Mergers, Acquisitions, and Downsizing, – Evidence
from the High-Tech Industry
Thesis MSc BA SIM
Supervisor: Dr. Killian J. McCarthy
Co-assessor: Dr. Jordi Surroca
University of Groningen
Corneliu Oprea
s2845490
Van Speykstraat 53b
corneloprea@icloud.com
9726 BK Groningen
Word count: 12120 JEL Classification: G34, J63Abstract
Contents
I. Introduction ... 1
II. Organizational Downsizing ... 2
III. The Resource-based view and human capital in the high tech industries ... 4
IV. The Efficient Market Hypothesis... 5
V. Managerial Experience and Challenges of Integration ... 7
VI. Methodology ... 8
VII. Results ... 14
VIII. Discussion and Conclusions... 19
IX Managerial Implications ... 21
X. Limitations and Future Research ... 21
References ... 22
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I. Introduction
Mergers and acquisitions continue to be a powerful tool for corporate development, global M&A activity reaching a staggering $3.5 trillion in 2014, an almost fifty percent increase compared to the previous year (Primack, 2015). To put that into perspective, only four countries had GDP numbers exceeding the value of M&A activity in 2014 (IMF, 2015). A September piece in the Financial Times notes that megadeals for 2015 will hit a record high, surpassing even the milestones reached during the infamous dotcom boom and the credit driven frenzy of the mid-2000s (Fontanella-Khan & Massoudi, 2015). According to experts, a new wave of M&A deals is on the horizon (Gribben, 2014; McCarthy & Dolfsma, 2013).
With M&A failure rates floating somewhere between 70 and 90 percent (Christensen, Alton, Rising, & Waldeck, 2011), questions arise regarding what makes or breaks a successful merger or acquisition, and what can be done to make this sixth wave less value destroying and more sustainable. The study of M&A performance thus emerges as a worthwhile endeavor (Zollo & Meier, 2008).
Arguably, M&A transactions, regardless of motive, commonly generate opportunities for workforce reductions (Loftus, Falconi, & Plumridge, 2014). As O’Shaughnessy and Flanagan (1998) argue, the decision of letting people go or not is one of the most important managers need to make as part of the post-merger implementation process. Reasons supporting the decision to trim headcount after a M&A event are various and range from eliminating redundant activities stemming from economies of scale and scope, to eliminating excess capacity in dwindling industries. Shleiffer and Summers (1988) suggest that changes associated with merger activities confer opportunities for firms to re-think implicit and explicit labor contracts, in the quest for increased cost efficiencies. Research generally found that significant reductions in labor size are likely to occur as post-merger firms scale down joint output and attempt to increase efficiency (Conyon, Girma, Thompson, & Wright, 2002). However, even with some workforce reductions needed in order to benefit from economies of scale, cutting quickly and deeply can reduce integration effectiveness, and, inadvertently, be the source of adverse effects for the long-term perspectives of the merged entity (Krishnan & Park, 2002). Scholars suggest that before deciding to downsize, issues such as conducting a skills needs analysis, and matching existing skills of the workforce to the capabilities needed should be thoroughly considered (Band & Tustin, 1995). Needless to say, such tasks are potentially time consuming, and rushing to meet increased efficiency and cost reduction targets, firms may engage in damaging layoffs.
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high personnel reduction potential, and then react accordingly. Second, it looks at the market’s reaction when the downsizing takes place, trying to determine if the magnitude of the personnel cuts and the company’s previous M&A experience influence this reaction. Such an avenue for research, while to my knowledge, not yet the target of scholarly pursuit, promises valuable insight into the dynamics of mergers and acquisitions.
While up to date, numerous studies have focused on the effects of organizational downsizing (Cameron, 1994; Cascio, 1993; Cascio, Young, & Morris, 1997; Krishnan, Hitt, & Park, 2007; McKinley, Sanchez, & Schick, 1995), there are none that zoom in on the narrow niche of personnel downsizing in the context of high tech mergers and acquisitions. It is then worthwhile to consider the implications of personnel reductions in such a unique scenario for at least two reasons. The first relates to better understanding the dynamics of personnel reductions around M&A events, periods of considerable strain for both acquirer and target (Cartwright & Schoenberg, 2006; Ranft & Lord, 2000). The second relates to the human resource dimension, and looking at M&A events through a resource-based perspective (Hitt, Bierman, Shimizu, & Kochaar, 2001; James, 2002; Ranft & Lord, 2000). The study then asks the following questions. Is it worthwhile to undertake a merger or acquisition if the prospect of personnel downsizing is imminent? How does the market react to the certainty of a significant human resource drain? How does previous M&A experience factor in? The present study thus aims to provide a new dimension to M&A transaction literature, pictured through a resource-based lens. Determining if and when downsizing plays a role into the successful implementation of a deal promises to yield valuable scholarly and managerial implications.
Exploring this was conducted by means of two separate event studies. They monitored the market’s abnormal reactions in connection to the events of interest, namely the announcement of a M&A transaction and then subsequent personnel divestiture announcements. The results are somewhat counterintuitive. While negative returns are observed following the announcements of transactions that will later downsize, they fail to predict how the market will react when the actual downsizing takes place. Furthermore, it appears that high M&A experience leads to negative market reactions when personnel cuts are announced, while the scale of the layoffs seems not to have any impact.
II. Organizational Downsizing
Defining it as a ‘planned elimination of positions or jobs’, Cascio (1993) acknowledges downsizing to be a phenomenon that has affected countless companies and employees since the late 1980s. It is synonymous to personnel layoffs/cuts/divestitures or workforce reduction.
The present paper looks at downsizing through an economic perspective, as defined by McKinley (2000). In this sense, it is assumed that managers are rational, efficiency-seeking actors that understand the connections between their decisions and organizational outcomes. The economic perspective thus views downsizing as a means of increasing productivity and economic viability (McKinley et al., 2000).
