The Business Review, Cambridge

Vol. 26 * Number 1 * Summer  2018

The Library of Congress, Washington, DC   *   ISSN 1553 - 5827

Online Computer Library Center, OH   *   OCLC: 920449522

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The Impact of Firms’ Aggregate Risk on Long-Run Performance: IPO Versus Matched Non-IPO equities

Dr. Marie-Claude Beaulieu, Université Laval, FSA, Qc, Canada

Dr. Habiba Mrissa Bouden, Université Laval, FSA, Qc, Canada




This paper focuses on the long-run performance of issuing versus comparable non-issuing firms. While most of the previous literature only accounts for the common risk factors to compute abnormal returns, this paper investigates a new approach that also considers the firms’ aggregate volatility processes to measure the long-run performance of their calendar-time portfolios. Our findings show that the firms’ aggregate risks differently affect IPO and comparable non-IPO equities’ returns during the first three years of IPO trading. Our results also reveal that when controlling for the portfolio’s volatility risk, the apparent underperformance of IPOs with respect to non-issuing firms is a reflection of a lower response to the volatility risk of IPOs relative to their matched non-issuing peers.  Previous research on initial public offerings (IPOs) reveals a long-term anomaly of IPO underperformance (Ritter, 1991 and Loughran and Ritter, 1995), which challenges our understanding of asset pricing. These authors report that IPOs underperform the market (or/and similar non-issuing firms) in the long-run when they compare IPOs’ returns to common market index returns1 (and/or long-run returns of comparable firms2). Behavioral3, financial4, agency problems5 and IPO market timing6 are proposed explanations for this phenomenon. Meanwhile, empirical studies on IPO long-run performance present mixed evidence. Brav and Gompers (1997) and Gompers and Lerner (2003) did not find evidence of long-run IPO underperformance. Barber and Lyon (1997), Kothari and Warner (1997) and Gompers and Lerner (2003) documented that the IPO long-run performance depends on the methodology used to measure abnormal returns, which could explain the mixed evidence in the behavior of IPO performance.  We note that the previous IPO literature does not consider firm risk in the measurement of IPO abnormal returns. Previous studies, such as Ritter (1991), often use the cumulative abnormal returns7 (CARs) and the buy-and-hold abnormal returns8 (BHARs) that are used in classic event studies. They also use the method of calendar-time portfolios based on Jensen’s (1968) alpha from the capital asset pricing model (CAPM) and the intercept from the Fama and French9 (1993) (Carhart10, 1997) three (four)-factor model. Although the latter approaches account for systematic risk (through the market, size, book-to-market and momentum factors), none of them has considered the risk associated with firms in abnormal returns’ measurement. In addition, these traditional approaches do not consider the time-varying variance of returns. Since the issuing firm does not have a historical record in the stock market, the uncertainty associated with its fair value is higher than for traded firms, which increases the complexity of the IPO pricing process. To gauge the importance of risk exposure, we conduct a comparative study between IPOs and their matched peers (among non-IPOs) in terms of long-run performance and control for the risk. Engle et al. (1987) proposed the autoregressive conditional heteroskedasticity ARCH-M (in mean) model to account for a time-varying volatility term in the expected returns dynamics (mean equation). In the same vein, we use an approach in which both the level and the variance of long-run returns are modeled with a generalized autoregressive conditional heteroskedasticity GARCH-M (in mean) specification to investigate the relationship between risks and returns for IPO and matched non-IPO portfolios. The objective of this paper is to determine the impact of firms’ aggregate risk on long-run performance and reveal how risk is priced in both IPO and matched non-IPO equities.  Our results highlight the importance of pricing the risk associated with firms, which represents a part of the abnormality in the traditional measurement of abnormal returns. Our findings also show that IPO underperformance with respect to matched non-IPOs disappears when we account for the firms’ aggregate risk. We attribute this IPO underperformance to a lower exposure to the systematic volatility risk for IPOs with respect to their matched non issuing peers. Engle et al. (1987) note that the variance of risky assets changes over time and affects asset returns. These authors show the existence of a relationship between risk and expected returns. In the IPO market, we question whether the variance of risky assets is sufficient given that investors may require supplementary returns for the risky firm. Since the IPO market is characterized by a high level of asymmetric information, we consider that the IPO equities as riskier firms compared with established firms.  Thus, it is interesting to determine how risk affects long-run prices, and as a result, long-run abnormal performance of IPO versus similar non-IPO equities. We test the following hypotheses:   H0: Firm aggregate risk does not affect expected long-run returns; as a result, abnormal performance estimates do not include an abnormality associated with the firm systematic risk premium.  H1: Firm aggregate risk significantly affects expected long-run returns; as a result, abnormal performance estimates partially include an abnormality associated with the firm systematic risk premium.  We focus on how aggregate volatility risk, which is our proxy for new information about common risk factors, is incorporated into the equity prices to cause changes in the long-run performance of IPOs versus their peers. Our sample consists of U.S. firms that issued ordinary common shares (codes 10 and 11) from January 2000 to December 2009. Following Brown and Kapadia (2007), IPOs with specific characteristics (i.e., units, closed-end funds, real estate investment trusts, American depositary receipts and shares of beneficial interest) are excluded from the sample. The number of ordinary common shares issued on Bloomberg between 2000 and 2009 is 1,440 shares. However, our sample only includes IPOs whose returns are available in the Center for Research in Security Prices (CRSP) database and whose sales, EBITDA (earnings before interest, taxes, depreciation and amortization), and EPS (earning per share) percentage change are available in the Compustat database industrial files (both active and research) during the quarter prior to the offer. After matching our sample with the available information in CRSP and Compustat, our final sample includes 571 IPOs (see Table 1). We note that 19% of our IPO sample went public in 2000, which is defined in the literature as a “hot-issue” period. The majority of new issues in 2000 (70%) are high-tech firms.  This table reports descriptive statistics on our IPO sample. We provide the numbers of IPOs per year and industry during the period 2000 and 2009. Each NYSE, AMEX, and NASDAQ IPO stock is assigned to an industry portfolio based on its four-digit SIC code (we use Compustat SIC codes for the fiscal year ending).  The industrial classification is based on the website of Kenneth R. French (  Our IPO sample is classified into five industry: (1) CNMR includes sustainable and unsustainable consumption, wholesale, retail, and some services (laundries, repair shops), (2) MANUF includes manufacturing, energy and utilities, (3) HITEC includes business facilities, telephone and television transmission, (4) HLTH includes health care, medical equipment and medicines, and (5) OTHER includes mining, construction, transportation, hotels, services, entertainment and financial sector. Net Sales, EBITDA and EPS are obtained from Compustat during the quarter prior to the offer. EBITDA represents Earnings Before Interest and Taxes and Depreciation (Quarterly) (Net Sales less Cost of Goods Sold and Selling, General, and Administrative Expense before deducting Depreciation, Depletion, and Amortization). EPS represents Earning Per Share percentage change divided by Net Sales (Quarterly).  Previous authors, such as Brav and Gompers (1997), often used the size (proxied by market capitalization) and book-to-market ratio to identify control firms for IPOs. Bhojraj and Lee (2002) criticized the selection of control firms on the basis of these last criteria due to the bias of the market price effect since it is well known that IPO prices are supported by the underwriters’ stabilization practices during the early aftermarket stage. In this framework, the market price does not necessary reflect the (unobserved) intrinsic value of the firm. Bhojraj and Lee (2002) showed the efficacy of matching firms on the basis of their fundamentals compared to matching on the basis of other techniques, including industry and size matches (p. 407). Hence, in this paper, we follow Bhojraj and Lee (2002) by matching firms in the same industry based on their fundamentals (net sales, EBITDA profit margin, EPS (earning per share) percentage change and leverage ratio).


