Acquisitions, Stakeholder Economies Of Scope, And Stakeholder

Acquisitions, Stakeholder Economies of Scope, and Stakeholder Orientation
ACQUISITIONS, STAKEHOLDER ECONOMIES OF SCOPE, AND STAKEHOLDER ORIENTATION
Douglas A. Bosse Robins School of Business
University of Richmond Richmond, VA 23173 [email protected]
(804) 287-1922
Jeffrey S. Harrison Robins School of Business
University of Richmond Richmond, VA 23173 [email protected]
(804) 380-9000
Robert E. Hoskisson Jesse H. Jones Graduate School of Business
Rice University Houston, TX 77005 [email protected]
(480) 276-0294
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Acquisitions, Stakeholder Economies of Scope, and Stakeholder Orientation
ABSTRACT An acquisition brings multiple stakeholder networks together into one combined firm, which inevitably results in changes to the relationships and value propositions the firm has with its stakeholders, and ultimately to the value the firm creates for them. In this paper, we argue that stakeholder economies of scope are possible through managing the stakeholder relationships of multiple business units in a way that creates more total economic value for stakeholders than if those businesses were each managed separately. For example, a broadly stakeholder-oriented acquiring firm can create a stakeholder economy of scope by expanding its broad stakeholder orientation to a newly acquired business unit. The increase in total economic value this generates for the combined network of stakeholders is not recognized in other types of economies of scope. Alternatively, we argue that when an acquiring firm with a narrow stakeholder orientation expands its orientation to a newly acquired division that is broadly stakeholder oriented, the combined firm experiences a reduction of total economic value, all else equal, due to what we term stakeholder diseconomies of scope. Stakeholder economies and diseconomies of scope have the potential to help explain more of the large variance in the performance of acquiring firms than has been explained previously.
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Acquisitions, Stakeholder Economies of Scope, and Stakeholder Orientation
INTRODUCTION Much of the strategic management literature is intended to explain firm financial performance. However, from its inception strategic management has also been interested in the broad purpose of the firm and its impact on society. For example, in an important early text, Learned, Christensen, Andrews and Guth (1965:17) identified four components of strategy, with the fourth being “acknowledged obligations to segments of society other than the stockholders (italics added).” This notion was carried forward as a firm’s “enterprise strategy” and discussed at a foundational strategy conference at the University of Pittsburg in 1977 (Schendel & Hofer, 1979: 11). Indeed, at the same conference Newman (1979: 45) presented a model that looks very much like what we now call a stakeholder map, reflecting the idea that the firm’s activities have an impact on a broad group of customers, suppliers, employees, financiers and the community, and that these stakeholders also have an impact on the firm. Of course, Freeman’s (1984) classic book, Strategic Management: A Stakeholder Approach, underlined this point and provided both justification for and advice about managing stakeholders. In spite of these early advances, some strategies have been studied largely from the perspective of their influence on one or a small set of stakeholders. For example, acquisitions are one of the most popular of all corporate strategies, and one of the most studied; however, the predominant, almost exclusive, dependent variable in these studies has been some variant of financial returns, predominantly for shareholders (i.e., Allen and Soongswang, 2006; Datta, Pinches & Narayanan, 1992; Hogarty, 1970; King, Dalton, Daily & Covin, 2004; Loughran & Vijh, 1997). Surely, though, shareholders are not the only primary stakeholders who experience M&A activity as value-enhancing or value-destroying. Consider that non-shareholder stakeholders often find their implicit contracts changing during the post-acquisition period
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Acquisitions, Stakeholder Economies of Scope, and Stakeholder Orientation
(Cording, Harrison, Hoskisson, & Jonsen, 2014; Shleifer & Summers 1988). The managers of acquiring firms ultimately have to decide the extent to which they are willing to trade off financial gains for shareholders against the interests of a wider set of stakeholders (Meyer, 2001).
