Academic journal article Economic Inquiry

Code Creation in Endogenous Merger Experiments

Academic journal article Economic Inquiry

Code Creation in Endogenous Merger Experiments

Article excerpt

I. INTRODUCTION

Groups and organizations often use specialized language, or "code," for coordinating economic activity. In this paper, we focus on the experimental creation of code among small laboratory groups, and what happens when groups are combined in a "merger."

Code is one facet of corporate culture, which is the value system, symbols, ideas, icons, stories, and language that express the informal contracts between a firm and its employees, customers, and suppliers--"how business is done" at a company. There is much popular writing about corporate culture, and interest among businesspeople, but little careful scientific research on how cultures are created, are changed, and affect performance. For example, many businesspeople say that conflicts in corporate culture contribute to merger failures (and there are prominent examples like the AOL-Time Warner merger). Firms are also interested in creating cultural systems that can motivate employees and create brand loyalty among customers.

While culture seems important, it is difficult to operationalize the vague concept of corporate culture precisely and measure it. Organizational economists writing about culture have singled out the role of code and categorization for firm productivity (e.g., Cremer, Garicano, and Prat 2004). We adopt the same emphasis on code, which is relatively easy to measure and create in the short span of a typical laboratory experiment. Code also has some properties shared by other components of culture, like values--for example, codes are often path dependent and difficult to recreate. Other components of culture besides code are set aside for future research.

To study code creation, we create simple "firms" in a laboratory setting and use a picture-naming paradigm in which they develop code. We then examine the impact on performance when two firms with specialized codes for different pictures are merged together. We are also interested in other features of a merger, such as perceptions of how difficult mergers are and the endogenous choice of whether to join the merger, and we measure these phenomena by having subjects bid for extra payments to join the merger. Our paper extends work by Weber and Camerer (2003), using different picture sets and endogenizing the subjects' choices of whether to join a merged group. Endogenizing their choices enables us to see whether subjects systematically underestimate the difficulty of merging and its economic consequences.

These experimental organizations are highly stylized and simple. Their simplicity gives us precision in measuring variables and understanding the determinants of performance. In the experimental world, the code words subjects use are their culture and the money they earn is their organizational performance. Furthermore, the experiments are just a starting platform onto which complications can be added. The long-run goal is to learn from a series of experiments, and just as theory develops from simple to complex, it is usually efficient to start with simple experiments and gradually complicate them. Because the design is obviously much simpler than large corporate behavior, concerns about the simplicity of the design are most useful when they come in the form of a suggestion of how to enrich the design, and a conjecture about how the enrichment will change the behavior.

A. Merger Failure

Although mergers are often met with excitement on Wall Street and in the boardroom, there is ample evidence that acquiring firm shareholders often lose from mergers (e.g., Andrade, Mitchell, and Stafford 2001). Most of these studies use stock market returns in a short window of time around the merger announcement, so they rely on the hypothesis that the stock market guesses future merger success accurately. By using only returns, it is impossible to tell whether mergers actually generate anticipated economic synergies years later and whether acquiring firms overpay even if synergies do result. …

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