Strategic Management Journal, Vol.

11, 283-295 (1990)

/
L MERGER MOTIVES AND MERGER PRESCRIPTIONS
(, FRIEDRICH TRAUlWElN
University of Bochum, Hurth, West Germany

The article surveys theories of merger motives and relates them to prescriptions for merger
strategies. The theories of merger motives can be classified into seven groups. Those theories
arguing with private information, managerial empire-building or process influences are
better supported by evidence than those tracing mergers back to efficiency gains or monopoly
power. The explanations of mergers in terms of raia'er activity or macroeconomic disturbances
cany the least plawibility. Strategy authors have &cussed mergers with respect to the
choice of acquisition mode, entry mode, and integration mode. The prescriptions on all
three topics are dominated by'the eficiency theory of mergers. For this reason they are
dangerous guides for participants in merger processes, On the other hand they provide an
t@ient language for communicating one's posinbn. The research in merger motives
should be redirected from the efficiency theory to explanations that build on decision
processes, co@icting goah, and ambiguous private information.

Why do mergers occur? Why can we observe no single approach can render a full account
premiums and bidding contests as in the case of (e.g. Steiner, 1975; Ravenscraft and Scherer,
RJR Nabisco? Is it because 'the public markets 1987). But knowing that the world is complex
are incapable of understanding the true value of cannot be the end of scientific endeavor. There-
c o p r a t e assets [or because] management was fore an attempt is made to order the merger
trying to steal the company from underneath the theories according to their plausibility and consis-
noses of its shareholders [or because] Wall Street, tency with the evidence. There are two possible
steeped in greed and ego, ran amok and overbid ways of getting evidence on motives; direct
for the company' (Barlett, 1988: Al)? The wave investigation and indirect inference from merger
of mergers and reverse mergers during recent outcomes. Direct investigation may produce
years has drawn widespread attention, but most unreliable results while inferences may be un-
of the academic and public discussion has been warranted. To offset these shortcomings both
devoted to the mergers' consequences. The kinds of evidence are used here with some
motives behind these mergers have received only caution.
modest attention although they ultimately decide The second main part examines the literature
whether a merger is attempted or not. dealing with prescriptions for merger strategies.
This article gives a critical overview of merger This field can be divided into three major
explanations and relates them to prescriptions topics: the choice between related and unrelated
for merger strategies. The first main part discusses acquisition, the choice between acquisition and
the explanations put forward for mergers and internal development, and the choice between
examines the evidence on the several theories. integration and autonomy of acquired units. This
This is not done to refute or prove a single part of the article aims at identifying the
theory. Most observers agree that mergers are underlying assumptions about the rationale
driven by a complex pattern of motives, and that behind a merger strategy. These assumptions
0143-2O951901040283--13$06.50 Received 21 Augur1 1989
0 1990 by John Wiley & Sons, Ltd.
284 F. Trautwein
contrast sharply with the evidence on merger
motives. The motive most merger prescriptions
implicitly rely on is scarcely supported by
evidence. The third and final part suggests some
Net gains
through
synergies I Efficiency
theory

Wealth Monopoly
conclusions following from this discrepancy.
Merger as Merger
rational benefits
choice bidder’s Raider
THEORIES OF MERGER MOTIVES shareholders
from target’s
shareholders
Merger motives have triggered far less theoretical Net gains Valuation
efforts than merger consequences. But still the through theory
private
field has brought forth a total of seven different information
theories. At the most general level those theories
Merger
that regard merger consequences as the moving benefits
Empire-buildins
theory
cause behind mergers can be distinguished from managers
those that do not. Gort’s (1969) disturbance
theory and those approaches that view mergers
as process outcomes belong in the second
Merger as
process
outcome
Merger as
I Process
theory

