Addressing Competitive Responses to Acquisitions

David R. King

Svante Schriber

Research consistently shows that acquisitions typically fail to improve the performance of acquirers,
leading to calls for theory development. 1 Traditionally, research takes the perspective of firm managers
and defines success or failure of an acquisition by its ability to improve the competitiveness of the
combined firms. Improved competitiveness for an acquirer can result from entering valuable new
markets,2 accessing valuable resources and capabilities,3 and realizing acquisition benefits during the
integration.4 Given recognition that the best time to attack a competitor is when they are distracted by
an acquisition,5 there is surprisingly little research on reactions by external stakeholders to acquisitions.

Consequently, the ability ofmanagers to predict, prevent, ormitigate the influence of

competitor retaliation to an acquisition can be expected to influence acquisition
performance. Still, the means of predicting or avoiding competitive responses have
not received significant research attention. This article addresses this gap and complements
the interpretation of acquisitions as competitive moves. Acquisitions are met by competitor responses that contest
the benefits of
making an acquisition. Further, since acquisitions
will vary in their vulnerability to such retaliatory
responses, we develop a framework that connects
acquisition attributes with the likelihood of competitor
retaliation and tactics to mitigate the effects of
retaliation.

Traditionally, competitive dynamics theory

focuses on competitor characteristics to predict the likelihood that competitors will
respond to a strategic move.22 There appears to be great potential in building on this
and related research that suggests firms can shape their competitive environment
to more favorable conditions23 to outline decisions in acquisitions that can lower
the likelihood of competitive responses.
By developing a perspective of competitive dynamics surrounding acquisitions,
we shift the dominant perspective in acquisition research that examines
the potential and realized value from a combination of acquirer and target
firms24 to considering the risk of competitor responses designed to lower the performance
of an acquirer.

Acquisitions are typically publicly announced, strategic in nature, and involve

investing substantial financial and managerial resources.33 This means competitors
react to reduce the benefits from completing an acquisition. In other words, tactics
to avoid and mitigate competitive responses to acquisitions represents an important
managerial consideration. Second, assessing the unique risk profile of a prospective
acquisition provides managers relevant information for evaluating target firms and
estimating acquisition performance. For example, considering competitor perspectives
using the Awareness-Motivation-Capability framework allows a repeatable
and structured approach to compare the risk of competitive responses. 34 As a result,
considering competitor responses as part of a firm’s acquisition processes could
benefit acquirer performance by capturing more of the value from an acquisition. 35

Although they are interrelated,36 we assess the risk of competitor retaliation

using the Awareness, Motivation, and Capability dimensions of competitive dynamics
before and after an acquisition completes. The opportunities for competitors to
intervene differ significantly before and after the completion of an acquisition. Before
an acquisition, acquirers typically assess their need for acquisitions in relation to their
overall strategy, and then begin the search and evaluation of targets, deal negotiation,
and the completion of due diligence. Competitor responses before an acquisition include appealing to government
regulators and driving up the price paid. The completion

of an acquisition transfers ownership, and it is followed by organizational

change, such as structural, procedural and legal, cultural, and identity integration. 37
Competitor responses after an acquisition include retaliatory price changes, completing
a follow-on acquisition, as well as poaching employees and customers. 38

Discussion
The success or failure of an acquisition is defined by its ability to improve
the competitiveness of the involved firms. Our combination of acquisition and
competitive dynamics research illustrates how improving the success of acquisitions
depends not only on pursuing benefits, but also mitigating the risk and
effects of competitor retaliation. Our integration of acquisition and competitive
dynamics research demonstrates that a traditional focus on the pre-acquisition
strategic fit or post-acquisition integration between firms is incomplete, and that
research attention must also begin to consider the competitive environment surrounding
an acquisition.