We examine how acquisitions are likely to affect the total incremental economic value created for a firm’s primary stakeholders, as a function of the stakeholder orientation of the acquiring and acquired firms. We define primary stakeholders as those that are involved in the value creating processes of the firm, which include employees, customers, suppliers, and capital providers (shareholders and financiers). We are using the term “economic value” in the traditional sense of what a stakeholder would be willing to pay for the utility received through economic exchanges with the firm. An acquisition alters the total amount of economic value a firm creates for its stakeholders, and our theory helps explain why.
This paper explains a novel type of economy of scope that has the potential to explain previously unspecified sources of value for a firm’s primary stakeholders. We call it a stakeholder economy of scope, defined as the value-creating economic benefits resulting from managing the stakeholder relationships of multiple business units together rather than separately. We are building our theory on the general concept of economies of scope, which are said to exist when one firm manages two or more business units in a way that creates more value than if those businesses were each managed separately (Cassiman, Colombo, Garrone & Veugelers, 2005; Panzar & Willig, 1981; Sakhartov & Folta, 2014). This concept has been enhanced and made more practical by distinguishing specific types of economies of scope such as: sharing activities (Singh & Montgomery, 1987), spreading core competencies (Prahalad & Hamel, 1990), improving internal capital allocation (Brouthers & Brouthers, 2000), spreading risk (Chatterjee, 1986), exploiting tax advantages (Scott, 1977), reducing competition (Bradley, Desai, & Kim,
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Acquisitions, Stakeholder Economies of Scope, and Stakeholder Orientation
1988), and restructuring poorly configured businesses (Chatterjee & Lubatkin, 1990). These other types of scope economies share at least two things in common. First, they assume that firms prioritize cost reduction and associated profit maximization above all other outcomes (Rumelt, Schendel, & Teece, 1991). Second, they largely depend on activities performed during the post-deal integration phase (Haspeslagh & Jemison, 1991), although the economic gains, if any, may be anticipated during the deal making process and thus absorbed into the share price of the acquiring firm before the merger is even consummated. Stakeholder economies of scope are similar in terms of their emphasis on the integration phase but, because they affect the aggregate economic value for all stakeholders, differ in terms of the outcomes they generate.
Stakeholder economies of scope depend on the assumption that all stakeholders are engaged with the firm through incomplete contracts, whether explicit or implied (Schreuder & Ramanathan, 1984; Werder, 2011), and not just the shareholders. It is well accepted that shareholders do not receive a fixed return but have residual claims on firm profit. The other primary stakeholders’ contracts, however, are incomplete in two ways. First, like shareholders, the total value they receive from the firm in any time period is not completely specified up front (Asher, Mahoney & Mahoney, 2005; Hoskisson, Gambeta, Green, & Li, 2018; Mahoney, 2013). Second, and more importantly for value creation, they are unlike shareholders in that the contributions they provide the firm are also incompletely specified (Asher, et al., 2005; Blair, 1995; Mahoney, 2013). The implication is that some of the variance (positive or negative) in economic value resulting from an acquisition can be understood to come from differences in the contributions made by the firm’s non-shareholder stakeholders during the integration period.
Developing theory about stakeholder economies of scope requires that we specify a time period for measuring outcomes that is long enough to include most of the acquisition integration
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Acquisitions, Stakeholder Economies of Scope, and Stakeholder Orientation
process. Thus, our propositions consider the sum of economic value at the acquiring firm after the acquisition has been integrated compared with the sum of economic value produced in both firms prior to deal announcement. This incremental value creation approach is consistent with Garcia-Castro and Aguilera (2015), who argue that although it is particularly difficult to measure total value created by a firm for its stakeholders at any point in time, it is a much more reasonable proposition to measure changes in value created from one time period to another. This idea of incremental value creation for involved stakeholders is operationalized in the empirical work of Lieberman, Balasubramanian, and Garcia‐Castro (2018).
In our propositions we argue that a broadly stakeholder-oriented acquiring firm can create a stakeholder economy of scope by expanding its stakeholder orientation to the newly acquired business unit. The increase in total economic value this generates for the combined network of stakeholders is not recognized in other types of economies of scope. Alternatively, we argue that when an acquiring firm that is not broadly stakeholder oriented expands its orientation to a newly acquired business unit that is broadly stakeholder oriented, the combined firm experiences a reduction of total economic value due to what we term stakeholder diseconomies of scope. The propositions we develop cover a range of possible combinations of acquiring firm and acquired firm stakeholder orientations.
