The Effect of Cultural Similarity on Mergers and Acquisitions: Evidence from Corporate Social Responsibility

Frederick L. Bereskin is Assistant Professor of Finance at the University of Delaware Alfred Lerner College of Business & Economics. This post is based on a recent article, forthcoming in the Journal of Financial and Quantitative Analysis, authored by Professor Bereskin; Seong K. Byun, Assistant Professor of Finance at the University of Mississippi; Micah S. Officer, Professor of Finance at the Loyola Marymount University College of Business Administration; and Jong-Min Oh, Assistant Professor of Finance at University of Central Florida College of Business.

A critical determinant of merger success is post-merger integration. In our forthcoming Journal of Financial and Quantitative Analysis article The Effect of Cultural Similarity on Mergers and Acquisitions: Evidence from Corporate Responsibility, we provide an examination of the role of similarity in merging firms’ corporate cultures on merger outcomes. Specifically, we study whether firms with greater cultural similarity are more likely to merge, and whether mergers of culturally similar firms are associated with better outcomes for the firms’ shareholders.

There is reason to expect corporate culture to affect mergers. As corporate culture is difficult and costly to change, and as mergers frequently involve numerous integration issues, combining firms (i.e., post-merger integration) has the potential to be significantly more challenging when the merging firms have different corporate cultures (e.g., beliefs and values). Survey evidence is consistent with this explanation. For example, a recent survey indicates that 48% of executives would abandon a potential merger if the two firms’ cultures were misaligned. Another survey indicates that 50% of executives view corporate cultural fit as critical for merger success, and that one quarter of executives view deficiencies in cultural fit as a crucial driver of merger failure. Similarly, cultural alignment is frequently noted by executives as a motivating factor for a merger, and high-profile merger failures are frequently attributed to differences in the firms’ corporate cultures.

One particularly important dimension of a firm’s corporate culture is its corporate social responsibility (CSR) performance. CSR practices are frequently communicated with key stakeholders and are driven by stakeholder preferences, thus reflecting the shared values within an organization. A key underlying assumption in our study is the notion that firms with similar CSR behavior will have similar corporate cultures—this leads to our hypothesis that mergers between culturally similar firms should experience fewer post-merger integration issues. For example, consider the merger of a firm that has a strong commitment to workplace diversity with a firm with a poor reputation in diversity. The combined firm would face greater challenges in integrating the two groups of employees compared to a situation where the employee groups broadly have the same level of commitment to diversity.

In contrast to the hypothesis that we test in our article, an opposing hypothesis is that dissimilarities in CSR behavior are associated with increased merger occurrence or success. For example, this would be the case if the merger leads to a value-enhancing cultural change in one of the merging firms. It could also be the case if dissimilarities in cultures create complementarities, for example if one firm’s strengths are matched by the other firm’s weaknesses, such that the combined firm is stronger in several dimensions. Ultimately, the effects of CSR similarity on mergers is an empirical question, which we test in our study.

In our study, we develop a unique measure of CSR similarity by using the Kinder, Lydenberg, and Domini (KLD) environmental, social, and governance (ESG) performance data. We compute the uncentered correlation between merging firms’ CSR performance among 124 distinct subcategories. Similar measures have been used in prior economics and finance studies to measure two firms’ technological similarity. Our measure recognizes the multi-dimensional nature of CSR (and thus corporate culture), while still offering an objective quantitative measure of two firms’ cultural similarity.

We find that CSR similarity between two firms is associated with a higher probability that those two firms merge. In particular, a one standard deviation increase in CSR similarity increases by 33% the odds of a pair of firms merging, relative to a control sample of hypothetical deals that did not occur. This magnitude is measured after controlling for characteristics associated with deals, acquirers, and targets. We also find that mergers of firms with higher CSR similarity are associated with 3.5% (3.1%) higher combined announcement returns on average (at the median)—reflecting greater anticipated deal synergies.

We then show that merging firms with high CSR similarity have a greater chance of successful deal completion (a one standard deviation increase in CSR similarity is associated with a 26% increase in the odds of successful deal completion), complete deals at a more rapid rate (18% more quickly, assuming a one standard deviation increase in CSR similarity), experience significantly better long-run operating performance (3.7% greater increase in abnormal operating performance for high-similarity deals), and experience significantly fewer ex-post goodwill write-offs in later years. These findings reflect more successful integration in mergers between culturally similar firms. We provide evidence that corporate cultures change less in these types of mergers, reflecting the fact that culturally-similar merging firms can avoid costly and challenging changes to their corporate cultures. Our results are robust to alternative measures of similarity and to different matching methods.

Finally, our study provides evidence of the mechanism by which CSR similarity affects post-merger integration: The effects are stronger among companies in labor-intensive industries, mergers of firms in the same industry, in horizontal acquisitions, for serial acquirers, and in large deals. This evidence indicates that the significance of cultural fit is strongest in deals where integration issues are of particular concern.

In conclusion, our study provides a unique approach to measure the similarity in firms’ corporate cultures, and shows the dramatic effects of cultural similarity on merger occurrence and outcomes. Our results strongly suggest that when firms with similar pre-deal CSR practices merge, they experience fewer post-merger integration issues.

The article is available for download here.

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