Use of OCAI and the Competing Values Framework in M&A
Corporate Culture and Financial Success of Mergers and Acquisitions
Kim Cameron[1], Carlos Mora[2]
Most organizational scholars and executives now recognize that organizational culture has a powerful effect on the performance and long-term effectiveness of organizations. Empirical research has produced an impressive array of findings demonstrating the importance of culture in enhancing organizational performance. In addition, culture plays a major role in accounting for the success of mergers and acquisitions (M&As). It has been found that a large majority of mergers fail to produce the hoped-for economic value due at least partly to culture mismatches. Examples appear frequently in the popular press citing merger or acquisition failure because of organizational culture incompatibilities.
What is missing from these accounts, and from the scholarly literature, is an analysis of how culture can be diagnosed in advance of an M&A in order to enhance the probability of financial success. What is needed is a way to help firms diagnose organizational culture as part of the due diligence process so that culture compatibility can become part of the equation for managing successful integration.
We make available to interested companies an instrument and a process for diagnosing organizational culture. This product, based on empirical analysis of M&As over a multi-year period, predicts successful and less successful mergers and acquisitions with a success rate of 97 out of 100. It provides firms with a way to determine, in advance of a merger or acquisition, the probabilities of cultural incompatibilities and conflicts and their effects on financial performance over time.
Theoretical Framework
The product was developed at the University of Michigan and is based on the Competing Values Framework (Cameron & Quinn, 1999). This framework is an insightful theory of organizational behavior and managerial leadership with strong empirical support and wide acceptance in organizational studies. It identifies four dominant cultural orientations that characterize organizations. Empirical analyses have determined that one or more of these four cultural types tend to be dominant in organizations as they progress through their developmental life cycles. The product diagnoses these cultural orientations and predicts the success of different combinations of cultures in merging or acquiring firms.
The Competing Values Framework differentiates the key trade-offs made by organizations as they pursue their objectives. These trade-offs are captured in two main dimensions. One dimension differentiates an emphasis on flexibility, discretion, and dynamism from an emphasis on stability, order, and control. For example, some organizations tend to be effective if they are changing, adaptable, and organic. Consider companies like Microsoft or Nike where neither the product mix nor the organizational form stays in place very long because agility and volatility are crucial to successful performance. Other organizations are effective if they are stable, predictable, and mechanistic. For example, longevity and steadiness in both design and output characterize most universities, government agencies, and conglomerates such as LTV Steel and Boeing. Successful performance requires consistency and evenness. This dimension ranges from versatility and pliability on one end to consistency and durability on the other end.
A second dimension differentiates an emphasis on an internal orientation, inner capability, integration, and unity from an emphasis on an external orientation, outward opportunity, differentiation, and rivalry. That is, some organizations have great value associated with their harmonious internal characteristics—for example, IBM and Hewlett-Packard have traditionally been recognized for a consistent “IBM-way” or “H-P way.” Other organizations have created value primarily by focusing on interacting or competing with others outside their boundaries—for example, Toyota and Honda are known for “thinking globally but acting locally,” or in other words, for having units adopt the attributes of the local environment more than a centrally prescribed approach. This dimension ranges from cohesion and consonance on the one end to separation and independence on the other.
Together these two dimensions form four quadrants, each representing a distinct cluster of values and orientations. They include elements referring to value creation, effectiveness criteria, leadership, structure, climate, strategy, and managerial approaches. What is notable about these four quadrants is that they represent opposite or competing cultures. Each continuum highlights cultural elements that are opposite from the cultural elements on the other end of the continuum--i.e., flexibility versus stability, internal orientation versus external orientation. The dimensions, therefore, produce quadrants that are contradictory or competing on the diagonal. The upper left quadrant, for example, identifies a culture that focuses on an internal, organic orientation, whereas the lower right quadrant identifies a culture that focuses on an external, control orientation. Similarly, the upper right quadrant identifies a culture that emphasizes an external, organic focus whereas the lower left quadrant emphasizes internal, control focus. These competing or opposite elements in each quadrant give rise to one of the most important features of the framework, the presence and necessity of paradox.
SEE FIGURE 1 OF QUADRANTS AT TOP OF ARTICLE
Each of the four quadrants has been given a label in order to characterize its most notable cultural characteristics. These labels were taken from scholarly literature describing various forms of organizational arrangements and attributes—clan, adhocracy, market, and hierarchy. As noted in the figure above, the clan quadrant is in the upper left, the adhocracy quadrant is in the upper right, the hierarchy quadrant is in the lower left, and the market quadrant is in the lower right. The framework predicts that there will be a negative relationship between diagonal quadrants and a neutral relationship between adjacent quadrants. That is, managers will find conflicts and difficulties when simultaneously addressing clan and market concerns on the one hand, and adhocracy and hierarchy concerns on the other hand. These predictions have been confirmed by scientific studies conducted at the University of Michigan.
