STRATEGIC OBJECTIVES, ALIGNMENTS, AND FIRM PERFORMANCE

Transcription

1 STRATEGIC OBJECTIVES, ALIGNMENTS, AND FIRM PERFORMANCE A dissertation submitted to the Kent State University Graduate School of Management in partial fulfillment of the requirements for the degree of Doctor of Philosophy by Kun Chen January, 2014

2 Dissertation written by Kun Chen B.A., Sichuan University, 2000 M.B.A., Kent State University, 2007 Ph.D., Kent State University, 2014 Approved by Chair, Doctoral Dissertation Committee Members, Doctoral Dissertation Committee Accepted by Doctoral Director, Graduate School of Management Dean, Graduate School of Management ii

3 ACKNOWLEDGEMENTS I am deeply grateful to all those people who have helped and supported me to finish this dissertation. First, I would like to thank my advisor, Dr. Michael Hu, and my dissertation committee members, Dr. Tuo Wang, Dr. Butje Patuwo, and Dr. Dandan Liu, for invaluable directions, comments, and advice. I would particularly thank Dr. Paul Albanese for his assistance with the mergers and acquisitions data. Without them, the dissertation would not have been possible. Second, I would like to thank my friends and colleagues in the doctoral studies for their suggestions and help. Last, special thanks will give to my wife, Qin and our little girl, Ella for their encouragement and full support. iii

4 TABLE OF CONTENTS Chapter 1 - Introduction... 1 Problem Setting and Research Objectives... 1 Structure of Dissertation... 4 Chapter 2 - Literature Review... 5 Overview... 5 Strategic Objective... 8 Corporate Strategy Resources and the Capabilities Based View Mergers and Acquisitions (M&A) Study one: Alignment between Strategic Objective and Corporate Strategy Study Two: Capability Alignment between Firms Chapter 3 - Methodology Overview Methodology Measures Data Sources Chapter 4 - Data Analysis and Results Overview Study One: Examining the Effects of Alignment Between Strategic Objective and Corporate Strategy on Firm Performance Study Two: Examining the Effects of Capability Alignment on Firm Performance Chapter 5 - Findings, Implications and Future Research Overview Summary of Findings Managerial Implications Limitations and Future Research References Appendix iv

5 LIST OF FIGURES Figure 1: A Resource-Based Approach to Strategy Analysis... 7 Figure 2: RBV Framework Figure 3: Capabilities of A Firm Figure 4: Capability Alignment Figure 5: Estimation Period Figure 6: Group Means and Comparison (2-digit SIC) Figure 7: Group Means and Comparison (3-digit SIC) Figure 8: Group Means and Comparison (4-digit SIC) v

6 LIST OF TABLES Table 1: Diversification Analysis Table 2: Strategic Objectives of a Firm Table 3: Value Creation, Value Appropriation, and Strategic Emphasis Table 4: Alignment between Strategic Objective and Corporate Strategy Table 5: Operationalization of Key Conceptual Variables Table 6: Distribution of Sample by Year Table 7: Distribution of Sample by Industry Table 8: Descriptive statistics Table 9: Sample Mean Table 10: Coefficients from Regression Model Table 11: Capability Alignment Group Table 12: Means of Different Capability Alignment Groups Table 13: Percentage of the Top 25% Firms in Each Capability Alignment Group Table 14: Percentage of the Bottom 25% Firms in Each Capability Alignment Group Table 15: Performance of Capability Alignment Groups Table 16: Categorization of Groups vi

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8 Chapter 1 - Introduction Problem Setting and Research Objectives Mergers and acquisitions (M&A) are one of the popular and important activities firms conducted in the business world. According to 2013 M&A report published by WilMerHale, global M&A transaction value increased to $2.57 trillion in 2012 from $2.16 trillion in In United States, the transaction value jumped 22% from $1.09 trillion in 2011 to $1.33 trillion in However, academics and practitioners are concerned with the fairly high failure rate (i.e., 60% to 80%) for M&A (Homburg and Bucerius 2005). Factors which impact M&A have been heavily researched for over three decades, but the mixed findings across different disciplines demonstrate the need for additional research. Scholars analyze M&A from different perspectives in different disciplines (Larsson and Finkelstein 1999; Birkinshaw et al. 2000). Strategic management studies M&A as the entry model to international markets. It compares the advantages and disadvantages of mergers, acquisitions, and Greenfield investments and tries to find out the characteristics of firms which successfully enter the international market (Lee and Lieberman 2010; Harzing 2002; Anand and Delios 2002). Finance scholars mainly analyze the transaction announcement effect on the stock market using event study to determine the abnormal stock returns and make profits (Hackbarth and Morellec 2008; Savor and Lu 2009). Organizational research examines the postcombination integration process and tries to understand how the partner-specific absorptive capacity reduces the information asymmetry and creates value for shareholders (Zaheer,

