Towards Reconciliation of Market Performance Measures to Strategic Management Research Author(s): Michael Lubatkin and Ronald E.

Shrieves Reviewed work(s): Source: The Academy of Management Review, Vol. 11, No. 3 (Jul., 1986), pp. 497-512 Published by: Academy of Management Stable URL: http://www.jstor.org/stable/258307 . Accessed: 05/12/2011 07:12
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? Academy of Management Review, 1986, Vol. 11, No. 3, 497-512.

Towards Reconciliation of Market Performance Measures to Strategic Management Research

LUBATKIN MICHAEL
University of Connecticut

RONALDE. SHRIEVES
University of Tennessee
Four research issues are identified that highlight the contrasting perspectives of strategic management and finance on event-study methodology. These issues then are used to evaluate five finance procedures used to calculate market-based performance measures. In each case, alternative procedures are recommended to make these measures more relevant both conceptually and statistically, for strategic management research. Parallel bodies of research about mergers have developed independently in the fields of strategic management and finance. In these two fields, similar conclusions are not reached. The consensus of studies appearing in the strategic management literature suggests that mergers, or certain types of mergers, may improve the performance of the acquiring firm (e.g., Kitching, 1967; Lubatkin, 1983; Porter, 1980; Rumelt, 1974). In contrast, the consensus of market-based performance studies appearing in the finance literature indicates that mergers do not lead to positive performance outcomes, or at best, lead to small gains (for summaries, see Halpern, 1983; Jensen & Ruback, 1983; Weston, 1981). The findings of the finance studies generally are consistent with the notion that the market for acquisitions is perfectly competitive in the sense that stockholders of the acquired firm capture any merger benefits through the premiums paid for their securities. In such a market, the diversification strategy that the acquiring firm follows is irrelevant to its shareholders' welfare. The apparent contrast in these conclusions is not surprising. Commenting specifically on the fields of strategic management and finance, Bettis (1983) stated that "The gap (in paradigm and methodology) generally is so broad that researchers on both sides forget that they often analyze the same phenomena albeit from different perspectives" (p. 413). The present authors agree. Focusing on corporate event studies, it is argued that hypotheses concerning the two disciplines often are fundamentally different. For example, strategy researchers focus on more than one test of performance applied by more than one category or organizational assessor (Rumelt, 1974). The literature on mergers was selected to highlight this point because mergers have been widely studied in both fields. (In this paper, the terms "mergers" and "acquisition" are used interchangeably to mean any transaction that forms one economic unit from two or more previous ones.) However, the issues raised here are relevant to any major corporate event studied in the management field.

Correspondence should be addressed to Michael Lubatkin, Business Environment and Policy, Box U41-B, University of Connecticut, Storrs, CT 06268.

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The goal of this paper is to demonstrate how the principal empirical methodology used in finance studies can be adapted to researchers in management. (The capital asset pricing model, or CAPM, and the market model are the principal versions of this methodology.) This goal is a particularly timely goal since researchers in management recently have given more attention to these models (e.g., Bettis, 1983; Lubatkin, 1983; plus two sessions held at the annual meeting of the Academy of Management, 1984). First, market-based performance measures are described and the contrasting perspectives taken by researchers of the two fields are discussed. From these contrasting perspectives, four research issues are identified. These issues include: differences in time frame, sampling frame, statistical methods, and performance analysis. Within this framework, it is argued that five procedures, common to this frame methodology, may be inappropriate for testing hypotheses from the strategic management literature. For each procedure, alternative procedures which reconcile the basic market-based performance measures to the research objectives of strategic management are suggested. A concluding section draws together the recommendations of this paper to show how each can be used in conjunction with the other.