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There seems to be however, more than one explanation as to why the phenomenon of downsizing is so pervasive. To further elaborate, it can be mentioned that using institutional theory, McKinley (1995) identifies three social forces that help explain why firms decide to downsize. Firstly, organizations may succumb to constraining forces, adopting actions that are believed to be ‘the norm’ in the search for legitimacy. They may also fall prey to cloning forces, firms mimicking the actions of others that are the most prestigious and notorious exponents of their respective industry. Lastly, learning forces shape the business environment thanks to managers that put into practice what they have learned in universities or other similar environments (McKinley et al., 1995). Summarizing, it is most often a cumulus of factors that is involved into pressuring firms’ conduct organizational downsizing, most likely a combination of future performance projections as well as adherence to the institutions that legitimize the practice of downsizing (McKinley et al., 2000).
Arguably, companies are of course lured in by the potential economic and organizational benefits downsizing is expected to yield. In this respect, Cascio (1993) notes that increased shareholder value, lower overhead, increases in productivity, and an overall leaner organization are some of the desired outcomes.
It is also common that in the case of M&A transactions, acquisition premiums are frequently paid, consisting of often high sums that are added to the stock value of the target at the time of the transaction. These high acquisition surcharges often lead to challenges in achieving the synergies expected from the integration of the two businesses (Sirower, 1997). While selling off some of the excess assets might alleviate part of the financial burdens generated by high acquisition charges, laying off workers is another practicable approach to reducing costs in the post M&A firm (Krishnan et al., 2007). Such reductions in personnel are expected to streamline the company’s operations and eliminate redundancies, therefore reducing costs and moving the organization towards the anticipated synergies (Bethel & Liebeskind, 1993; McKinley et al., 2000).
It is often the case however, that anticipated outcomes fall short, and layoffs do not deliver the expected results. This is largely because the decision to downsize is quite complex and entails significant implications, many such actions being ill-informed or not informed at all (Cameron, 1994) . While downsizing possibilities are naturally generated by a merger or acquisition, and they are even required if the organization is to achieve the potential economies of scale, overzealous scaling down of the workforce can result in poor integration and damage to the long-term capabilities of the firm (Cascio, 2002; Krishnan & Park, 2002; Krishnan et al., 2007). Nevertheless, it is often the case that managers engage in downsizing actions without fully grasping the difference between layoffs and strategic downsizing. As Band and Tustin (1995) argue, if companies aim to increase productivity per head, this can only be achieved by strategic downsizing and not just an arbitrary slashing of jobs.
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linear headcount ratios”. Even with seldom positive Wall Street reactions that follow the promise of reduced costs and increased competitiveness, surveys found that two-thirds of the companies which employ downsizing, do it again a year later, and most do not achieve their long-term targets (Cameron, 1994). The particularities of the knowledge intensive high-tech industries also seem to play an important role when considering the benefits and shortcomings of downsizing. Guthrie et al.(2008) find not only that reductions in workforce have a damaging effect on firm performance, but also exhibit considerable contingency effects, these unwanted consequences being amplified in certain industries. Results show that the negative consequences of organizational downsizing are more harmful in R&D-intensive industries, such results being attributed to their reliance on valuable human resource endowments (Guthrie & Datta, 2008).
Further, using a sample of 364 downsizing announcements by U.S. - based firms, Nixon et al. (2004) find that downsizing results in negative market returns. They attribute the results to losses in valuable human capital that outweigh the benefits of reduced costs. There is also evidence that while promising to reduce costs, downsizing frequently generates expenses that cancel out or even outweigh the savings made with less personnel. It is often the case that companies take huge charges against earnings, in order to cover sometimes massive severance packages (McKinley et al., 1995).
Finally, also worth taking into account is that downsizing efforts can backfire due to causal ambiguity situations that may result in a defective appraisal of capabilities. While the acquirer will audit the resources and capabilities of the acquired firm, they will most likely rely on outcome measures that will not reflect the underpinnings of how the company actually operates (James, 2002). Such a deficient analysis could result in decisions that can negatively impact important pieces of a somewhat opaque mechanism.
III. The Resource-based view and human capital in the high tech industries
Starting with Penrose (1959), the resource-based view pictures the firm in terms of its resources and not in terms of their output (Wernerfelt, 1984). Penrose views the firm as an assembly of resources, each potentially capable of productive services. Resources that are valuable, unique and strenuous to imitate can provide footing for a firm’s competitive advantage (Amit & Schoenmaker, 1993; Barney, 1991). According to the resource-based literature, human capital is not only the bearer of knowledge that is critical to the firm’s competitive edge, but also the means by which this knowledge is shared and applied, and has for a long time been considered a fundamental resource in most firms (Grant, 1996; Pfeffer, 1994). In contrast to the industrial organization model, variance in firm performance can now be attributed to the fact that firms differ when it comes to their human capital (Hitt et al., 2001). Tacit knowledge capabilities, mostly unique and difficult to imitate, are often stored within the firm’s human capital, and are embedded in the workers’ skills and their work relationships (Nelson & Winter, 1982). Such characteristics of knowledge capabilities make tacit knowledge more likely to provide strategic advantage as compared to explicit knowledge (Lane & Lubatkin, 1998).
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can be seen as the basis of firm strategies (Barney, 1991), and are of critical importance in their implementation (Schoenecker & Cooper, 1998). Positive outcomes are often considered being the result of the interaction between strategy and resources (Hitt et al., 2001). Such intangible resources are more likely to provide competitive advantage due to the fact that they are ‘often rare and socially complex’, thus difficult to imitate (Barney, 1991; Black & Boal, 1994; Itami, 1987; Peteraf, 1993). As a corollary, it follows that in the case of post-M&A firms, human resources belonging to both parties will be crucially important to the successful implementation of future strategies and ultimate deal performance.
