Valuing technological synergies in mergers
Introduction
Although a substantial literature has examined the stock market valuation of firm’s innovative assets such as R&D expenditures, patents and citations to these patents (see Hall, 2000 for a survey), there are relatively few empirical studies investigating whether stock market investor and acquiring firm could value the innovative assets in mergers. We propose that the value of target firm’s innovative assets in mergers should be the sum of its stand-alone value (when it is not acquired), and the value of technological synergy stemming from combined with the acquiring firms. Although people could estimate the stand-alone value of targets’ innovative assets based on the prior studies on the stock market valuation of firms’ innovative assets, it is a challenge to value the technological synergy, because we have limited knowledge about where it stems from and how to measure it.
In this paper, we propose that technological synergies in mergers stem from two sources. The first source is technological complementarities. The combination of two companies with complementary technological capital allows the acquiring firm and target firm to combine their specific skills to make further innovations of new products and technologies by internalizing issues related to property rights and technology transfer. The second source is the litigation value of the target’s patents. If target firms have some patents that are of value to acquiring firms’ competitors, acquirers could utilize these patents to initiate or defend lawsuits against competitors, or use patent citation as a basis to contest rivals’ patent application. A recent case on the acquisition aiming to obtain litigation value is Rockstar, the consortium backed by Apple, Microsoft, BlackBerry, Sony, and Ericsson that bought the Nortel patents for $4.5 billion, sued Samsung, HTC Corp, Huawei and four other companies for patent infringement. The underlying cause of this patent war is Samsung, Huawei and HTC all manufacture phones that operate on Google’s Android operating system, which competes fiercely with Apple and Microsoft mobile products1.
To capture the two sources of technological synergies, i.e., technological complementarities and litigation value, we utilize the patent citation data from the U.S. Patent and Trademark Office to construct four measures: (1) the count of cross-citations between the patents of the acquirers and the targets (i.e., mutual dependency); (2) the count of common citations by acquirer’s and target’s patents to the same set of prior patents (i.e., upstream relatedness); (3) the count of prior acquirer’s and target’s patents cited by the same later patent applications by other companies (i.e., downstream relatedness); and (4) the count of patent citations by acquirer’s rivals to target’s patents. The first three measures represent technological complementarities, and the last measure is designed to capture the litigation value of the target’s patents.
We hypothesize that these measures of technological synergy are important considerations of acquiring firm and stock market investors in the valuation of target firm’s innovative assets. First, these measures are expected to be positively related to the merger premium offered. Second, the stock market could also incorporate the information of technological synergy in the market price response to the merger announcement. The expected total synergy gain of a merger, measured as both percentage and dollar change in the capitalization of the target and acquiring firms over the event window, is positively correlated with the technological synergy measures. In addition, we propose that stock market investors should take into account the ease or difficulty in integrating the two companies, from administration to research. Therefore, we posit that the expected total gains of acquirer and target’s shareholders from technological synergy decrease with the difficulty of post-merger integration, as proxied by geographical distance between the target and the acquirer’s headquarters.
Third, to verify whether our measures could capture the acquirers’ and stock market investors’ expectations of technological synergy, we further examine the predictive power of technological synergy measures on post-merger innovation performance. We hypothesize that these ex-ante measures could capture realized technological synergy in the post-merger period (e.g., an increase in the number of patent outputs, especially those in the overlapped technology classes, and market share).
We construct a sample of 1,572 horizontal acquisitions identified for the period between January 1, 1977 and December 31, 2004. We concentrate on horizontal acquisitions because the technological synergy in mergers is more likely to be found among firms engaging in similar research and development efforts. Using the NBER patent database to construct the four technological synergy measures for hypotheses testing, we obtain the following results. First, we find a positive association between acquisition premium and the measures of technological synergy. The result holds after controlling for pre-merger intellectual assets of the target, including target’s R&D stock, patents stock, and citations stock. Second, the measures of technological synergy are also positively correlated with both dollar and percentage measures of total synergy gains. Specifically, an increase of one patent cross-citation between the merger parties leads to an increase of nearly one million dollars in acquisition premium and an increase of 2.57 million dollars in total synergy gains. An increase of one patent citation received by target from the acquirer’s rivals is associated with an increase of 0.17 million dollars in acquisition premium and 0.36 million dollars in total synergy gains.