This paper makes three primary contributions. First, it develops a deductive explanation for a novel form of value creation in M&A. Stakeholder economies and diseconomies of scope offer a richer understanding of why acquisitions can lead to wide variance in total firm performance. Second, this paper applies stakeholder theory to corporate strategy and highlights some important dynamics that underlie value creation through M&A activity. Finally, the logic we develop can guide executives at acquiring firms with specific advice that hinges on the
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Acquisitions, Stakeholder Economies of Scope, and Stakeholder Orientation
degree to which their firm is broadly stakeholder oriented. We begin by defining three types of stakeholder orientations.
FIRM-LEVEL STAKEHOLDER ORIENTATION A firm with a broad stakeholder orientation manages for stakeholders by seeking “to identify and understand how the welfare of its stakeholders is affected by the actions it takes” (Freeman, Harrison, Wicks, Parmar & de Colle, 2010: 62) and, as a result, enjoys strong relationships with multiple types of stakeholders (Choi & Wang, 2009; Freeman, 1984; Hillman & Keim, 2001; Jones, 1995; Sisodia, Wolfe & Sheth, 2007). The visions of these firms tend to be broad in terms of the influence of the firm on many stakeholders and even society at large (Freeman, Harrison & Wicks, 2007). Their leadership focuses on fostering strong relationships with stakeholders (Bridoux & Stoelhorst, 2016; Jones, Harrison & Felps, 2018). The instrumental benefits of a broad stakeholder orientation are well described in other work, and there is a large body of empirical evidence that suggests such a stakeholder orientation can even generate higher focal firm shareholder performance (i.e., Choi & Wang, 2009; Henisz, Dorobantu & Nartey, 2014; Hillman & Keim, 2001; Sisodia, et al., 2007). The benefits arise because stakeholders who receive value that exceeds their expectations tend to respond by providing additional effort, resources, and information that, in aggregate, improves firm performance (Bosse et al., 2009; Harrison et al., 2010). A broadly stakeholder-oriented firm views its stakeholders as actors who have intrinsic worth of their own (e.g., Donaldson & Preston, 1995; Jones, 1995) and explicitly recognizes the challenges associated with serving multiple stakeholders’ objectives. In addition to what we are calling a broad stakeholder orientation, other orientations toward stakeholders exist within firms (Brickson, 2005, 2007; Jones, Felps & Bigley, 2007). One
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Acquisitions, Stakeholder Economies of Scope, and Stakeholder Orientation
of the most common is a single stakeholder orientation focused on shareholder returns (Stout, 2012), or what we will call a shareholder dominant orientation. This firm orientation is supported by popular financial theory (i.e., Brealy, Myers & Marcus, 2017; Danielson, Heck and Shaffer, 2008; Jensen and Meckling, 1976) and the moral argument that focusing managers on the objective of maximizing profit for equity holders will maximize social welfare as, eventually, all economic resources will flow freely to their highest and best use for society (Friedman, 1970; Jensen, 2002). This perspective also asserts that limiting managers’ discretion by measuring them against the central objective of shareholder value maximization prevents them from making decisions that serve themselves (Jensen, 2002). In addition, the public accounting profession uses this orientation as a foundation for its approach to auditing (Beyer, Cohen, Lys, & Walther, 2010; Harrison & Van der laan Smith, 2015). It is even considered by some to be a legal requirement, and although this argument has been largely refuted, it has become institutionalized to the point that many managers and business scholars still support it (Heminway, 2017; Kelly, 2001; Marens & Wicks, 1999; Stout, 2012).