9 Hernandez, and Banerjee 2010). Human resource management focuses on the role of human resources in M&A (Aguilera and Dencker 2004) and how M&A impact a firm's top management and employees (Kiessling and Harvey 2006). In the marketing field, scholars also analyzed M&A. For instance, in the analysis of integration process, researchers focus on how the integration of marketing resources will impact firm performance (Homburg and Bucerius 2005). Wiles and colleagues (2012) examine the effect of brand acquisition on stock returns. But, compared to the proliferation of research on M&A in other fields, fewer studies in the marketing field have been done. This dissertation will approach M&A from the marketing perspective and two research questions will be answered. The first research question is: How do strategic objective and corporate strategy influence firm performance, and specifically: What is the effect of alignment between strategic objective and corporate strategy on M&A performance? M&A generally include two parties: the acquiring firm and the target firm. Previous researchers propose the strategic fit between two parties and are concerned with the link between performance and the strategic attributes of dyads (Cartwright and Schoenberg 2006). On the one hand, researchers find that the merger of two similar firms leads to better M&A performance as opposed to the merger of two dissimilar firms (Kaplan and Wiesbach 1992). Similarity is defined according to their business relatedness. The shared similarity between two firms such as management style and culture enable them to leverage the resources and capabilities to increase firm performance (Palich, Cardinal, and Miller 2000). On the other hand, 2

10 researchers also find that the M&A of two different firms have better performance if two firms can complement each other. Two firms are complementary if they have different resources and capabilities which can potentially be combined or reconfigured to create value that did not exist in either firm before the M&A (Kim and Finkelstein 2009). Research results can be mixed for a number of reasons. It could be a consequence of the fact that there are many different strategic objectives which firms want to accomplish through M&A and therefore, a clear analysis cannot be made. Firms pursue different strategic objectives for their growth, such as distribution channel building, new product development, and market development. M&A are only one of the methods a firm can use to acquire resources and thus achieve its objectives. If firms with different objectives are examined together, the mixed findings are inevitable. Since previous research ignores the important role of strategic objective on M&A, in this paper, strategic objectives and the related corporate strategy should be analyzed in order to answer what factors will influence a firm performance in the context of M&A. The second research question is related to partner selection, or how acquiring firms identify their best target firms. Through M&A, firms can acquire critical resources to build competitive advantages and then implement specific strategies to make profits. It is evident that there are two steps for M&A transactions. The first step is the selection process. A firm needs to identify a target firm that it is interested in acquiring. After a firm identifies the target firm, and the target firm also agrees to the transaction, the second step is the real investment and/or integration process. In M&A, two firms will redeploy resources, such as tangible assets 3

11 and employees, between them. After firms complete the two steps, they can really pursue their objectives. In short, a firm needs to select a target firm carefully, and then redeploy the critical resources between the two firms after the transaction is completed (Bucklin and Sengupta 1993). This paper will focus on the first step and tries to answer: what factors impact target selection of acquiring firms in M&A? Structure of Dissertation To complete my research objective, the dissertation will be structured as follows. Two studies are proposed to answer the two research questions. In chapter 2, the literature on firm strategic objective, corporate strategy, and firm capabilities is reviewed. The conceptual framework which suggested the role of marketing and R&D capabilities on firm performance (Dutta, Narasimhan, and Rajiv 1999) will be discussed. Based on the literature review and the conceptual framework, the hypotheses will be developed in study one and two, respectively. An examination will be made of a) how the alignment between strategic objective and corporate strategy and b) how the alignment of capabilities (i.e., marketing and R&D capabilities) between two firms will influence their performance. In Chapter 3, the methodology, operationalization of the constructs, and data sources will be discussed. Chapter 4 will present data analysis and the results. Study one examines the effects of alignment between strategic objective and corporate strategy on firm performance, and study two accesses the effects of capability alignment on firm performance. The findings and their implications for managerial practices, limitations, and suggestions for future research will be discussed in Chapter 5. 4

12 Chapter 2 - Literature Review Overview According to Grant (1991), strategy is the match between an organization's internal resources and skills, and the opportunities and risks created resulted from its external environment. A firm needs strategy to serve its customers and create wealth for its shareholders. However, the formulation of strategy is not an easy task for most firms. Grant (1991) proposes a resource-based approach to help firms formulate their strategies (See Figure 1). Based on Grant's approach, the process for a firm to formulate a strategy is: 1) identify the firm's resources and capabilities; 2) understand its strengths and weaknesses relative to competitors in the marketplace; 3) evaluate potential sustainable competitive advantages based on the resources and capabilities; and 4) formulate the strategy that can best exploit the firm's resources and capabilities and take external opportunities. Following this process, firms can formulate the appropriate strategy on the basis of current resources and capabilities and thereby increase the firm's profitability. Another path a firm can follow is to start with the strategic objective then consider the proper strategy and competitive advantage basis and predict the resource requirements. If there is a resources gap, the firm must obtain the required resources to build the competitive advantage and thereby accomplish the strategic objective. Grant's framework is then 5