Disturbance
macroeconomic theory
category. In the first category most theories focus phenomenon
on shareholders’ interests while one group focuses
on managers’ interests and their deviations from Figure 1. Theories of merger motives.
shareholder value maximization. Finally, those
theories dealing with shareholders’ gains can be information and therefore allocate capital
distinguished according to the postulated source more efficiently.
of merger gains. These are either net gains 2. Operational synergies can stem from com-
through synergies or private information or bining operations of hitherto separate units
wealth transfers from a target’s shareholders or (for example a joint sales force) or from
from customers. Further possible sources of knowledge transfers (Porter, 1985). Both
wealth transfers are employees and the state. kinds of operational synergies may lower
But wealth transfers from employees have not the cost of the involved business units or
received much factual importance (Jensen, 1984). may enable the company to offer unique
Wealth transfers through tax savings are promi- products and services. These potential
nent in many mergers but cannot explain more advantages have to be weighed against the
than a fraction of the premium usually paid cost of combining or transferring assets.
(Kaplan, 1987). Figure 1 orders those theories 3. Managerial synergies are realized when the
included in the survey. bidder’s managers possess superior planning
and monitoring abilities that benefit the
target’s performance. A sideline to this
Efficiency theory
argument are the positive motivation effects
This theory views mergers as being planned and ascribed to LBOs (Jensen and Murphy,
executed to achieve synergies. In general, three 1988).
types of synergies can be distinguished.
The idea of financial synergies has received sharp
1. Financial synergies result in lower costs of theoretical criticism. The main argument is that
capital. One way to achieve this is by financial synergies of any kind cannot be achieved
lowering the systematic risk of a company’s in an efficient capital market. Research has
investment portfolio by investing in unre- shown that indeed there is no evidence for a
lated businesses. Another way is increasing lower systematic risk or a superior internal capital
the company’s size, which may give it market (Rumelt, 1986; Montgomery and Singh,
access to cheaper capital. A third way is 1984). Size advantages, however, seem to exist
establishing an internal capital market. An in the capital market (Scherer et al., 1975).
internal market may operate on superior Managerial and operational synergies, on the
 Merger Motives and Merger Prescriptions 285

