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A “Psychological Contract” for M&A Success

Retention of key managers improves performance after new bonds are formed.

(originally published by Booz & Company)

Title: Supply-Chain Corporate Venturing through Acquisition: Key Management Team Retention (Fee or subscription required.)

Authors: Timothy Kiessling (Bilkent University), Michael Harvey (Bond University and University of Mississippi), and Miriam Moeller (University of Queensland)

Publisher: Journal of World Business, vol. 47, no. 1

Date Published: January 2012

Many acquisitions are followed by a general housecleaning of key managers, a move that is often seen as necessary for making improvements. But this study of the acquisitions of supply chain firms in 72 industries finds that the opposite is true: Executives at companies that retained an acquired firm’s top managers reported better financial performance than those that let them go.

That conclusion undermines a large body of prior research — much of it grounded in decades of hostile conglomerate-building — that suggested that firms are typically purchased because they are underperforming and that fresh leaders are the linchpin to a turnaround.

It’s not so much that the previous studies were wrong, the authors suggest, as that the business landscape itself has changed. More and more firms are acquiring companies to compete globally, they say, and the target is no longer underperforming firms, but rather “successful ones that when combined create even greater success.” Although the new study is focused on supply chain deals, its lessons are relevant to other acquisitions in an era of increasing globalization.

But how does the new owner secure the loyalty of an acquired company’s leaders, who often fear that they will be replaced or marginalized? Crucially, the authors found that monetary incentives, such as bonuses for meeting sales or production targets, aren’t as effective as the establishment of a “psychological contract.” Essentially a mutual agreement about employees’ rights, obligations, and career goals, the new pact is needed to replace the understanding that the managers had with their old company before it was acquired.

In their study, the authors first sought to gauge the financial performance of targeted firms after they were acquired. This represents a challenge, however, because most firms that release financial data issue consolidated statements, making it difficult to isolate one unit’s stand-alone performance. The authors also wanted to measure less-tangible metrics, such as whether key employees were retained and continued to be productive and whether the acquired company meshed with the organization’s overall strategic goals.

To gather data on all three elements — financial performance, employee effectiveness, and goal attainment — the authors surveyed 99 top executives who directly participated in the recent purchase of supply chain firms. The executives were involved with deals around the world, but were all based in the United States, where most international acquisitions originate. An expert panel — including academics, consultants, a senior vice president from General Electric Company’s M&A department, a senior executive in charge of logistics at a US$10 billion U.S. firm, and a European CFO in charge of acquisitions — assisted the authors in drawing up a questionnaire.

The respondents were asked to rate their experiences on a seven-point scale and to provide information on management retention, firm performance, and the market turbulence surrounding the deal. Questions on financial performance included whether the acquired firm’s net profit was smaller than anticipated, whether the price paid for the new company was too high for the benefits received, and whether the valuation of the target firm represented its true worth.

After controlling for company size, the method of acquisition, and the ownership structure of the target firm, the authors found that the post-acquisition retention of key managers led to better performance in the business units they helmed.

The trick for an acquiring company, then, is to hold on to those managers. If a company “fails to embrace the new employees and to reestablish the psychological contract, defection may occur,” the authors write. Accordingly, the acquiring firm should identify the key management team as early as possible in the merger process, the authors say, and discuss mutual long-term goals that aren’t purely economic, but tied to security and career growth within the new organization. This effort is of particular importance, the authors found, when the managers have key external relationships with important accounts, distributors, or sales channels.

Another reason to start the process as early as possible: The global nature of the supply chain and differences in local cultures can make it daunting to forge psychological contracts. Indeed, the authors found that the larger firms in their study had a much more difficult time retaining and integrating key managers.

The need to connect psychologically with acquired managers becomes greater during times of economic upheaval, the authors found, when dynamism in the market leads to increased competition for talent.

“Although outsourcing, off shoring, etc., are occurring, many firms are still acquiring to strengthen and leverage their competencies globally,” the authors conclude. “Thus the dynamic global environment in which all firms are competing will require the development of the psychological contract, especially in the hypercompetitive industries where products, services, [and] customer needs are constantly changing and the supply [chain] management becomes even more critical.”

Bottom Line:
When acquiring a firm, a company should identify and retain the target’s key managers in order to achieve better financial performance. The managers’ experience, connections, and insider knowledge are vital. But a bigger paycheck isn’t necessarily the best way to secure their loyalty, and acquiring firms that forge a psychological bond with new employees, based on shared goals, are more likely to hang on to important managers.

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