Massimo G. Colombo, Politecnico di Milano

1. CAMBRIDGE, March 2009 INNOVATION DRIVEN ACQUISITIONS OF HIGH-TECH START-UPS: NEW INSIGHTS FROM THE INCENTIVE AND COMPETENCE PERSPECTIVES Massimo G. Colombo, Politecnico di Milano

2. The acquisition of high-tech start-ups • Surge of interest in the M&A literature on the acquisition of high-tech start-ups (Bloningen and Taylor 2000, Desyllas and Huighes 2008). • Key element of the external technology sourcing strategies of large established firms (Kale and Puranam 2004). • The post-acquisition reorganization process (Jemison and Sitkin 1986, Haspelagh and Jemison 1991) crucially influences the innovation impact of these acquisitions. • Focus of the extant literature on the dichotomy between structural separation and structural integration. • Less attention to non-structural (i.e. behavioral) aspects, with a few exceptions (Ranft and Lord 2002, Graebner 2004).

3. The acquisition of high-tech start-ups • Aim of the paper: • Focus attention on a particular aspect of the post-acquisition reorganization process: should decision authority over the post-acquisition innovation activity of the acquired start-ups : • delegated to the acquired key inventors; • or centralized within the acquiring firm? • Management of high human capital individuals: key aspect of the post-acquisition reorganization process. • New insights from combining: • Arguments inspired by the competence-based perspective; • Arguments rooted in the economics of organizational design (Colombo and Delmastro 2008) relating to individual incentives.

4. The acquisition of high-tech start-ups • Theoretical model which predicts under which circumstances delegation is more effective than centralization. • Testable propositions relating to: • The direct effect on the effectiveness of delegation of the type of acquisition: • explorative or exploitative. • The interaction effect between the type of acquisition (either explorative or exploitative) and: • The technological relatedness between the acquiring and acquired firms; • The establishment of prior alliances between them; • The prior acquisition experience of the acquiring firm.

5. The extant empirical literature: Stylized facts • The innovation impact of the acquisition of high-tech start-ups often is disappointing: • Poor post-acquisition innovation output of the acquired inventors (Kapor and Lim 2007); • Departure of star scientists and engineers (Ernst and Vitt 2000). • Moderating effect of the structural integration of the acquired start-up as opposed to structural separation: • structural integration generally damages post-acquisition innovation output (Paruchuri et al. 2006, Kapor and Lim 2007); • Stronger negative effect if: • the acquired firm is in explorative stage (Puranam et al. 2006); • the acquirer use the acquired start-up as a source of ongoing innovations (Puranam and Srikanth 2007); • Smaller negative effect if the acquiring firm has greater acquisition experience (Puranham and Srikanth 2007).

6. The extant empirical literature: stylized facts • Structural integration is more likely (Puranam et al. 2008): • with strong interdependencies between the acquiring and acquired firms; • when the combining firms lack “common ground” (i.e. operate in different technological areas) • The negative effect of structural integration are not uniform across individual inventors (Paruchuri et al. 2006): inventors that suffer the most are: • those with divergent technological expertise from the one of the acquiring firm; • those that rely more on co-authorship.

7. Open issues • Need to go beyond structural aspects of the post-acquisition reorganization (Haspelagh and Jemison 1991, Pablo 1994, Larsson and Finkelstein 1999, Ranft and Lord 2002, Zollo and Sing 2004). • Importance of managerial aspects: delegation of decision authority. • Structural separation and delegation of decision authority are (almost) independent aspects: structural separation is compatible with centralization of decisions (and viceversa). • Need to take into consideration the longitudinal dimension of post-acquisition reorganization: • Timing of reorganization decisions; • Sunk costs and path-dependency.

8. The traditional view of the incentive perspective • Property rights theory (Aghion and Tirole 1994): • The acquisition of a high-tech start-up involves a change in the allocation of property rights; • The acquirer gains control over the post-acquisition innovation activity of the acquired start-up; • Acquired innovative entrepreneurs become salaried employees and have no ex-post bargaining power; • They lack appropriate incentives to make relation-specific investments; • If the relation-specific investments of acquired entrepreneurs are important for innovation: Negative effect on innovation

9. The traditional view of the incentive perspective • Traditional agency theory (Holmstrom 1989): • The acquisition of a high-tech start-ups by a (generally larger ) firm generates agency costs: Negative effect on innovation • Hidden action problems inherent in innovation activity become more severe and are a source of diseconomies of scale in R&D (Zenger 1994): • Free rider problems in team production as agents’ individual effort is difficult to monitor; • Indirect monitoring quite inefficient; • Externality in innovation activity: the incentives of the acquired innovators are disaligned with those of the acquiring firm; • Hidden information problems in the early post-acquisition period: difficult to identify who are the acquired key inventors.

10. New insights from recent developments in the incentive perspective • Innovation activity is modeled as a multi-task agency relation: the acquiring firm does not know in which task (R&D project) the acquired key inventors are most productive. • The acquired key inventors possess specific knowledge on local technological matters (Jensen and Meckling 1992). • This specific knowledge is based on “soft” information (i.e. non-verifiable from third party): room for strategic communication (Dessein 2002, Marino and Matsousaka 2005, Friebel and Raith 2007, Alonso et al. 2008, Dessein et al. 2008). • The acquired key inventors enjoy private benefits (Aghion and Tirole 1997) in performing R&D activity (“taste for science”). • Key dilemma: • If acquired key inventors are in charge of selection of R&D projects, the project they chose is likely to diverge from the one the acquiring firm would chose should it have the same information set; • if the acquiring firm is in charge the selected R&D project may not be the optimal one because of lack of relevant information.

11. New insights from recent developments in the incentive perspective • Need to elicit implementation effort from the acquired key inventors, which is complementary to good decision in R&D project selection (Raith 2004, Van den Steen 2006). • Technological uncertainty in R&D activity: it magnifies the information advantage of the acquired key inventors (Zabonjiik 1996, Prendergast 2002, Baker and Jorgensen 2003, Raith 2004). • The greater the “combination potential” of the acquisition, the greater the marginal product of the effort of the acquired key inventors, the more important effective R&D project selection (Raith 2004). • Externality problem: Need to coordinate decisions relating to the post-acquisition innovation activity of the acquired start-up with the other operations of the acquired firm: • lack of coordination generates bad performance; • locally optimal decisions need not to be optimal for the acquiring firm: trade-off between high-powered local incentives and firm-level incentives (Stein 2002, Alonso et al. 2008, Dessein 2008).

12. New insights from recent developments in the incentive perspective • For the acquiring firm it is important: • With delegation of decision authority to the acquired key inventors: to deter choice of low pay-off projects (Baker et al. 1992); • With centralization of decision auhtority: to enforce orders (Marino et al. 2006); difficult with star scientists: • They are difficult to replace if they decide to leave (Ranft and Lord 2000, 2002); • They can easily find a new job. • Different priors between the acquired key inventors and the acquiring firm (Zabonjik 2002, Van den Sten 2006, 2007): • with centralization of decision authority the acquired key inventors have low incentives to provide effort if they think that acquiring firm’s managers take bad decisions. • With delegation, the provision of high-powered incentives to acquired key inventors makes problems rising form divergence of decisions even worse.

13. The benefits and costs of delegation of decision authority to the acquired key inventors: a synthesis

14. Factors favoring/hindering the delegation of decision authority to the acquired key inventors

15. The role of technological relatedness, prior alliances, and prior acquisition experience

16. Delegation or centralization of decision authority: A synthesis