Merger performance varies greatly depending on the number of pre-merger third-party ties connecting the acquiring firm to its partner, according to a new study by researchers at the Yale School of Management and INSEAD.
Mergers and acquisitions perform poorly, on average, but there has been little insight into what accounts for the variation in performance. In the study, published in Administrative Science Quarterly, the authors found that the number of indirect ties, such as common clients and shared suppliers, affect both acquiring firms’ choice of partners and the performance of the combined firm after the merger. The study revealed that the probability of being acquired rose, but performance of the combined firm declined, with the number of pre-merger third-party relationships connecting the firms.
“Mergers destroyed value, on average, only because they usually combined firms with third-party connections,” says Olav Sorenson, the Frederick Frank ’54 and Mary C. Tanner Professor of Management, who co-authored the study with Michelle Rogan, assistant professor of entrepreneurship at INSEAD. “Our results strongly implicate picking the wrong partners as one of the primary factors underlying the poor average performance of acquisitions.”
Sorenson and Rogan examined how indirect ties affect the choice of acquisition partner and post-merger performance by analyzing data from mergers and acquisitions that occurred in the global advertising industry from 1995 to 2003. Third-party relationships between firms are generally difficult to ascertain; however, ad agency clients are regularly reported in industry trade publications, making common clients a convenient measure of third-party ties in that industry.
The results show that the number of common clients significantly and positively predicted acquiring firms’ choice of partner. The probability of choosing a partner with common clients increased with the physical distance between the firms, and also increased among potential partners serving distant industries. As the number of common clients increased, the performance of combined firms declined, both because they lost clients and because they sold less to the clients they retained. Firms with no common clients experienced no effects to positive effects on post-merger performance.
The authors suggest that the results could be attributable to two factors. “Either managers hold positively biased beliefs about those connected to them through common clients, or they restrict their searches for potential acquisition partners to those they already know, despite the disadvantages of doing so, ignoring targets that may have more potential but with whom they have no indirect ties,” says Sorenson.
Sorenson and Rogan expect the study findings to apply not only to advertising agencies, but also to merged firms in other industries, and across indirect ties other than common clients.
“Picking a (Poor) Partner: A Relational Perspective on Acquisitions” is published in the June 2014 issue of Administrative Science Quarterly.