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The Value of Creativity: Creativity as a Valuable Form of Symbolic Capital in Organizations

Dr. Frederik Hertel, Aalborg University, Aalborg, Denmark

Dr. Irina A. Weisblat, Ashford University, San Diego, CA




Previous analysis (Hertel, 2015) indicates that workers doing industrial cleaning in the food industry are forced to be creative in their everyday organizational life. Hertel and Wicmandy (2017) show that everyday creativity becomes a tool for reducing time consumption and, thereby, enables the workers to solve additional cleaning tasks that were not initially included in their work load. According to Richards (2010), there is a lack of scientific methods for assessing everyday creativity. We conducted a case analysis in order to clarify whether such creativity can be compared to and understood as a new kind of symbolic capital originally explored by Bourdieu (1990, 2002) and Portes (1998). It is our hypothesis that a method for valuing everyday creativity must be based on a three-dimensional model involving: the economic contribution, the social impact, and the character of the creativity involved. The first dimension is economic and it aims to rate the contribution to the production of surplus. The second dimension intends to rate the social impact of the everyday creativity produced. The third dimension is the character of the creativity and it rates the complexity of the everyday creativity involved.  The aim of this article is to contribute to the development of a method for valuing everyday creativity. Before addressing this question, we would like to illustrate why it is of interest to deal with valuing creativity. Our interest in the subject started when we were working on the case study (Hertel & Wicmandy, 2017) conducted in a company specialized in industrial cleaning in the food industry. We realized that industrial cleaners must be considered creative. However, it was not a big “C” (Richards, 2007) but a small “c”, also known as everyday creativity. We studied the team of cleaners composed of a mix of ethnic Danes with traditional attitudes and migrants from the Eastern European countries. The study began three years ago and the purpose of it was to understand the management style and methods used in developing strong teams of industrial cleaners. We observed the team manager who faced several challenges of daily operations. The case study provided a wealth of ethnographic material about the everyday work environment and team management. Before conducting the case study, we had an expectation that the team members received on-the-job-training and followed some specific instructions when performing their job duties. What we actually saw was a management style that allowed each individual team member to plan their work, execute the work activities, and evaluate the work performed. The team manager was responsible for the quality of work and ensured that his team did not apply fixed cleaning schemes or routines. Industrial cleaning is a complex process, and each team member must be creative in completing the assigned tasks.  The team of workers cleans at night and finishes before the production starts in the morning. Industrial cleaning is a four-stage process. First, the articles are flushed in water; then, soap (chemical substance) is applied; after that, the articles are flushed in water once again; and finally, another chemical compound is applied to ensure disinfection. Cleaning the production area and appropriate articles makes everything appear visibly nice and spotless. Yet, the cleaning process must also meet the invisible, bacteriological standards established by regulatory agencies and, sometimes, by retailers. At first glance, industrial cleaning seemed to be a repetitive process of eliminating all visible and invisible dirt. But these routines, or what we call mental schemes, immediately produced a number of problematic blind spots threatening the production. A blind spot is any article or part of the production area that are not noticed by the worker during cleaning and, therefore, not being properly handled. Blind spots can be unavoidable when the workers keep on following their cleaning routine. However, if workers do not strictly follow the fixed cleaning schemes prescribed by their instructions, the blind spots may be minimized or completely avoided due to a smaller chance of repeating the identical and highly problematic mistakes. Workers must frequently change their cleaning techniques, strategies, and methods in order to avoid reproducing the blind spots. The situation is associated with the everyday pressure of developing new cleaning processes.  Working under pressure of these constantly changing techniques, industrial cleaners must be creative in order to solve the occurring problems and complete their tasks. A continuous need for efficiency and reduced time consumption creates another pressure for creativity. In industrial cleaning, time is a scarce resource for the cleaning team. Saving time is not just a matter of meeting the deadlines. It is merely an attempt to properly allocate the time required for: a) cleaning tasks that arise unexpectedly and, thus, require more time than planned; and b) cleaning areas that are not part of the normal work load. Cleaning routines, or mental schemes for cleaning, require either maintaining the fixed time schedule or increasing the time needed to do the job right. Workers, therefore, not only struggle with the blind spots, but they are also forced, constantly, to create new strategies that would reduce the time consumption. Variations in the cleaning assignments create the third pressure for creativity. Cleaning the production line for filleting fish is never a standard procedure. Daily variations in the production flow, work hours, amount and type of fish handled on the production line may result in considerable changes in the