The interaction effects between tactics are usually idiosyncratic to each

particular deal and its competitive environment. Put differently, not only does it matter that no two acquisitions are
alike,87 the competitive landscape and potential
for retaliation will also be unique for each acquisition. For example, actions
made by larger firms are more visible and are more likely to drive competitor
retaliation.88 However, larger competitors tend to announce responses quickly
as a signal to protect their image, but they are then slow to implement them. 89
The consequence is that the tactics need to be balanced against each other into an
overall acquisition strategy. While selection based on pre-acquisition characteristics
of combining firms remains important and can influence competitor retaliation to
an acquisition, anticipating improved acquisition performance from pre-acquisition
characteristics likely relates to a necessary but not sufficient condition. Instead,
improved acquisition performance depends on managing both internal organizational
processes with external competitive dynamics. To the extent that a combined
focus on internal and external (as well as pre-acquisition and post-acquisition) considerations
is achieved, managers will realize more of the gains expected from an
acquisition for their firms and shareholders.
Research clearly shows that acquisitions, on average, do not create value. 90
Mainly, research has focused on factors internal to combining firms, including poor
strategic fit or problems during integration. However, additional insight can be gained
from considering factors external to the involved organizations. While prior acquisition
research has pointed to dynamics in business relations, little explicit attention has
been given to competitor retaliation to acquisitions. This is curiously at odds with the
dominant strategic perspective that acquisitions can contribute to competitive advantage
and represent a strategic move by firms. As a result, our consideration of the
competitive dynamics surrounding acquisitions, as well as our identifying the factors
that influence it, offers a more balanced perspective for acquisition theory.

Managing liability risk after

a merger or acquisition
Sarah Beckett Ference, CPA

LESSON 1: CAREFULLY SELECT CONTINUING

CLIENTS AND ENGAGEMENTS

As part of this analysis, ask

questions such as:
■ How does this new client compare to the firm’s
“ideal” client profile? Would the firm have accepted
the client absent the transaction?
■ Are the services provided to the new client
consistent with the combined firm’s business
strategy and risk appetite?
■ Do any potential or actual conflicts of interest or
threats to independence exist?
■ If the new client presents risks to the firm, can
the firm adequately manage these risks?
≫ Does the firm have the knowledge and experience
to serve the new client competently?

LESSON 2: OVERSEE ALL PERSONNEL,

REGARDLESS OF LEVEL
Failure to exercise appropriate oversight, supervision,
and control of the work and personnel after
the consummation of a merger or acquisition can
result in significant liability exposure.

Adherence to professional standards, regulatory

requirements, and firm policies and procedures is
the responsibility of all members and employees
of a firm and should be appropriately monitored.
Training or Q&A sessions for new personnel can
help them understand the acquiring firm’s processes
and expectations. Work performed by personnel
of the acquired firm should be reviewed by the
acquiring firm for adherence to quality-control
procedures. For new locations, consider placing a
firm leader in the new location to provide on-site
guidance and oversight.

LESSON 3: THINK AND ACT LIKE ONE FIRM

Firms that choose to undertake a merger or acquisition
often look to acquire firms with a similar
vision, strategy, and culture. While it is difficult to
quantify these intangible considerations, a failure
to integrate firm culture is generally the primary
reason firms do not realize the financial benefits
and synergies of a merger or acquisition.
If each firm continues to operate separately,
it may lead to poor employee engagement and
confusion regarding which standards or protocols to
follow. Merged firms may not think of themselves
as one firm, operate as one firm, or run their businesses
in the same manner. Failure to integrate can
result in internal issues, and unnecessary distractions
may increase the likelihood of an error in the
delivery of client services.

Inside Debt and Mergers and Acquisitions

Hieu V. Phan∗
In this research, I examine the link between CEO inside debt holdings and
corporate risk taking in merger and acquisition (M&A) activities and its implications
for bondholder, shareholder, and firm value. M&As are among the largest
and most readily observable forms of corporate investment. Furfine and Rosen
(2011) document that, on average, M&As increase the default risk of the acquiring
firms; therefore, they represent discretionary risk taking by the CEOs. In
addition, M&As tend to intensify the inherent conflicts of interest among shareholders,
bondholders, and managers (e.g., Jensen and Meckling (1976), Masulis,
Wang, and Xie (2007)). For these reasons, M&As provide a unique ground for
testing the potential effects of debt-like compensation on corporate investment
and financing strategies and the implications of these effects for shareholder,
bondholder, and corporate manager wealth.