The Case for Market-Based Performance Measurement

Research in strategic management is founded on the notion that strategy influences corporate performance. To date, this notion has more conceptual appeal than empirical support. Consider, for example, the literature on corporate diversification. A widely held belief is that firms that diversify in a related manner will perform better than firms that diversify in an unrelated manner. Rumelt (1974) first found empirical support for this relatedness prescription. Subsequent studies, however, have uncovered results that seriously question its adequacy (e.g., Bettis & Hall, 1982; Christensen & Montgomery, 1981). 498

Other policy prescriptions have met a similar fate. For example, studies that test for a link between corporate performance outcomes and merger strategies (e.g., Kitching, 1967; Singh & Montgomery, 1984), organizational structures (e.g., Chandler, 1962; Lorsch & Allen, 1973; Rumelt, 1974), strategic planning systems (e.g., Kudla, 1980; Wood & LaForge, 1979), composition of corporate governance (e.g., Schmidt, 1977; Vance, 1978), executive succession (e.g., Lieberson & O'Connor, 1972; Weiner & Mahoney, 1981), and so on, all arrive at weak or inconsistent findings. Is the theory at fault, or are the measures used to evaluate corporate performance inappropriately selected? A review of the literature on corporate performance measures suggests the latter may be true. Strategy research traditionally has defined performance by some accounting-based index such as return on assets and/or sales growth. Each of these measures, however, captures only one dimension of performance (Dalton, Todor, Stendolin, Fielding, & Porter, 1980; Ford & Schellenberg, 1982). In addition, the importance of each measure may differ across strategic contexts (Cameron & Whetten, 1981; Gupta & Govindarajan, 1984). Steers (1975), for example, recommended that performance be measured along multiple dimensions and that weights be assigned to each dimension to reflect the specific strategy of the focal organization. This elaborate approach, however, would not necessarily generate accurate indices of corporate performance. Measurement problems associated with accounting-based measures are as well documented as those of hybrid measures (e.g., price/ earnings) which incorporate both accounting and market-based measures (e.g., Hong, 1977; Lev & Sundar, 1979; Rappaport, 1983). Finally, traditional measures of performance are not necessarily correlated with the value of the firm (Beaver, Kettler, & Scholes, 1970;Gonedes, 1973). The importance of this latter point cannot be understated. High valuation justifies attractive compensation packages, inhibits proxy battles for

control, and enhances the firm's future effectiveness by allowing less costly access to additional equity and debt capital (Branch & Gale, 1983). High valuation, therefore, is a performance goal that extends beyond the domain of stockholders. Given the pitfalls of employing traditional measures of corporate performance, are there other, more reliable measures? A strong case has been made for a measure developed from capital market theory. Stated simply, this model assesses the impact of an event (e.g., a change in leadership) on a firm's security by estimating "normal" or expected return to its stock in the absence of an event (Fama, Fisher, Jensen, & Roll, 1969). This is done by adjusting the firm's observed common stock returns (appreciation plus dividends) for general stock market movements over the period surrounding the corporate event of interest. The "abnormal" or unexpected return to the stock represents the difference between its observed return and its normal or expected return, given the general market effects. Of course, abnormal returns do not measure realized operating performance; rather, they capture investors' anticipation of firm specific events on future performance. To the extent that the capital markets are efficient, that is, security prices reflect all available information (Fama, 1976), any change in price represents the present value of the change in the expected cash flow to the firm. There are a number of advantages to measuring performance in this manner. First, stock prices represent the only direct measure of stockholder value. Second, stock prices are believed to be fully specified; that is, they are not limited to a specific aspect of performance such as sales growth or profits, but rather reflect all relevant information aspects of performance. Third, stock prices are readily available for all publicly traded firms and their competitors. Fourth, stock prices are reported objectively. Fifth, stock prices have been shown to "see through" managers' attempts to manipulate reported accounting measures. Sixth, the abnormal returns measures that are computed from the stock price compare favor499

ably to the less specified measures of market performance such as annual changes in stock price. Unlike the latter measures (e.g., Weiner & Mahoney, 1981), abnormal returns are adjusted to account for general market movements, inflation, and the firm's market risk, or beta. Finally, these measures provide a basis for evaluating investors' assessment of the impact of a managerial decision (e.g., to merge, to divest, to reorganize, etc.), or the impact of events outside the direct control of management (e.g., a rivalrous act by a competitor, a precipitous rise in energy price, etc.). There are also limitations to measuring corporate performance in this manner. For example, an assumption underlying the construction of this measure is that the only stakeholder that matters is the fully diversified investor. This assumption, fundamental to modern financial theory, runs counter to the notions of strategic management. Strategic management recognizes the need for business organizations to be accountable to many stakeholder groups, each evaluating performance along different criteria. Strategic management also recognizes the importance of managing unsystematic risks such as entry barriers. (The issue of whether the management of unsystematic risk is compatible with modern financial theory is debated between Bettis, 1983, and Peavy, 1984.) The point of this paper, therefore, is not to suggest that abnormal returns represent the only true measure of performance; rather, that this measure reflects the viewpoint of the common shareholder better than do accountingbased measures, and with modifications, may prove to be a powerful test of corporate performance.