cleaning required at night. Such changes force the cleaning team to apply what we define in this article as everyday creativity. At this point, it is important to stress that in spite of demands for creativity, this case study on industrial cleaning shows that radical originality is quite rare. We found that examples of radical originality involve difficult problems of cleaning a coat of dirt on a filleting line. Applying multiple chemicals did not solve the problem, and the cleaning team spent a lot of time and manpower scrubbing the problem spots every night. The coating of dirt evolved again and again. The increased cleaning time eventually lead to a crisis situation among the team members. Since no solution was found by the team, an audit was contacted in order to get a new approach to the problem. A consulting specialist suggested to use a foaming agent in order to foam the soap product with a chemical compound that usually does not foam. By foaming the soap, the chemical composition of the product actually changed, which suddenly helped remove the coating of dirt quickly and effectively. The audit described this emerged process as a novel solution. We further submit that this novel solution is an example of radical originality. In this situation, the solution to the problem was combined with flexibility, since the process included a new interpretation of the available soap. After this incident, the cleaning team continued creatively experimenting with the soap that usually did not foam. Due to application of a foaming agent to the soap that normally would not foam – once or twice a week, the cleaning time was reduced and the quality of cleaning noticeably improved. The case study of industrial cleaning (Hertel, 2015) showed that workers who unconsciously followed a fixed cleaning scheme were producing the work of low quality and failed to reduce the time consumption. In their daily task of industrial cleaning, workers must be aware of the need to work creatively, in addition to the freedom of planning and executing the tasks assigned by their manager. This case study hardly identifies an exceptional instance of creativity. This agrees, however, with the concept of a small “c” – everyday creativity produced by ordinary people that was highlighted by Richards (2007). The most elegant definition of creative acts was probably offered by Bruner (1969) who saw them as an “effective surprise – the production of novelty” (p. 30). Such an effective surprise, as discussed in the next section of this paper, is comparable with Schutz’s (2005) depiction of the shock. Metaphorical clashes between elements of distinct knowledge paradigms can produce a surprise or shock and, therefore, may be viewed as examples of creativity. This is what Lakoff and Johnson (1980) described as a source domain used for understanding a target domain. For example, in 1873, Herbert Spencer applied the concept of organization in biology to better understand social entireties (Morgan, 1980). Consequently, in this paper, we understand creativity as a phenomenon of producing an effective surprise or shock by making someone transition from one meaning, or understanding of reality, to another. In order to accept a phenomenon as a result of creative acts, others must accept it as both novel and original. One way to deal with creativity is to distinguish between different kinds of contradictions, such as modus operandi versus opus operatum. While modus operandi focuses on someone conducting a creative process, opus operatum emphasises cleaning, for example, as a creative product. Hertel (2015) found inspiration from Plucker, Beghetto and Dow (2004) in developing a definition for creativity. Plucker, Beghetto and Dow (2004) defined creativity as“the interaction among aptitude, process, and environment by which an individual or group produce a perceptible product that is both novel and useful as defined within a social context” (p. 90). But while trying to make Plucker, Beghetto and Dow’s (2004) definition fit the case of industrial cleaning, it becomes quite obvious that we first must develop a concept for cleaning as a creative product. We decided to name the product of cleaning as cleanliness. Apparently, we did not mean the obsession with cleaning, but the state of something being clean. It is possible that cleanliness, as a concept, is opened to different levels of clean or unclean, as noted in prior writings by Hertel (2015). We can, probably, all agree that cleanliness is useful, but it is quite difficult to develop a method that enables us to evaluate cleanliness as novel or original. Not being able to evaluate cleanliness in terms of novelty and originality tests our ability to think of cleanliness as a product. We, therefore, suggest changing our approach from focusing on cleanliness as a product to viewing cleaning as a process containing creative acts. This paper, therefore, focuses on modus operandi as the only possible road to evaluate creativity in industrial cleaning. While concentrating on problem solving, we also notice the traditional distinction between convergent and divergent thinking (Kaufman & Sternberg, 2010). Convergent thinking is about solving problems with a fixed or only one right answer. Divergent thinking refers to open problems without straight answers. Since cleaning workers in the food industry facility are dealing with complex problems, the creativity involved must be understood as a matter of divergent thinking. Research on creativity is often based on test of divergent thinking involving such categories as: fluency, flexibility, originality, and elaboration of ideas. However, divergent thinking is not necessarily identical to creativity (Runco, 2008). Also, the traditional way of testing divergent thinking proposed by Torrance (2008) and Torrance, Ball & Safter (2008) does not necessarily teach us much about creativity, as suggested in Baer’s (2008 & 2011) writings.


