Kenneth R. Ahern, Daniele Daminelli, and Cesare Fracassi
Lost in translation? The effect of cultural values on mergers around the world
Journal of Financial Economics | forthcoming

The primary goal of corporate mergers is to produce synergy gains. By combining the assets of two companies, costs can be reduced and new revenues produced. To realize these synergies, employees of the merging firms must coordinate with each other; a task that is easier said than done. In cross-border mergers, where employees may have conflicting values and beliefs, coordination is especially difficult. Mistrust, misunderstanding, or mismatched goals are likely to impair coordination. For instance, it is more acceptable to question authority in some cultures than it is in others. Likewise, in some cultures, teamwork is more valued than individual aspirations. Hence, in settings where cultural differences are likely to inhibit integration, we would expect to see fewer mergers and lower gains in those mergers that do occur.

While cross-border mergers have historically been rare, since the 1990s they have become a major component of global investing activities. In large part, the ascendancy of cross-border mergers has been driven by deals in new markets. At the peak of global merger activity in 2007, more than half of all targets were located outside the top five merger markets (U.S., U.K., Canada, Germany, and France), compared to less than 30% in 1990. The increased activity in a more diverse set of countries emphasizes the need to understand the role of cultural differences in cross-border mergers.

Cross-border mergers are common among neighbors, trading partners, and countries with similar laws

The complexity of worldwide merger patterns is illustrated in Figure 1. The size of the arrows connecting countries is proportional to their total cross-border merger activity over 1985 to 2008. Merger partners are clearly not random. For instance, both the U.S. and Canada, and the U.S. and the U.K., have strong cross-border merger ties, but Canada and the U.K. have relatively few cross-border deals. In addition, some of the largest domestic markets have few cross-border mergers, most notably Japan. Japan is the fifth largest domestic merger market in the world, but less than 6% of acquisitions of Japanese companies are made by non-Japanese firms. In contrast, over two-thirds of acquisitions are made by foreign acquirers in Germany, the seventh largest target nation.

The pattern in Figure 1 is consistent with multiple interpretations, including geographic proximity, historical trade relations, and shared legal origins. It is also consistent with cultural differences. For instance, Hong Kong and Austalia are relatively close geographically and both share a common history with the UK, but they have little cross-border merger activity. At the same time, they have widely different cultural values. In our study, we formalize this intuition and predict that cultural differences negatively affect the incidence and gains of cross-border mergers.

1: Cross-border merger patterns
This figure shows the volume of cross-border activity for the 20 most active domestic M&A markets, 1985–2008. The most active cross-border merger flows are indicated by the width of the arrows between countries.

Do cultural differences discourage mergers?

To test this hypothesis, we focus on three cultural dimensions that are the most commonly identified in sociology and economics:

  1. Trust versus Distrust (whether people believe that others can be trusted);
  2. Hierarchy versus Egalitarianism (whether people believe they should follow the rules dictated by higher authorities); and
  3. Individualism versus Collectivism (whether people believe they should sacrifice personal gains for the greater good of all).
Though other dimensions might be important, we think these three are particularly relevant in cross-border mergers.

First, in economic transactions characterized by uncertainty, trust is the confidence that a counterparty will fulfill her side of the deal. As far back as Arrow (Book 1972), economics scholars have recognized that trust facilitates trade. This could lead to more cross-border mergers, since integration costs are reduced. In contrast, trust may preclude the need for a merger if more trust allows for arm's-length contracts.

Second, egalitarian cultures rank the importance and social power of all members relatively equally, whereas hierarchical cultures delineate members into multiple vertical ranks of power. In a firm, this means that workers are more likely to follow instructions from superiors in hierarchical cultures. Differences in the norms of hierarchy could inhibit post-merger coordination. Hierarchical bosses might not understand that egalitarian workers are unlikely to follow their orders without justification. Likewise, egalitarian bosses might not be respected by hierarchical workers if the boss treats workers as equals.

Third, in individualistic societies, it is expected that people will seek to maximize their self-interest, without regard to the well-being of society-at-large. In contrast, collectivist cultures emphasize group goals, and the aspirations of individuals are tied to social obligations. Clearly, following a merger, individualistic employees may not work well with collectivist employees, and vice versa.

We first investigate the impact of cultural differences on the dollar volume of cross-border mergers. From the SDC database, we collect mergers across the globe, including public, private, and subsidiary firms, from 1991 to 2008. This generates a sample of 20,893 cross-border mergers across 52 different countries. These mergers are aggregated into 27,753 country-pair-years. We measure national culture using survey responses from the World Values Survey (WVS), the largest study ever conducted on cultural values, covering 97 societies on six continents, and representing more than 88% of the total world population.

Following a long tradition in international economics, we use a “gravity”, where we measure distance in cultural space, not just geographic space. We control for both acquirer-and target-country fixed effects to capture any country-level effects that do not vary over time, such as legal origin, investor protection laws, religion, and language; year fixed effects to control for worldwide macroeconomic shocks, such as currency crises and changes in world market valuations; time-varying country-level variables, such as GDP, GDP/Capita, and imports and exports; and country-pair variables such as geographic distance, shared language, religion, and institutions. This approach is designed to isolate the effect of cultural differences, while holding constant all other variables.