The managers of a shareholder dominant firm tend to treat non-shareholder stakeholders as instruments for the creation of shareholder value (Garcia-Castro & Aguilera, 2015; Jones, et al., 2007). Thus, leadership in this sort of firm is focused on minimizing the value appropriated by all other stakeholders in order to maximize the residual value available for shareholders (Coff, 1999; Freeman et al., 2010; Friedman, 1970; Jensen & Meckling, 1976). Consequently, the shareholder dominant orientation is particularly relevant to the context of acquisitions because there is so much change and thus so many opportunities to essentially rewrite existing formal and informal contracts with stakeholders. An acquiring firm with a shareholder dominant orientation will attempt to extract as much value as possible from non-shareholder stakeholders so that it can
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Acquisitions, Stakeholder Economies of Scope, and Stakeholder Orientation
be reallocated to shareholders. One of our arguments, to be developed in detail in a later section, is that such activities are likely to be value destroying over the long run.
It is possible to distinguish firms based on their stakeholder orientations. Examples of these differing stakeholder orientations can be found in the 2017 rankings by Just Capital (Justcapital.com), a company that polls Americans to determine which issues matter most and then evaluates the largest publicly traded companies based on these issues.1 In the semiconductor and equipment industry, Just Capital’s 2017 survey reports that Intel and Texas Instruments both treat their employees, customers, shareholders, and communities in ways that exceed what these stakeholder groups tend to get from other firms. We are describing these firms as broadly stakeholder oriented. Shareholder dominant firms are also found in the semiconductor industry. For example, Justcapital.com reports that Xilinx generates exceptional shareholder value but does not stand out for its treatment of any other type of stakeholder.
We do not claim all firms fit perfectly into one of these two ideal types (Clark, Steckler, & Newell, 2016), but rather that many firms fall somewhere in between in their stakeholder orientations (Brickson, 2005, 2007; Jones et al., 2007). Consequently, we add a third firm-level orientation. We use the term “narrowly stakeholder oriented” to indicate a firm that manages for a comparatively smaller set of stakeholder types. Such a firm may be emphasizing excellent treatment of stakeholders they perceive as being most essential to their value-creating activities or most salient based on power, legitimacy or urgency (Mitchell, Agle & Wood, 1997).2 In the semiconductor industry, Qualcomm is one example of a narrowly stakeholder-oriented firm
1 Just Capital has identified 39 components of seven major issues of concern to Americans. They then use numerous sources of information to rate companies on these components. A Research Advisory Council of academics, economists and subject matter experts ensures that rigorous methods are used. They also give the rated companies an opportunity to respond to their ratings and provide additional data before the ratings are published. 2 These ideas are somewhat similar to the concept of “enfranchised” stakeholders in work by Klein, Mahoney, McGahan and Pitelis (2017).
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Acquisitions, Stakeholder Economies of Scope, and Stakeholder Orientation
because Just Capital’s 2017 survey reports it is exceeding the expectations of its employees and communities, but its shareholders and customers are not benefitting from the same level of attention and value creation. Applied Materials is another narrowly stakeholder-oriented firm in this industry. In direct contrast to Qualcomm, Applied Materials is creating exceptional value only for its customers and shareholders. For the sake of clarity, we define narrowly stakeholder oriented firms as those focusing primarily on the welfare of two or more primary stakeholders but not all of them. The Micro-behaviors Arising from Orientation
The broad stakeholder orientation is largely enacted and maintained via informal social norms (Scott, 1995) as actors across the stakeholder network reward and punish others for supporting or violating, respectively, their perceived norms of social justice (Harrison et al., 2010). Shared beliefs and understandings about the intrinsic value of stakeholders underlie and reinforce informal codes of conduct that include rewards, taboos, and sanctions (North, 1991). Consistent with the broad stakeholder orientation, a growing literature in behavioral economics shows that when a group of people can reward and punish each other for upholding or violating acceptable social norms, respectively, they collectively benefit from greater cooperation (see Fehr, Fischbacher, & Gatcher 2002; Fehr & Gachter, 2000). Broadly stakeholder oriented firms tend to adopt norms associated with high levels of trust, resource sharing, joint wealth creation, and relational contracting, which can lead to high productivity levels (Bridoux & Stoelhorst, 2016; Jones, 1995; Jones, Harrison & Felps, 2018). Individuals quickly learn that cooperative behavior eventually improves their collective outcomes whereas uncooperative or untrustworthy behavior is actually costly to themselves and the firm.
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