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Is Corporate Social Responsibility a Guarantee of Financial Performance?– With the Multi-faceted Analysis on FTSE Global Index as an Example

Dr. Ming-Jian Shen, Takming University of Science and Technology, Taiwan




Is there an inevitable contradiction between the pursuance of shareholder’s profit maximization and corporate social responsibility behaviour? This study uses the panel data model to analyse the FTSE Global Index of constituent stocks, based on various aspects such as industry characteristics, scale, country difference, and taxation; explores, in detail, the relationship between the CSR practised by the corporation, its levels, and financial performance as well as validates whether or not the implementation of CSR results in a tax-saving effect for the business and a time lag effect on financial performance. The results of the empirical analysis aid in the clarification of the perceived shortfall between CSR and performance in the past; for example, research showed that there is a variation in the performance of the return on assets and return on equity in financial industries, and verified that CSR indeed has a tax-saving and lag effect on financial aspects. Overall, the empirical results tend to support the hypothesis on the influence brought about by society and the implementation of CSR results in a positive influence on financial performance.  The subprime mortgage crisis in the United States in late 2007 and the filing of a formal request for bankruptcy protection in September 2008 by Lehman Brothers, an American investment company, led to a financial tsunami, the need to rebuild the global economy and a significant decline in economic growth. This was mainly due to the real estate bubble and high financial leverage on financial engineering operations, affecting the economy all over the world. Significant losses were experienced by investors which led them to conduct protests in the streets and accuse the banks of violating the role of a virtuous keeper.  As a channel for trading financial commodities, the banks aimed to achieve optimal profits but neglected risks and the obligation to provide honest information to its investors, thus creating a lose-lose situation for both the investors and the banks in a time when the economy was declining, which shows the importance of social responsibility between financial credits and investor protection. Moreover, when the contaminated milk powder incident broke out in 2008 in Mainland China – due to factors such as price competition, the Sanlu Group, a state-owned food company, added an industrial ingredient called “melamine” to the milk powder they produced, thereby causing serious harm to consumers’ physical health and life – further investigation discovered that “melamine” was also contained in the products of a lot of manufacturers and their related products were sold all over the world. This neglect in quality control by the corporations and government triggered the attention of the World Health Organization. In an example of an environmental protection issue, the British Petroleum Company, the world’s third largest energy resource company, encountered an oil spill incident in 2010. The spill stemmed from a sea-floor oil gusher that resulted in the explosion of Deepwater Horizon, which drilled on the British Petroleum-operated Macondo Prospect, causing a huge amount of crude oil to flow into the Gulf of Mexico. The oil spill caused extensive damage to marine life, which led to a high level of awareness and a call for improved safety precautions on oil extraction by the biological and environmental protection organizations. Furthermore, people all over the world started to attach more importance to the sustainability of the environment. In 2011, the tsunami that was formed due to the earthquake-damaged cooling system of a nuclear power plant in Fukushima, Japan, caused a radiation leak affecting surrounding residents living 30 km from the power plant. The danger brought about by radiation to the environment caused people worldwide to reflect on the safety of nuclear energy.  All the above cases lead us to one important issue – corporate social responsibility, CSR. Along with the events and discussion of the relevant incidents, society began to pay more attention to CSR issues, believing that aside from seeking economic growth via profits under the regulations of the law, corporations should also seek a higher level of growth as well as protect the rights and benefits of its stakeholders, for example: employees, consumers, minority stockholders, community, environment, etc.  In developed countries like Europe, the Americas and Japan, there are several overseas large-scale pension funds or mutual funds which choose companies who implement corporate social responsibility in relation to stock selection. Although there have been many scholars in the academe who have researched this issue, it has been given particular importance in recent years. Yet, within academic circles there are different opinions regarding corporate social responsibility and its influence. According to Friedman (1970), the implementation of corporate social responsibility entails costs for the stakeholders; Friedman considered this a waste and believed that the only social responsibility a corporation should accomplish is to ensure that the stakeholders earn the optimal profits. However, Mulligan (1986) suggested another point of view. He believed that the implementation of corporate social responsibility would help companies promote trust.  Is there indeed an inevitable contradiction between profit maximization and corporate social responsibility? The related researches on the implementation of CSR in business from an academic perspective don’t fail to include the effect of CSR on business administration performance; however, no consistent conclusion has been provided to date. On the other hand, the characteristics of the financial industry are different from those of other industries, playing important roles on both the overall and individual economy, which is why a more rigorous standard and treatment is applied to financial industries as compared to others, be it in terms of legal supervision or social recognition. As a result, the financial industries should place more importance on CSR. ; however, previous research on CSR has seldom discussed the effects of CSR implemented by financial industries on financial performance, and quite a few studies made a cross-industry comparison as well as investigating whether or not the influence of CSR on performance causes a time lag and in a tax-saving effect. This study explores the effect of CSR implemented by financial and non-financial industries on financial performance, taking into consideration the industry difference variable.  The World Business Council for Sustainable Development (WBCSD) stated: corporate social responsibility is a commitment to contribute to the development of the economy by continuously abiding the proper virtues and regulations as well as devote one’s effort to improve the quality of life of the employees, their families, overall local community and society. Thus, the corporate behaviour of abiding legal regulations is only just the most basic baseline. Corporate social responsibility as defined by the European Commission (EC) is the factor harmonizing social and environmental aspects that need to be taken consideration of by the companies during their interaction with stakeholders in business operations and voluntary basis. The World Bank Group (WBG) defined corporate social responsibility as the combination of the relationship, value perceived, conformity to law, respect to related policies concerning people, community and environment between companies and its stakeholders. It is the commitment made by the company for its contribution to continuous development so as to enhance the stakeholders’ quality of living. The United Nations Conference on Trade and Development (UNCTAD) believes that CSR refers to how the company combines social demands and goals and also how influence could be created over them. Currently, CSR involves the CSR standards and performance in multinational corporations such that it plays the role of developing stability, prosperity and equality in the global society aspect. The knowledge on CSR in early studies is but of legal level, in which the operational activities of a corporation are carried out under the regulations of the law and doesn’t need to assume any additional social responsibility – as stated by Friedman (1970), the only responsibility of a corporation is to create profits. On the other hand, what is more commonly accepted is that corporations are part of society and take up and use the resources of society in order to sustain continuous development, thus, aside from creating economic profits for its shareholders, the corporations should also consider the overall interest of society. Can CSR finally build a standard that is particularly or globally recognized? Although no consistent answer has yet emerged, because corporation is carried out in a global corporate scope, it should then face problems on the regulatory demands of different countries, the degree of transparency and cultural differences. Under a globalized environment, whenever we encounter issues of social responsibility that are given significant attention, the corporation should adopt some flexible methods and build a consistent standard or action taking into account local culture and prioritizing demands, as well as accept the difference in process and outcome – this is what CSR is all about.  In 1990, a social responsibility investment research institution, Kinder Lydenberg and Domini (KLD), developed the KLD Domini 400 social Index. The said Index was filtered out from the S&P 500 Index using the traditional social standards, adopting a fair method of elimination and using a fixed positive viewpoint in filtering, such as diversification, employee relations, product safety, and environmental protection records that equally integrated the company’s positive and exceptional performance on social and environmental records in a framework.  In 1999, the New York Stock Exchange, together with the Sustainable Asset Management (SAM) in Zurich, Switzerland, collaborated to build the Dow Jones sustainability Index (DJSI), making use of the Dow Jones industry Index as the basis of the constituent stocks. It evaluates the corporation’s business opportunities and risk by looking at the economic, environmental and social aspects, and uses a systematic corporate sustainability evaluation method in selecting the companies within the index, thus, the constituent stocks of DJSI are favoured by the investors. 


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Creating Synergies in Cross-Border M&A – Case Studies of Japanese Outbound Acquisitions

