % given no mergers or acquisition happen to a firm. Secondly, M&As are a major, corporate strategy to grow the business by creating synergies between newly created companies. This type of activity is frequent all around the world however developed markets account for its largest share. The importance of M&A transactions is reflected by the increase of their value and number. Institute of Mergers, Acquisitions and Alliances (IMAA) has reported the growth of worldwide announced deals from almost 10.000 to over 40.000 in the years 1988 – 2014. The yearly value increased from almost $1 trillion to $3,27 trillion over the same period. The highest, historical level was reached in 2007, before the global financial crisis and totaled $4,1 trillion.

This thesis contributes to the existing literature because the research part is executed based on the date sample composed of M&A transactions completed after the year 2000. Krug et al. (2015) argued that the existing studies in the field were mainly based on the firms acquired in the years 1980s through 1990s. The author argued that this is a significant limitation of the existing

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literature. This thesis uses a sample of transactions executed in the years 2002-2010 which adds an evidence for the recent transactions. The difference between the characteristics of the M&A transactions of 1980-1990s and 2000s may shed new light on the target management turnover. Martynova and Renneboog (2008) pointed out that the M&A wave of 1980s and early 1990s is characterized by highly hostile approach whereas the M&A wave after the year 2000s is not. The degree of hostility may have an impact of the behavior of the acquirers towards the target management teams. In the less hostile environment, the probability of the target management retention may be expected to be higher.

The thesis aims for answering the question why some top executives of acquired firms are retained after a transaction is completed. The thesis investigates some possible decision factors that may influence the decision made by acquirers. Specifically, three factors are tested to clarify whether and how they influence the probability of target executives retentions. Firstly, does it matter whether target firm and acquirer operate in the same industry? Secondly, does relative size of a target firm to an acquirer has an impact? Thirdly, can the target pre-acquisition financial performance predict which executives will be retained? All these hypotheses are tested by using a probit model that includes the tested variables and control variables. The probit regression applies the log-likelihood method to verify the significance of the hypothesized factors.

The research part of the thesis is based on a sample of 100 mergers and acquisitions that involved public, U.S. based firms. The research period includes the years 2002 – 2010. The data sample was created based on the various data extracted from the several data bases, i.e. SDC Thomson One, Securities and Exchange Commission (SEC) fillings and CRSP. Certain restrictions were imposed on the data sample as suggested by a study on mergers and acquisitions by Kaplan and Weisbach (1992). Only large transactions that exceed the value of $100 million are included which ensures availability of data. Certain industries such as insurance, utilities or

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railroad were excluded from the data sample to avoid impact of the national authorities on the M&A transactions. The final data sample includes 50 transactions in which a target executive was retained after a takeover and 50 transactions in which it did not happen.

There are several reasons why the factors of target‟s executives retention are interesting. How the target executives who stay or depart differ from each other? What do decision makers of acquiring firms look at while making the decision about the retention? Can the particular target executives increase their chances of being retained? The research on the antecedents of target‟s executives retention may help acquirers to make a better decision which target executives should be retained. The acquirers gain knowledge on how market and particular industries behave in this field. On the other hand, target executives of acquired firms may understand how to increase their chances of being retained. The probability of retention may also serve them as a proxy of their value which again may be used for negotiation about terms of retention as well as expected compensation after a transaction is completed.

This following part of this thesis is organized according the order. In the second section, major theories and empirical findings related to the subject are discussed. This forms the foundation for the hypotheses which are derived and presented in the third section. Presentation of the methodology follows in the same chapter. Section four incudes explanation on the data sample, its sources, assumptions and summary statistics. Thereafter, results of the regression analysis are presented and discussed. The last section concludes and also presents limitation of the thesis as well as suggestion for further research in the subject.

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2. Literature overview

This section presents the main theories in the existing literature regarding the subject of the thesis. It is also discussed what the theories predict with regard to this research. Finally, the section discusses empirical evidence found in relation to the theories.

2.1 Management turnover in the M&A transactions

The subject of management turnover has been already researched by organization and strategy scholars for long time (Pfeffer 1984). It is an interesting topic to study because it reflects important organizational arrangements and decisions (Hambrick 1989). The executive departures of acquired firms is one of the possible contexts of that matter. The management replacement surrounding mergers and acquisitions significantly influences the post-bid performance of a company and its employees (Buono and Bowditch 1989, Schweiger and Walsh 1990). The existing literature reported the empirical evidence on both positive and negative influence of the target management turnover, dependent on the various characteristics of the data samples. The detailed discussion of the evidence is presented in the subsequent paragraphs of this section. Analysis of the reasons of the turnover itself yields interesting results. On average, the management replacement around takeovers is much higher than in the regular circumstances. Researchers consistently reported that around 25% of target executives depart in the first year after a transaction which is almost three times higher figure than an average, when no such transaction occurred. The turnover of the target management increases consistently over time. Around 60% of the target executives hired at the moment of a transaction of merger and acquisition departs in the fifth year after a transaction is completed (Furtado and Karan 1990, Hambrick and Cannella 1993, Martin and McConnell 1991, Walsh 1989, Walsh and Ellwood 1991). First, the M&A context of turnover was systematically researched by Walsh

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(1988) and several empirical evidences were presented since then. The major findings are discussed below.