other hand, have been criticized as evasive ones, where three in four failed. Montgomery
concepts that are often claimed for mergers but and Wilson (1986) reported similar figures but
seldom realized (Kitching, 1967; Porter, 1987). no difference between the two types of diversifi-
One important variation of the efficiency theory cation. Ravenscraft and Scherer (1987) estimated
of mergers is Jensen’s management competition a divestiture rate of one in three, and found the
model (Jensen, 1986). This model resembles most active acquirers in their sample to be less
earlier arguments by, e.g. Alchian (1950) and profitable than the U.S. industry average. A
Manne (1965). Jensen pictures takeovers as a third group of studies has investigated synergy
disciplinary force in the capital market, which categories. In the initial study, Kitching (1967)
functions as a market for corporate control. concluded that it was financial, not operational,
Managers who invest in projects with negative synergy that could be achieved through mergers.
net present value instead of paying the excess Twenty years later, Chatterjee (1986) obtained
cash flow to their shareholders are threatened closely similar results. In a more specific study,
by competing management teams. The latter Shelton (1988) analyzed how far relatedness
provide an external control that substitutes for categories explained value gains in mergers.
the insufficient internal control by shareholders. She found the categories to be only partially
Jensen acknowledgesthat one way for incumbent significant.
managers to waste excess cash is to engage in There is further indirect evidence on Jensen’s
mergers themselves. In these cases he sees the management competition model. In two articles
debt accumulated in the deals as an effective (1984, 1986) Jensen himself surveys the stock
controlling device against further deviations from market evidence and concludes that it is largely
shareholder value maximization. Jensen and his supportive of his model. Further backing comes
predecessors relax the efficiency argument. They from Walkling and Long (1984), who report that
do not argue that all mergers are undertaken to variables associated with managerial welfare
promote the efficiency of the corporate world, explain targets’ bid resistance better than variables
but that this is their aggregate effect. associated with shareholder welfare. On the
Merger makers frequently cite synergy argu- other hand, the performance results obtained by
ments to justify their actions (Friedman and Ravenscraft and Scherer (1987) and Porter (1987)
Gibson, 1988; Maremont and Mitchell, 1988; cast a doubt on the stock market results.
Porter, 1987). The differing perception of close Besides the divestiture rates mentioned above,
observers (Dobrzynski, 1988a, b; Rothman, 1988; Ravenscraft and Scherer found that acquired
Smith and Sandier, 1988) is the best indicator companies had an above-average profitability
that direct evidence can produce unreliable prior to a merger, and that acquiring companies
results. were below-average performers.
Indirect evidence on the efficiency theory In sum, the efficiency theory’s record is
comes from three different types of studies. unfavorable. It appears to be consistent with
Event studies as summarized by Weston and stock market quotations but far less with compa-
Chung (1983), Jensen (1984), Dennis and McCon- nies’ actual performance. If one regards financial
nell (1986), and Ravenscraft and Scherer (1987) statements as more reliable than stock prices the
show that the stock market in general values efficiency theory has to be rejected. However, if
mergers positively. Almost all of the gains, one assumes the capital market to be efficient
though, are reaped by the targets’ shareholders the theory can be held (except for the idea of
while the bidders’ shareholders gain nothing on financial synergies). But adherents to capital
average. Moreover, Ravenscraft and Scherer market efficiency have to explain where the
show that over 21 years only two of the most missing link between the public information from
active acquirers of the 1960s outperformed the financial statements and the public information
S&P industrials index. Studies using company incorporated in the stock price is.
performance data paint an even bleaker picture.
Porter (1987) found that more than half of the
Monopoty theory
acquisitions by major U.S. companies failed.
On the other hand, his study showed related This explanation views mergers as being planned
acquisitions to turn out better than unrelated and executed to achieve market power. This
286 F. Trautwein
cannot only occur in horizontal acquisitions. of the century (Rhoades, 1983) can be ‘sold’ on
Conglomerate acquisitions may allow a firm to efficiency grounds or by arguing that the relevant
embark on the following activities: market is broader.
There is some indirect evidence on the mon-
1. The firm can cross-subsidize products. Pro- opoly consequences of mergers. Jensen (1984)
fits from the position in one market are
summarizes a number of event studies that deal
used, for example, to sustain a fight for
with the effects of merger announcements,
market share in another market. Philip FI’C investigations, and merger cancellations on
Morns allegedly did this after acquiring competitors’ stocks. Under the monopoly theory
Miller. competitors’ stocks should rise upon an announce-
2. The firm can aim at simultaneously limiting ment and drop if the merger is challenged or
competition in more than one market. cancelled. Since competitors’ stocks do not fall
One way to do so is tacit collusion with
on the two latter events Jensen rejects the
competitors it meets in more than one monopoly theory. Two other recent studies
market. This theory of mutual forbearance
directly examine the role multimarket contacts
was developed by Edwards (1955). A
play. Scott (1982) found that they were only
practical example is building a foothold in
associated with high profits if seller concentration
a competitor’s main market who in turn was high, too. Contrary to that, Feinberg (1985)
possesses such a foothold position in the
found a generally positive relationship, although
firm’s main market (Porter, 1985). Other
it was much weaker on the industry level
possible ways of limiting competition in
compared to the company level. Finally, the
more than one market are reciprocal dealing
above-mentioned performance results from the
and combining business functions such as
studies by Ravenscraft and Scherer, and by
purchasing. The two latter phenomena are
Porter, apply here, too. They clearly contradict
hard to evaluate since they can be synergistic
the picture of successful extortion of monopoly
as well as anti-competitive.
profits through non-horizontal mergers.
3. The firm can aim at deterring potential
In sum, the monopoly theory’s record appears
entrants from its markets. One possible way
to be even weaker than that of the efficiency
of achieving this is concentric acquisition by
theory. The results on companies’ performance
a market leader. Deterrence of potential
are mixed while the event studies are unfavorable.
competition is even harder to evaluate than
However, the results are not as devastating as
the activities mentioned in the previous
Jensen (1984) and Ravenscraft and Scherer (1987)
paragraph. The elusive character of potential
claim.
competition seems to be the reason for its
ever-changing fate in antitrust (Steiner,
1975). Valuation theory
These kinds of advantages have been referred to This approach argues that mergers are p!snned
as collusive synergies (Chatterjee, 1986) or and executed by managers who have better
competitor interrelationships (Porter, 1985). information about the target’s value than the
These labels illustrate that from the firm’s point stock market (Steiner, 1975; Holderness and
of view these advantages are as beneficial as the Sheehan, 1985; Ravenscraft and Scherer, 1987).
synergy types discussed above. But there is a Bidders’ managers may have unique information
clear difference at the level of the economy. about possible advantages to be derived from
Collusive synergies represent no efficiency gains combining the target’s businesses with their own.
but wealth transfers from the firm’s customers. Or they may have detected an undervalued
The efficiency gains sometimes accruing to company that only waits to be sold in pieces.
monopolistic competition do not occur in non- Similarly, managers proposing an LBO may
horizontal mergers (Scherer, 1980). possess unique information about what they can
It is not too surprising to find no claims that do with a business once they are no longer under
a merger is made to achieve monopoly power. the influence of a corporate headquarters.
Even mergers that are widely perceived to follow Like the financial synergy argument this
this aim, like the merger wave around the turn hypothesis conflicts with that of an efficient
 Merger Motives and Merger Prescriptions 287