Dr. Shigeru Matsumoto, Professor, Kyoto University, Japan




The success or failure of mergers and acquisitions (M&A) is determined by the synergies the company generates after the acquisition. In this paper, we explore the mechanism of synergy creation from overseas M&A. After investigating horizontal acquisitions from existing research and their relationship with synergies, we examine, in the form of case studies, three Japanese companies that have successfully realized synergies from their acquisitions of European businesses. We find that these companies achieved sustainable growth and used economies of scope, rather than of scale, by expanding their products and regional coverages in cross-border operations.  In 2016, the number of overseas acquisitions by Japanese companies reached 635, which was a record high for the third consecutive year; moreover, the amount spent on them exceeded 10 trillion yen, a record high for the second consecutive year. Due to the maturity of the domestic market, an increasing number of Japanese corporate managers are seeking growth overseas. Internal reserves of Japanese companies exceeding 400 trillion yen (Ministry of Finance, 2017) combined with a historically unprecedented monetary easing policy meant that the acquisition activity has continued. On the other hand, the management of several companies became deadlocked after acquisition. Even recently, reviewing synergies and profit plans, leading companies such as Japan Post, Toshiba, and Kirin have reported significant impairment losses in relation to overseas acquisitions.  An acquisition starts with negotiations in which the buyer offers the target company a price that includes a premium on the standalone value of the business. If the sellers, or in other words, the shareholders of the target company are not satisfied with this premium amount, they will not agree to the acquisition, and it will not proceed. For the buyer, this premium is a payment for control and, partly, a prepayment for the value that will be created after the acquisition. As the acquiring company expects to add greater value to the target, it incorporates these synergies and justifies the premium. Accordingly, an impairment loss after an acquisition can be considered a recognition of an overly optimistic outlook in relation to synergies. How can overseas acquisition lead to sustainable growth in profits? This is a major challenge for the management of Japanese companies that have embarked on M&As in earnest. In this paper, we will present case studies of three Japanese companies, whose business sites we visited, and outline their process of synergy creation. Finally, the sources of synergies and the management approaches after the acquisition that elicited them will be shown. This paper seeks to answer the question: How are synergies generated in outbound acquisitions? The objectives of acquisitions are different in each case; however, achieving profit growth by creating synergies remains the ultimate goal. Referring to the synergistic effect that one plus one is greater than two, Ansoff (1965) introduced the concept of value creation through acquisition. Sirower (1997) defined synergies as the excess profits earned by the integrated company after the acquisition over the sum of the individual profits of the acquiring and acquired companies. For evaluating enterprise value, Shaver (2006) defined synergies as the difference between the present value of future profits earned by the acquired company through integration after an acquisition, and the present value of future profits it would be expected to earn if there was no acquisition.  Regarding outbound acquisitions by Japanese companies, Matsumoto (2014) surveyed 116 cases from 1985 to 2001 with acquisition prices of at least 10 billion yen and found that nearly 70% were cases of horizontal integration in the form of the acquisition of a similar business. These were acquisitions with the objectives of increasing global market share, establishing local production, and adding to the distribution network. On the other hand, horizontal-type integration accounted for more than half of the 51 failure cases (out of 116), in which the acquiring company ended up withdrawing from or selling the business it acquired at a loss. It appears that in these cases, synergies have not been realized from horizontal integration conducted overseas. Here, we shall briefly explore the current hypotheses on the management after an acquisition.  The management of the acquiring company examines whether to grant autonomy to the management of the acquired company or absorb it fully. Research in the United States has established that with highly similar businesses, integration by absorption is more common (Larsson & Finkelstein, 1999), and less autonomy is granted to the acquired company (Datta & Grant, 1990). In acquisitions with overlapping sources of synergies, rapid restructuring is essential so that extensive management integration after the acquisition can be achieved. In the next stage, the acquiring-side managers need to choose whether to create synergies using the management resources of the target company, or to utilize their own management resources for the acquired business. Contrary to the commonly held belief that they are good for both sides and build a win-win relationship, synergies are generated by the acquiring company or the acquired company via either using or eliminating the other’s management resources. For example, Maksimovic, Phillips, and Prabhala (2011) surveyed 1,483 acquisitions, which included acquisitions of 12,893 factories, in the US manufacturing industry from 1981 to 2000. They reported that within three years of the acquisition, 27% of the factories were sold and 19% closed; within five years, 30% were sold and 27% closed.  