Literature reports many reasons why companies perform M&A transactions. The ultimate purpose is the firm survival on the market and wealth creation for the firm owners. M&A can support this purpose in many, different ways. The typical rationale include creation of synergies between companies, diversification of business activities, growth, gaining access to valuable resources and achieving a competitive advantage (Bruner 2004). This thesis follows the strategic management perspective which argues that M&As purpose is to provide a bidding company with a competitive advantage (Capron and Pistre 2002). This is achieved by providing the bidder with unique combination of all resource that a target company owns. Among others, target employees and top management are an important asset. In particular, target executives play a significant role because they decide on company‟s strategy and top-line execution. Bertrand et al.(2003) argued that the top executives determine company‟s investment, financial and organizational decisions. Thus, taking control over a target company and retaining its executives would support the bidder. On the other hand, acquirers also take control and force target executives to leave companies because it is believed that current, target‟s management team underperforms. This case is predicted by the agency theory. Both theories are discussed in details in the following subchapter.

2.2 Agency theory

The agency theory assumes that manager‟s role is to represent shareholder‟s interest while operating companies (Jensen and Meckling 1976, Fama and Jensen 1983). A management team is appointed by firm‟s owners to maximize their wealth. Shareholders assess the management‟s capabilities to utilize companies‟ resources and generate certain profit. If the firm‟s value is not maximized by the manager and board of directors is not able to discipline them, dissatisfied shareholder may sell the shares of that company. If the view on the management performance

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is consistent among shareholders and they sell the shares, the share prices goes down. This is possible for public companies listed on stock exchanges. The decrease of share‟s price may be a signal for a competitive company that a certain management team underperforms. If the competitive managers believe that they can generate higher profits given the firm‟s resources, this will lead to taking control over that firm and replacing the incumbent and incompetent executives. This represents a market for corporate control in which more capable managers acquire firms run by less capable managers (Jensen and Ruback 1983). The replacement of a management team is expected to have a positive impact on a firm and to improve its financial performance. Clearly the merger and acquisition transactions are supposed to lead to high turnover of target‟s executives. Consistent with the predictions of the agency theory, researchers show empirical evidence. Martin and McConnell (1991) argued that turnover of top executives increases significantly following an acquisition in comparison to average industry management change. The incumbent managers of a target company underperform relative to comparable firms. The authors also point out that the type of deal, i.e. friendly or hostile, do not significantly change the turnover rate which means that the overall disciplinary role occurs. Krug et al. (2015) concluded that majority of the takeovers through the 1990s were driven by the agency theory. Once board of directors cannot perform the disciplinary role of poor performing target executives, the shareholders benefit from replacement of incumbent management teams.

2.3 Strategic management view

Strategic management view differs significantly from the agency theory. The former one focuses on how to create maximal competitive advantage through an acquisition. Acquirers benefit from taking control over unique set of resources and skills. These can be combined with the existing of an acquirer to build economies of scale or to create synergies. Thus, strategic management

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perspective views human resources a valuable asset (Walsh and Ellwood 1991). Especially top executives offer general management skills as well as firm-specific or industry-specific knowledge. Executives understand company‟s internal environment and corporate policy. They have an established relationship with crucial customers and suppliers. They may have a very specific knowledge about a certain technology or processes. All these components create unique human capital. Hitt et al. (2001) supported the notion that human capital influences firm‟s performance in a direct and moderate way. Thus, the acquirers can leverage the value of top executives to gain a competitive advantage and increase the odds for positive result of the acquisition. Strategic management view predicts high retention rate of target executives after a completion of a transaction. Cannella and Hambrick (1993) provided the evidence that departure of target executives is disruptive to the post-acquisition performance. This is especially related to the top executives such as CEO, Chairman or President. Zollo and Singh (2004) also supported the view by showing that high level of top management replacement has negative impact on a firm‟s performance in the long-term period of 3 years after a transaction. The most recent research of Butler et al. (2012) also supported the resource-based view on the target top management. The authors argued that the target executives are an intrinsic resource of an acquired company. Thus, the high retention rate is related to better post-acquisition performance. Similarly, the practitioners of the M&A transactions advised that minimizing the target executives turnover is an important factor for the success of the integration process (Fubini et al. 2006, Shill and Mackenzie 2005).

