How to Avoid an Unsuccessful Merger

Research suggests that integrating workforces in the merger of two companies is very costly and very difficult, said Michael Gibbs, clinical professor of economics. “This is because of the lost productivity that comes from mixing workforces with different types of human capital and intangibles that make them productive when working together,” Gibbs said during a Becker Brown Bag Series talk presented by The Becker Center on Chicago Price Theory, at Harper Center on November 12.

“Factors such as firm-specific human capital, corporate culture, institutional knowledge, social networks, and implicit contracts lose some of their value when two different groups of employees must work together,” he said. “Another potential factor affecting the process is conflict and favoritism between the two groups.”

Gibbs based his conclusions on his study of 595 mergers of two private companies in Denmark from 1980 to 2000, co-authored with Kathryn Ierulli and Valerie Smeets. “Denmark is a good setting for studying these issues because it has a workforce that is highly homogeneous and tends to have a highly cooperative culture,” he said. “You would expect much less workplace conflict and much easier integration than in other economies. In addition, turnover costs are low, so the labor force is flexible. Thus economic effects of mergers on the workforces can act fairly directly.”

Employees of a company acquired in a merger are more likely to leave after the merger. As a separate effect, the smaller one company’s workforce is compared to the other, the more likely its workers are to leave after the merger. In effect, the majority pushes out the minority workforce. In most cases, the minority group is the target company’s workforce.

According to theory that Gibbs and his coauthors developed, mergers that require integration of equally sized workforces would be the most costly to implement. Consistent with this idea, firms of similar size almost never merge. In addition, in most cases the merging firms avoid extensive integration, Gibbs said. The extent to which workers move from one of the two merging companies to the other is very low, he said.

The researchers also found that the small fraction of employees sent to work with the other firm’s employees after the merger tend to be the most highly skilled. This suggests that merging companies share best practices and exploit synergies primarily by having their best employees collaborate across the two groups, rather than extensively mixing workforces.

A striking finding of the study is that while target employees have high turnover as a result of merger, the newly merged company hires new employees to take their jobs, Gibbs said. “This suggests that it’s easier to integrate new hires than it is to integrate a block of target-company employees,” he said. “That makes sense, because the acquiring company can use its own recruiting policies, orient new employees to its culture, create its own implicit contracts, and train them in its firm-specific human capital and so forth. The new hires don’t have baggage and are not a power bloc.”

If the above conclusions are true, benefits of in mergers must come primarily from sources other than full-scale organizational integration, such as sharing clients, technology, or ideas, Gibbs said. “This includes sharing parallel product lines, or increasing geographical coverage, as such mergers require little integration,” he said.

An excellent example of Gibbs’ interpretations of the Danish data can be found in Cisco, a “serial merging company” that buys companies with creative network hardware and absorbs them, he said. Cisco explicitly avoids mergers with companies of similar size and strongly prefers smaller companies, Gibbs said. In building leadership teams during a merger, Cisco gives human resources prominence, he said.

“Cisco always assesses the fit of the management style, the corporate culture, etc.,” Gibbs said. “They sometimes cancel mergers if they decide the fit isn’t good. Once they decide to go ahead with a merger, they tell employees of the target company, ‘This is an acquisition. It is not a merger of equals. The more flexible and positive you are, the better it will be for you.’”

—Phil Rockrohr