Differences in Trust and Individualism reduce cross-border mergers

Table 1 presents Tobit regression estimates of the effect of cultural differences on the level of cross-border activity across the 27,753 country-pair-year observations. The dependent variable is the log of dollar volume of cross-border merger activity between two countries. We find that greater cross-country differences in trustfulness and individualism are significantly related to less cross-border merger activity, even after including a multitude of controls. In tests not reported here that control for country-year fixed effects, we find significant and negative coefficients on each of the three cultural distance measures.

1: Cultural distance and merger volume
Dollar volume of cross-border mergers
Change in Trust –2.68*** –2.57***
Change in Hierarchy –0.73 –0.49
Change in Individualism –3.10*** –2.92***
Observations 27,753 27,753 27,753 27,753
One, two, and three stars mark statistical significance at the 10%, 5%, and 1% level, respectively.


This table presents the coefficient estimates of regressions of the natural log of the aggregate dollar value of all mergers from acquirer country i to target country j from 1991 to 2008 on the log of cultural differences. All regressions control for the year of the merger, characteristics of the acquirer and target nations that do not change over time (such as legal history), and a host of time-varying control variables (such as GDP and imports).

Cultural distance has substantial consequences for merger activity. A change from the 25th to the 75th percentile in the distance in trust leads to a decline in the natural log of the dollar value of mergers of 0.436. For the same change in the distance of individualism, merger activity falls by 0.334. These are large effects when compared to the average of the natural log of dollars in cross-border mergers of 1.02. These results provide strong evidence that cultural differences have a substantial negative effect on the dollar volume of cross-border mergers, consistent with the hypothesis that firms avoid mergers where cultural distance imposes additional costs on integration.

One concern is that cultural values could proxy for omitted institutional features of a country. For instance, residents of countries with a history of fair and orderly government could be more trustful and hierarchical. We address these endogeneity concerns, by using genetic and somatic differences to proxy for differences in cultural values. In these instrumental variables tests, we find evidence consistent with our main results.

Value creation is smaller when cultural differences are larger

We next estimate the effect of cultural differences on the value created by mergers. In order to measure value, we use a smaller sub-sample of 827 deals from 35 countries, where acquirers and targets are both publicly traded firms with available stock price data. For each deal we compute the acquirer's and target's abnormal returns in the three days surrounding the announcement of the merger, where abnormal returns are daily returns minus the return of the Datastream country index of the firm. We take the sum over three days to generate a cumulative abnormal return (CAR). We take the average of these CARs, weighted by each firm's market value, to form the Combined CAR, our proxy for synergy gains.

Table 2 presents estimates of the effect of cultural differences on combined returns in cross-border mergers. We include the same controls as before, and also add deal-level characteristics known to affect announcement returns, such as form of payment, and a control for the fact cross-border mergers do not occur randomly. We find that the greater is the distance between two countries along the cultural dimensions of trust and individualism, the lower are the combined announcement returns of a merger. This effect is consistent with the results found for the role of trust and individualism on the volume of cross-border mergers.

The value effects are also economically meaningful. Increasing the distance in trustfulness from the 25th to the 75th percentile leads to a 28% reduction from the median combined return of 2.1%, and a 16% reduction of the average combined return of 3.6%. For the same change in individualism, there is an equal drop in abnormal returns. In dollar terms, this implies a range of value loss for median-size firms of roughly $14 million. For average-size firms, the loss is roughly $50 million.

2: Cultural distance and combined abnormal returns
Combined CAR( – 1, + 1)
Change in Trust –0.06*** –0.05*
Change in Hierarchy 0.01 0.02
Change in Individualism –0.08** –0.07*
Observations 827 827 827 827
One, two, and three stars mark statistical significance at the 10%, 5%, and 1% level, respectively.
This table presents regressions estimates of the combined abnormal announcement return of combined abnormal returns over 1991 to 2008 on the log of cultural differences. All regressions control for the year of the merger, characteristics of the acquirer and target nations that do not change over time (such as legal history), and a host of time-varying control variables at the nation-level and firm-level.

To verify our results, we conduct additional robustness tests. First, we investigate cultural differences across regions in the U.S., rather than across countries, to hold institutional features like government fixed. Second, we run tests that exclude all U.S. firms from the sample. Third, we investigate the effects of national culture on long-run stock market returns. Fourth, we run matched-sample tests where cross-border deals are matched to domestic deals in the same country and industry. And fifth, we use alternative survey measures of culture. In each of these cases, we find that cultural differences reduce the likelihood of mergers.

In summary, we find evidence consistent with the idea that cultural differences create obstacles to realizing synergy gains in mergers. These findings overturn a long-held belief that culture is of secondary importance in mergers. Instead, the results highlight the need for managers to carefully consider the challenges in integrating two sets of diverse employees, especially when they hold widely different fundamental beliefs and values.

Zhang Zeduan: Along the River During Qingming Festival. China, Song Dynasty, 11th century.. These are sections from the full scroll, which is 10 inches in height and 5.74 yards in length. It has been called “China's Mona Lisa,” not only because it is the most famous Chinese painting, but also because sections of it have been reproduced, reinterpreted (and forged) by many other artists. This scroll's home is the Palace Museum in the Forbidden City. A digital animated(!) version was displayed at the World Expo 2010 at the China Pavillion. (Presumably without Mickey.) As a national treasure, it was lent to an exhibition in Hong Kong in 2007 to commemorate the tenth anniversary of Hong Kong's reunion with China, and to the Tokyo National Museum in 2012 to symbolize the (more) normalized relationships between China and Japan.

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Journal of Financial Economics.
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