2.4 Specific context of target executives retention

Virany et al (1992) argued that the management turnover around M&As should not be considered in isolation but rather in a specific context. Thus, researchers have examined various characteristics of which major are related to transaction, firms or management teams. This thesis follows the certain features examined by the classical paper in the field (Walsh 1988).

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Specifically, the following attributes will be checked: industry relatedness, relative size between acquirer and target, and pre-acquisition performance of a target company. These factors are discussed in details in the following subchapters.

2.4.1 Industry – relatedness

The term of industry relatedness in the context of mergers and acquisitions is defined by a degree to which target and acquirer operate on the similar markets based on similar technology, process, products and knowledge (Teece et al. 1994). M&A literature distinguishes two types of transactions in the category of industry relatedness which are horizontal or vertical. The former one describes M&As in which target and acquirer operate in similar industries, whereas the latter one describes M&As in which target and acquirer operate in unrelated industries. If both firms operate in the related industries, management of an acquirer may have enough knowledge and skills to run a target firm without executives of the target. On the other hand, acquirers who take over industrially unrelated targets may only want to act as passive investors and continue target‟s strategy (Salter and Weinhold 1979). In the latter case, acquirer‟s management has little experience in operating an acquired business. Thus, Pitts (1976) argued that acquirers should ensure retention of target executives to avoid losing valuable knowledge about the firm, its products and markets. Following the above arguments, the target executives retention is expected in case of unrelated mergers and acquisitions. The existing research reports opposite empirical evidence on that matter. Buchholtz et all. (2003) reported positive relationship between retention ratio and industry relatedness for a sample of tender offers. Walsh (1988) found no relationship whereas other researchers found negative relationship for a group of both mergers and acquistions (Hambrick and Cannella 1993, Walsh 1989).

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2.4.2 Target relative size

Walsh (1989) pointed out that target relative size to an acquirer may influence the retention of target management. The large difference may imply that acquirer‟s management team is able to coop with operating an acquired company. The management team of a much smaller target firm may lack skills of operating within a large organization. Thus the target executives may seem to be less valuable and would be expected to depart. On the other hand, if the difference between two firms is small, the target management team may have necessary skills and experience to join the new entity after a transaction. Replacement of such managers by outsiders may be more difficult and costly in case of relatively large companies. In addition, the integration process of companies of a similar size may be more difficult which implies expected retention of target executives. In line with the theoretical predictions, Walsh (1989) provided an empirical evidence that the larger the difference between target and acquirer, the lower the probability of target executives retention. However, the research was only based on data sample of mining and manufacturing companies from 1980s whereas the thesis examines a broader sample of industries.

2.4.3 Target executives pre-acquisition performance

M&A press and literature provides a widespread perspective that firms operated by incompetent executives tend to exhibit poor performance and in results become targets in M&A transactions (Jensen 1988). If a more competent management team of an acquirer replaces the target‟s incumbent managers, this should lead to an improved performance. Agency theory scholars represent that view (Jensen and Ruback 1983). On the other hand, some researchers do not necessarily agree that firm‟s performance is a proper indicator of management‟s competence. There are events and market forces that are outside of the management‟s control. It may be the case that poor performance is linked to firm‟s limited access to critical resources

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such as financing or distribution channels. Thus, executives cannot be blamed for poor performance nor it can represent manager‟s knowledge and skills. Cannela and Hambrick (1993) presented evidence that pre-acquisition performance does not provide a strong indication of executive abilities. Finally, several studies in the field use the pre-acquisition performance as an indicator of top executives performance. The evidence found suggested that the pre-acquisition performance of target CEOs positively influenced the retention ratio (Weisbach 1988, Wulf and Singh 2011). The pre-acquisition performance may thus indicate which top executives are more successful. These executives are supposed to be retained because they are seen as a valuable human resource for the acquirer.

Given above literature overview, this thesis aims for contributing in explaining why certain target top executives are retained by an acquirer and others are not after a transaction is completed. The following chapter presents hypotheses that were tested and methodology that was applied in the thesis.

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3. Hypothesis and methodology

This sections explains the hypotheses and methodology applied to verify the hypotheses. Econometric model is presented which is followed by detailed discussion of included dependent and independent variables. The section ends with a discussion on potential problems of the regression analysis and how the problems were addressed in the thesis.

The goal of the thesis is to extend the existing empirical evidence on the factors that influence the management turnover in the acquired companies, following a merger or an acquisition. Researchers have tested variety of factors to explain the event which was discussed in the literature overview. This thesis follows the certain features examined by the classical paper in the field (Walsh 1988). Because contradictory results are reported for those antecedents of target‟s management turnover , the thesis aims to add additional empirical evidence in the subject. The set of industries in this study sample differs from the samples used before the year 2000. The thesis‟ data sample consists of a larger share of knowledge-based industries such as high technology or specialized healthcare whereas the past data samples included significant share of manufacturing industry. The difference in the composition may have an impact on the results.