It is also worthwhile to briefly state the reasons for selecting the high-tech sector as stage for the present study. Link (1988) suggests, mergers and acquisitions are important sources of innovation for firms in the more technologically oriented industries. Furthermore, merger and acquisition importance is greater in industries where competition is primarily technologically based. High tech firms appear to have a more aggressive acquisition agenda as compared to firms in other industries, being driven by constant struggles towards greater innovation performance and a desire to keep up the pace in very dynamic markets (Capron & Mitchell, 2000). Further, it is observable that the high tech industries, in the last decades, have set the stage for unprecedented global competition. Increased internationalization of world trade coming from agreements such as NAFTA or the more recent Trans-Pacific Partnership (TPP), and other law changes such as the U.S. Telecommunications Act of 1996 stimulate high tech companies to undertake increasing amounts of M&A transactions (Cloodt, 2005). In the case of high-tech firms, where many acquisitions are motivated by the desire of augmenting strategic technological capabilities, retention of key human capital is vital as it is the repository of the so called tacit and ‘socially complex’ knowledge (Ranft & Lord, 2000).
IV. The Efficient Market Hypothesis
The event study methodology is well grounded not only in the fields of accounting and finance, but also in the domain of merger and acquisition research. It is rooted on Eugene Fama’s (1970) landmark article ‘Efficient Capital Markets’. The efficient market hypothesis (EMH) is based on the idea of a random walk, a term used in finance that characterizes a price series where all subsequent price shifts represent random departures from the previous ones. The underpinning logic is that information flows freely throughout the market, and thus new information is instantly reflected in the stock prices (Fama, Fisher, Jensen, & Roll, 1969).
Event studies are therefore heavily used in the field of mergers and acquisitions. When a company decides to acquire another, a significant amount of information is released to the market. Making use of White’s view that ‘markets can be understood as tangible cliques of producers observing each other’ (White, 1981), and Eugene Fama’s (1970) efficient market hypothesis, we can infer that the market will digest all readily available information and predict significant shifts in human capital before they take place. Their reaction will be accordingly, under the form of stock price fluctuations.
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Flanagan, 1998). Using a sample of 60 large, highly related acquisitions from the 1992-1995 period in the United States, Krishnan and Park (2002) found that 70 percent of them subsequently laid off employees. Another flag can be that of the previously mentioned high acquisition premiums. When paying large sums over the book value of the acquired company, the acquirer may find itself in a tough spot when it comes to generating the synergies the acquisition was expected to yield (Sirower, 1997). Naturally, both these problems can be tackled by employing personnel divestitures.
Considering all that was stated above, we can therefore argue that following an M&A event, operating under considerable time pressure, downsizing actions can result in damaging losses of key personnel, therefore negatively impacting the organization’s future performance. A negative relation between the announcement of an M&A deal with high downsizing potential and stock market prices appears likely. We therefore hypothesize:
Hypothesis 1. Organizations that downsize will be subjected to negative market reactions.
It is accepted that one of the main benefits of mergers and acquisitions is embodied by the access to organizational learning opportunities and then making use of the knowledge generated as a result (Cloodt, 2005; Goshal, 1987). Remembering the previous note which stated that downsizing companies experience learning capacity depletion that is ‘greater than indicated by linear headcount ratios’, it can be reasoned that larger losses in human capital will result in increasingly deficient performance (Reynolds Fisher & White, 2000). As the number of workers that are let go increases, the higher the chances that valuable human resources are amongst the ones that are being lost.
Also, event studies that have looked at market reactions after corporate downsizing announcements found that they had a negative impact on returns. Furthermore, these negative effects were stronger in the case of more severe downsizing actions (Nixon et al., 2004). These adverse reactions were attributed to losses of human capital and company knowledge that were more acute in the case of more employees being laid off. In the context of an unsure post- M&A entity, it is easy to envision these effects being manifested with at least the same intensity as in the case of non-M&A firms.
Lastly, the previously mentioned costs associated with significant personnel cuts need to be taken into consideration. Large sums are to be spent on severance packages for each dismissed worker, and these sums only go up if the company subsequently decides replacements are needed (McKinley et al., 1995). It is only reasonable to assume that larger downsizing actions will result in larger downsizing costs, and that these costs are more likely to cancel out or even outweigh the cost savings related to the reduction in force.
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reaction registered by the company.
V. Managerial Experience and Challenges of Integration
Among issues that lead to M&A failure, the most commonly encountered causes are cultural issues, failure to integrate technologies, inability to achieve synergies and re-engineer the merged companies, failure to develop a viable new entity strategy, more focus on cost cutting rather than increasing market share and last but not least, human capital issues (Smith & Hershman, 1998). Even with M&A transactions commonly being one-time events with often disappointing results, it is believed that top management can gain experience from past M&A activity, this making them better prepared in handling future deals (Appelbaum, Gandell, Yortis, Proper, & Jobin, 2000; Hitt, Harrison, & Ireland, 2001).
Managerial experience is likely to come in handy when dealing with some of the adverse effects that downsizing firms face. Maertz et al. (2010) note that recent layoff survivors manifest generally lower perceived organizational performance, they are more concerned in regards to the security of their jobs and display lower levels of attachment to the organization. Even more, polls conducted by the American Management Association showed that almost half of the companies surveyed were not ‘well prepared’, nor did they anticipate the problems generated by downsizing endeavors. More than half reported commencing downsizing activities with no plan in place that considered valuable employee retention, and job redeployment (Cascio, 1993).
Acquisition experience can lead to increased knowledge structures, suggesting companies that act as buyers should analyze and learn from previous similar transactions (Hitt et al., 2001; Levinthal & March, 1993). With human resource management being a forefront tool for ensuring M&A success, the findings of Nikandrou and Papalexandris (2007) suggest that experienced companies provide advancement and mobility opportunities that can raise employee commitment, therefore contributing to the firm success when handling significant personnel restructuring. Harmful side effects of downsizing that ripple through the company such as low morale and distrust of management, can potentially be countered by skilled managers and efficient organizational structures that evolved in time, by virtue of experience. As Joseph Bower explains in a 2001 article for the Harvard Business Review, ‘integration is hard to pull off, but a few companies do it well, consistently’ (Bower, 2001). The present study hence forwards the idea that previous merger and acquisition experience aids organizations develop capabilities that allow them to successfully manage integration challenges. These companies will in turn be more likely to generate M&A value for their shareholders as opposed to companies with less or no experience.