Further investigation of the operating performance and value implications of

CEO inside debt holdings indicates that CEO inside debt holdings are positively
correlated with short-term M&A announcement abnormal bond returns and longterm
operating performance, but negatively correlated with M&A announcement
abnormal stock returns. In addition, I find that acquiring firms restructure CEO
compensation packages post merger to mirror their capital structure. Although my
main sample is limited by disclosure rules starting in 2006, my primary findings
hold when I follow Sundaram and Yermack (2007) in estimating inside debt for
2005 and expand the M&A sample to additionally include acquisitions in the
year 2006. Also noteworthy is the fact that my findings are robust to alternative
specifications, survive potential self-selection and endogeneity bias corrections,
and persist after several robustness checks. Overall, my evidence suggests that
CEO inside debt holdings motivate risk-decreasing M&As, which benefits the
acquirer bondholders at the expense of shareholders in the short term; however,
acquiring firms restructure CEO compensation packages post merger to mitigate
CEOs’ incentives to pursue corporate activities that lead to wealth transfer from
shareholders to bondholders or vice versa in the long term.

Financial economics literature suggests that EBC (equity based compensation) is designed to align the interests
of managers and shareholders and motivate managers to take risks for the
shareholders’ benefit (e.g., Coles et al. (2006), Datta et al. (2001)). 6 Conversely,
debt-like compensation, which helps to align the interests of managers with those
of debtholders, is expected to induce managers to avoid risk-increasing actions
that could increase the likelihood of default. When managers receive compensation
in both debt and equity, they should run their firms in a way that considers
the interests of both debt and equity investors.

I have shown thus far that CEO inside debt holdings are associated with riskdecreasing
investment, as evidenced by the positive correlation between CEO
inside debt holdings and the likelihood of diversifying M&As. In this section,
I investigate the link between CEO inside debt holdings and the acquirer’s financial
leverage following an M&A completion as well as the methods of payment
for M&A targets.
The agency problem of debt that motivates risk shifting should diminish
in importance when managers hold large inside debt, which enables firms to
raise debt not only at a lower cost, but also with fewer restrictive covenants
(Anantharaman et al. (2014)). Better access to the external debt market at a lower
cost may lead to an increase in the financial leverage of the acquirers following
an M&A deal. However, higher financial leverage increases the risk of default.
Furthermore, the process of raising debt to make cash payment for M&A targets
is analogous to substituting the more liquid and less risky assets (i.e., cash) with
(target) assets that are more risky and less liquid, which would ultimately hamper
the interest of the existing debtholders. Therefore, I predict that CEO inside
debt holdings are negatively correlated with the change in financial leverage post
merger and cash payments for M&A targets.

Summary and Conclusions

Inside debt is a crucial part of executive compensation, but empirical research
to date has mostly overlooked this form of compensation. Agency theory
predicts that debt-like compensation aligns the interests of managers and external
debtholders and motivates managers to run firms in a way that serves debtholders’
interests. Consistent with agency theory, my empirical investigation of the relation
between CEO inside debt holdings and M&A activities shows that CEO inside
debt holdings are associated with risk-decreasing M&As. Specifically, CEO
inside debt holdings have a negative effect on M&A propensity. When firms do
engage in M&As, CEO inside debt holdings motivate diversifying M&As, lowering
financial leverage, and using stocks for payment; these holdings also have
a negative impact on the change in acquiring firm risk following the M&As. In
the short term, inside debt-biased CEO compensation has a positive impact on the
acquirer’s M&A announcement abnormal bond returns but a negative impact on
its abnormal stock returns, implying wealth transfer from shareholders to bondholders.
Over the long term, changes in CEO inside debt holdings are positively
correlated with acquirers’ postmerger operating performance. I also find evidence
that, to alleviate the concern that a biased structure of CEO compensation could
motivate corporate behavior, which leads to wealth transfer from shareholders to
bondholders or vice versa, acquirers restructure the composition of CEO compensation
post merger in a way that mirrors their firms’ capital structure. Finally, it is
crucial to emphasize that this research examines only one form of debt-like compensation,
namely, pension and deferred compensation. There may be other forms
of debt-based compensation, such as direct debts, that have not been covered and
could potentially be interesting topics for future research.
TAKEOVER DEFENSES, INNOVATION, AND VALUE
CREATION: EVIDENCE FROM ACQUISITION
DECISIONS
MARK HUMPHERY-JENNER*