capital market. It has been argued that the two market’s reaction. It could be argued that bids
are not incompatible because the latter only based on private information will involve smaller
requires that all publicly available information is premiums because they can be less easily matched.
incorporated in the stock price (Ravenscraft and However, this is not true because private infor-
Scherer, 1987). If the bidder possessed private mation is not one-dimensional (Wensley, 1982).
information about the target’s value (excluding Several bidders may have different pieces of
synergies at the moment) he would reveal it in private information on one target. Moreover, bid
his bid. The stock price would climb to reflect prices are influenced by considerations like ‘how
the new information leaving the bidder in a can we discourage competitive bids?’ or ‘how
winner’s-curse situation. In this sense an efficient much can we get away with?’.
market does not preclude the existence of There is widespread evidence that merger
undervalued target firms, but only the possibility makers justlfy their actions in terms of the
of capitalizing on revealed private information valuation theory. Ravenscraft and Scherer (1987:
(Wensley, 1982). 9, ftn 14) cite a wide array of according statements.
But this interpretation is too narrow. Wensley Probably the most telling piece of information is
also notes that those who possess private infor- how widespread the disbelief in stock market
mation have to cope with its ambiguity. A efficiency is. In the often-cited Harris poll in
prospective bidder envisages a number of future 1984, 60 percent of the executives thought their
states of the world and his target’s value in each company was undervalued while 32 percent
state. He ends up with a set of states nobody agreed with the stock market, and 2 percent felt
else envisages because his situation is one of overvalued (Blcsiness Week, 20 February 1984).
genuine uncertainty (Shackle, 1%9, 1972). His These statements are clearly not sufficient to
problem then is to validate his expectations, make the valuation theory the merger explanation
which he ultimately does in his offer. The of choice. Managers claim efficiency goals also,
other market participants face a corresponding without producing too much evidence. But the
problem. Unless the bidder reveals an unequivo- concept of private information as a basis for
cal strategy for the post-merger period they mergers warrants further consideration, since it
cannot incorporate his private information into shows a way the problematic assumption of
the market price because they do not possess the capital market efficiency can be avoided.
necessary knowledge. The stock price rises,
though not because of a new estimate of the
Empirebuilding theory
company’s income stream. The reason lies in the
bid itself, weighed with the possibilities that According to this theory, mergers are planned
enough shares are tendered and no competitive and executed by managers who thereby maximize
bidder emerges. their own utility instead of their shareholders’
The difference between the valuation theory value. This approach has its roots in the original
and other merger explanations is its recognition study on the separation of ownership and control
of the role which genuine uncertainty plays in in the corporation (Berle and Means, 1933). Its
strategic decisions such as mergers. Capital underlying idea was contained in the various
market participants cannot fully evaluate the managerial theories of the firm (Baumol, 1959;
information on which a bid is based. What is Marris, 1964; Williamson, 1964) and explicitly
more fundamental, even the bidder cannot do formulated by Mueller (1969). Recently, Rhoades
so. The very nature of private information, its (1983) and Black (1989) have developed related
ambiguity, makes it impossible for him to reach merger explanations.
confidence about the bid’s basis. The common thread of the managerial theories
The problem with assessing the valuation of the firm is the maximization of managers’
theory’s validity is that it is not possible to derive goals subject to constraints put upon them by
any specific propositions about merger results. the capital market. In Baumol’s model managers
The owner of private information places a higher maximize revenues subject to a minimum profit
value on certain assets than does their current requirement. Marris’ model overcomes this static
owner. He will offer a premium based on his perspective and instead postulates the financially
private expectations and on his assessment of the sustainable growth rate of assets as the goal
288 F. Trautwein