Again, making use of the notion that markets make use of all available public knowledge (Fama, 1970), we can envision that they will react differently (positively in this case) when such companies make downsizing announcements following a merger or acquisition. We thus formulate the last hypothesis:
Hypothesis 3. Companies with more M&A experience witness positive market reaction
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VI. Methodology
1. Research Setting.
All of the data used in the present study was collected using the Thomson Reuters SDC Platinum and Thomson Reuters Datastream databases. Downsizing announcements were collected using LexisNexis, with special focus on the business wire services (Konchitchki & O'Leary, 2011). SDC Platinum is a database powered by the Toronto based Thomson Reuters, one of the most prominent mass media and information organizations worldwide. The database contains reliable data on bond and equity new issues, M&A transactions, syndicated loans, and project finance. With respect to Mergers and Acquisitions, the database contains over 900,000 global transactions, from the 1970s up to present day, and includes around 280,000+ US-target and 620,000+ non-US-target transactions (Thomson Reuters, 2015a). The initial sample of M&A transactions was obtained using a targeted query on the SDC platinum database. Similarly, Thomson Reuters Datastream provides a wide range of global financial data, both real time and historical. With respect to the current study, the database contains financial data on company equity prices, indices, options and bonds (Thomson Reuters, 2015b). From Datastream, data was retrieved regarding acquirer stock prices, performance, and overall market performance for stock market indexes such as the S&P 500, FTSE, and the Dow Jones.
2. Sample.
Using the Thomson Reuters SDC database, transactions consisting of mergers and acquisitions in the high tech industry was obtained for the 1999-2014 period. As mentioned before, the high tech industries provide a good setting for the study as technological capabilities are likely embedded in the ‘tacit and socially complex’ knowledge of the target’s human capital pool (Ranft & Lord, 2000). The first event in the sample took place on January 18th 1999 and the last was recorded on December 17th 2014. For the previously stated reasons, the sample was conditioned to include only acquiring companies that operated in the high-tech sector. A requirement condition was that both the acquirer and target were publicly traded companies. This was necessary given that subsequently, the study would require information that is made available only by publicly traded companies. Applying these two criteria led to a significant reduction in the number of transactions SDC would be able to retrieve. This resulted in a total of 1098 events being included in this initial sample, with acquirers coming from a total of 34 countries. Most acquirers came from the Anglo-Saxon world, namely the United States (702), followed by Canada (78) and the United Kingdom (71). By value of transaction, the largest event recorded was the US$164.7 billion merger between America Online and the Time Warner Corporation, the smallest transaction value was US$ 0.13 million, recorded at the merger of Ivrnet Inc. and Home Media Corp. of Canada.
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3. Variables
3.1. Independent variables 3.1.1. Downsizing
The method employed for the present paper is an event study. This is a highly vetted approach by accounting and finance literature for delivering an appropriate representation of a company’s market value by using its stock price. The methodology presents a reliable instrument for evaluating the connections between managerial decisions and the value subsequently created or lost for the firm (Wilcox, Chang, & Grover, 2001). Firstly, we must distinguish the events of interest to our study.
The major independent variable used in the study, downsizing, was measured at two levels. First, in order to determine if the markets do react negatively to transactions that eventually lead to downsizing, the binary variable ‘down’ displays ‘1’ in the case of companies that subsequently lay off employees and ‘0’ in the case of those that do not. Personnel divestitures taking place within a one year period after the initial transaction are considered as being in connection to the M&A, following similar studies (Krishnan & Park, 2002). At the second level, downsizing was measured as the percentage reduction out of the total number of workers in the consolidated organization. The percentage is related by the variable ‘down_percent’. This was undertaken in order to see if the market takes into account the size of the downsizing efforts. The technique is consistent with several other studies that measure the same variable (Bethel & Liebeskind, 1993; Krishnan & Park, 2002). Searching for downsizing announcements was done using LexisNexis, a common and reliable source for event study announcements (Konchitchki & O'Leary, 2011), with particular interest towards the Public Relations (PR) Newswire and Business Wire services. For robustness I also frequently crosschecked with Google News, as in some cases, it was found that Google News can retrieve stories to which LexisNexis is blind (Weaver & Bimber, 2008) . A thorough search using more than 30 keywords was conducted and revealed 233 distinct downsizing announcements, corresponding to 21.22% out of the total sample. A list of the keywords employed for the search queries can be found in the appendix section. An electronic archive of all the announcements used in this study was also created.
When available, the percentage of people being laid off was retrieved from the layoff announcements found on LexisNexis, the others were computed using employee number data from Datastream, for both acquirer and target. A considerable number of downsizing events suffered from lack of data, both in the news sources and Datastream. As mentioned before, 127 downsizing announcements were found that pertained to the final sample, and out of these, 78 reliable corresponding percentages were available.
3.1.2 Managerial experience
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Accounting for a more dynamic perspective of the resource-based view, the capability lifecycle theory (CLC), asserts that organizational capabilities follow a general pattern that consists of their founding, development and maturity (Helfat & Peteraf, 2003). The lifecycle theory expects that reduced utilization of any certain established capability, in our case the ability to successfully manage mergers and acquisitions, degrades the level of the said capability (Helfat & Peteraf, 2003). It is thus reasonable to assume that experience accumulated two decades earlier, by what would be mostly different staff, will not be of any use to the Lockheed Corporation in their attempt to successfully integrate the operations of Martin Marietta. The experience will thus be measured as transactions undertaken by the acquirer two years prior up to the focal merger of acquisition. The second step was obtaining a list of all the high tech transactions recorded by the SDC database for the period 1997 – 2014, a total of 40,949 events. The number is significantly greater the initial sample due to the fact that now the query allowed non-listed companies to be retrieved. Following, in the case of companies that registered downsizing events in our sample, a count was made that revealed the number of transactions they were involved in two years prior to the event of interest. The common identifier was the SEDOL, CUSIP or ISIN number, whichever available. Query and count was done using STATA.