3.1 Hypotheses

The first hypothesis tests whether transactions in which targets and acquirers operate in similar industries, show higher target management retention level than in case of transactions between industrially unrelated companies. The hypothesis is built on the assumption that all executives gain industry- and firm-specific expertise which is important for the success of a firm. The knowledge is difficult to be coded and is rather embodied in the executives themselves.

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Thus, if acquirers takeover firms industrially unrelated to acquirers, then the target‟s management retention is predicted to be higher than in the opposite case.

Hypothesis 1 (H1): Target executives in the industry unrelated transactions will be more likely to be retained.

The second hypothesis derives from two assumptions. Firstly, firms which take control over targets of relatively similar size to them, may have organizational problems to replace the target management team. Hiring outsiders in the disruptive event of mergers and acquisitions may add risk to the integration and success of both companies. Secondly, firms of a similar size are run by management teams who are exposed to similar corporate and bureaucratic orders. Thus, executives of such targets will be familiar with operating at the corporate level of an acquirer. Given the arguments, the hypothesis tests whether relative size of acquirer and target firms have a positive influence on the probability of the target management retention.

Hypothesis 2 (H2): Target executives of relatively large firms in comparison to acquiring companies, will be more likely to be retained.

The third hypothesis aims for testing whether pre-acquisition financial performance of target company matter in case of decision regarding retention of target executives. The performance is regarded as a proxy for track record of target executives. It is expected that the more successful target executives are valued more by the acquirers thus these executives are offered to stay after a transaction is completed. Thus, the pre-acquisition performance of a target firm should positively influence the retention ratio.

Hypothesis 3 (H3): Target executives of better performing firms will be more likely to be retained.

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To prove the above hypotheses, the following probit model is applied: Y = Φ ( β1*X1 + β2*X2 + β3*X3 +Z) + ε

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where Y is a binary variable equal to 1 if a target executive‟s retention occurs or 0 otherwise, β1,…,β3 denote coefficients of the involved variables, X1,…,X3 are independent variables, Z

represents a set of control variables and ε is a random variable and is assumed to have a normal distribution. Both the independent and dependent variables are discussed below in details.

Dependent variable Y is represented by binary variable which equals one if target firm executives are retained, and zero otherwise. The retention is identified if at least

one of the target top executives is hired in any capacity either within the target firm or an acquiring firm after a transaction is completed. The retention is verified in the proxy statements surrounding the announcement or completion of a transaction. Given the data limitation described in the section “Data and descriptive statistics”, it is also assumed that no retention is present if SEC filings does not mention the retention explicitly. If acquirers offer the target executives only temporary employment lasting less than a year and that information is present in the proxy statement, then no retention is assumed.

Independent variables X are chosen based on the existing literature in the field (Walsh 1988, Wulf and Singh 2011, Buchholtz et al. 2003, and Bargeron et al. 2009). The variables consist of characteristics which are relevant to the target firm, target industry and the transaction itself. The measurement and significance of all variables are explained below.

X1: Industry relatedness is represented by a binary variable which is equal to one if the target and acquirer operate in the same 3-digit Standard Industry Classification code (SIC) and zero otherwise. When acquirer and target operate in the related industries, then target executives are expected to have lower retention rate than if the firms operate in different industries

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(Buchholtz et al. 2003). In the latter case, the target executives offer industry-specific skills and knowledge which may be a valuable asset for the acquirer.

X2: Target relative size is measured by the ratio of target market capitalization and the sum of the market capitalization of the target company and the acquiring company, measured 10 days before the announcement date of the transaction. Executives of relatively large target firms may be a valuable asset to retain. The managers have experience with operating a company at a similar level as the acquirer.

X3 : Target Return on Assets (ROA) is an industry-adjusted ratio of target‟s net income in the last

12 months prior announcement date of a transaction and target‟s total assets reported for the fiscal year in which a transaction occurred. The industry-adjustment was applied by subtracting industry average ROAs from a firm ROA. The industry averages were calculated for all the companies in the study period on the basis of the same Industry Mid Code as reported by Thomson One data base. It may be assumed that target executives of highly performing firms characterized by high ROA may be seen as more successful and thus more valuable for the acquirer. In such a case the retention rate is assumed to be higher.

3.2 Control variables

The regression model contains several control variables which were used by researchers in the similar field before. Firstly, length of the transaction is a numeric variable and is represented by the number of days between effective date of the transaction and the announcement date reported by the data base Thomson One. Then, target market capitalization controls for a firm size and economies of scale (Hitt et al. 1997). The variable is defined as a logarithm of market capitalization of a target company, measured 10 days before the announcement date of the transaction. The measurement follows the example presented by Wulf and Singh (2011).