13 concerned not only with the deployment of existing resources, but also with the development of the firm's resource base (Grant 1991). The changing market requires firms to constantly upgrade their resources and capabilities to develop competitive advantages and achieve strategic objectives. In sum, Grant's framework emphasizes three components which are critical to a firm's profitability. First, it is the relationship between resources/capabilities and a firm's competitive advantages. Second, in order to best exploit the competitive advantages, a firm needs to formulate strategic objectives then develop and deploy the strategies. Third, to accomplish the strategic objectives, a firm needs to either develop the critical resources/capabilities internally or obtain the resources externally, if the existing resources are insufficient for strategies. M&A are the method that firms can use to obtain resources/capabilities externally. This chapter will proceed in four major sections. First, the concept of the strategic objective of a firm will be described. Second, the importance of corporate strategy and its impact on firm performance will be reviewed. Third, the relationship between firm resources and firm performance will be discussed. Fourth, the relationship among strategic objective, corporate strategy, and capabilities in the context of M&A will be summarized. 6

14 Figure 1: A Resource-Based Approach to Strategy Analysis Resources Capabilities Competitive Advantage Strategy Performance (Grant 1991, p. 115) 7

15 Strategic Objective An overriding objective is critical to the successful functioning of a business enterprise (Boyd and Levy 1966). Firms need to set some strategic objectives to accomplish and find specific strategies on the basis of competitive advantages to grow (Grant 1991). One of the popular tools which firms use to formulate the strategic objective is the Ansoff (1957) model. In this model, firms can set strategic objectives, such as market penetration, product development, market development, and diversification, based on two dimensions (i.e., market and product) (See Table 1). Also, researchers can use one dimensions to classify the strategic objectives. For instance, diversification can be defined according to the product industry (Kamien and Schwartz 1975) or market (Anand and Singh 1997). Anand and Singh (1997) state that, when searching for growth opportunities, managers often face two obvious choices: consolidating their operations within their markets or diversifying into new markets. This dissertation will follow the proposal of Anand and Singh (1997) and define strategic objectives using one dimension - market (See Table 2). Firms have two objectives to achieve: enhancement and diversification. If a firm tries to strength its existing capabilities and builds competitive advantages within its current market, the strategic objective is enhancement. If a firm tries to enter into a new market, the objective is diversification. While this study is only focusing on the use of the market dimension to define strategic objectives, it doesn't mean that the effects of product is irrelevant. Since the product is the 8

16 basis to serve the market, the product dimension is embedded into these two objectives. Enhancement means that firms serve current or new products to current market. Diversification shows that firms can enter into a new market with existing products or new products. 9

17 Table 1: Diversification Analysis Market Current Product New Current Market Penetration Product Development New Market Development Diversification (Ansoff 1957, p. 114) 10

18 Table 2: Strategic Objectives of a Firm Strategic Objective Current Enhancement Market New Diversification 11

19 Corporate Strategy After firms set their strategic objectives, the next step is to formulate the strategies. Overall, the concept of Strategy refers to "the dynamics of the firm's relation with its environment for which the necessary actions are taken to achieve its goals and/or to increase performance by means of the rational use of resources" (Ronda-Pupo and Guerras-Martin 2012). In practice, strategy exists at multiple levels in an organization - corporate, business, and functional (Varadarajan, Ayachandran, and White 2001), and can be defined according to different dimensions. Uotila and colleagues (2009) propose the balance between exploration and exploitation activities for a firm in response to changes in its environment. Exploration refers to the utilization of existing knowledge, and exploitation refers to the development of new knowledge. In other words, a firm should select the strategy to allocate resources to utilize the existing knowledge and also develop new knowledge for its growth. The balance will help the firm to achieve superior performance (March 1991; Uotila et al. 2009). The explorationexploitation framework also proposes a tradeoff between short term and long term development under different environmental conditions. Aspara, Hietanen, and Tikkanen (2010) categorize the strategy differently into business model innovation and replication. They found that firms that have a high strategic emphasis on business model innovation as well as a high emphasis on replication exhibit a higher profit growth than firms that do not strategically emphasize either dimension. 12

20 In the marketing field, the impact of marketing strategy on firm performance is measured by an increase in revenues and customers, and by the creation of market-based assets such as brand equity and customer satisfaction (Hanssens, Rust, and Srivastava 2009). According to Mizik and Jacobson (2003), strategy can be defined based on the relative emphasis on two processes (see Table 3). The first process is value creation which refers to innovating, producing, and delivering products to the market. Value creation is more R&D-driven and longterm oriented. The second process, called value appropriation, refers to extracting profits from the marketplace. Value appropriation is more marketing driven and short-term oriented. The authors use strategic emphasis to represent the tradeoff between value creation and value appropriation since firms usually have limited resources for these two processes. They find that, if a firm increases its emphasis on value appropriation relative to value creation, the stock market reacts favorably. In this paper, the use of the term corporate strategy will follow the proposal made by Mizik and Jacobson (2003) that has two levels: strategic emphasis on value creation (i.e., R&D emphasis) and strategic emphasis on value appropriation (i.e., marketing emphasis). The implementation of corporate strategy needs resources and capabilities (Grant 1991). Therefore, next section will discuss the relationship between resources/capabilities and firm performance. 13