The desirability of antitakeover provisions (ATPs)

is a contentious issue. ATPs can lead to shareholder
wealth destruction by insulating managers from
disciplinary takeovers and enabling them to engage
in empire building. However, without ATPs, managers
of hard-to-value (HTV) firms, which might
trade at a discount due to valuation difficulties, are
exposed to “opportunistic takeovers” (which aim
to take advantage of low stock prices), potentially
causing managerial myopia and underinvestment
in innovative projects. Thus, in HTV firms, ATPs
might serve as credible commitments to encourage
managers to make value-creating investments, but
in easier-to-value firms, they might lead to inefficient
governance.

Managerial entrenchment is typically associated

with self-interested takeovers that destroy shareholder
wealth (Harford et al., 2012; Humphery-
Jenner, 2012; Humphery-Jenner and Powell, 2011;
Masulis et al., 2007, 2009). Here, the entrenchment
enables managers to resist the “market for
corporate control” (a key disciplinary mechanism
that exposes poorly performing managers to disciplinary
takeovers). This enables managers to act
self-interestedly without fear of external discipline
One such self-interested action is a self-interested
takeover (Haleblian et al., 2009). For example,
takeovers sometimes increase equity-based pay
(Harford and Li, 2007; Ozkan, 2012) and bonuses
(Grinstein and Hribar, 2004). Managers might
also aim to increase corporate size, which could
increase CEO power and managerial entrenchment
and, thus, reduce employment risk (Gomez-Mejia
et al., 1990; Haleblian and Finkelstein, 1993).

Managerial entrenchment could also be a driver

of innovation through acquisitions in some firms,
particularly in HTV firms. HTV firms have investments
that are difficult to value and strategies that
can be difficult to quantify. This is because their
investments can be long term, rely on intellectual
capital, and/or depend on key personnel. However,
the market is often “myopic” and penalizes
firms with these traits (Ali et al., 2012; Woolridge,
1988), often emphasizing the possibility of
“disastrous” outcomes in long-dated investments
(Martin, 2012; Weitzman, 2009). While properly
structured incentive contracts would insulate
managerial compensation market myopia (Thanassoulis,
2013; see, e.g., Makri et al., 2006), such
schemes cannot protect managers from predatory
or opportunistic takeovers, which aim to
purchase relatively underpriced targets. Thus, if
managers are not protected from these opportunistic
takeovers, managers of HTV companies might
be deterred from undertaking innovative investments
(Stein, 1989). Takeover protection removes
this risk. Therefore, in HTV companies, takeover
protection (i.e., managerial entrenchment) might
actually encourage managers to pursue investments
that induce value-creating innovation.

Abstract
The desirability of antitakeover provisions (ATPs) is a contentious issue. ATPs might enable
managerial empire building by insulating managers from disciplinary takeovers. However, some
companies, such as “hard-to-value” (HTV) companies, might trade at a discount due to valuation
difficulties, thereby exposing HTV companies to opportunistic takeovers and creating agency
conflicts of managerial risk aversion. ATPs might ameliorate such managerial risk aversion
by inhibiting opportunistic takeovers. This paper analyzes acquisitions made by HTV firms,
focusing on whether the acquirer (not the target) is entrenched in order to examine the impact of
entrenchment managerial decision making. The results show that HTV firms that are entrenched
make acquisitions that generate more shareholder wealth and are more likely to increase
corporate innovation, suggesting that ATPs can be beneficial in some firms.