Less than half of the factories acquired were still held five years after the acquisition.  Regarding the methods and results of using appropriate management resources after a horizontal integration, Capron (1999), who conducted a long-term evaluation of 253 cases in Europe and the United States, found that synergies were more likely to be realized when using the management resources of the acquiring company. The reasons cited for this were that the asymmetry of information at the time of the acquisition caused a time lag in understanding the management resources of the acquired business, and that the management of the acquired company also resisted such efforts. On the other hand, as the acquiring company is well aware of its own management resources, it can easily use them to provide an environment for the generation of synergies. Even in the case of eliminating an overlapping business, synergies are greater when eliminating the assets of the acquiring company, but, in fact, it has been noted that the cases of selling or closing the assets of the acquired company are three to five times higher. It is difficult for the acquiring company to generate synergies either by acquiring and closing a similar but less competitive business, or by keeping its own business despite the business it acquired being more competitive. Restructuring is less ambiguous, and synergies are more likely when the focus is on the acquiring company’s own business. The use of the acquiring company’s management resources in the acquired business is indispensable for synergy creation. With regard to the relationship between horizontal integration by acquisition and sustainable growth, Harrison et al. (2001) examined domestic acquisitions of highly similar businesses by US companies in the 1990s. They note that in a horizontal integration, where synergies are obtained from overlapping businesses, it is possible to realize synergies over a short period by utilizing economies of scale, but sustainable profit growth cannot be expected unless a monopoly position is achieved. For example, the acquisition of Mobil by Exxon realized synergies in the short term through the consolidation of refineries and service stations. However, in this acquisition, there was no source for creating added value beyond economies of scale, such as rationalization of management or expansion of market share, and synergies to support long-term profit growth were not obtained.  Further, Zaheer, Castaner, and Souder (2013), who considered 86 cases of horizontal integration by acquisition with focus on the complementarity of products and technologies, reported that an acquiring company that finds complementarity as the source of synergies can achieve moderate integration while giving the acquired company a high level of autonomy. Complementarity in an acquisition is defined not as having a low level of similarity, but as creating high value by combining independent businesses (Ansoff, 1965; Lewellen, 1971; Penrose, 1959). In real-world acquisitions, similarities and complementarities coexist in the acquired company; there are cases in which the acquiring company both respected the autonomy and absorbed the business of the acquired company in the post-acquisition management process.  In sum, there are two approaches to create synergies via horizontal integration: pursuing economies of scale as the source of synergies by eliminating overlaps, mainly seen in domestic consolidation, and pursuing economies of scope by effectively utilizing existing management resources, with complementarities in products and sites, as the source of synergies. Regarding post-acquisition integration, the absorption of the business is given priority under the former method, while under the latter method, the autonomy of the acquired company is respected. Whichever the method, a prerequisite for the creation of synergies is that extensive management resources are available within the acquiring company. In the next section, we shall consider the process for the creation of synergies from cross border acquisitions by examining how selected Japanese companies realized such synergies.  As noted earlier, when it comes to Japanese outbound acquisitions, currently many acquisitions of a similar company, or horizontal integrations, fail. Despite 50 years of M&A research, the probability of an acquisition succeeding has still not improved in Europe and the United States (Cartwright & Schoenberg, 2006). As full-fledged overseas M&A activity by Japanese companies began only 30 years ago, given the short history and very few success stories, studies on post-acquisition management and synergies are insufficient. Therefore, in this paper, we use a case study method to construct a theory suitable for providing a new viewpoint in a developing research area. We visited the management sites of potential synergy realization in acquired businesses, and in reference to the on-site findings as well as to discussion points in the existing research, outlined the process of synergy creation.


