In recent years, growth through acquisition has been an important strategy for many firms. While considerable attention has been devoted to merger valuation analysis, less consideration has been paid to successful integration of merging firms (Carey, 2000; Anonymous, 1999). Differences in culture, corporate philosophy, management style, corporate structure, and compensation are just a few of the important subjects to be reconciled. Much media attention has been given to the difficult issues of combining management and structuring executive compensation packages (Schellhardt, 1999). DeVoge and Shiraki (2000) suggest that issues involving employees are often the most poorly handled in mergers and acquisitions, and that this poor handling can create problems that may undermine the success of the merger. Yet, at the executive level, mergers can create problems due to uncertainties about job responsibilities, power sharing, and compensation. This study focuses on one of these important issues, namely compensation issues.
Recent merger activity has motivated considerable discussion of executive pay. In some cases, significant differences in pre-merger compensation structure and magnitude have raised interesting questions of firm compatibility. One recent example is the merger between Citicorp and Travelers Insurance. John S. Reed, CEO of Citicorp, and Sanford I.
Weill, CEO of Travelers, agreed to act as Co-Chairmen and Co-Chief Executive Officers for the new firm, Citigroup. Prior to the merger, Weill had substantially higher compensation than Reed. Media reports raised doubts that Weill and Reed could successfully integrate the two firms and predicted turf battles in the future (Dwyer, 1998). Anecdotal evidence suggests that retention issues may arise during acquisitions. In our sample, of the 1,612 executives listed in the proxy statement as top-five executives of the pre-merger acquiring firms, only 1,112 appear as one of the top-five executives after the merger. Furthermore, target-firm executives seldom appear in the top-five list after the merger. (1) Assuming the desire to retain top executives from both firms, at least in the short term to facilitate post-merger integration, large differences in total compensation may create challenges for the integration process. These challenges may be particularly important when the merger is outside the acquiring firms' c ore competencies and there is a critical need to retain target-firm executives for their expertise. In fact, Walsh (1988) suggests that a merger may be attractive due to the acquisition of target-firm management.
Acquiring and target firms can exhibit pre-merger differences in either levels of compensation or in compensation mix, including salary and performance-based components such as bonuses, restricted stock, long-term incentive plans, and stock options. The compensation disparities can be particularly troublesome if they impede integration of the two firms after the merger. Closing large pay gaps can begin to chip away at the merger's proposed savings. Alternatively, allowing large differences in compensation to continue after the merger can result in morale problems among members of the lower-paid executive team. Equity theory (Adams, 1963, 1965) suggests that when individuals perceive that large inequities in relationships with others exist, individuals feel distress and use various techniques to reduce that distress, including but not limited to, altering or terminating the relationship.
While research on executive compensation has increased dramatically in recent years, (2) research examining the relation between merger activity and compensation structure is limited. Two studies examine whether post-merger executive compensation is associated with post-merger firm financial performance. These studies find mixed results. Schmidt and Fowler (1990) find that post-merger compensation for acquiring firm executives does not relate to post-merger firm financial performance. …