i i ESSAYS ON CORPORATE STRATEGY: EVOLUTION OF CORPORATE CAPABILITIES AND THE ROLE OF INTANGIBLE ASSETS DISSERTATION Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of The Ohio State University By Asli Musaoglu Arikan, MBA ***** The Ohio State University 2004 Dissertation Committee: Approved by Professor Jay Barney, Adviser Professor Karen Wruck Professor David Hirshleifer _________________________ Professor Anita McGahan Adviser Professor Konstantina Kiousis Business Administration Graduate Program Professor Oded Shenkar i i Copyright by Asli Musaoglu Arikan 2004 ii ABSTRACT This dissertation is comprised of in depth analysis on the broader topic of corporate strategy with emphasis of the role of intangible assets. The first chapter looks at the performance implications of acquiring firms that have highly intangible assets structures. The second essay looks at dynamic characteristics as well as outcomes of developing intangible yet valuable corporate level capabilities in relation to managing alliances and acquisitions. The final section looks at the role of intangible assets in contracting between and within firms by utilizing property rights theory and the resource based view. A consistent finding regarding mergers and acquisitions (M&A) is that: on average shareholders of target firms earn significant economic gains whereas shareholders of acquiring firms break-even (Jensen and Ruback, 1983; Jarrell et. al., 1988). Despite this general finding M&A activity has persisted, increasing in number and transaction value because, managers often perceive M&A activity as a mechanism for growth (e.g. Penrose, 1959). Therefore, it is natural to ask, `What type of assets are worth buying?' This paper investigates the long-run performance effects of acquiring intangible versus tangible targets. Intangibility of target is proxied by multiple measures based on iii R&D, advertisement and human capital stocks, and the Tobin's q 1-year prior to the corporate event. Using a sample of M&A transactions spanning a 4 year period (1988- 1991), long-run-buy-and-hold expected returns are calculated by constructing portfolios of cohort firms that pursue M&A activity and tracked for 5 years. Each firm's long-run- abnormal performance is calculated as the excess return to the benchmark portfolio. Results show that on average, acquirers of intangible targets earn negative abnormal returns, whereas acquirers of tangible targets break-even. However, for the whole sample, there is no evidence of long-run abnormal returns. Existence of asymmetric misvaluation between M&As of intangible versus tangible targets is tested by regressing short-run returns on the buy-and-hold long-run returns. Results provide evidence for market overreaction to the announcements that involve highly intangible targets. Overall, findings suggest that on average, ownership claim to the target's intangible assets via M&A does not transfer the associated economic value. In the second section I investigate how long it takes for publicly traded firms within the United States to develop corporate capabilities for conducting alliances and acquisitions effectively. The development of corporate capabilities has been difficult to study directly because little information has been available on the accumulation at the corporate level of performance-enhancing knowledge. The research reported here relies on a dataset that tracks the behavior of the 3,595 firms that went through an initial public iv offering (IPO) between 1988 and 1999 to show how quickly corporate capabilities developed from the earliest years of firm formation. In particular, we conduct an event-study analysis to investigate how the abnormal returns to alliance and acquisition announcements changed as the firms accumulated experience in conducting deals of each type. The results suggest that firms accumulated capabilities for executing and managing both alliances and acquisitions, and that investors came to expect that firms would continue to exploit their specialized capabilities into the future. Finally I provide discussion of the theoretical implications of the empirical findings and contribute to the literature on corporate strategy and resources based view by incorporating insights from the property rights literature which can be considered as the recent development extension of transaction cost economics. v Dedicated to my grandmother, Guzide Egilmez vi ACKNOWLEDGMENTS I wish to thank my adviser Jay Barney, and my committee members David Hirshleifer, Konstantina Kiousis, Anita McGahan, Oded Shenkar, and Karen Wruck for their intellectual support, encouragement, and enthusiasm which made this thesis possible. I am grateful to Ilgaz Arikan for his continued support and stimulating discussions on all aspects of my research interests. I wish to also thank to Laurence Capron, Russ Coff, Ken Hatten, Anne-Marie Knott, Harbir Singh, Ralph Walkling, Julie Wulf, and Bernard Yeung for their helpful comments. The author also benefited from discussions with Josh Lerner, Dan Levinthal, Jan Rivkin, Anju Seth, Jamal Shamsie, Scott Shane and Sid Winter. All the errors remain mine. vii VITA December 1, 1972…………Born – Izmir, Turkey 1994……………………….BS Istanbul technical University, Istanbul Turkey 1997 ………………………MBA University of North Carolina 2003-Current …………… Instructor, Boston University PUBLICATIONS Barney J.B., Arikan A.M. 2002. The resource-based view. Origins and implications. In Hitt M.A., Freeman R.E., Harrison J.S. (eds.), Handbook of Strategic Management. Blackwell Publishers: Oxford, UK; 124-188. Arikan, A.M. 2002. Does it pay to capture intangible assets through mergers and acquisitions? Academy of Management Meetings Best Paper Proceedings Arikan, A.M. 2003. Does it pay to capture intangible assets through mergers and acquisitions? In Strategic Management Society Book Series on M&A Summit Arikan, A.M. 2003. Cross-border mergers and acquisitions: What have we learned? In B.J. Punnett, and O. Shenkar (Eds.) 2 nd Edition of Handbook of International Management Research, University of Michigan Press FIELDS OF STUDY Major Field: Business Administration Minor Field: Financial Economics viii TABLE OF CONTENTS Page Abstract ii Dedication vi Acknowledgments vi Vita………………… vii List of Tables x List of Figures xii Chapters: 1. Introduction 1 2. What Type Of Assets Is Worth Buying Through Mergers & Acquisition? 