Contrasting Conceptual Focus

Market-based performance measures have been used in financial economics to study the effects of events such as dividend announcements (e.g., Fama et al., 1969), merger announcements (e.g., Mandelker, 1974), tender offers (e.g., Dodd & Ruback, 1977), and changes

in capital structure (Masulis, 1983) on common stock prices. Recently, researchers in strategic management have given it more attention, using it to evaluate the impact of mergers (Burgman, 1983; Lubatkin, in press; Singh & Montgomery, 1984), divestitures (Montgomery, Thomas, & Kamath, 1984), diversification (Montgomery & Singh, 1984),product-market interventions (Bettis, Chen, & Mahajan, 1984), executive succession (Reiganum, 1985), strategic planning systems (Kudla, 1980), and strikes (Newmann, 1980). Opportunities to employ this methodolody, however, are not limited to research in strategic management. Other applications include research in organizational behavior (e.g., to assess the impact of changes in top management reward systems and changes in top management leadership styles on stockholders) and organizational theory (e.g., to assess the impact of structural changes and changes in corporate governance). A danger exists, however, when a technique developed in one discipline is borrowed without first questioning the assumptions underlying that technique. A paradigm of strategic management, for example, is that a corporate action such as a merger is the outcome of a series of related events or tactics where each increases or decreases the probability of the final outcome (see Mintzberg's, 1973, discussion of strategic "gestalts"). The full performance impact of the merger cannot be assessed solely by observing the returns associated with the final event (e.g., the merger's announcement date, or its legal transaction date). In the case of mergers, these events or tactics related to the merger process include: the decision to begin an acquisition program, the decision about which specific diversification strategy to employ, the act of purchasing stock in various possible targeted firms prior to any formal takeover attempt, the disclosure of information that clarifies which firm or firms are targeted, any opposition to the takeover attempt, the formal announcement by the acquiring firm, and any other act that provides information about final merger act.

Researchers in finance, however, generally view corporate events quite differently than do researchers in strategic management. Events are defined more in tactical terms, perhaps because the power of the market model is enhanced by the fact that the timing of the impact of a tactic is more easily identified. (Research on merger tactics under the heading "market for corporate control" is surveyed by Jensen & Ruback, 1983.) While questions directed at tactics are interesting, equally interesting questions concerning the nature of strategic events generally have been overlooked. This is not to say that finance does not recognize limitations of event-study research. Recent literature reviews of merger studies attest to this (Copeland & Weston, 1983; Halpern, 1983; Jensen & Ruback, 1983;Weston, 1981). This literature, however, offers few recommendations to assist the study of broader questions that relate to strategic events. The research issue sections that follow show (a) how the prevalent finance perspective has influenced the manner in which the marketbased performance measures are constructed, and (b) how these measures can be adapted to become more consistent with the strategic management paradigm. Research Issue 1: Time Frame-Selecting Relevant Horizon Length the

Researchers who use the market model methodology select either daily or monthly returns data. In both cases, a security's returns are defined as the change (daily or monthly) in stockholder's wealth and are based upon the closing price of a security after adjusting for any stock splits, additional stock issues, and dividends. Following a technique related to the capital asset pricing model, a time series of a security's returns ordered relative to an event of interest (such as a merger) are regressed against a comparably ordered time series of returns calculated on a broad-based stock market index. The residuals from such a regression are interpreted as abnormal returns, or the security's