3.2 Dependent variable
Post-announcement performance. As the present research uses an event study approach, the underlying theory is that of the efficient market hypothesis. Employing the efficient market hypothesis, this research looks at the fluctuations in a security’s price following the release of new information. According to the efficient market hypothesis, the price of any given security is today’s value of future cash flows expected to be generated by the firm’s assets, and, at any time, the price is the reflection of all the available information to the market players (Fama, 1970). If newly available information suggests that future earnings are to be impacted in any way, the market will timely adjust the security’s price.
In accordance with event study methodology, the performance around the event of interest will be measured by computing the cumulative abnormal returns (CAR). The measurement of CARs is detailed under the ‘Statistical Methods’ section.
3.3 Control variables
The paper aims to control for several factors that may influence the effects of organizational downsizing on M&A performance.
The (a) nature of the acquisition, be it domestic or international is taken into account as it was found international acquisitions play a role in value creation for the acquiring firms (Markides & Ittner, 1994). In order to account for domestic or international deals, a dummy binary variable was created ‘intl’, that took the value ‘0’ when the transaction was domestic, and the value ‘1’ when the deal was international.
The (b) relative size of the deal was also taken into consideration, as Fuller et al. (2002) found that the relative size of the target as compared to the bidder influences subsequent returns. A variable that would convey the deal’s size was created, ‘dv’ and was computed as the ratio between the acquirer and target’s market capitalizations at the time of the transaction.
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diversification variable was taken into account as studies found that acquiring firm excess value declines after diversifying events (Graham, Lemmon, & Wolf, 2002), and that differences in market value growth can be expected between firms that choose narrow spectrum diversification (NSD) as opposed to those who opt for broad spectrum diversification (BSD) (Wilcox et al., 2001).
Lastly, the (d) financial slack enjoyed by the acquirer is taken into account. Bruner (1988) notes that bidders, enjoy significantly more financial slack as compared to a general sample of firms. Resource rich firms may be looser when it comes to acquisitions in their pursuit of value creation, thus taking less time in considering appropriate acquisition opportunities, and how to subsequently integrate operations. The financial liquidity of the acquirer is here gauged by the ‘quick ratio’ variable, an index which compares the total cash, market securities and accounts receivable against the total liabilities the company is subject to.
4. Statistical Methods
The metric for assessing the performance of M&A deals in the presence of downsizing actions was the fluctuation of their stock prices. In order to assess these price shifts, an event study was used to assess security performance before, during, and after a downsizing event took place. This method was chosen as its validity was confirmed by previous studies which investigated both merger (Duso, Gugler, & Yurtoglu, 2010) and downsizing events (Krishnan & Park, 2002; Nixon et al., 2004).
MacKinlay (1997) puts forward event studies as an easy way to measure the “effects of an economic event on the value of firms”. An event study uses Eugene Fama’s (1970) assumption that markets are efficient, and that any new information is timely incorporated by the market, and subsequently reflected in the stock price. Looking at prices around a downsizing event in the context of a merger or acquisition, we will therefore be able to observe how markets judge that decision. Bearing in mind that the current price of a security is assumed to incorporate all future expected cash flows generated by the firm’s assets, we can consider this as the market’s ability to predict the success or failure of a specific deal. The event study is designed as follows, in line with MacKinlay (1997) and Brown (1985).
4.1 Event window
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For measuring the impact of the specific event, in our case, the M&A or downsizing announcement, a measurement of the abnormal returns generated around the event is required. MacKinlay defines the abnormal return as the ex post returns over the event window minus the normal returns over the same event window. The normal returns are the expected returns that would have been generated without the event ever taking place. For any given firm i and the event date , abnormal returns (AR) are computed as:
ARiRiERi|X
Where, ARi represent the abnormal returns, Rirepresent the actual returns, and, ERi|X represent the normal returns for the given time period (For establishing if the returns made by a specific security were negative or positive in comparison to normal market returns, a benchmark was used as suggested by MacKinlay (1997). The normal market returns were selected to be the market indices corresponding to the exchange on which the specific company was listed. Most frequently used were the Dow Jones, S&P and the FTSE indices. Using this benchmark allows the study to account for fluctuations that were caused by market-wide events (market woes caused by terrorist attacks for example), and that were not particular to an individual company.
4.2 Measuring Abnormal Returns
The cumulative abnormal returns (CAR) will be used as a measure for performance, given that they represent the market’s reaction to newly revealed information. In line with Brown and Warner’s (1985) guidelines, the CAR’s will be obtained as follows. The day of downsizing announcement is defined as day ‘0’. For each security, a maximum of 252 daily return observations will be used, consisting of a year’s worth of trading days around a given event, called the designated ‘estimation period’. The cumulative abnormal returns will be measured using a five day event window, [-2 through +2], the designated ‘event window’. All securities in the sample have at least 230 daily returns for the estimation period, and at least 3 daily returns in the event window.
In the context of innovation it can be argued that a one or two day period after the merger or acquisition takes place is not enough for determining the ultimate success of failure of the venture. As it takes time to integrate workforces and operations, achieve synergies and produce valuable propositions, an ex-ante estimation by efficient markets on the profitability of the deal could be considered fragile. To alleviate this concern, the present paper turns to a study by Duso et al. (2010) who show that by using a long window ( 25 or 50 days before the event) around the announcement date, studies can increase the ability of capturing ex-post merger effects. Using two methodologies in order to assess merger effects, namely event studies based on market reactions to the merger announcements, and the second based on accounting data, they find empirical evidence that the abnormal returns and the ex-post profitability of mergers are positively and significantly correlated (Duso et al., 2010).
Once the event has been pinpointed and the estimation window has been established, cumulative abnormal returns (CAR) will be computed as follows.