5 2.1 Resource-Based View And Competitive Advantage 8 2.2 Controls For Other Factors 11 2.2.1 Agency Motives 12 2.2.2 Information Asymmetry And Financing Of Intangible Assets 14 2.2.3 Market Over- Or Under-Valuation Of Growth Opportunities 17 2.3 Methodology And Data 20 2.3.1 Valuation Of Intangible Assets 21 2.3.2 Which Measure Of Performance? 24 2.3.3 Why Not Traditional Event Methodology? 26 2.3.4 Long Run Buy & Hold Abnormal Returns 29 2.3.5 Calculating Reference Portfolios 31 2.4 Data 32 2.5. Results 36 2.6 Discussion And Conclusion 44 3. How Long Does It Take To Build Corporate Capabilities For Conducting Alliances And Acquisitions? 50 3.1 Antecedents 51 3.2 Theory And Hypothesis 53 3.2.1 Industry And Time Effects 58 3.3 Data 59 3.4 Descriptive Statistics 61 3.5 Methods 64 3.6 Results 66 ix 3.7 Conclusion 72 4. Why Do We Observe Heterogeneous Governance Choices For Similar Transactions? Theoretical Issues In Corporate Strategy 73 4.1 Overview 74 4.2 Theoretical Background 78 4.2.1 Transaction Cost Economics 78 4.2.2 Property Rights Theory 80 4.2.3 Capabilities View Of The Firm And Agency Costs 82 4.2.4 Hybrid Forms As Real Options 83 4.3 Model Setup And Intuition 84 4.4 A Real World Example 92 4.4.1 Who Should Own What? 94 4.4.2 Case 1: Agent j B 1 (Manufacturing Division Of Pfizer) Owns T Target B 2 'S (Arqule's) Assets 95 4.4.3 Case 2: Target B 2 (Arqule) Continues To Own Its Assets 96 4.5 Discussion 97 List Of References 99 [...]... background and the hypotheses are presented In the second section methodology used and the data are discussed In the third section, the main results are presented Fourth section includes the theoretical discussion of and empirical tests for other confounding effects In the fifth section, the relevant robustness tests and their results are presented In the final section theoretical and managerial implications... higher than the likelihood of unexpected positive news 19 Hypothesis 8a: Negative deviation between the market's initial response and the long-run performance of the buyers represent market overreaction Hypothesis 8b: Positive deviation between the market's initial response and the long-run performance of the buyers represent market underreaction 2.3 Methodology and Data Management and financial economics... between the market reactions to the two types of M&A announcements 2.2.2 Information Asymmetry and Financing of Intangible Assets There are two main concerns that might affect the long-run performance of buyers adversely The first one is related to the increased debt burden of the buyers to finance large transactions, such as M&A of highly intangible targets that also have large market capitalizations The. .. are, on the one hand, trying to internalize new growth opportunities, but on the other hand more likely to suffer from potential pricing, integration and maintenance problems of the targets due to causal ambiguity, complexity and tacitness of the very same intangible assets 6 Villalonga (1999) tested this assertion by using the predicted value from a hedonic regression of Tobin's q as a measure of resource... to the separation of ownership and control, and tax considerations Asymmetric information creates a ``lemons'' market (Akerlof, 1970) for R&D project financing because the investors have a hard time distinguishing good projects from the bad ones when the projects are long-term R&D projects (Leland and Pyle, 1977) Therefore investors require a ``lemons'' premium (Hall, 2002) In the case of highly intangible. .. post-event integration, and the ``lemons'' problems are more severe for the case of intangible assets, tax considerations are more favorable As the riskiness of a project increases, the expected rate of returns increases As the expected rate of return increases the investor is willing to pay less Hypothesis 6: Buyers of highly intangible targets will pay a lower premium in comparison to buyers of highly tangible... (Daniel and Titman, 2001) However, this definition of tangible information may not correspond one-to-one to the tangibility of the asset base In essence, the validity of this tangible information is more in question when the firm's asset base is highly intangible A firm with highly tangible assets is more likely to provide all the relevant information about its nature as tangible information in the form of. .. overreactions or underreactions to information, but on average these effects are cancel each other out (Fama, 1998) On the other hand, it is fair to say that the long-run underperformance of buyers of intangible targets imply that firms that develop an expertise to manage M&As of such targets can create competitive advantage The second chapter is organized as follows In the first section, the theoretical... allocations to persist over time, there have to be other systematic factors that impede corrections to irrational expectations If there are such impediments, than it is plausible to entertain the existence of irrational expectations of firm performance when M&A of intangible targets are concerned For the purposes of testing for agency motives in this context, the following hypotheses are developed: Hypothesis... sources of financing for the marginal R&D project since in both cases the cost of capital would be the same However, as widely researched, this theorem fails in practice due to several reasons As discussed in detail by Hall (2002), the divergence between the internal and the external cost of capital is due to the information asymmetries between the inventor and the investor, moral hazard on the part of the . i i ESSAYS ON CORPORATE STRATEGY: EVOLUTION OF CORPORATE CAPABILITIES AND THE ROLE OF INTANGIBLE ASSETS DISSERTATION Presented in Partial Fulfillment of the Requirements for the Degree. analysis on the broader topic of corporate strategy with emphasis of the role of intangible assets. The first chapter looks at the performance implications of acquiring firms that have highly intangible. alliances and acquisitions. The final section looks at the role of intangible assets in contracting between and within firms by utilizing property rights theory and the resource based view. A consistent