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The Relationship Among Research Quotient, Firm Performance, and Biotechnology Industry

Dr. Han-Ching Huang, Chung Yuan Christian University, Taiwan R.O.C.

Calista Amelia Irawan, Chung Yuan Christian University, Taiwan R.O.C.




Innovation is one of the drivers of economic growth since innovation can increase the market value by producing new products with competitive advantage. Traditionally, innovation is proxied by patent. Nonetheless, patent is not universal, since more than 50% companies in COMPUSTAT do not patent their new products (Cooper, Knott, and Yang, 2017). Therefore, we use Research Quotient (RQ) provided by Cooper, Knott, and Yang (2017) as an indicator of innovation to avoid the above flaws since RQ is not based on patent or citation data. Specifically, the RQ measure is better at capturing the value creation of a firm owing to innovation. In this paper, we explore the differences between biotechnology industry with higher level of R&D intensity and other industries with lower level of R&D intensity. We find RQ has a positive impact on firm value, proxy by Market-to-Book Value. Contrary to our hypothesis, we find that the relation between RQ and future stock return (or firm value) is lower in biotechnology industry than in other industries.  Firm innovation are important to firm growth and performance. Nevertheless, Lev and Zarowin (1999) document that a firm must allocate some budget for R&D spending, which is calculated as incurred expense, to commit to research-based innovation. Because R&D may have negative effect on earnings in short term period, some managers are not prone to invest in R&D. MacKenzie (2005) argues that there is an uncertain time lag between initial research spending and product revenue, which could result in unprofitability for that firm.  Patents have traditionally been associated with innovation of countries and firms (Van der Eerden and Saelens, 1991). Patents can be defined as indicators of important technology positions and innovative activity, which can help policy makers and analysts to measure weak and strong areas in national or firm innovation systems. Hirshleifer, Hsu, and Li (2013) argue that patent information enables a firm to estimate other characteristics, such as R&D efficiency and stock market value. Therefore, we can use the number of patents controlled by a firm to value a firm’s intangible assets. The higher patent grant is associated with a higher probability of future profit since patent grant is usually represented potential a new product in the future. Nonetheless, the marketability of a patent is still uncertain. Usually, the patent grants do not directly produce future profitable products, and they just bring a small effect on market value. However, Patel and Ward (2011) find that the patent system provides some information to indicate which patents are more likely to generate future profits. To assess the patent importance, we can use the citations of a patent to value the profitability of invention (Trajtenberg, 1990; Hall and Bagchi-Sen, 2005). Patel and Ward (2011) argue that using citations to patents could be a measure of patent value. Thus, patents and citations are measures of innovative output. Moreover, Hirshleifer, Hsu, and Li (2013) document that approved patents are usually the way to officially introduce the innovations to the public. Prior literature generally uses patent to measure innovation of firms. Nevertheless, patent as an indicator also has some shortcomings. Cooper, Knott, and Yang (2017) document that patents are not universal, because more than 50% of companies in COMPUSTAT don’t patent their new products.  However, it does not mean that firms that do not patent their products do not innovate.  Firms decide not to patent their products for different reasons; for instance, to file and defense for patents requires high cost, and patents also expose the innovative products in the risk of being copied by other parties. To overcome the unreliability of patent as an innovation indicator, there is another way of measuring firm innovation, called Research Quotient (RQ). RQ may explain the optimal budget for research because RQ is defined as the ability of firm to generate revenues from its budget that is allocated for R&D investment (Cooper, Knott, and Yang, 2017). Using RQ as an indicator of firm innovation is better than other indicators because RQ measures the productivity of R&D department. That is, RQ can describe how much fund a firm allocated for R&D department to exploit their capabilities to produce a new innovative product that can be the firm’s competitive advantage and be transformed into revenues.  Hirshleifer, Hsu, and Li (2013) investigate the impact of firm innovation on stock market return or firm value. They explain the innovation in association with the innovative efficiency (IE). RQ can help a firm decide the effectiveness of R&D investment relative to the other investments and observe how R&D expenditure can affect a firms market value. Cooper, Knott, and Yang (2017) use RQ to investigate the impact of firm innovation on firm’s stock market returns and its firm market value.  Biotechnology industry has special characteristic, such as high cost and long-time research to develop a new product. After passing through many stages, a new product could be failed. Considering the above risk, some managers even cut their investment on R&D to achieve short-term orientation and better number of earnings on financial report (Sood and Tellis, 2009). Biotechnology, as a firm with relatively higher level of R&D intensity, is expected to have higher productivity in creating new products, compared to other industries with the same size. Higher productivity in creating new product is associated with higher revenues. Thus, we explore the Relationship among Research Quotient, Firm Performance, and Biotechnology Industry.  