21 Table 3: Value Creation, Value Appropriation, and Strategic Emphasis Value Appropriation Value Creation Strategic Emphasis extracting profits innovating, producing, and delivering products to the market tradeoff between value appropriation and value creation 14

22 Resources and the Capabilities Based View Resources-Based View Introduced by Barney (1991), the resources-based view (RBV) points out the relationship between the resources and the competitive advantages of a firm. In his article, Barney proposes that a firm's resources and capabilities can be viewed as bundles of tangible and intangible assets including a firm's management skills, its organizational processes and routines, and the information and knowledge it controls. Sustained competitive advantages are derived from the resources and capabilities that a firm controls (Barney 1991). The resource-based view makes two assumptions (Barney 1991). First, firms within an industry (or group) are heterogeneous with respect to the resources that they control. Second, these resources are not perfectly mobile across firms, and thus heterogeneity can be long lasting. Therefore, if a firm's resources are valuable, rare, imperfectly imitable, and strategically non-substitutable, these resources may generate sustained competitive advantages for the firm (See Figure 2). According to RBV, possessing valuable resources allows firms to exploit opportunities and/or neutralize threats. But if the same resources are possessed by a large number of firms, then each firm has the capability to exploit opportunities. Resources need to be rare in order to develop competitive advantages. Imperfectly imitable resources are those valuable and rare resources which cannot easily be obtained by other firms. Strategically nonsubstitutable resources are those for which other firms cannot find equivalent substitutes. 15

23 Overall, firms can be viewed as collections of resources, and those resources allow firms to generate and sustain competitive advantages (Wernerfelt 1984; Barney 1991; Barney, Wright, and Ketchen 2001). RBV emphasizes this relationship between resources and competitive advantages. 16

24 Figure 2: RBV Framework Firm Resource Heterogeneity Firm Resource Immobility Value Rareness Imperfect Imitability Substitutability Sustained Competitive Advantage (Barney 1991, P. 112) 17

25 Capabilities and Firm Performance RBV emphasizes the role of resources on a firm's competitive advantages. Furthermore, research in the marketing field provides empirical support for two specific firm resources: marketing capability and R&D capability. Marketing Capability Day (1994) highlights the importance of marketing capability. In Day's view, an organization with strong marketing capability has two distinctive features: market sensing and customer linking capabilities. Market sensing means a firm has the ability to sense events and trends in their market ahead of their competitors. Customer linking refers to creating and managing customer relationships. Strong marketing capability means that a firm exhibits superiority in identifying customers' needs and in understanding the factors that influence consumer choice behavior (Dutta, Narasimhan, and Rajiv 1999). These capabilities can help the firm realize superior performance by satisfying customers better than its competitors (Day 1994). Moreover, strong marketing capability can increase the firm's operating efficiency by reducing the firm's working capital needs and increase shareholder's wealth (Rao and Bharadwaj 2008). Day (1994) particularly proposes that market orientation is one of the marketing capabilities. Market orientation was conceptualized from behavioral and cultural perspectives (Homburg and Pflesser 2000). Both perspectives emphasize that firms should learn about 18

26 customers and markets in order to continuously sense and act correspondingly (Kohli and Jaworski 1990; Narver and Slater 1990). Market orientation is a potential resource for comparative advantage (Hunt and Morgan 1995), and has a positive effect on business performance in both the short and the long run (Matsuno and Mentzer 2000, Kumar et al., 2011). Market orientation affects a firm's performance through innovation, customer loyalty and product quality (Kirca, Jayachandran, and Bearden 2005). More specifically, market orientation is positively related to new product performance by facilitating creativity of new products and related marketing programs (Im and Workman 2004). Therefore, marketing capability is critical to firms. R&D Capability Another important capability of firms is R&D. Previous literature reviews show that innovation can be divided into three components based on the timing of introduction: idea, new product development, and commercialization of the product(chaney, Devinney, and Winer 1991). Using meta-analysis methodology, Rubera and Kirca (2012) review the relationship between a firm's innovativeness and its performance outcomes. Firm innovativeness refers to a firm's receptivity and inclination to adopt new ideas that lead to the development and launch of new products. Rubera and Kirca found that innovativeness indirectly affects a firm's value through its effects on market position and financial position. Commercialization can increase demand, increase profit market, and lower customer acquisition and retention costs (Bayus, 19