500

returns in excess of the market's expected (or normal) returns. When monthly returns data are used, the stock returns for the firm and the market usually are regressed over 60 months before and then 60 months after the event of interest. When daily returns are used, the stock returns of the firm and the market typically are regressed over 150 trading days before and then 150 trading days after the day of the event of interest. Before 1978, most published event studies used monthly returns data. However, as the availability of daily returns data has increased, so has its use. Proponents of daily returns data claim that its use increases the power of statistical tests by allowing the researcher to isolate more effectively the market's reaction to one particular event or tactic with a known date (Brown & Warner, 1980). (Examples of merger tactics were presented in the previous section. For a good summary of nonmerger-related tactics such as provocative price changes, establishment of fighting brands, etc., see Porter, 1980.) The present authors assert, however, that using daily returns data may be inappropriate when the research objective is to assess the full impact of a strategic event. First, strategic events cannot be dated precisely because they represent the outcome of a series of related events. To understand the impact that these related events can have on the performance measures for a particular merger, it is important to recognize that the capital markets act in a relatively efficient manner (i.e., the future benefits of an action are incorporated rapidly into a security's price). Since strong evidence supports the notion that the market is efficient, (Copeland & Weston, 1983; Jensen & Ruback, 1983), each merger-related event results in a reassessment of value which will be capitalized into the firm's stock price as the event becomes known to the marketplace. For example, abnormal returns associated with the merger announcement will reflect only the valuation impact of the marginal information contained in that event. A recent study by Schipper and Thomp501

son (1983) lends support to this conjecture. They examined the market's response to a firm's first public announcement of its intention to engage in an acquisition program and found that some of the value of later mergers is capitalized into the firm's stock price at the time that the acquisition program is announced. Second, the short time horizon employed when using daily returns data may not capture the full series of strategic event-related returns. Indeed, merger studies that employed monthly returns data reported abnormal market returns 18 months or more prior to the merger (e.g., Elgers & Clark, 1980; Langetieg, 1978;Mandelker, 1974). To the extent that the prior related information has positive value (as was found by Schipper & Thompson) and that this information becomes public more than 150 days before the event, studies that employ daily returns data will understate strategic event-related abnormal returns. This problem can be minimized by extending the time horizon (i.e., to at least 6 years, or about 1560 trading days). To do so, however, would deny the principal advantage of using daily returns data which is to compute abnormal returns over short horizons, thereby reducing bias caused by the influence of extraneous events. In addition, computing abnormal returns daily over 1560 days rather than monthly over 60 months is like measuring the length of a football field with a micrometer rather than with a yardstick. Assuming the results would be the same, the added computational cost would be wasted. More importantly, the results may not be the same. Researchers have observed bias introduced with the use of daily returns due to certain characteristics of the data (e.g., Cohen, Hawawini, Maier, Schwartz, & Whitcomb, 1983). This bias is tolerated, however, when the objective of the research is to focus on one isolated event or tactic. Monthly returns data also may introduce bias. While their required long horizon reduces bias due to the elimination of related events, it also increases the likelihood that extraneous events will be captured. Fortunately, in large samples,

the influence of these extraneous events will be partially averaged away, while the influence of related events will be captured systematically to the extent that these related events occur consistently across the sample. This bias associated with extraneous events also can be reduced by shortening the horizon. However, the market model's regression coefficients have been shown to be sensitive to the length of the time period over which they are estimated (Gonedes, 1973). The use of five years of data when using monthly returns, therefore, has been rationalized as representing an acceptable tradeoff between estimating reasonably stable coefficients and capturing the impact of extraneous events. In addition, there is no theoretical justification for shortening the horizon. The length of the horizon depends on the nature of related events, of which little is known: When do they begin? Does their sequence, in terms of their order and the time interval that separates them, vary across firms? Do investors' interpretations of each event vary across firms? Are strong earnings and high liquidity an "event" extraneous to merger, or a cause of merger? If it is a "cause," will investors begin to discount the value of a later merger at the time when they become aware of this performance trend? These and other questions highlight opportunities for future research. In summary, it is argued that the properties of monthly returns data make the data more appropriate to use when studying the market's responses to a strategic event, while daily returns data are more appropriate when studying tactics of strategies. In each case, however, tradeoffs must be recognized. Research Issue 2: Sampling Frame-Selecting the Relevant Sampling Units Market model event studies which use monthly data returns commonly exclude firms that have participated in the same type of event during some specific period around the date of the event of interest (e.g., Choi & Philippatos, 1983; Langetieg, Haugen, & Wichern, 1980). According to its 502