Third, we find the positive association between technological synergy and total synergy gains is more pronounced when the geographical distance between acquirer and target is shorter or they are located in the same city. Fourth, we verify the validity of these measures of technological synergy by showing that they are predictors of the post-merger realized synergy. Our difference-in-differences analysis suggests that, compared with withdrawn deals with technological synergy, the completed deals with technological synergy allow the combined firm to generate more patents in the overlapped technological classes and increase its market share in the post-acquisition period.
This paper contributes to the literature in several ways. First, it is related to existing research on the synergistic effect of M&A transactions. Theories have emerged to explain how synergy is created through mergers: more efficient management (Lang et al., 1989), economies of scale (Ravenscraft and Scherer, 1989, Houston et al., 2001), the re-deployment of assets to more profitable uses (Capron, 1999), the exploitation of market power (Anand and Singh, 1997, Baker and Bresnehan, 1985, Barton and Sherman, 1984), financial synergy (Slusky and Caves, 1991, Fluck and Lynch, 1999), as well as asset complementarities from product market interactions and technological overlaps (Hoberg and Phillips, 2010, Bena and Li, 2014). We extend this literature by studying how acquiring firms and stock market investors value the technological synergies of the merger stemming from technological complementarities and litigation value. The valuation of synergies from mergers of technology firms is of interest to both academicians and practitioners. Following Statement of Financial Accounting Standards (SFAS) 141 and International Financial Reporting Standards (IFRS) 3, firms and their accountants need to value the intangible assets acquired in a business combination transaction. In addition, the literature has long recognized innovation as the engine of economic growth (Aghion and Howitt, 2005), therefore, valuing innovative assets is important to guide corporate and national policies relating to innovation.
Second, our study is related to the literature on the technological overlap and proximity in M&As. This strand of the literature builds upon the measures of technological proximity or patent portfolio overlap (e.g., see Jaffe, 1986, Mowery et al., 1998). Using a sample of horizontal acquisitions in electronics and chemical industries, Chondrakis (2016) shows that technological proximity, cross citation, and common citation are positively correlated with the probability of acquisition and the reaction of the stock market to the acquisition announcement. Using a sample of manufacturing firms, Sears and Hoetker (2014) investigate how technological overlap (i.e., target overlap and acquirer overlap) is correlated with cumulative abnormal returns of the acquirer. Grimpe and Hussinger, 2008, Grimpe and Hussinger, 2014 document that the acquirer is willing to pay a higher price for the target firm with higher technological proximity with the acquirer and higher preemptive power in its patent portfolio. Using a sample of the U.S. firms in the medical devices and photographic equipment industry from 1988 to 1996, Valentini (2012) finds that M&As have a positive effect on patenting output, but decrease patent impact, originality, and generality. Based on a sample of M&As from the drug, chemical, and electronics industries, Makri, Hitt, and Lane (2010) document that complementary scientific knowledge and complementary technological knowledge both contribute to post-merger invention performance. Using a sample of 31 in-depth cases of M&A deals, Cassiman, Colombo, Garrone, and Veugelers (2005) find that technological and market-relatedness affects the inputs, outputs, performance and organizational structure of the R&D process. Using a sample of 1,879 M&As, Kallunki, Pyykkö, and Laamanen (2009) find that firms can enhance the effect of its R&D spending on its current market value and future profitability through technology-oriented M&As. Our study differs from these previous studies by 1) constructing a new measure of technological synergy based on the citations on the target from rival firms and analyze its effect on acquisition outcomes, 2) documenting a positive effect of geographic closeness on technological synergy, and 3) providing the evidence that firms may gain competitive advantages in the product market (e.g., maintaining or increasing market share) through building their technological competitiveness from M&A activities.