27 Erickson, and Jacobson 2003), and therefore increase long-term financial performance and firm value (Pauwels et al., 2004). Innovation can also be categorized based on two common dimensions which underlie most definition of the construct: 1) newness of technology - the extent to which the product incorporates a new technology, and 2) customer-need fulfillment - the extent to which it fulfills key customer needs better than existing products do (Chandy and Tellis 1998). There are four different innovations based on these two dimensions. Incremental innovations involve relatively minor changes in technology and provide relatively low incremental customer benefits. Market breakthroughs are based on core technology that is similar to existing products but provide substantially higher customer benefits. Technological breakthroughs adopt a substantially different technology than existing products but do not provide superior customer benefits. Radical innovations involve substantially new technology and provide substantially greater customer benefits, relative to existing products. Researchers find both breakthrough innovation and incremental innovation are positively associated with firm performance which is measured by profit (Sorescu and Spanjol 2008). Overall, strong R&D capability leads to short product life-cycles and a high rate of new product introduction (Dutta, Narasimhan, and Rajiv 1999), and is critical to firms as well. Marketing and R&D Capabilities Both marketing and R&D capabilities are critical to firms. But neither marketing nor R&D can serve customers well alone. The effect of marketing capability on firm performance is strengthened when marketing capability is combined and integrated with other capabilities 20

28 such as innovativeness (Menguc and Auh 2006). Similarly, R&D and operations capabilities, along with interactions with marketing capability, are important determinants of firm performance (Dutta, Narasimhan, and Rajiv 1999) (See Figure 3). Dutta and colleagues find that the most important determinant of a firm's performance is the interaction between marketing and R&D capabilities. In other words, the synergy between marketing and R&D occurs to fulfill customers' needs and leads to better firm performance. Firms need to not only come up with innovations constantly but also commercialize these innovations into the kinds of products that capture consumer needs and preferences. In short, R&D capability and marketing capability together not only lift stock returns of firms (Srinivasan et al., 2009), but also lower firms' systematic risk (McAlister, Srinivasan, and Kim 2007). 21

29 Figure 3: Capabilities of A Firm Marketing Capability Sales Resources R&D Capability Quality-Adjusted Technological Output Operations Capability Cost of Production (Dutta, Narasimhan, and Rajiv 1999, p. 553) 22

30 Dynamic Capabilities View RBV states that resources - valuable, rare, inimitable and non-substitutable - make it possible for firms to maintain a competitive advantage (Barney 1991). However, most firms face a constantly changing business environment and their competitive advantages cannot last long. In other words, previous findings were based on a static environment and ignored the changing environment. Teece, Pisano and Shuen (1997) introduce the dynamic capabilities view to address this gap which posits that a firm can leverage the performance impact of existing resources through resource configuration, complementarity, and integration. The management of firms can deploy and redeploy resources in response to changes in the business environment (Eisenhardt and Martin 2000). When a firm faces either high or low technological turbulence, marketing and R&D capabilities still have the most effects on firm performance (Song et al. 2005). Particularly, when in a high-turbulence environment, the effect of marketing capabilities are lower; but the effect is strengthened when it is bundled together with innovativeness (Menguc and Auh 2006). Finally, the meta-analysis conducted by Krasnikov and Jayachandran (2008) summarizes the relationship between firm capabilities and firm performance: 1) marketing, R&D, and operations capabilities are positively related to firm performance; 2) given the previous statement, marketing capabilities still have a stronger impact on firm performance than do R&D and operations capabilities. 23

31 In summary, RBV and dynamic capabilities view confirm the critical role of resources, especially marketing and R&D capabilities, on competitive advantages and firm performance. Next, M&A, the methods through which firms obtain critical resources, will be discussed. 24

32 Mergers and Acquisitions (M&A) M&A M&A refer to "all interfirm linkages that lead to the integration of two entities which includes the merging of two companies on an equal basis as well as acquisitions in which one firm plays a dominant role and obtains majority ownership over another" (Yang, Lin, and Lin 2010). Through M&A, a firm's executives have complete control over decision making, and they can eliminate redundant resources easily. They can also use any surplus resources to generate economies of scale, or they can cut costs by eliminating those resources (Dyer, Kale, and Singh 2004). Transaction Cost Economics and M&A According to Shelanski and Klein (1995), different governance structures are related to different transaction costs. Transaction costs come from market frictions such as asymmetric information in the business environment (Penrose 1959; Chi 1994). Without the transaction costs, contracting can dominate the governance structures (Mahoney 1992). Since there is market frictions, a firm can stay in business only if it can do better than others in the market by weakening market frictions. The transaction costs economics proposes the foundation of 25

33 existence to the firm (Mahoney 2001). Also, the transaction cost economics supports why firms will select different governance structure (such as M&A) to reduce their costs. The transaction cost economics and the resource-based view are complementary theory (Mahoney 2001). The resource-based view seeks to delineate the set of market frictions that would lead to firm growth and sustainable advantages while the transaction cost economics seeks to delineate the set of market frictions that explain the existence of the firm. In other words, RBV emphasizes the revenue side and transaction cost economics focuses on the cost side. When firms make decisions to obtain resources, they need to choose the approach which can effectively balance the internal and external resources and protect their interest (Shelanski and Klein 1995). If the cost to reduce the opportunistic behavior of another party is very high, the two firms may integrate their businesses into one firm to minimize continuous transaction costs via M&A. If, on the other hand, the integration costs are higher than the anticipated benefits to be gained, firms may consider other alternatives instead of M&A (Williamson 1991; Hoffmann and Schaper-Rinkel 2001). Motivation to M&A Due to the critical role of resources to firms, firms need to obtain the key resources in order to pursue their strategic objective. Firms can develop critical capabilities internally, or acquire resources externally. 26