proponents, this period of "clean data" (typically three years before and three years after the event being studied) helps to ensure that regression coefficients estimated over the full 60 months before and 60 months after the event will reflect only the influence of a single event. (The use of daily returns data is partially justified as a means of avoiding the necessity of applying a "clean data" screening criterion, since it is unlikely that an event firm will experience the same event twice within the shorter horizon involved.) Clean data may reduce estimation error, but two problems arise. First, it may result in a nonrepresentative sample. For example, the sample of mergers that pass this screening criterion includes only acquiring firms that are relatively inactive in the acquisition market. This systematic exclusion of more frequently merging firms has been casually observed, but not documented (e.g., Langetieg et al., 1980, p. 372). It is, however, well documented in strategic management studies that active acquirers differ strategically (e.g., Rumelt, 1974), structurally (e.g., Pitts, 1976), and experientially (Jemisen & Sitkin, 1986) from inactive acquirers. To the extent that a firm's activity in the acquisition market is related to its performance outcome from merger, the clean data screening procedure may result in biased estimates of the impact of mergers. A second problem of the clean data criterion is that the screen reduces the sample size. The reduced sample may result in an overall erosion of the power of the significance test to resolve hypotheses of interest, even if the selection criteria results in smaller estimation errors. The following exercise will approximate the extent to which the clean data screening procedure affects sample characteristics and results in sample size reduction in merger studies. To this end, merger activity for the population of New York Stock Exchange (NYSE)acquiring firms and for two samples drawn from the population are documented. The information for the population is taken from the Federal Trade Commission's listing of large, nonpartial mergers during the period 1948-1979. This NYSE population,

like the typical market-based merger sample, includes only mergers in which the acquired firm was a manufacturing or mining firm with assets exceeding $10 million in book value and where the ownership position in the acquired firm exceeded 50 percent. Two samples of acquiring firms then are developed from this population. The first sample requires only that there is a lengthy period of monthly stock return data available, both preand post-merger, for the surviving firm (see notes to Table 1 for details). The second sample additionally requires that the surviving firm does not participate in another large merger for 36 months before or 36 months after the merger in question. This latter sample represents the typical "clean" merger sample found in finance studies which employ monthly return data. By construction (though not by research intent), the acquiring firms in the second sample are merger "inactive. " Using the merger history information for all NYSE acquiring firms and carefully accounting for name changes, a merger activity, or "frequency" measure, is developed for each of the samples. This measure is calculated by counting the number of large mergers in which each acquiring firm participated during 1948-1979. For example, if an acquiring firm participated in four mergers during that time period, each of its mergers received a frequency measure of four. For comparison purposes, the number of mergers for the population and each sample which fall into various merger activity (frequency) categories are presented in Table 1. The second sample (clean data) differs in content and in size from the population and first sample. Only 21 percent of the NYSE population of large mergers were by acquiring firms that had only one large merger; 40 percent of the second sample of mergers were by single-merger firms. Similarly, 47 percent of the NYSE population of mergers were by acquiring firms that had more than three large mergers; only 24 percent of mergers in the second sample are represented as "active" acquirers. The first sample, however, 503

is similar in content to the NYSE population. To the extent that active acquirers (e.g., first sample) differ from the inactive acquirers (e.g., second sample) in terms of strategy, structure, and performance, the commonly used "clean data" sampling procedure results in nonrepresentative merger samples. In addition, the size of the second sample is almost 60 percent smaller than the first (315 vs. 768 mergers). In summary, it is argued that the results of studies employing the clean data screening criterion cannot be interpreted as representative of the effects of events in general without explicitly considering the impact of sample content and sample size differences on the statistical results. Research Issue 3A: Statistical Methods Correcting for Sampling Dependencies Cross-sectional dependencies may exist between the time series of abnormal returns estimated for each event-firm in a sample. When this occurs, the variance of the performance measures will be inflated, lowering the power of the standard statistical tests. Researchers in finance believe that the primary occurrence of such dependencies is when sample events cluster by calendar time. This assumption may be soundly based: business and economic regression applications involving time series data document the problem of autocorrelation. For example, Jarrell and Bradley (1980) found that government regulation influenced the market valuation of a number of different securities that shared a common event month. To overcome these temporal dependencies, the abnormal returns associated with mergers that share the same calendar month are averaged with a procedure referred to as the Jaffee (1974)/ Mandelker (1974) adjustment procedure. The equally weighted series of abnormal returns that results from this procedure are each treated as a single case for statistical tests (see Brown & Warner, 1980, for a more detailed description of this procedure). Researchers preoccupied with temporal dependencies, however, may overlook a potentially