The key question is: Can this framework for diagnosing organizational cultures be used to predict the success of a proposed merger or acquisition based on the cultural orientation of the firms? The answer is a resounding “yes.” What is required is that managers from potential merger partners complete a diagnostic instrument. This instrument will provide a profile of each company’s culture prior to the merger. We will analyze the characteristics of both profiles and the types of matches or mismatches that exist between the two organizations. Predictions of financial success can be produced, and managers can be cued regarding areas of potential opportunity or challenge in creating a successful merger. Empirical predictions of success have been produced by analyzing stock value adjusted according to the Capital-Asset Pricing Model (CAPM), one of the most popular valuation techniques used in financial analyses.
For interested readers, a brief explanation is provided below of the main approach used in creating a predictive model of merger success based on the culture diagnosis instrument.
Financial Data: Capital-Asset Pricing Model
To explain how our predictions of merger success work, we explain briefly the Capital Asset Pricing Model (CAPM). CAPM is a valuation technique that removes the market expectation from the return of a stock and leaves as residual the portion of the stock return due exclusively to the idiosyncratic portion of the company’s performance that cannot be explained by market movements. Using market data we capture the stock return of the lead company on the day the merger is announced and one year after. Using CAPM statistical techniques we compute the “abnormal return” of the stock value after overall market effects are removed. The analysis involves examining whether there is any statistically significant correlation between the post-acquisition stock returns of the acquirer and the differences between the acquirer’s and the target’s pre-acquisition cultures as measured along the specific dimensions indicated by the model. The basic idea is that if cultural congruence (or lack of congruence) can explain cross-sectional differences in the stock return performances of acquirers, then there is a strong financial reason to be more thorough in a consideration of corporate culture prior to an acquisition.
A Summary of Data Analyses
Using commercial data services we obtained a list of 106 mergers that have occurred over the last ten years. The list included the names of the merging companies, the announcement date, and other relevant information pertaining to the merger itself. From those mergers, we identified 33 cases for which we had already obtained culture data for both buying and selling companies prior to the merger announcement date. For each company we computed four (adhocracy, clan, hierarchy and market) average culture scores across the culture diagnosis instrument. We then computed a difference score subtracting the selling score from the buying company score on each one of the four quadrants of the Competing Values Framework.
Using the CAPM methods we obtained abnormal returns for the buying company after one year of the announcement date. Merged companies with abnormal returns of 20% or more were considered successful while merged companies with abnormal returns of –20% or less were considered unsuccessful. Merged companies with abnormal returns between –20% and 20% were considered neutral. There were 5 successful companies and 4 unsuccessful companies.
Using a clustering technique called discriminant analysis, results indicated that our culture diagnosis serves to predict which companies will be successful and which will be unsuccessful. Based on culture data alone, the discriminant function correctly classified six of the eight successful companies and five of the six unsuccessful companies. The predictive capability of the findings, based on organizational cultures of successful and unsuccessful firms, was significant at the .034 level.
SEE FIGURE 2 OF RESULTS AT TOP OF ARTICLE
The Clan Effect
We also analyzed the effects of each culture type on financial success. We found that when the selling company has a higher clan average score than the buying company, the merger tends to be successful. This finding is compatible with the portrayal in the scholarly M&A literature of the buying company as a dominating partner. To resist the disorienting effects of new cultural orientations, the company being acquired should have a strong clan culture that will provide moral and professional support to its members. On the other hand, when the buying company has a higher clan score than the selling company, the merger tends to be unsuccessful. This finding suggests that the role of the buying company is to provide direction and/or resources but to refrain from trying to alter human resource routines in the company being bought.
The Adhocracy Effect
High adhocracy average scores have a negative impact on the financial success of the merger. This is true for both buying and selling companies. This finding suggests that high levels of innovation, speculation, and experimentation are dysfunctional during the process of a merger and just afterwards. Clarity and direction are more effective than is the uncertainty that accompanies rapid and frequent change or creative action.
The Hierarchy Effect
When both selling and buying companies have a high hierarchy average score the merger tends to be successful. On the other hand, when both companies have low hierarchy scores the merger tends to be unsuccessful. This finding suggests that companies need the stability offered by hierarchy values to weather the dislocations created by the radical changes that usually accompany a merger.
The Market Effect
When the buying company has a higher market average score than the selling company the merger tends to be successful. This finding suggests that the market culture of the buying company should aggressively lead the productivity and strategy of the new merged company. Companies with weak market cultures may want to consider buying market leadership through acquisitions.
Conclusion
It is clear that corporate culture has an impact on the success of mergers and acquisitions. Moreover it is possible to predict the financial success companies involved in these transactions based on their cultures. Inasmuch as cultural incompatibility is a pervasive reason for M&A failure, such predictive power is a key leverage point in the due diligence process. Successful mergers tend to be typified by buying companies with higher than average market and hierarchy cultures and lower than average clan and adhocracy cultures. Sellers in successful mergers tend to have higher than average clan cultures and lower than average adhocracy and hierarchy cultures.
Of course, a large number of statistical analyses have been conducted on a variety of organization types and cultural profiles, and this executive summary contains only a glimpse of the relevant findings. An entire diagnostic package is available from us that can assist organizations in predicting and managing the merger and acquisition process successfully.
Reference: Kim S. Cameron and Robert E. Quinn (1999) Diagnosing and Changing Organizational Culture. Reading, MA: Addison Wesley.
[1] The University of Michigan, School of Business Administration
[2] morac@umich.edu