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3.3 Model

In the empirical part of this thesis, various characteristics of transaction and involved companies were tested to estimate their impact on the probability of the target executives retention after a transaction is completed. Three hypotheses have been developed based on the existing literature. To test the hypotheses, a nonlinear probit model is applied which follows the approach of other researchers in the field, e.g. Wulf and Singh (2011). The probit regression is performed in the Stata® 13 software. The application estimates the coefficients of the model by applying the log likelihood method. This approach follows the suggestion of Long and Freese (2006). The parameters of the probit model are found when the following log likelihood function lnL is maximized in the Stata software. The following equation is solved

where Φ is the cumulative normal distribution, wj are the optional weights.

After the coefficients of the model are estimated, the next step is to compute the marginal effect of the independent variables as it is suggested by Hoetker (2007). The marginal effect informs on how a change of a single, independent variable by one unit influences the probability of the dependent variable, given all other independent variables are set at their mean values. The change by one unit is different for binary and continuous variables. For a binary variable, an unit change is meant by a change of the value from zero to one. For a continuous variable, the change is represented by an instant change, given an unit is very small. This is the most common approach to calculate the marginal effect (Long 1997). Stata‟s “mfx” command is used to estimate the marginal effects of all, independent variables (Norton et al. 2004).

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4. Data and descriptive statistics

This section clarifies how the data sample was constructed. Restrictions and limitations of the data sample are mentioned as well. Thereafter, summary statistics and correlation matrix are presented and discussed.

The study sample consists of large mergers and acquisitions that were announced and effective in the period of 1/1/2002 – 31/12/2010 in the USA. The chosen time span encompasses the years of both bull and bear market in order to balance the data sample. The period 2002 – 2007 is considered as the bull market and the period 2008 – 2010 is considered as the bear market due to global financial crisis. The number of transactions in the chosen period fluctuates strongly, dependent on the market condition. The data is gathered from various sources. The data on mergers and acquisitions deals is extracted from the SDC Thomson One 1 database. The following types of transactions are included: tender/merger, tender offer, exchange offer, merger of equals. Mergers of parent company with its subsidiary were excluded from the sample. Historical market capitalization of companies comes from the CRSP2 database. This information

is cross-checked with SEC filings and Stooq website to ensure accuracy of the data.3 Information

on target executives and their retention come from the data base EDGAR which contains Securities and Exchange Commission (SEC)4 filings surrounding the transaction announcement. The primary data base consists of 2619 transactions. Thereafter, additional restrictions are imposed on the data sample which follows the example of similar studies in the field. Kaplan and Weisbach (1992) suggest a set of restriction towards data samples applied in studies about mergers and acquisitions. First of all, transactions of minimum value of $100 million

1 Official website: http://thomsonreuters.com/en/products-services/financial/market-data/sdc-platinum.html 2 Official website: https://wrds-web.wharton.upenn.edu/wrds/

3 Official website: http://stooq.com/ 4 Official website: http://www.sec.gov/

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are considered. The use of large deals ensures an access to reliable and complete data on pre- and post-deal status of the involved entities and their executives. Secondly, the transactions in the sectors such as insurance, railroad or utilities are excluded because the companies are heavily influenced by regulators. Thus, the transactions may not represent the regular, market conditions. Both target and acquiring company must be listed on U.S. stock exchanges, i.e. New York Stock Exchange (NYSE) or NASDAQ in the year when a transaction occurs. The payment method used in a transaction is limited to the two major ones, i.e. cash and stock or mix of both. In addition, an acquirer is assumed to gain control in the course of the transaction. Thus, the acquiring company cannot play a role of significant shareholder of a target firm before the deal and must hold minimum of 51% of shares after the transaction. After the above restrictions are applied, the data base results in 541 completed mergers and acquisitions. The final limitation of the data sample is caused by limited data availability on the post-transaction status of a target executives as the information is not necessarily public. In order to collect and verify above information, several data bases are commonly used, i.e. the Directory of Corporate Affiliations, Dun and Bradstreet Million Dollar Directory, Lexis-Nexis, ExecuComp and SEC filings. Due to availability of access, only the records in the ExecuComp and SEC filings are checked. The former date base misses information on many targets and acquirers in the data sample. Moreover, only executives with the status of CEO or CFO are reported for the research period. Once target executives are retained in any other position than CEO or CFO of the acquirer, their status cannot be obtained from the ExecuComp anymore. Thus, SEC filings are the leading source of the target executives status surrounding a transaction. Wulf and Singh (2011) report that SEC filings only inform about the status of the top-five highest paid executives. If the acquired target executives are retained at a lower rank, their status may be missing in the yearly filings. Bargeron et al. (2009) suggest a solution to this limitation of the data bases. They observe that acquirers express their intention to retain target executives in the SEC filings surrounding the announcement date of a transaction.