pursued by managers. Williamson introduced the managerial abuse (Bartlett, 1988; Dobrzynski,
concept of managers’ expense preference, which 1988a, b).
he modeled as a compound variable containing There is only some related evidence from work
factors such as company cars, excess staff or concerned with merger consequences but it is
prestigious investments. Mueller built on Marris’ mostly supportive. You et al. (1986) found that
work and developed a growth maximization management share ownership and the number of
model of mergers. Interestingly, Marris excluded inside directors were negatively associated with
mergers from his model because he regarded merger results. Amihud and Lev (1981) found
them as a financially unsustainable strategy. management control to be associated with engage-
Mueller did not discuss Marris’ concern but the ment in conglomerate mergers. Both results
general evidence on the amount of acquisitions support the empire-building theory. Walsh (1988)
by individual companies (Porter, 1987) stands reported that merging companies have a higher
against Marris’ conjecture. executive turnover than non-merging companies,
An empire-building argument is not necessarily which supports an explanation of mergers in
confined to the motive of growth maximization. terms of managers’ quest for opportunities.
This is shown by Rhoades’ (1983) analysis of the Ravenscraft and Scherer (1987) concluded from
merger wave of the 1960s. Rhoades juxtaposes the case studies accompanying their study that
the profit motive and the power motive as possible empire-building aspects play some role in merger
explanations of business behavior. Comparing the decisions. Rhoades (1983) and Black (1989) each
evidence on the merger waves around the turn surveyed some of the evidence on merger
of the century and in the 1960s he concludes that consequences and found it to be consistent with
in the meantime the power motive has replaced their own empire-building arguments.
the profit motive as the moving force behind In sum, the empire-building theory has to be
large companies’ conduct. given the most credit of the theories investigated
Another recent development in this field is up to this point. This is subject to two reservations.
Black’s (1989) overpayment hypothesis. Black First, the evidence collected until today is
postulates that managers overpay for targets relatively limited. Second, ‘empire-buildingtheo-
because they are overly optimistic and because ry’ is a common name for a variety of merger
their interests diverge from those of their explanations, each with its own limited factual
stockholders. In an efficient capital market the support. This is also true of the other six merger
overpayment should result in an according drop explanations, but the empire-building theory
in the bidder’s stock price. Black argues that this covers a much broader range than, for example,
does not occur because investors anticipate the the monopoly theory.
overpayment (or other means of cash waste).
With this interesting argument Black can reconcile
Process theory
the assumption of information efficiency with the
theory of managerialism. A fifth, only rudimentarily developed theory of
Again, it is not too surprising to find no merger motives has its background in the
instances where managerial goals are cited to literature on the strategic decision process. This
justify a merger. But the empire-building theory research field has produced a vast amount of
enjoys a popularity in the business press that models that describe strategic decisions not as
seems to grow proportional with the size of a comprehensively rational choices but as outcomes
merger. In the case of Philip Morris’ bid for of processes governed by one or more of the
Kraft, observers seemed to be divided between following influences:
management’s synergy explanation and a compet-
ing one that involved management’s desire for 1. Practically all work on decision processes
growth and new fields of activity, fueled by argues with Simon (1957) that individuals
excess cash (Dunkin, 1988; Friedman and Gibson, possess limited information processing capa-
1988; Rothman, 1988; Smith and Sandler, 1988). bilities. Therefore, the search for infor-
In the case of the LBO proposed by RJR mation and alternatives may be abridged,
Nabisco’s management, the reactions were almost evaluations be incomplete, and cognitive
entirely in favor of an explanation in terms of simplifications be used.
 Merger Motives and Merger Prescriptions 289

