human capital integration in mergers and acquisitions

Human Capital Integration in Mergers and Acquisitions

Paolo Fulghieri Merih SevilirUNC-Chapel Hill Indiana University

Conference on Finance, Labor and InequalityJune 2019

Fulghieri/Sevilir () Integration in M&A 06/19 1 / 22

Motivation

Why DaimlerChrysler Never Got into GearHBR 2007

The two organizations never were integrated into anything thatapproached a cohesive whole. The potential synergies that wereused to justify the deal went unrealized.

...the two organizations couldn’t cooperate to the extent necessaryto make the combination work.

realizing synergy.... would have required deep integration of Daimlerand Chrysler.

German engineers would have had to design cars using parts createdby American engineers and vice versa. The management team wouldhave had to develop a global brand strategy.

...none of this happened. They ran the two organizations as separateoperations.

Motivation

The two organizations never were integrated into anything thatapproached a cohesive whole. The potential synergies that wereused to justify the deal went unrealized....the two organizations couldn’t cooperate to the extent necessaryto make the combination work.

Motivation

This paper

Model of post-merger integration where divisional managers choosebetween "collaboration with other division" or "competition for otherdivision’s resources"

collaboration: managers integrate resources, skills and assets, andwork together towards "synergy", which is impossible in absence ofcollaboration effort

competition: managers focus exclusively on divisional resourceswithout collaboration, and compete for each other’s resources

collaboration involves more costly effort; it has both upside (synergy)and downside (dis-synergy), relative to competition

This paper

Main Result

Collaboration incentives depend on nature of physical assets and humancapital assets. Collaboration is more likely for

greater levels of human capital complementarity

lower levels of physical asset similarity between divisions

Main Result

Collaboration incentives depend on nature of physical assets and humancapital assets. Collaboration is more likely for

greater levels of human capital complementarity

lower levels of physical asset similarity between divisions

Intuition

Greater human capital complementarity:

firm has greater reliance on human capital to internalize synergies(lower labor monopsony power); fewer post-merger layoffs and highermanagerial wages

managers are more willing to collaborate: exert greater (costly) effortto create upside, and are more willing to bear downside ofcollaboration effort

Intuition

Greater human capital complementarity:

firm has greater reliance on human capital to internalize synergies(lower labor monopsony power); fewer post-merger layoffs and highermanagerial wages

managers are more willing to collaborate: exert greater (costly) effortto create upside, and are more willing to bear downside ofcollaboration effort

Intuition, cont’d

Greater physical asset similarity:

firm has greater ability to reallocate assets from one division toanother (greater monopsony power)

managers are less likely to collaborate, and more likely to compete toobtain other division’s resources

lack of collaboration leads to layoffs/downsizing

Intuition, cont’d

Implications

Collaboration incentives weaker in horizontol mergers/consolidatingmergers; stronger in diversifying and vertical mergers

merge-spin transactions: consistent with regulators’(FTC’s)demand on divestiture and sale of overlapping assets of mergingparties; e.g., Dupont-Dow Chemicals, Time Warner -Verizon

Tate and Yang (2015): employees in diversified firms exhibit higherproductivity, and receive a wage premium, relative to those in focusedfirms

Implications

Collaboration incentives weaker in horizontol mergers/consolidatingmergers; stronger in diversifying and vertical mergers

merge-spin transactions: consistent with regulators’(FTC’s)demand on divestiture and sale of overlapping assets of mergingparties; e.g., Dupont-Dow Chemicals, Time Warner -Verizon

Tate and Yang (2015): employees in diversified firms exhibit higherproductivity, and receive a wage premium, relative to those in focusedfirms

two divisional firm - formed as a result of mergereach division employs a manager - M1 and M2divisional assets owned and controlled by corporate headquarters - CHQrisk-neutrality, no discounting

Timeline

date 0: managers choose to collaborate or not (compete), and exert effort

no-collaboration: exert effort to create value using existing divisional assetsand resourcescollaboration: exert (more costly) synergy effort. If both managerssucceed, there is upside (innovation). If only one manager succeeds,downside relative to no-collaboration

date 1: effort outcomes observed; bargaining over surplus allocationdate 2: payoffs realized and allocated

Payoffs

No-Collaboration

State SS SF

keep both divisions 2yclose one division βy y

β > 1 measure of reallocation value of physical assets

Payoffs, cont’d

Collaboration

State SS SF

keep both divisions syclose one division (1− θ)sy (1− d)y

s > 2: upside of collaboration; d < 1 : downside of collaborationθ: human capital complementarity/diversity

No-collaboration - Surplus allocation

Payoffs based on Shapley values:

State SS:β ≤ 4 :

M1 =(4− β)y

6;M2 =

(4− β)y6

CHQ =(2+ β)y

3β > 4 :

M1 =βy2;M2 = 0

CHQ =βy2

No-collaboration - Surplus allocation

State SF:

M1 =y2,M2 = 0

CHQ =y2

Collaboration - Surplus allocation

State SS:

M1 =(1+ θ)sy

6,M2 =

(1+ θ)sy6

CHQ =(2− θ)sy

Collaboration - Surplus allocation

State SF:

M1 =(1− d)y

2,M2 = 0

CHQ =(1− d)y

Managerial effort-competition

maxp1p1p2

(4− β)y6

+ p1(1− p2)y2− 12p21 ; β ≤ 4

maxp1p1p2(

12× βy2) + p1(1− p2)

y2− 12p21 ; β > 4

Managerial effort-collaboration

maxp1p1p2

(1+ θ)sy6

+ p1(1− p2)(1− d)y

2− k2p21

Proposition∂πS∗CHQ

∂θ > 0 for θ < 2s−3(1−d )s .

An increase in θ results in higher wages, and also greater synergy effort.For suffi ciently low values of θ, the second effect dominates, and CHQexpected profits increase in θ.

PropositionManagers choose to collaborate if human capital complementarity(diversity of human capital) between them is suffi ciently high, that is, ifθ ≥ θM where

θM ≡

θ1M ≡6k+3(1−d )y−

√k (1−d )(6−y (1−β))sy − 1 for β ≤ 4

θ2M ≡2(6k+3(1−d )y )−3

√k (1−d )(4−(β−2)y )

2sy − 1 for β > 4.

Decentralization

Can CHQ induce more collaboration if she can commit to not engaging inex post resource reallocation?

Decentralization: allocate divisional resources at t = 0 , and engage inbilateral bargaining with each divisional manager, without ability toreallocate resources across divisions

PropositionDecentralization expands the parameter space over which managerschoose to collaborate for β > 4; it shrinks it for β ≤ 4.

If CHQ can commit not to engage in resource reallocation, managerialincentives to collaborate would be stronger for β > 4, and weaker forβ ≤ 4.Decentralization is desirable when CHQ’s ability to reallocate resources ishigh: consistent with "decentralized R&D budgets improving innovationincentives in firms with active internal capital markets" in Seru (2014)

Conclusion

CHQ’s ability to reallocate resources across divisions may impedecollaboration and integration

Greater collaboration incentives in seemingly unrelated acquisitions, orin mergers between industries with greater human capital diversityand complementarity

Consistent with merge-spin transactions, mechanisms reducing overlapbetween merging parties may promote collaboration and integration

human capital integration in mergers and acquisitions

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