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Majority of the statements specifically name a target executive and her future position after a completion of a deal, e.g. “(…)Upon completion of the transaction, Michael Brodsky, Youbet‟s Executive Chairman, will join CDI‟s Board of Directors and its Executive and Strategy Committees.”5 Alternatively, acquirers state that “it is generally expected that a number of target

executive officers will remain after the merger is completed.” A deal is classified to involve a retention of a target executive if any of above mentioned statement are present in the SEC filing surrounding the announcement date of a transaction. Described limitation led to a sample of hand-collected data. The final data sample consist of 100 transactions. Table 1 summarizes statistics of the data sample after hand-collection of information on target executive retention. The data sample includes one dependent variable, i.e. retention of a target executive by an acquirer after a transaction is completed. The average retention rate is 50%. Based on the information from SEC filings, most of the retained executives are target CEOs who join board of directors or management team after the completion of a transaction. Alternatively, target CEOs and executives leave shortly after the deal or are offered short-term consultancy contracts to streamline the integration process between target and acquirer. The mean of industry relatedness and length of a transaction are similar between the original data sample and the final one. The average length of a transaction is 143 calendar days which is in line with an average of 135 days reported for M&A transactions in the USA and 153 days reported in the similar study of Wulf and Singh (2011). Return on Assets (ROA) for firms included in the final data sample is positive and significantly better than the same ratio reported for firms included in the original data base.

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Table 1 Summary statistics of the data sample.

Target executive retention equals one if any of the target executives were retained in any position in the new entity after a completion of a deal. Industry relatedness equals one if acquirer and target operated in the same 3-digit SIC industry code in the fiscal year of a transaction, and zero otherwise. Length of a transaction denotes number of calendar days between announcement and effective date of a transaction. Target relative size is defined as a ratio of target market value/(target market value + acquirer market value), measured 10 working days prior announcement of a transaction. Log(target market value) indicates natural logarithm of target market value, measured 10 working days prior announcement of a transaction. Target Return on Assets (ROA) is a ratio of target‟s net income in the last 12 months prior announcement date and target‟s total assets reported for the fiscal year in which a transaction occurred.

Tables 2 reports summary statistics for two subsamples which were created on the basis of retention of a target executive. The interesting observation is that the subsample that includes retained target executives is characterized by longer period of a transaction and significantly higher ROA ratio if compared to the subsample where executives were not retained. The data supports the expectation of Wulf and Sigh (2011) that executives of better performing companies stay and that retention of valuable employees lengthens the transaction. The later one is caused by longer negotiations of executive‟s new position and her compensation.

Dependent variable Obs. Mean Median Std. Dev. Min Max

Target executives retention 100 0,50 0,50 0,50 0 1

Independent variables

Industry relatedness 100 0,56 1,00 0,50 0,00 1,00

Length of a transaction 100 143 120 106 32 581

Target relative size 100 0,21 0,17 0,17 0,003 0,59

Log (target market value) 100 9,0 8,9 1,1 7,4 10,8

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Table 2 Summary statistics of two subsamples, i.e. one if target executive was retained and another one if target executive was not retained after a completion of a transaction.

Even though the size of tested sample and the control group were chosen arbitrarily, the descriptive statistics are fairly similar to those found in the other papers. The means of the major variables such as industry relatedness, length of a transaction and Adjusted Target ROA are very similar to the means reported for the same variables in the study of Wulf and Singh (2011).

Table 3 present a correlation matrix of the data sample. None of the variables are significantly correlated with each other. The largest correlation ratio occurs between the length of a transaction and the target market value (log). This may indicate that transactions which involve larger targets may be more complex. The negotiation and integration process lasts longer thus the length of such transaction is accordingly higher. Lack of significant

Table 3 Correlation matrix of all independent variables

Dependent variable

Target executives retention

Independent variables Obs. Mean Std. Dev. Obs. Mean Std. Dev.

Industry relatedness 50 0,52 0,50 50 0,60 0,49

Length of a transaction 50 151 125 50 135 82

Target relative size 50 0,17 0,16 50 0,24 0,18

Log (target market value) 50 9,02 0,63 50 8,89 0,70

Adj-Target ROA 50 0,01 0,24 50 -0,02 0,19 No (Y=0) Yes (Y=1) Industry relatedness Length of a transaction Target relative size Log (target

market value) Target ROA

Industry relatedness 1

Length of a transaction 0,02 1,00

Target relative size 0,03 0,34 1,00

Log (target market value) 0,04 0,49 0,30 1,00

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Figure 1 presents breakdown of acquirers and targets per macro industry specified by Thomson One database. Around 80% of transactions occurred in the following industries: high technology, health care, energy and power, and telecommunication. Firms in the sample group represent all market, macro industries but the Government and Agencies industry. The latter one was excluded because it is highly regulated by governmental authorities, contrary to typical, market industries.