34 First, firms can develop resources through internal development by relying on its own resource endowments rather than using external resources from other firms, although the firm may or may not pursue resources independently (Yang, Lin, and Lin 2010). For example, researchers find that market-based organizational learning has been identified as an important source of sustainable competitive advantage. Firms without such learning skills can identify the key capabilities of other firms who own competitive advantages in the marketplace. Then, they can benchmark these capabilities through investment for learning, and build their own competitive advantages (Vorhies and Morgan 2005). Other options for obtaining resources include buying important resources through factor market or hiring talented employees in order to create unique capabilities. Firms can also work with other parties such as consumers, suppliers, and competitors to generate competitive advantages. But a firm's resources have two common attributes. One is that the resources owned by one firm are limited. At any point in time, a firm usually doesn t have all the resources that it needs to implement its strategy. The other attribute is that resources are hard to obtain directly from the factor market especially if there is a need to obtain them within a short period of time. In R&D-intensive industries, technological know-how cannot be bought directly even if employees with such knowhow are enticed away from a competitor because it is difficult to evaluate an individual's knowledge and transmit to others (Vanhaverbeke, Duysters, and Noorderhaven 2002). Evaluation of know-how may lead to the risk of attenuation because technological know-how may be leaked to others during the evaluation process. In addition, it 27

35 is very difficult to directly transmit the know-how between firms because technological knowhow may be tacit or embedded in other knowledge. Also, firms develop routines in limited business scope over time, which constrain their ability to recombine existing resources and the learning capabilities (Wiklund and Shepherd 2009). Second, because it is often difficult to generate resources internally, a firm may need to rely on external sources to obtain resources. M&A are one of the methods a firm uses to access the external resources. M&A can bridge the resources gap between a firm's current resources and required those by strategic objectives (Hoffmann and Schaper-Rinkel 2001). Resource acquisition is one of the motivations for firms to conduct M&A. Scholars also find that M&A activities can be started from the managerial level. Three motives for managers to recommend M&A are synergy-seeking, managerialism and hubris (Seth, Song, and Pettit 2002). Synergy motive states that managers want to build the economic value of the firm. Managerialism suggests that managers promote the acquisition for their own utilities at the cost of the firm at large because, most of time, their benefits will increase as the firm size increases. The hubris motive suggests that managers make mistakes in evaluating a target firm. Seth and colleagues find that M&A can create value for shareholders if managers want to seek synergy from the transactions but destroy value if it is driven by managerialism. However, the issue of a manager's perspective is the subjective categorization of motives and lacks of objectivity. Walker (2000) divides the motivations for M&A into five objectives such as economies of scale, exploitation of asymmetric information, mitigation of agency problems, market power, 28

36 and tax credits utilization. But these objectives are not at the same level. Some are strategic objectives and some are merely tasks that a firm needs to complete. Furthermore, literature provides mixed findings about what objectives can generate great value for the firm. Researchers analyze how firms use M&A to expand their boundaries (Villalonga and Mcgahan 2005). When firms want to make the most efficient utilization of sustaining economies of scale and scope, and when firms have less strategic uncertainty and lower need for strategic flexibility, they often attempt to acquire firms in same or different industries (Hoffmann and Schaper-Rinkel 2001). Through M&A activities, the strategic objectives that firms want to accomplish can be exposed. Walter and Barney (1990) have shown that M&A are means for firms to expand current product lines and markets, and also to enter into new business. The business boundaries of M&A transaction naturally show the objective, not subjective, measure to strategic objectives of a firm. Study one: Alignment between Strategic Objective and Corporate Strategy The literature review shows that firms can obtain critical resources through M&A and also M&A transactions exposed their strategic objectives. Mizik and Jacobson (2003) find that capital market favors the one-way movement from value creation to value appropriation. However, both value creation and value appropriation are important processes to achieving sustained competitive advantage for firms. Firms should create value first and then begin to extract profits. Two processes are highly correlated and 29

37 therefore, the arguments may not be completed. The strategic objective will be injected to their proposal and the interplay of strategic objective and corporate strategy will be discussed. Previous research investigates the importance of strategic consistency to organizational survival (Lamberg et al., 2009). Firms which are not in line with their past behaviors may lead to an imbalance between capabilities and real actions to compete in the market, and thus resulting a negative performance. In the context of M&A, the objectives that firms want to achieve should be consistent with their existing strategy. The hypothesis to explore here is that there is alignment between strategic objective and corporate strategy. Diversification and R&D Emphasis Diversification allows firms to leverage the capabilities needed to serve alternative markets. The advantages of diversification can arise from two resources: market power advantages and synergy (Palich, Cardinal, and Miller 2000). Compared to the benefits, there are also coordination costs associated with diversification (Zhou 2011). Coordination costs come from the interdependencies between existing and new business. When a firm diversifies, it needs to address with three elements of coordination: communication, information processing, and joint decision making (Marschak and Radner 1972). Firms can benefit from diversification if the synergy benefit is higher than the coordination cost (Zhou 2011; Helfat and Eisenhardt 2004). However, in the short run, firms usually will face a high coordination cost. For example, when a firm wants to merge with a 30