The findings of this paper are as follows. First, we find that firm innovation, in term of RQ, have positive and significant impact on firm value, as measured by Market-to-Book Ratios (MTB). Thus, higher RQ is associated with higher MTB. Moreover, the effect of RQ on MTB in biotechnology industry is significantly lower than that in other industries. We also investigate the effect of RQ on future stock return, which is taken one or two years after RQ takes place. We find that RQ has a negative impact on future stock return. Specifically, the impact of RQ on future return in biotechnology industry is lower than that in other industries.  Biotechnology industry has special characteristic. This industry requires high cost and long-time research to develop a new product. After passing through many stages, a new product could fail. This condition makes the investment in biotechnology industry riskier compared to other industries. Some managers even cut their investment on R&D to achieve short-term orientation and better number of earnings on financial report (Sood and Tellis, 2009). Other factors that can influence the difference in R&D budgets include target market, product market of competition, the size and ages of a firm. Biotechnology is categorized as a firm with relatively higher level of R&D intensity (Hall and Bagchi-Sen, 2007). The commitment to funding R&D as long-term investment brings a firm to create new products. The greater allocation for R&D spending, the more productive that firm is in creating innovative products (Cardinal and Hatfield, 2000). Biotechnology industries with high R&D intensity will have high RQ since Clark and Griliches (1982) argue that R&D investment has a positive effect on the growth rate of total factor productivity. All of the specifications examined yielded about 18-20 percent rate of return to R&D investment. By having high RQ, the firm market value and stock market returns become higher. Other industries with the same size as biotechnology industry may have lower RQ because those industries have lower allocation on R&D spending, resulting in lower firm market value.  H1: The impact of firm innovation on firm value in biotechnology industries is stronger than that in other industries.  H2: The impact of firm innovation on stock market returns in biotechnology industries is stronger than that in other industries. We use the RQ data from 1996 to 2009 and sample the firms that are listed on US stock market. We obtain the accounting related variables from Compustat and return (stock price) related variables from the Center for Research in Security Prices (CRSP). For representing broad industries in the market with high intensity of innovation, we choose firms from five industries, one of them must be biotechnology industries, and others are industrial and commercial machinery and computer equipment, electronics and communications, transportation equipment, and instruments and related products.  We show the sub-industries of biotechnology industries in Appendix A. We choose these specific industries because firms in these industries have R&D which has a vital role for the long-run competitive advantage of firms (Blanco and Wehrheim, 2015). Moreover, these sectors of industries have the highest ratio of R&D expenditure and net sales among all industries (OECD, 2013).  Table 1 presents summary statistic for all main variables. We have removed all the missing and/ or irrelevant data into 1706 samples data. The mean value of samples of total assets is $10.474 million and average market value of samples is $14,812 million. The average RQ is 0.098 (standard deviation of 0.06). While for future stock return (Rt-Rf), past performance and asset growth only have 1572 samples data, because some data are incomplete. The mean value of future stock return is -0.035, whereas average value of past performance is -0.039. Last, the average value of asset growth is 0.111, showing that in average of samples data have a growth in their asset about 10%. Based on Cooper, Knott, and Yang (2017), we use RQ to depict the percentage increase of revenues from a 1% increase in R&D investment, holding other variables constant. High RQ indicates a large number of innovations which are reasonably effective exploited them or small number of innovations which are extremely effective exploited them.  RQ is an indicator which is universal and unitless because the data to estimate RQ can be collected from financial data in every firms.  Moreover, the unitless characteristic of RQ make RQ becomes uniform measurement in interpreting across firms either within the same industry or across industries. Endogenous growth theory proposes that RQ empirically can be a proxy for firm R&D investment, firm value and growth (Knott and Vieregger, 2014). Random coefficient model is used to capture RQ for each firm year or to estimate R&D elasticity because each coefficient has the following components: the direct effect of the explanatory variable and the random component that proxies for the effects of omitted variables or firm-specific error, that are denoted by β_ and β_i , such as given in eq. (2):


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