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more important source of dependency, namely, that which is firm-specific. Firms differ in their ability to obtain positive market performance results. For example, firms differ in the characteristics of the industry of which they are a member (Christensen & Montgomery, 1981), the strategy that they follow within their industry (Porter, 1980), the strategy that they follow when diversifying into other industries (Yip, 1982), their intervention capabilities (Hitt, Ireland, & Palia, 1982), the fit between their strategy, organizational structure, culture, and leadership style (Porter, 1985), and the degree to which their management team sees themselves as an "agent" of stockholders (Fama, 1980). Each of these firmspecific factors influences the stock returns of a security whether or not an event occurs. Unless controlled, these factors may bias the returns observed for and ascribed to an event. Other firm-specific factors deal more directly with the administrative processes involved with planning, implementing, and controlling an event. In the case of mergers, these factors include the ability to adequately investigate a candidate's competitive position (e.g., Ebeling & Doorley, 1983), to identify undervalued securities (e.g., Allen, Oliver, & Shwallie, 1981), to assess strategic fit (e.g., Salter & Weinhold, 1978), to assess organizational fit (e.g., Kitching, 1967), to assess cultural fit (e.g., Marks, 1982), and to manage the acquisition process itself while minimizing administrative impediments (Jemison & Sitkin, 1986). Each of these factors may influence the timing and magnitude of merger-related market returns. For example, investors may respond earlier and with more certainty to the first few acquisition tactics of a firm that has a proven track record of successful mergers than they would to a firm that has been unsuccessful or to one without prior acquisitions (Asquith, Bruner, & Mullins, 1983; Hofer & Chrisman, 1984; Lubatkin, 1982). Collectively, these firm-specific influences may create a dependency problem in samples that contain more than one merger consummated by the same acquiring firm. Table 2 depicts the like505

lihood of this occurring. The two samples referred to in the previous section are compared after they have been adjusted either by common calendar time ("time-adjusted") or by common acquiring firm. In the latter case ("firm-adjustment"), all mergers completed by the same acquiring firm are treated as a single observation. As expected, the incidence of common acquiring firms in the first sample (containing merger activev" as well as merger "inactive" acquiring firms) is high; the firm-adjustment procedure reduces the observations by 56 percent. Even in the second sample, which involves only mergers completed by relatively inactive firms, the number of observations is reduced by 18 percent after the firm-adjustment procedure. To summarize, if cross-sectional dependencies due to firm-specific effects are important, as management literature suggests, then many event studies may have understated the significance of their results due to the reduced power of significance tests. Research Issue 3B: Statistical MethodsAssuming a Homogeneous Population Researchers in finance often assume that events such as mergers represent a homogeneous occurrence. For example, they commonly test the null hypothesis that mergers in general do not provide any benefits to the stockholders of the acquiring firms. (A recent exception is the study by Wansley, Lane, & Yang, 1983.) Table 2 Content Analysis of Sample by Adjustment Procedures
First sample Original Sample Size: After Time Adjustment: After Firm Adjustment: Second sample ("clean" data)