38 target firm which operates in a different market, there are coordination costs associated with crossing different industries and the one-time transaction cost (Zhou 2011). Additionally, when two firms are different because they conduct business in different marketplaces, there are increased coordination costs. Two firms may be different in management style. Management style includes the factors such as the management group's attitude towards risk, their decision-making approach, and preferred control and communication patterns (Covin and Slevin 1988). Different management style increases the coordination costs between two firms and thus has a negative impact on merged performance (Datta 1991). Finally the dissimilarity in industry make it difficult to redeploy resources between two firms (Prabhu, Chandy, and Krishnan 2005) and increase the coordination costs as well. For instance, one important resource is the intangible assets such as know-how. The dissimilarity between two firms constrains the redeployment process and thus leads to inherent inefficiency and low firm performance (Seth, Song, and Pettit 2002). The analysis of diversification through M&A shows that firms need time to deploy resources to create value in the new market before extracting profits. Strategic emphasis on value creation is more R&D driven and means that firms need to allocate more resources for innovation. Since firms are new to the market, they need time to learn customers and enhance existing products or provide new products to serve them. R&D emphasis is consistent with diversification objective in this aspect. Strategic emphasis on value appropriation is more marketing driven. For a new market, marketing activities are necessary to understand consumers and stimulate the sales, but, often 31

39 these are not the top priorities for firms initially. Firms should emphasize R&D first and provide the solid basis for marketing activities if they expect to earn profits. In sum, diversification objective is aligned to R&D emphasis. In contrast, if a firm wants to diversify but the corporate strategy has a marketing emphasis, the firm may not have the foundation necessary to generate profits. Enhancement and Marketing Emphasis When a firm wants to achieve the strategic objective of enhancement, the firm should try to strength its position within the current market. A firm can make investments to expand the production capabilities and reduce its unit cost of product. Firms can invest to build the distribution channel or outsource to a third party in order to improve the product delivering speed and post-sale services. Firms also can extend their current product line and provide more products to current consumers. In short, firms can increase the output of existing resources, including tangibles assets such as equipments and manufacturing facilities, and intangible assets such as brands, marketing, and R&D capabilities, and provide better products to customers relative to their competitors. Through achieving an enhancement objective, a firm improves its performance and increases the shareholder value (Anand and Singh 1997). Two firms considering M&A in the same industry should have common structural patterns and interlinked structures within the R&D units. The common structure serves as a basis for realizing innovative resource combinations and streamlining the innovation process (Grimpe 2007). Product innovation provides a solid basis to serve the customers and help the realization of an enhancement objective. The firms should also have more overlapping 32

40 resources in the same market. The new firm that results from M&A can achieve the economies of scale by disposition and rationalization of redundant assets, use of more specialized or costeffective technologies, and spread of the fixed costs over a larger sales volume (Anand and Singh 1997). Also M&A can reduce the level of product market competition because of the decreased number of competitors in the market (Fulghieri and Sevilir 2011). Through M&A, firms can reduce their manufacturing, operations costs etc., and finally reduce the total costs (Panzar and Willig 1981). M&A can also enhance product innovation (Prabhu, Chandy, and Ellis 2005). Knowledge is field specific in nature, and each firm possesses some knowledge in that field. Thus, the merged firm should have deeper knowledge in that field compared to either of the pre-merged firms. The depth of knowledge will produce more innovations. Similarity is the extent of overlap in the fields of knowledge of two firms (Prabhu, Chandy, and Ellis 2005). If there is sufficient similarity, the acquiring firm will be able to easily understand the knowledge possessed by the target firm, increase the absorption capability, and lead to more innovations (Mowery, Oxley, and Silverman 1996). Along the spectrum of the development of firms, there are different constraints within firms which create barriers for firm efficiency improvement. The resource redeployment between two firms following M&A can effectively relax or break the institutional and organizational constraints. For example, the redeployment will reconfigure the product mix by either strengthening the attractive products and/or reducing the presence of unattractive 33

41 products (Krishnan, Joshi, and Krishnan 2004). Firms can ultimately increase their revenue in the marketplace. Marketing emphasis means that firms invest more resources to extract profit from the current market. Marketing expenditures can strengthen brand names leading to loyal customers who create the stable cash flows for a firm thereby reducing the risks and uncertainty that firms face (Keller 2003). Also, strong brand names facilitate the brand extension and lead to better firm performance. Therefore, marketing emphasis is aligned to enhancement objective by facilitating the whole process. for summary): Based on the above discussion, the following hypothesis can be proposed (see Table 4 H1: Firms with alignment between strategic emphasis and strategic objective have higher performance. H1a: For the enhancement objective, firms with strategic emphasis on value appropriation have higher performance than those which focus on value creation. H1b: For the diversification objective, firms with strategic emphasis on value creation have higher performance than those which focus on value appropriation. 34

