Performance Measurement in Corporate Governance: Do Mergers Improve Managerial Performance in the Post-Merger Period?

Abstract

Inspired by the Coase (1937) theory of the firm, we demonstrate the usefulness of the Data Envelopment Analysis (DEA) based clinical approach as a corporate governance tool for measuring managerial efficiency in the pre-merger and post-merger period. We analyzed the Healy et al. (1992) merger sample over a ten-year period, approximately five years before and five years after merger by using a predominantly managerially controlled performance efficiency measure, i.e., DEA. Our individual, firm-level, year-by-year analyses indicate that the managerial performance of the merged firms generally improved in the post-merger period as documented in the extant finance studies of mergers and acquisitions. However, there were also significant number of cases (18%) where we could not observe the improved managerial efficiency using this dis-aggregated approach. We believe this is an important contribution to the managerial efficiency issues arising from governance decisions of mergers and acquisitions in that DEA by focusing on managerially controlled measures of inputs and outputs of individual firms provide firm-specific and yearly measures of managerial performance using a common metric. DEA, unlike aggregated performance measures, provides a much more individualized and less aggregated measures of managerial performance. In this sense, DEA is a finer tool at the discretion of corporate governance committees to determine the performance of managers on an individual firm-by-firm and year-by-year basis. DEA can be tailored by corporate governance consultants to a very short window (one or two years or quarters) or even a longer window, depending on the decision context and decision maker preferences. While decision makers need to be sensitive in interpreting DEA measures of efficiency, it is certainly an additional measure at the discretion of the governance board of directors, particularly, the compensation committee, to determine whether the managers lived up to their promise, especially in the post merger period.

Finally, DEA because of its individual firm-level and yearly (or even quarterly) analysis avoids many of the problems of traditional pooled cross sectional regression analysis, i.e., non-comparability of accounting choice and financing differences across mergers in a cross sectional pooled regression approach. We conclude that the DEA-based dis-aggregated approaches are useful tools in the hands of corporate governance boards with an interest in yearly or even quarterly managerial performance at the individual firm level. Similar approaches can also be applied to other corporate governance decisions, such as, management buy-outs which take management efficiency as the primary goal, hostile takeovers where disciplinary actions are expected to lead to improved efficiency, or even apparently value increasing mergers that eventually lead to divestitures (Fluck and Lynn,1999).

Keywords: Coase, Corporate governance, Merger & Acquisition, Performance measurement, DEA, Political Economy

JEL Classification: C44, C67, D57, L81, C44, C61, C67, D57, D61, G30, G34, K22, L61, M40, M41, P16