2. Organizational routines play the central role perceived cultural differences (Sales and Mirvis,
in Allison’s (1971) organizational process 1984) can influence an acquisition and the post-
paradigm and in Cyert and March’s (1963) merger integration process.
behavioral theory of the firm. The multi- In a summary of earlier studies concerned with
plicity of participants and their limited the acquisition process, Power (1983) reported
rationality prevent a comprehensively mostly supportive evidence. The majority of
rational solution of problems. The organi- studies concluded that the acquisition indeed was
zation resorts to routines that have proven not a comprehensively rational decision. They
successful in the past. Old solutions for found suppressed uncertainty, lack of planning,
similar situations are tried on new problems. political influences, varying process participants,
New solutions are only sought after the old and no agreed-upon acquisition criteria. Song
ones have failed. Over time, the organization (1982) gathered evidence that supports the
learns in the sense of developing a set assertion that senior executives’ background plays
of routines for different problems; it is a role. As reported above, Walsh (1988) found
adaptively rational. executive turnover to rise after a merger, a fact
3. Political power is the core category in that may indicate procedural conflicts. Finally,
Allison’s (1Vl) political process paradigm Duhaime and Schwenk (1985) and Jemison and
and Pettigrew’s (1977) analysis of strategy Sitkin (1986) gathered illustrative material on
formulation. Strategic decisions are inter- how cognitive umpUications and other process
preted as the outcome of political games factors can affect a merger.
played between an organization’s subunits In sum, the evidence on the process theory
and outsiders. Tactical considerations and can best be described as ambiguous. The available
mutual adjustments dominate the decision evidence is largely supportive. At the same time,
process. it is so scarce as to forbid any far-reaching
inferences.
Some recent work can be subsumed under the
heading ‘process theory’. Duhaime and Schwenk
(1985) discuss the influence of individuals’ limited
Raider theory
information processing capabilities on acquisition
and divestment decisions. Roll (1986) works out This label can be applied to a sixth possible
the implications of managerial over-optimism. In merger motive discussedespecially in the business
his hubris hypothesis managers’ expectations are press. Its basic hypothesis is seldom stated overtly
systematically erroneous with an upward bias but is implied in the term ‘raider’. Holderness
since a stock’s market price serves as a downside and Sheehan (1985) interpret the term as meaning
cut-off point. Overly good expectations lead to a person who causes wealth transfers from the
bids that would not be made by rational bidders. stockholders of the companies he bids for. These
Jemison and Sitkin (1986) take an explicit wealth transfers include greenmail or excessive
acquisition process perspective and present a compensation after a successful takeover.
framework of four organizational process impedi- The first problem with the raider theory is that
ments to successful acquisition integration. the wealth transfer hypothesis is illogic. In a
There is even less evidence relating to the successful bid the ‘raider’ pays other stockholders
process theory than to the empire-building theory. a premium to become the controlling stockholder
The scarcity of direct evidence can be seen as of the company. Any extortion scheme would hurt
being caused by merger makers’ attempts to him disproportionately, while partially bought-out
rationalize their actions. But news coverage of stockholders might still enjoy a net gain from his
the last two megamergers, for example, revealed activities. In the case of greenmail, wealth is
interesting details of the crucial role personalities transferred from the company and, ultimately,
play (Sterngold, 1988). This is also shown by the from the stockholders. However, the real question
high priority investment bankers give this issue the latter have to ask is why their board made
when preparing a deal (Mergers & Acquisitions, the payment. In terms of the board‘s fiduciary
1982). Some case studies give accounts of how duty this can be justified only if a higher bid can
political and structural matters (Gaddis, 1987) or be expected, or the company can improve its
290 F. Trautwein

stock price on its own, for example through account of how disturbances affect individual
restructuring (Jensen, 1984). expectations is not sufficient for his hypothesis
The second problem with the raider theory is that this overturns the ordering of expectations.
the completely unfavorable evidence. In their However, Gort’s theory is not hit by Wiggins’
study of 69 mergers initiated by some of the most (1981) argument that it cannot explain premiums.
prominent so-called raiders, Holderness and This only depends on the difference in expect-
Sheehan (1985) found targets’ shareholders’ to ations and on competitive processes in the capital
gain in all cases. This replicates the general market.
evidence on targets’ shareholders’ gains from
mergers as summarized, e.g., by Jensen (1984):
the average abnormal gains range from 8 percent PRESCRIPTIONS FOR MERGER
in proxy contests to 30 percent in tender offers. STRATEGIES

This section turns the attention to strategy

Disturbance theory
prescriptions relating to acquisitions. Figure 2
In Gort’s (1969) theory merger waves are caused puts the three topics discussed here into the
by economic disturbances. They cause changes broader perspective of competitive strategy. The
in individual expectations and increase the general analysis in this section aims at identifying the
level of uncertainty. Thereby, they change the merger motives that are either explicitly or
ordering of individual expectations. Previous non- implicitly assumed in the theories and practi-
owners of assets now place a higher value on tioners’ manuals in the three categories. Since
these assets than their owners, and vice-versa. the literature on the three topics is vast, the
The result is a merger wave. review is confined to major recent work in the
This theory is not considered further for three field.
reasons. First, it does not discuss the institutional Competitive strategy can be separated into
framework for mergers. But especially in a corporate- and business-level strategy. The former
macro-level explanation this has to be included is concerned with a company’s product-market
to explain, for example, why the oil crisis in scope and the interrelationships between business
1973/74 did not trigger a merger wave like the units. The latter is concerned with the competitive
one in the late 1960s that was not connected to advantages of single-businessunits and with joint
any major economic disturbance. Second, most operations. The choice of a product-market scope
disturbances are of a sectoral nature. This should can be further separated into the questions of
lead to a sectoral pattern of mergers. But this which markets to serve and how to serve them.
can be observed only in some cases; the food or With respect to mergers this translates into
oil industries are examples; the merger wave of the questions of which companies to acquire
the 1960s is a counterexample. Third, Gort’s (acquisition mode) and when to acquire a business

Competitive strategy
I

Corporate-level Business-level
strategy strategy

Choice of Coordination of Pursuit of

product-market business competitive
scope units advantage

I
Cholce of Choice of Choice of
acquisition entry integration
mode mode mode

Figure 2. Mergers as a topic in competitive strategy.

