When we try to understand corporate strategy decisions, we should examine the factors affecting the way executives approach key situations. Specifically, we should seek to comprehend how career concerns might shape strategic choices. Consider the research of Todd Gormley and David Matsa. They conducted an interesting study of over 2,220 firms in which managers learned that government officials had identified something used in their manufacturing process as a carcinogen. The scholars analyzed the strategic choices that followed this discovery. Here is what they found, according to a summary of the research published by Kellogg Insight.
âThey started buying other firms,â says Matsa. Discovering that their workers had been exposed to a carcinogen was linked to a 6% increase in acquisitions. But critically, acquiring these companies didnât actually create any value for shareholders. Thatâs because, rather than making more strategic purchases, the troubled firms overpaid for large and unrelated âcash cowsââfirms whose healthy profits might offset any future payouts the company would have to make.
âWe likened it to how tobacco firms diversified into food when the health risks of smoking became more pronounced legally,â says Matsa. (Consider, as the most famous example, Phillip Morrisâ acquisition of Kraft Foods in 1988.) âThe managers were looking for a way to reduce risk.â
Matsa and Gormley argued that that the managers pursued this strategy to reduce their personal exposure. Because their compensation was closely tied to the firmâs performance, their own finances would have been disproportionately hit by the firmâs collapse. And because a catastrophe would likely cost them their jobs, their careers also hung in jeopardy.
Similarly, they studied firms which operated in states that made it difficult for companies to execute hostile takeovers. They described these firms as "protected" in that managers did not face a high risk of being displaced/terminated by another company undertaking a hostile takeover. Here is what the research demonstrated about the strategic choices made by these executives in "protected" situations:
Moreover, just as seen in the previous study, these managers actively reduced risk by pursuing safe, diversification-focused acquisitions. Their firms undertook 27% more acquisitions compared with unprotected businessesâwith two-thirds of these transactions diversifying the firms into new industries rather than building on existing strengths. Disproportionately, the firms targeted âcash cows.â And their caution negatively impacted their companiesâ value, investments, and growth. âThese incremental acquisitions destroy shareholder value on average,â Matsa says.