Figure 1 Breakdown of acquirers and targets per industry.

The industry names follow Thomson Financial Macro Industry specification, i.e. from left: Media – Media and Entertainment, Realest – Real Estate, Materls – Materials, Staples – Consumer Staples, Finance – Financials, Retail – Retail, CPS – Consumer products and services, Ind – Industrials, Telecom – Telecommunication, Energy – Energy and Power, Health – Healthcare, HT – High Technology. Total number of acquirers/targets equals 100.

Moreover, 96% of the acquirers buy 100% of the target shares in a transaction. Only 4% of acquirers held minor stock before a deal however they owned above 90% of the target share thereafter. This ensures that the data sample represents acquires which had a decisive power to choose the management team and board of directors at the stage of a merger or an acquisition.

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Acquirers in the sample used three payment methods, i.e. cash only (27%), stock only (26%) and mix of both (47%).

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5. Results

This section shows the empirical results of the relationship between target management retention and various characteristics of a transaction and involved companies. The hypotheses are discussed in the same order as they were presented in the section three. Discussion and interpretation of the results are presented as well.

Table 4 presents the results of the probit regression analysis. The coefficients and standard errors of the model were estimated in the Stata software by applying the log likelihood method. Three equations were solved to verify the hypotheses tested in this thesis.

Table 4 Results of the regression analysis of a probit model. The signs ***, **, and * represent significance at the 1%, 5%, and 10% level, respectively. Standard errors are reported in the parentheses.

(1) (2) (3)

Industry relatedness 0,220 0,213 0,222

(0,261) (0,260) (0,260)

Lenght of a transaction -0,002 -0,002

(0,001) (0,001)

Target relative size 2,431 2,280 2,223

(0,851)*** (0,836)*** (0,821)***

Log (target market value) -0,243 -0,353

(0,238) (0,214)*

Target ROA -0,360 -0,537 -0,030

(0,639) (0,617) (0,629)

N 100 100 100

R-sq 0,076 0,069 0,069

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The first hypothesis regarding significance of industry relatedness in executives retention is not supported by the results in this thesis. The coefficient is not significantly different from zero. The existing literature provides mixed results in this topic. Buchholtz et all. (2003) reported positive relationship between retention ratio and industry relatedness, whereas Walsh (1988) found no relationship and other researchers found negative relationship (Hambrick and Cannella 1993, Walsh 1989). There may be a case that data samples are constructed from different industries which yields inconsistent results. It may be the case that the measurement of the industry relatedness itself is not most accurate. Fan and Lang (2000) discussed the limitations of the measurement based solely on the SIC code. The system is does not reveal the type of relatedness explicitly. Especially the vertically related business are prone to lack of relatedness measured by SIC code. Moreover, certain businesses are seen as complimentary however SIC code reports them as unrelated. The SIC code is consistently used among the researchers in the field of target executives retention. However, applying another measurement could shed a new light on the significance of the industry relatedness.

The second hypothesis predicts positive impact of target relative size on the retention level of target top executives. The regression analysis yields the expected results. The coefficient of this variable is statistically significant at the 1% confidence level. The same results are obtained for all three regression equations which differ by the combination of variables. Hoetker et al. (2007) suggests to report marginal effect for probit models as the marginal effect is more informative. Table 5 shows the marginal effects for the target relative size variable. The instant change of the variable increases the probability of the target executives retention by 89% to 97%. The result is statistically significant. It is assumed that all other independent variables are set at their mean values for this data sample. The results are consistent with the empirical evidence of Walsh (1989) and Wulf and Singh (2011). The target relative size may be also linked to the theory of relative standing introduced by Hambrick and Cannella (1993). The theory assumes that the behavior of the acquirer‟s management has a significant impact on the retention of the target‟s

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management. If the target‟s management feel inferior and lose their status, they tend to leave quicker. The theory may be linked to the significance of the target relative size to acquirer. Once the difference between the sizes diminishes, the management team of both parties operate at a similar corporate level thus they may treat each other as equal partners.

The third hypothesis tested whether target‟s pre-acquisition performance explains the retention of the target executives. The pre-acquisition performance is measured by the industry-adjusted Return on Assets (ROA) ratio. The results of the probit regression and the marginal effect do not support the hypotheses. This thesis reports contrary results to the existing literature. Wulf and Singh (2011) reported positive and significant relationship between the target executive retention and the ROA ratio. However, the evidence is based on a data sample of friendly mergers. Bargeron et al. (2009) also supported the positive impact of the target‟s pre-acquisition performance on the executives retention, given the pre-acquisition performance was measured by the Tobin‟s Q ratio instead of ROA.