Third, our paper also adds to a new and growing branch of literature on the effect of M&A on innovation performance. Ahuja and Katila, 2001, Prabhu et al., 2005 find that the relatedness of acquired and acquiring knowledge bases has a non-linear (inverted U) impact on the subsequent innovation output. Higgins and Rodriguez, 2006, Zhao, 2009 provide evidence that the firms engaging in acquisition activities have often experienced declines in technological innovation during the years prior to the bid, and the acquisition help firms’ innovation efforts in subsequent years. The model of Philips and Zhdanov (2013) suggests that small firms optimally decide to innovate more when they can sell out to larger firms, while large firms conduct less R&D because they can obtain access to innovation through acquisition. Bena and Li (2014) find that the existence of technological overlaps between any two firms has a positive effect on merger pair formation and post-merger innovation output. Galasso and Simcoe, 2011, Sevilir & Tian, 2012 provide evidence on the positive effect of M&As activity on acquirers’ post-merger innovation outcomes. Although most of the prior studies use the increase of post-merger patent counts as the measure of innovation performance, we could not clearly identify whether the increase of patent counts is really generated from the merger with a specific target firm. The reason is that some of the new patents do not belong to the technological fields that overlapped with the target’s innovation. In contrast, we develop a more refined measurement of post-merger increase of patent output, namely, the change of patent output in the overlapped technological subcategories where both acquirers and targets have patents prior to acquisition.
Finally, our study is also connected to the growing literature on the influence of geography on M&A. Kedia, Panchapagesan, and Uysal (2008) find that, in domestic acquisitions, acquirers experience higher returns when they are geographically closer to targets, potentially due to better information sharing between firms that are closer to one another. Erel, Liao, and Weisbach (2012) show that the shorter is the distance between two countries, the more acquisitions between the two countries are observed. Different from these prior studies, our paper focuses on the investigation of whether the expected gain from technological synergy varies with the difficulties to coordinate innovative activities after the merger, as proxied by the geographic distances between acquirers and targets.
Section snippets
Hypothesis development
In this section, we develop hypotheses on the valuation of technological synergy in mergers by acquiring firm and stock market, and how the ex-ante measures of technological synergy could capture realized synergy in post-merger period.
Research design
In this section, we describe the sample selection procedure, the calculation of the four measures of technological synergy, and present the summary statistics of the data. In addition, we present a comparison of firms and deals characteristics for the full sample and the subsamples of deals with technological synergy.
Empirical results
In this section, we report the results of our empirical analysis in four subsections. We examine the valuation of technological synergy by testing the relationship between technological synergy and acquisition premium and total synergy gains. We then explore whether the expected gains from technological synergy varies with the difficulty of merger integration as proxied by the geographical distance between acquirers and targets. Finally, we investigate the influence of ex-ante measures of
Conclusion
We show in this paper that expected technological synergy in mergers between two companies with intellectual properties is priced. Acquirers incorporate it in the merger premium offered. The stock market’s valuations of the mergers at announcement also reflect this expectation. Specifically, an increase of one patent cross-citation between the merger parties leads to an increase of nearly one million dollars in acquisition premium and 2.57 million dollars in total synergy gains. An increase of
CRediT authorship contribution statement
Shi Li: Conceptualization, Data curation, Formal analysis, Writing - original draft. James S. Ang: Supervision, Conceptualization, Writing - review & editing. Chaopeng Wu: Conceptualization, Methodology, Formal analysis, Writing - original draft. Shijie Yang: Methodology, Formal analysis, Validation, Writing - review & editing.
Declaration of Competing Interest
The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.
Acknowledgements
The authors thank Don Autore, Jan Bena, Yugang Chen, Gonul Colak, Ahmad Ismail, Jan Jindra, Kai Li, Chen Lin, Jun Ruan, Laura Starks, Alexander Triantis, Qian Sun, for helpful discussions. We are also grateful to seminar participants at FMA Doctoral Student Consortium (May 2009), FMA Asia Conference (July 2012), Xiamen University, Sun Yat-sen University, for comments. This work was supported by the Natural Science Foundation of China (Grant 71402156, 71722012, 71272082, 71790600, 71790601), Key
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