42 Table 4: Alignment between Strategic Objective and Corporate Strategy Strategy Strategic Objective Enhancement Diversification Marketing Emphasis R&D Emphasis Aligned Aligned 35

43 Study Two: Capability Alignment between Firms In the strategic management literature, two distinct causal mechanisms, resource picking and capability building, have been proposed to describe how firms create value (Makadok 2001). If firms decide to acquire external resources through M&A, the target selection process is related to resource picking. The redeployment after M&A is part of capability building. Further, a firm can build competitive advantages through use of the capability building mechanism only after the firm has acquired the expected resources (Makadok 2001). Researchers propose the positive impact of resource redeployment following M&A on firm performance. Capron, Dussauge, and Mitchell (1998) show that firms frequently redeploy resources, especially R&D, manufacturing, and marketing resources, to and from an acquired firm, and they also redeploy managerial and financial resources to an acquired firm. For marketing resources, the redeployment of brands, sales forces, and general marketing management expertise significantly influences the revenue and the overall firm performance (Capron and Hulland 1999). Furthermore, the redeployment speed of marketing resources has a positive impact on market-related performance, and thus has positive impacts on a firm's financial performance. The successful post-acquisition R&D integration also has a positive impact on a firm's earnings and market share (Grimpe 2007). The importance of the redeployment process emphasizes the critical role of target selection. Without the appropriate resources from the target firm, the acquiring firm cannot 36

44 build unique resources through the integration process. Selecting the right target firm is the prerequisite for successful M&A. The dominant logic in M&A holds that similarity between two firms is the primary source of strategic fit that improves acquisition performance. But research also supports that complementarity, where two different firms combine their resources which results in value that two firms cannot create before the combination, leads to better firm performance (Harrison et al 1991; Helfat and Peteraf 2003; Kim and Finkelstein 2009). The findings of Dutta et al. (1999) support the critical role of marketing and R&D capabilities in firm performance. But the findings are confined to a single firm. In the dissertation of Trainor (2009), the author extends Dutta and his colleagues' model to check the effects of capacity fit on knowledge creation and knowledge output of the merged firm. He finds that, in M&A, the fit between the high marketing capability of one firm and the high R&D of another firm demonstrates the highest post acquisition knowledge creation. The created knowledge is the basis for innovations and is linked to better firm performance. Using the above mentioned findings, the model will be extended to examine how the alignment of two firms' capabilities will influence the firm performance for different objectives (See Figure 4). 37

45 Figure 4: Capability Alignment Firm One Firm Two Marketing Capability Marketing Capability R&D Capability R&D Capability Capability Alignment Firm Performance 38

46 Capability Alignment and Firm Performance Previous literature shows how marketing and R&D capabilities are critical to firm performance. But how capability alignment between two firms leads to higher performance is still not clear. For example, when one firm has strong capabilities, and acquires another firm with strong marketing and R&D capabilities in the same industry, the absorptive capacity of acquiring firm is very high, but similarities between the two firms likely do not provide enough differences to enrich R&D capabilities of the acquiring firm (Makri, Hitt, and Lane 2010). In contrast, if one firm has strong marketing but weak R&D, and another firm has weak marketing but strong R&D, the two firms can benefit from the complementarity (Harrison et al 2001). Though the exact combination of capabilities between two firms is not certain, acquiring firms should look for different capabilities for their objectives. Therefore, the proposal is that there should be capability alignment between the acquiring firm and the target firm. And empirical results will be used to have a better understanding about the capability alignment in M&A transactions. The following is proposed: H2: Firms with capability alignment should have better performance relative to firms without capability alignment. 39

47 Chapter 3 - Methodology Overview This chapter first describes the methodology which is used in this paper: event study. Abnormal stock returns will be used to measure the firm performance in study one and study two. Study one examines the effect of alignment between corporate strategy and strategic objective on an acquiring firm's performance. Study two examines the capability fit between two firms but still from the acquiring firm's perspective. Finally, the operationalization of dependent and independent variables will be discussed. Lastly, data sources and the sample will be introduced. Methodology Through the above analysis, it is expected that strategic objective and corporate strategy will impact firm performance in the context of M&A. The objective also influences partner selection since different capabilities are required for different objectives. All those decisions will impact a firm's future costs and revenues. According to efficient market hypothesis (EMH) proposed by Fama (1970), the price of a security is the present value of the expected future cash flows of a firm. The price, at any given time, will reflect all the available information about the firm's current and future profit potential. If there is information which may impact the future cash flows of a firm, the security price will change when the information goes public. Therefore, an event-study methodology will be used in this paper which assesses 40