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the benchmarks used, S&P, FTSE, Dow Jones indices, etc. We can relate any security’s returns to that of the returns of the market portfolio (MacKinlay, 1997). For stock ‘i’, the market model is:
Rit i iRmt it, and Eit 0variti
Further following MacKinlay (1997), we note that under general conditions, an ordinary least squares (OLS) method is an appropriate estimation procedure for the market model parameters. The OLS estimators for the market model parameters for the estimation window can be computed as: 𝛽̂𝑖 =∑ (𝑅𝜄𝜏− 𝜇̂𝑖)(𝑅𝑚𝜏− 𝜇̂𝑚) 𝛵1−1 𝜏=𝜏0 ∑𝛵1−1(𝑅𝑚𝑡− 𝜇𝑚)2 𝜏=𝜏0 𝛼̂𝑖 = 𝜇̂𝑖 − 𝛽̂𝑖𝜇̂𝑚 With 𝜇̂𝑖 = 1 𝛵1− 𝛵0 ∑ 𝑅𝑖𝜏 𝛵1−1 𝜏=𝛵0 And 𝜇̂𝑚 = 1 𝛵1− 𝛵0 ∑ 𝑅𝑚𝜏 𝛵1−1 𝜏=𝛵0
Now that we have returns for our sample and market model parameter estimates, we can further measure and analyze the abnormal returns for the sample using (MacKinlay, 1997):
𝐴𝑅𝑖𝑡 = 𝑅𝑖𝑡 − 𝛼̂𝑖− 𝛽̂𝑖𝑅𝑚𝑡
Next, we need to aggregate the abnormal returns in order to make comprehensive inferences for the event that we are interested in. we define CAR as the cumulative return for the sample. The CAR is the sum of all registered abnormal returns (MacKinlay, 1997):
𝐶𝐴𝑅𝑖(𝑡1, 𝑡2) = ∑ 𝐴𝑅𝑖𝑡 𝑡2
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5. Two event studies
The process depicted above will be performed twice, for a total of two separate event studies. This reason for this is that we want to capture the market’s reaction at two distinct points in time. The first event study that will measure CAR1 attempts to see how the market reacts to the announcement of M&A deals that will, in the future, employ personnel downsizing. Thus, CAR1 is first on the timeline, and measures the abnormal returns around the date at which the M&A deal is sealed and made public. Following, CAR2 attempts to measure the market’s reaction to actual announcements of personnel layoffs following the M&A deal. Doing this we aim to see if the market further penalizes the company. Using CAR2 we also attempt to see whether or not the amount of workers being laid off amplifies the reaction, and if companies with large M&A experience manage to generate positive reactions. Conducting the event study and computing the CARs was done using STATA. Testing the hypotheses will be done by means of OLS regressions. In order to account for industry specific effects, the ‘cluster’ option for standard errors available in STATA was used (Akdogu, 2009). Clustering was performed at a 1st digit SIC code level.
VII. Results
1. Descriptive Statistics 1.1 Location
The final sample consists of 732 companies. Most transactions were domestic, as expected, granted that the United States remains the largest market for mergers and acquisitions, and the majority of U.S. transactions target domestic companies (Baigorri, 2015). Even so, around a fifth of the transactions took place across borders. The most active acquirer in the sample was the IBM Corporation with 18 transaction, followed by Oracle with 16 transactions, and Cisco with 11 transactions.
Table1. Frequency of international deals
International Frequency Percent
No (0) 586 80.05 Yes (1) 146 19.95
Total 732 100
1.2 Downsizing
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Table2. Frequency of downsizing announcements
Downsized Frequency Percent
No (0) 605 82.65 Yes (1) 127 17.35
Total 732 100
1.3 Diversification
Another variable that is worth looking at in more detail is the one that portrays diversification. The way diversification is measured was by looking at the acquirer and target SIC codes. SIC, an abbreviation for ‘Standard Industrial Classification’ is a code system used to classify industries by using a four digit code. For measuring diversification, the SIC codes of acquirer and target were compared, a well vetted method of measurement in such cases (Wilcox et al., 2001). This was approached as follows. The SIC codes were split making use of dummy variables, ‘asic1’ corresponding to the first digit of the code, ‘asic2’ corresponding to the first 2 digits, and finally ‘asic3’ corresponding to the first 3 digits. The same was then done for the target SIC code, using ‘tsic’. A last dummy variable was then created in order to note the degree to which the sic codes matched. Whilst the largest percentage of acquisitions were highly related, almost a quarter of transactions were concluded between firms operating in industries that were completely unrelated. Table 2 presents the results.
Table3. Diversification percentages
Diversification Frequency Percent Cumulative
0 (no match) 169 23.09 23.09 1 (1st digit match) 74 10.11 33.2 2 (2 digit match) 43 5.87 39.07 3 (3digit match) 137 18.72 57.79 4 (full match) 309 42.21 100 Total 732 100
An interesting observation is that out of the 127 downsizing companies in the sample, 94 acquirer-target pairs, corresponding to 74 percent display a 2 digit level SIC match. This result is in line with that of Krishnan and Park (2002), and our assumption, that related acquisition are more likely to result in downsizing.
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Table4. Descriptive statistics
VARIABLES No Mean SD MIN MAX
Available Cash 707 33.35 870.1 -688.3 23,109 ROA 711 -1.390 25.51 -194.3 54.39 Deal Size 685 170,594 995,201 0 2278,0000 Quick Ratio 712 2.245 2.513 0 35.28 Downsize percentage 78 13.33 11.79 0.560 55.56 Time to announcement 127 171.84 143.21 0 663 Experience 119 5.160 7.580 0 53 2. Regression Results 2.1 The first Event Study
Negative CARs are registered for 424 (60.31%) M&A announcements Initial regression results for the first event study that computed CAR1 are presented in Table 5.