 Merger Motives and Merger Prescriptions 291

instead of building it internally (entry mode). potentially successful and he regards managers
The coordination of business units translates into as exerting a major influence on the success of
a third question, namely whether and how to a merger. The same two assumptions underlie
integrate acquired business units (integration other strategy prescriptions. If the analysis of the
mode). performancdiversification relation is to be
meaningful it has to be assumed that managers
Acquisition mode influence merger success and that merger success
plays a central role in their decisions. Whether
One stream of work on the acquisition mode this success is seen as stemming from internal
involves evaluation models that have been pro- efficiency gains or collusive practices remains an
posed for merger simulation. The models by open question. However, two facts favor an
Shay (1981), Silhan and Thomas (1986) and Kroll interpretation exclusively in efficiency terms.
and Caples (1987) differ in complexity but have First, there is no evaluation model for monopoly
two things in common. They assume an efficient gains corresponding to the three synergy evalu-
capital market and, following from that, regard ation models mentioned above. Second, except
synergies as the only justification for mergers. If for Porter (1980, 1985) no author proposes to
these authors propose their models for merger look for collusivesynergies as bases of competitive
evaluation this implies that they regard the advantage. The focus is always on internal
efficiency theory as the valid explanation of strengths in an adversarial environment.
mergers.
These models draw on the major stream
Entry mode
of work concerning diversification that follows
Rumelt’s (1986) study of the relationship between Once a company has decided to enter a new
diversification and performance. Rumelt found market the central decision is between acquisition
that some groups of related diversifiers outper- of an incumbent company and internal develop-
formed the unrelated diversifiers. This Finding ment of a business. Several authors have pre-
was mostly upheld in later strategy studies, sented guidelines for this decision. Porter (1980)
although industrial organization researchers, describes it as a function of the investment
using different measures of diversification,largely costs including those necessary to overcome the
found no relationship (Palepu, 1985). Recent industry’s barriers to entry, the expected costs of
research tends toward a consensus that relat- retaliation, and the expected cash flow. If a
edness is associated with superior performance company wishes to develop a business internally
(Montgomery and Singh, 1984; Kusewitt, 1985; it faces the industry’s barriers to entry and the
Palepu, 1985; Shelton, 1988). need to achieve a competitive advantage. If it
This result is also reflected in the management decides to acquire an incumbent it has to
literature (Salter and Weinhold, 1979; Drucker, determine its maximum purchase price and a way
1981; Porter, 1985). Salter and Weinhold (1979) of achieving a competitive advantage. In Porter’s
go back to Ansoff’s product-market matrix opinion only the ability to change the industry’s
reflecting different types of relatedness. They use structure can justify an entry, because otherwise
this matrix to suggest certain paths to successful no entry should yield an above-average return.
acquisitions. In a similar vein Drucker and Porter Lorange, Kotlarchuk and Singh (1987) present a
each suggest that acquisitions should be made closely similar analysis.
around a common thread, and that potential Roberts and Berry (1985) also include some
contributions to the acquired business should other entry options such as licensing or joint
play a role in the decision. venture. They determine the suitability of an
This stream of work on the acquisition mode entry mode in terms of the market’s familiarity
resorts to the efficiency theory of mergers, too. and the technology’s familiarity; thereby, they
This can be demonstrated by starting from capture both supply and demand characteristics
Drucker’s five rules for successful acquisition. In and the question of relatedness. In general,
their review of the evidence on Drucker’s rules they recommend both acquisitions and internal
Paine and Power (1984) identify two implicit development for more familiar new businesses.
assumptions he makes: he regards mergers as The main reason they cite is the greater corporate
292 F. Trautwein
involvement required by these entry modes. This a merger’s success. In the recent literature
increases the risk of failure in unfamiliar areas. prescriptions cover the whole range from prepara-
A special topic in this context is the choice of tory measures (Shrallow, 1985) to the post-
a target. When contemplating acquisitive entry merger acculturation process (Malekzadeh and
into an industry a company usually will find more Nahavandi, 1987). For example Drucker (1981)
than one candidate. Several authors have made recommends paying attention to organizational
recommendations about which target should be culture and management turnover and integrating
selected. For example Kusewitt (1985) concluded a new business by switching a significant number
from his study that targets should be above their of managers between the parent and the acquired