Table 5 Results of the marginal effects in the probit regression. The signs ***, **, and * represent significance at the 1%, 5%, and 10% level, respectively. Standard errors are reported in the parentheses. The marginal effect is calculated for each independent variables separately, given all other independent variables are set at their mean values.

(1) (2) (3)

Industry relatedness 0,087 0,084 0,088

(0,103) (0,103) (0,103)

Lenght of a transaction -0,0006 -0,0009

(0,0006) (0,0006)

Target relative size 0,969 0,909 0,886

(0,339)*** (0,333)*** (0,327)***

Log (target market value) -0,097 -0,140

(0,095) (0,085)*

Target ROA -0,143 -0,214 -0,118

(0,255) (0,246) (0,251)

N 100 100 100

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6. Robustness check

There are some potential problems with the regression analysis. Leightner and Inoue (2012) pointed out that omitted variable bias is one of the most, serious problems of regression analysis. The problem occurs when a model misses an independent variable that meets two criteria. Such a variable needs to be a determinant of a dependent variable and to be correlated with one of the independent variable. The bias causes incorrect estimation of coefficients and standard errors of an independent variable which is correlated with the omitted variable. To minimize the impact of the problem, the thesis includes control variables which were typically applied by researchers in similar studies.

Another potential problem of the regression analysis is called multicollinearity problem (Farrar and Glauber 1967). It occurs when one or more independent variables are highly correlated with each other. The problem leads to poor estimation of the coefficients of the model. The matter is addressed in this thesis by performing a multi-regression analysis of all involved variables to test their mutual correlation. The results and discussion are presented in the table 4 in the chapter “Results”.

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7. Conclusion

This section includes the summary of the thesis. Potential problems and limitations are discussed. The sections ends with a suggestion regarding future research in the subject.

This thesis aims for investigating why some target top executives are retained by acquirer after a transaction whereas other executives depart. In order to provide empirical evidence on the subject, three explanatory variables were tested. These are industry relatedness between acquirer and a target, target relative size to an acquirer and finally target executive pre-acquisition performance represented by target ROA in the trailing year before a transaction. The hypotheses were tested in a probit model estimated by the likelihood method in Stata software. The data sample consists of 100 mergers and acquisitions. All the transactions occurred in the USA in the years 2002 – 2010. The results indicate that target relative size to an acquirer matters. This variable‟s coefficient is positive and significant thus the larger the relative size of a target, the higher chances that the target top executives are retained. The results are in line with the empirical evidence found so far (Walsh 1989, Wulf and Singh 2011).

There follows an implication of the results in a wider business context. The target executives of relatively larger firms to acquirers may expect better negotiation position with an acquirers. These executives offer higher value to an acquirer thus they may try to negotiate more favorable agreement, position or a compensation.

This thesis is not free from certain limitations. First problem is related to data availability on the target executives status after a merger or an acquisition which is problematic for many researchers in that field. The lack of data may lead to a bias in the construction of a data sample. Collecting data on the executives‟ turnover is also time-consuming and vulnerable to timing issue. The turnover may be so frequent that the impact of the change is not visible. The problems have been also reported by Krug (2015). This weakens the generalization power of the conclusions

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drawn from the empirical research. This thesis followed one of the solutions to this problems suggested in the literature. It is assumed that the target top executives are retained if the proxy statements filed in SEC around a transaction express this intention explicitly. However, researchers have provided an empirical evidence that these statements are sometimes not honored so that the target executives depart shortly after the transaction is completed (Hartzell et al. 2004). If such a cases were prevailing in the data sample, the results of the regression analysis would be biased. Secondly, the data sample is limited to transactions that exceed the value of $100 million. Thereis potentially a large amount of smaller transactions in which a target operates in high technology industry. Retention of the such target‟s executives might be more frequent as the executives are normally also founders of such firms. Then, acquirers would also gain valuable human resources who could continue to develop a product within the structures of a much bigger organization.

The subject of target executives retention may be further researched. Examination of management turnover in specific industries may shed new light on the topic. Certain industries such as high technology require specific knowledge which may be difficult to be coded. Thus, researching management retention and its impact on post-bid performance in knowledge-based industries may lead to different conclusions. Another interesting context may be provided by looking at the international mergers and acquisitions. Majority of the empirical evidence uses data samples that include U.S. companies. Empirical evidence from different countries might show whether cultural differences may impact the management retention. Especially strong evidence may come from South-East Asian countries where seniority and long-term relationship with a company is valued. Studying cross-board transactions presents also evidence if target‟s expertise in another country‟s law, corporate governance standards or market-specific dynamics may all be a significant factor for an acquirer from a different country.

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