Table 5. Regression results for CAR1
(1) (2) (3)
VARIABLES Model 1 Model 2 Model 3
Downsizing -0.00885** (0.00180) Deal Size 0.00807*** 0.00782*** 0.0162 (0.00123) (0.00122) (0.0144) International 0.00280 0.00248 -0.0475*** (0.0172) (0.0167) (0.00265) Diversification 0.000162 0.000746 -0.00596 (0.00337) (0.00320) (0.0146) Year 0.00351** 0.00349** 0.00750* (0.000649) (0.000636) (0.00178) Quick Ratio -0.00586 -0.00613 0.000588 (0.00440) (0.00441) (0.0147) Experience -0.000452 (0.000206) Constant -7.142** -7.089** -15.20* (1.294) (1.267) (3.585) Observations 678 678 117 R-squared 0.052 0.053 0.147
Robust standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1
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announcement. It suggests the market reacts more positively to the announcement of large transactions. In Model 2 we test the market’s prediction effect, introducing the dummy ‘downsizing’, a binary variable that displays ‘1’ in case that the company later performed downsizing actions and ‘0’ otherwise. The regression results support our assumption, as it appears that the market reacts negatively to the M&A announcements that subsequently downsize. The result is significant at a p<0.05 level. The deal’s relative size remains highly sifnificant. Model 3 takes a preliminary look at the experience factor, however this appears not to have any significant influence. Hypothesis 1 finds support at a p<0.05 significance and 0.053 R squared.
2.2 The second Event Study
From the initial sample of 732 companies, downsizing announcements were found for 127, this translating into 17.35 percent of the companies in the sample employing personnel cuts in relation to the M&A. This generated 127 cumulative abnormal returns for the second event study. The most negative value recorded in the sample is -.648 and the largest is .705. The mean value for CAR2 is -.00734. Furthermore, the sum of all cumulative abnormal returns is negative, totaling -.932. It appears that, on average, the companies in our sample experienced negative market reactions when releasing information relating to personnel cuts.
2.2.1 Magnitude of downsizing
Regression results for testing the impact of downsizing magnitude on CAR2 are presented in Table 6.
Table 6. Regression results for CAR2
(1) (2) (3)
VARIABLES Model 1 Model 2 Model 3
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Hypothesis 2 asserted that the magnitude of the downsizing action will influence the vehemence of the market reaction. We argued that larger downsizing actions will perform worse than more moderate ones. The hypothesis is again tested by means of OLS regression. Model 1 introduces the control variables, deal size again playing a significant role. Model 2 adds in the magnitude of the downsizing action as percentage of the reduction in force from the consolidated organization. We can observe that magnitude has no significant effect on stock performance in the event window. Contrary to the study’s assumptions, larger downsizing actions do not trigger larger negative market reactions. Thus, Hypothesis 2 is not supported. Adding in experience, we can observe a slight increase in R squared but no significant effects are to be noted.
2.2.2. M&A Experience
Hypothesis 3 put forward the idea that companies with significant M&A experience would be perceived as being better equipped to navigate personnel reductions. The market would then react positively, anticipating the good results of a successful integration. The hypothesis was first tested using a probit regression. The dependent variable used was a dummy binary variable ‘downsize_destroy’. It was generated by adding up the cumulative abnormal returns from the first and second event studies. By doing this, the study hoped to capture the full extent of the market reaction. The variable would display ‘1’ if the total sum of the abnormal returns was negative and ‘1’ otherwise. Results for the probit regression are found in Table 7.
Table7. M&A Experience (1) VARIABLES Model 1 Experience 0.215** (0.0838) Constant -0.0748 (0.157) Observations 92
The results are counterintuitive. The regression results indicate that previous M&A experience positively influences value destruction. It appears that in the case of companies previously involved in more M&A transactions the market responds more negatively in the case layoffs are announced.
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VIII. Discussion and Conclusions
While business analysts often attempt to predict layoffs in the wake of major mergers or acquisitions, and then make subsequent forecasts on how the consolidated entity will perform in the marketplace, the present study looked into the possibility of that forecaster role being attributed to markets. The study was conducted using two separate event studies, using a sample of 732 high tech M&A transactions taking place over 15 years, in the 1998-2014 period. The findings are further elaborated.
1. Markets have potential as downsizing forecasters
The first hypothesis put forward the idea that markets can act as forecasters, incorporating available information and reacting accordingly when merging companies display a high potential for upcoming downsizing actions. Making use of the efficient market hypothesis and the notion that markets incorporate all readily available information and subsequently reflect it in the stock price (Fama et al., 1969; Fama, 1970), the study brought forward the idea that certain characteristics will act as triggers. Taking a RBV perspective, the study assumed sensing losses in valuable human resources, the reaction will be a negative one. Evidence for this assumption was gathered from M&A and organizational downsizing literature that propose various deal characteristics as predictors of subsequent downsizing actions. For example, Krishnan and Park (2002), using a sample of 60 large US mergers and acquisitions, find that highly related acquisitions are much more likely to subsequently cut workforce, further confirming the results of O’Shaughnessy and Flanagan (1998). Other studies look at the influence of acquisition premiums (Sirower, 1997) or even phrasing of the announcements (Ro, 2015).
The initial event study examined abnormal returns registered around the date an M&A transactions is announced to the public. Data supported the idea that negative abnormal returns are more likely to be recorded for organizations that do employ personnel cuts no longer than one year after the initial transaction announcement This provides some evidence in support of the notion that markets can act as forecasters of personnel cuts in the wake of M&A deals. However, these returns provide no prediction as to how the market will react when the company actually announces personnel cuts. A possible reason for this can be found in the relatively long time span between signing the deal and announcing the personnel cuts. The average window between events in the sample was 171 days. During this time, it can be envisioned that the market incorporates various other information that interfere with the initial reaction.
2. Downsizing Magnitude
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intensive, as larger losses of valuable human resources generate negative ripple effects across the organization.
