Why mergers fail sometimes

The common explanation for the failure of mergers is based on the observation that managers tend to create large economic empires. The prospect of being able to lead an even larger company through the merger is tempting for many. Managers do not necessarily maximize shareholder value but are more interested in their benefit, which is more power and money and typically increases with the size of their company. However, this approach cannot explain why mergers lead to unsatisfactory stock values even if managers are not acting on their own but keeping an eye on shareholder interest.

Perhaps, as a second attempt to explain – managers overestimate the future performance of the merged company because they estimate the synergy gains too optimistic – one speaks of “manager hubris” – or because they do not foresee the difficulties after the merger. Moreover, mergers fail when managers underestimate internal conflicts. An experiment confirmed that subjects in the laboratory do not foresee the problems that arise from different organizational cultures. However, it remains unclear why managers expect a priori a positive result, and why the result looks so bad at the end. The entire decision-making process remains a “black box”. 

The behavior of the partners

The explanatory approach focuses on the behavior of the merger partners before and after the merger decision. It is modeled how before a merger decision the two potential merger partners collect information about the other. At the same time, a residual amount of information is hidden from the partners. Once the merger has taken place, both companies must strive for integration.

But this is often lacking. Although companies are usually aware of the fact that there are organizational difficulties when they decide to merge. At the same time, however, failures can not be attributed solely to the lack of similarity and compatibility of the merging firms. Because, as has been shown, the merger of partners with similar corporate culture often does not work better, but rather worse. 

The crux with the information

It is true that future partners will gather information about each other before the merger. But only part of the information is accessible to potential merger partners because, before the merger, it is not advisable to divulge all company information. 

First and foremost, if the merger does not materialize, one company could use that knowledge in competition to the detriment of others. Besides, full disclosure of information may violate competition rules. 

Secondly, the synergy effects and thus the measurable success of the merger depends on the creation of a common corporate culture. A common corporate culture is when members of an organization share similar attitudes and beliefs. This facilitates communication and joint action. At the time of the merger, the cultures of the merger partners are often not insignificant, but after the merger, they can move towards a common culture in the integration process. However, if the two units continue to differ too much in their practices, conflicts and misunderstandings occur. These prevent the merged entity from functioning well. And one can go further and say: Unless the differences in corporate culture have been reduced by the end of the integration phase following the merger, the cost of the merger will outweigh any synergies that may arise. The merger thus creates losses, and thus it can be described as failed.

Thirdly, a common corporate culture does not arise overnight. In many ways, creating a new joint corporate culture is time-consuming. Managers and employees are often reluctant to leave their usual paths and adopt approaches from the merger partner. As long as the two parts of the company have not come close enough, the management decisions of the other side are often unclear. During the integration phase, it is particularly likely that decisions of the other side will be misunderstood. Integration efforts are difficult to establish in advance or to pin down in hindsight.

And fourth: Organizational adjustments on both sides go hand in hand. It examines the case where it is useful for one partner to adapt to the other as it also increases the benefit of the partner’s ability to adapt. A department has more incentive to integrate if it thinks its partner is likely to. However, there is also a strategic uncertainty about how much each other will make an effort. Greater efficiency can only be achieved if the partners succeed in gaining mutual trust.

The effort of integration

Based on these assumptions, the result of the model may make it favorable for a company to agree to the merger because it expects its success and yet not to make any integration efforts after the merger. If a company’s expectations about potential synergies from a merger are moderate, it will merge and expect its partner to make the necessary integration efforts. However, if the expectations are high, a company will always make integration efforts. If they are low, they will not want to merge anyway.

Expectations of possible synergies depend on the information that both merger partners receive before making the decision. Thus, if both companies have moderate expectations of the synergies of the merger because they receive only part of the information about the other, the merger may fail. The failure can not be averted by the increased exchange of information in the negotiation process of the merging partners. Because this information exchange remains untrustworthy. After all, each of the partners has strategic motives for distorting the information withheld because he wants the counterpart to make the integration efforts he wants to avoid.

Times of economic growth is usually associated with higher capital and therefore lower transaction costs, leading to more mergers. Lower costs not only lead to more mergers but more failures as well. If one partner only has a small negative impact on not being fully involved in the integration, both partners will be “lazy” in the post-merger era, leading to more failures. It is therefore quite possible that differences between companies increase the chances of a successful merger because in these cases managers become aware of the problem of different corporate cultures. Empirical evidence shows that culturally diverse partners in post-merger problems are more aware and therefore make more effort and perform better.

If both partners are very different from the outset, it is difficult in empirical evidence to conclusively conclude that the merger has failed. There are two types of costs: not only the lack of integration must ultimately be paid dearly by the lack of synergy gains. Efforts to bring together very different corporate cultures are also associated with higher costs. Using an experiment, scientists simulated the fusion situation in a co-ordination game. It turns out that the best possible result for both partners lies in the cooperation, but the subjects nevertheless cooperate less frequently when the profits for the solution “I do not cooperate when the other cooperates” rise.

Finally, inaccurate information about possible synergy gains leads to more failures. The companies rely too much on the positive signal that the partner has decided to merge with them. If potential partners spend too little time collecting information, failure after the merger can be particularly severe. However, this is difficult to systematically verify in empirical terms. Because, for obvious reasons, potential merger partners hide from the public when they begin their negotiation talks. A fusion experiment, allowing participants the opportunity to talk to each other before the start of the actual merger negotiations, could provide clarity here.

The presented analysis is an attempt to open the “black box” of organizational processes of newly merged companies by theoretically exploring ways in which managers make integration decisions. Many points in the process remain unclear. What influence do strong or weak executives have on the merger process? Is integration negatively affected by misinterpretations, and does the adjustment process accelerate once the right direction is taken? How do differences in the size and power of partners affect mergers?