industry’s average in profitability and growth unit. Yunker (1983) and Shrivastava (1986)
potential and should be about 5 percent of the give detailed accounts of integration issues.
acquirer’s size. The latter recommendation is Shrivastava also postulates that the necessary
consistent with findings and recommendations degree of post-merger integration depends on
by, among others, Kitching (1967). the merger’s objectives and on company features
The work on the mode of entry implicitly such as size ratio. Porter (1985) recommends
resorts to the efficiency theory, too. Porter treats aligning business units by a horizontal strategy
the entry decision as a complex investment aiming at synergies.
project involving barriers to entry, purchase price All the authors regard some degree of inte-
determinants, and the ongoing need to achieve gration as inevitable. Indeed, if synergies other
a competitive advantage. In a related study Yip than lower costs of capital are a merger’s rationale
(1982) found evidence that only some variables integration is mandatory. Mergers aiming at
associated with barriers to entry were significantly wealth transfers from customers or other share-
correlated with the choice of an entry mode. A holders do not require integration beyond reallo-
variable indicating growth motivation, on the cating capital. Mergers undertaken to satisfy
other hand, had the highest coefficient. Roberts managers’ interests do not require integration
and Berry (1985) treat the problem with a beyond exchanging some executives. So if the
different focus but from the same point of view. authors on post-merger integration recommend
For them the critical issue is not overcoming more than shifting capital or managers they
structural forces but allocating scarce manage- implicitly rely on the efficiency theory of mergers.
ment time and coping with uncertainty. In this respect they are even more specific than
The literature on how to choose the right authors on the first two topics. Some of the most
target has an even narrower perspective. Here, detailed accounts of possible synergy sources and
the point of view is that of an investment calculus. obstacles have been developed in the context of
But the recommendations in part conflict with integration (Yunker, 1983; Porter, 1985).
some of the findings on the subject. The acquirers
in Ravenscraft and Scherer’s (1987) sample
bought above-average profitable companies, as CONCLUSIONS
advocated by Kusewitt, and in general fared
poorly. This result and the one obtained by Yip The survey of merger explanations suggests an
indicate that it may prove fruitful to part with ordering in three groups. The valuation, empire-
the efficiency theory of mergers in this area, too. building, and process theory of mergers have the
highest degree of plausibility. The available
evidence is favorable though severely limited.
Integration made Next come the efficiency and the monopoly
theories of mergers. In both cases there is more
The third topic is the choice of an integration evidence, but it is mainly unfavorable. Finally,
mode as treated in the strategy literature. With there are the raider and the disturbance theories.
the recent surge in merger activity this topic has These theories are rather implausible, as well as
received a lot of interest, although it can be unsupported by evidence.
traced back to Kitching (1967). He found This result contrasts with most of the previous
the existence of a merger manager and the surveys. Jensen (1984), Weston and Chung
organizational relationship to be critical for (1983)’ and Wiggins (1981) all supported the
 Merger Motives and Merger Prescriptions 293

efficiency theory against some of the competitors Trying to understand the opposite party’s moves
investigated here. Only Ravenscraft and Scherer in a merger in terms of the efficiency theory is
(1987) favored an empire-buildingargument. This almost sure to lead to erroneous results. For
seeming contradiction is explained by the fact example in the case described by Gaddis (1987)
that only Ravenscraft and Scherer do not focus efficiency considerations would have led to a
on event studies. The other authors’ support of completely different way of integration. But such
the efficiencytheory seems to root in their belief considerationswere buried under divisionalpower
in capital market efficiency. This points at struggles.
the core of the problems involved in merger Second, the efficiency theory nevertheless
explanations. provides an efficient language for ‘selling’ mer-
First, the current state of research in merger gers. Mergers need marketing just like products,
motives is unsatisfactory. The most promising and effectively addressing the public or regulatory
explanations have hardly been developed while institutions in a merger may be critical ‘to its
the most popular ones seem to have only very success. Managing third-party perceptions and
limited explanatory power. Research in this field timing the merger process are two of the most
should be redirected at explanations that build important tasks for both sides in a merger.
on decision processes, conflicting goals, and Studies of mergers suggest that managers know
ambiguous private information. about this better than researchers (Gibson, 1988).
Second, research should part with the assumption
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