In order to test this hypothesis the study measured the percentage of workers being let go from the combined organization, using data from downsizing announcements and the Datastream database. Regression results showed that, in our sample, the magnitude of personnel cuts have no significant impact on the market’s reaction. The study therefore found no support for the organizational downsizing literature that backed the assumptions.
A possible explanation for the lack of support could again stem from the relatively long period between deal closure and downsizing announcement. It can be argued that the average delay of almost half a year permits the company to make a thorough assessment of its workforce needs. Employee retention programs and job relocation plans can be put in place (Band & Tustin, 1995). A decision resembling strategic downsizing rather than random cost cutting could alleviate stakeholder concerns regarding loss of personnel.
3. Managerial Experience
Drawing on organizational learning literature, the final hypothesis advanced the idea that by previously experiencing M&A transactions, organizations will be better prepared at handling the struggles of future integration. This is in line with scholars arguing that organizations considering M&A transactions should learn from their previous transactions (Hitt et al., 2001; Levinthal & March, 1993). Using all the high tech M&A transactions available on Datastream for the 1997-2014 period, we were able to asses in how many transactions the companies in our sample were involved prior to the focal event.
The results obtained from 92 transactions in our sample were counterintuitive, the data suggesting that increased M&A experience leads to negative returns when announcing downsizing actions. It appears that the market reacts negatively to downsizing announcements made by companies that put too much effort into acquisition efforts.
An explanation for this might be that resorting to downsizing may signal problems in the case of high frequency acquirers which focus too much on short-term gains. Such problems could stem from inability to integrate workforces and increased managerial strain in successfully coordinating an ever increasing number of acquisitions. Financial problems could also be the trigger for layoffs in the case of high frequency M&A players. As overhead related to labor is almost always one of the company’s main expenses, cutting labor costs can be a quick and dirty solution to patching up more systemic problems (Baumol, Binder, & Wolff, ). As previously mentioned, considering that companies frequently pay highly inflated acquisition premiums for ensuring a smooth transaction, these premium-related costs can quickly translate into debt (Sirower, 1997). This seems particularly salient as debt financing is found a significant downsizing determinant following mergers and acquisitions (Amihud, Lev, & Travlos, 1990), and poorly performing firms often resort to job cuts (Ofek, 1993).
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performance research in the context of personnel downsizing. It argued that the prospect of personnel layoffs in the wake of a M&A deal will send valuable information to the market, which, will in turn act accordingly. Adopting a resource based perspective, it was argued correctly that markets will react negatively at the announcement of a M&A deal that will generate personnel cuts in the future. Surprisingly, it appears that when companies do actually downsize, the magnitude of the layoffs has no effect on market reaction. Furthermore, the data indicated that previous M&A experience negatively impacts the stock price when downsizing actions are made public. While the study resulted in somewhat counterintuitive results, it aimed to be a first step into towards the exploration of a significant gap in M&A research. Its limitations should only act as incentive for further, more elaborate studies.
IX Managerial Implications
As merger and acquisition transactions are set to reach record values for 2015, there is little doubt regarding their ongoing pervasiveness in the corporate world (Fontanella-Khan & Massoudi, 2015; Primack, 2015). It is then more important than ever for not only managers but also shareholders to seriously consider their due diligence when pondering a merger or acquisition. As recent research into the area constantly doubts the benefits of both M&As as well as organizational downsizing, it stands to reason that managers and shareholders should thoroughly consider how the possibility of personnel cuts will weigh in on the ultimate performance of the deal. Even if only week evidence was found by the present study, it is nevertheless worth taking into consideration that the market knowledgeably reacts to M&A related downsizing.
The high tech sector seems to be a perfect setting for such questions, as mergers and acquisitions are very important in acquiring new technological capabilities. While scouting for new capabilities is highly incentivized by the necessity to remain competitive in highly innovative industries, the loss of human resources can be particularly harmful as these industries heavily rely on the availability and quality of human capital. The decision to let people go or not is undoubtedly one of the most important managers need to consider in a post M&A scenario (O'Shaughnessy & Flanagan, 1998).
While the data available in this study does not yield definitive conclusions, the counterintuitive results hopefully serve to signal how unpredictable the field still is. The present study then aims to serve not only as a warning to the importance of human resource management in the wake of M&A deals, but also to highlight the necessity of future studies in the field.
X. Limitations and Future Research
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unavailability of data for the control variables. Future studies should take into account these data availability limitations if they aim to analyze such a narrowly targeted segment of transactions.
With a 21.22 percent initial sample downsizing frequency questions also arise regarding the efficiency of employing LexisNexis when looking for announcements made by relatively obscure companies. It is worth noting these data limitations when considering future studies in similar settings. A future research into high tech mergers and acquisitions might obtain better, more significant results by employing a considerably larger sample that would mitigate data gaps.
However, generalizability problems for such a study not only stem from missing data problems. A future study might also account for country-market differences. Given that the SDC database is heavily Anglo-Saxon oriented, the U.S. and the U.K. accounted for the overwhelming majority of transactions in our sample. The results could be skewed towards the Anglo-Saxon markets.
Another shortcoming might stem from the large average time span between transaction and downsizing announcement. The average of 171 days can account for the lack of correlation between the market reactions corresponding to the two event studies. As previously acknowledged, large amounts of information could have been processed and numerous trajectory changing events registered during that time. This could account for the lack of predictability the first abnormal returns manifest towards the second ones.
Furthermore, given that the study focused entirely on the narrow niche of high tech M&A transactions, the results might not be relevant to other industries. A general study accounting for various industries would be an interesting contribution to not only in an M&A setting but also for organizational downsizing literature.
As the high tech industries continue to gain momentum on the global industrial scale, it is only natural that managerial studies pertaining to this branch will proliferate. Hopefully, the present study is only the first attempt among many others to come in the quest for better understanding the dynamics involved in the powerful business phenomena of mergers and acquisitions.
Acknowledgement
I would like to thank Dr. Killian McCarthy for his tremendous support and guidance during the entire process of writing the present thesis. I also thank Achillefs Daskalakis for his great companionship.
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