768 247 339

315 177 257

In contrast, the central objective of strategic management research is identification of discrete diversification characteristics in order to compare the performance outcomes associated with each characteristic. This literature strongly suggests that events such as mergers do not represent homogeneous phenomena, but rather can be categorized along a number of dimensions, including the diversification strategy employed by the acquiring firm (Kitching, 1967; Lubatkin, 1983), the market structure characteristics of the participating firms (Porter, 1980; Yip, 1982), the ability of the acquiring firm's management team to consolidate the acquired firm's management team and operations (Jemisen & Sitkin, 1986), the accumulated experience of the acquiring firm's management team in the acquisition market (Burgman, 1983; Hofer & Chrisman, 1984; Lubatkin, 1983), and the relative size of the merging firms (Dundas & Richardson, 1982; Kitching, 1967). The fact that the event studies from the field of finance often assume that their uncategorized sample of events such as mergers are drawn from a homogeneous population may have led them to report results which fail to reflect important regularities in returns to merger activity. Research Issue 4: Abnormal Performance the Relevant Benchmark Analysis-Selecting of Normal Return "A security's price performance can only be considered 'abnormal' relative to a particular benchmark. Thus, it is necessary to specify a model generating 'normal' returns before abnormal returns can be measured" (Brown & Warner, 1980, p. 207). The assumption underlying the market model is that the correct benchmark is the return after adjusting for market returns. The measure of abnormal return, therefore, is the residual or "error" term in the regression of the merging firm's period-by-period returns on those of a general stock market index. The basic research question tested in event studies that adopt this benchmark is: "Does the performance of an event firm differ from what is expected after con506

trolling for the general or market-wide influences on the stock's returns?" Researchers have suggested various modifications of the basic market model to control additional systematic influences on returns. For example, an industry factor has been suggested as a second independent variable to better explain the variation in a security's performance (Langetieg, 1978). The obvious difficulty with the industry factor, however, is that there is no correct industry context for many diversified firms. As a result, few studies have adopted this measure. A second correction factor that recently has received more support involves a well-matched control group (e.g., Choi & Philippatos, 1983; Langetieg, 1978). For each event firm, researchers select a control firm, one that shares similar industry membership, asset and sales size, and financial characteristics. The market model is then run on both firms. The control firm's "abnormal" performance is subtracted from the event firm's "abnormal" performance. The difference score is theoretically free of a number of potential methodological biases. As Choi and Philippatos (1983) observed with merger studies, however, there is a problem with this control procedure: "Ifthe impact of the merger is perceived by other firms in the industry (in the form of market share, output pricing, and other actions), the control firm's performance may not be totally free of the event" (p. 243). A second problem is that closely comparable firms may not be available for all firms selected in a sample. Finally, researcher bias and error may be introduced when choosing these control firms. Management literature on topics as diverse as turnaround (Hofer, 1980; O'Neill, in press), diversification strategies (Salter & Weinhold, 1978), executive succession (Weiner & Mahoney, 1981), and mergers (Levitt, 1975) suggest a different benchmark, one that addresses more directly the concerns of managers who are trying to improve their firms' performance. Translating this notion to capital market studies, the correct benchmark of normal performance becomes the firm's own

abnormal performance over some period of time before the market notices the influence of some strategic event. The basic research question for event studies that employ capital market measures and adopt this benchmark or control is: "Does the anticipated event induce a significant change in the performance of the event firm?" Therefore, two new measures of abnormal performance (average paired-difference and cumulative paired-difference) are suggested as more consistent with the paradigms of strategic management. These measures are constructed by first partitioning the time series of abnormal returns for each event firm into a benchmark period and an event-impact period. The benchmark period is that period before the market demonstrates an awareness of an impending event; the event-impact period is that period beginning with the first sign of awareness and continuing up to the event-date. A paired-difference score then can be calculated for each event firm by subtracting the average monthly (daily) returns estimated during its benchmark period from that estimated during its event-impact period. As constructed, the paireddifference score represents the average monthly (daily) change in abnormal returns. This difference score is averaged with difference scores computed for other firms in the sample that share similar events to form an average paired-difference score, or APD. (This measure is comparable to the traditionally computed "average abnormal return" score, or AR.) Multiplying the APD score by the number of months (days) in the event-impact period gives the cumulative change in abnormal performance associated with an event, or CPD. (This measure is comparable to the traditional "cumulative average abnormal return" score, or CAR.) A limitation of the difference score is that it may not be possible to identify the precise date of market awareness for each event firm because a firm's returns are influenced by many eventssome related to the event of interest and others not. Assuming that these unrelated events do not occur systematically across a sample of firms 507

sharing similar events, however, a portfolio grouping procedure can be used to aid in estimating this date. Here, the plot of the time series of cumulative abnormal returns for the sample of event firms is used (Fama et al., 1969). While this plot may reveal a real trend, it also may give the appearance of one when none is present (Brown & Warner, 1980). Traditionally computed measures of abnormal returns, however, also suffer from a similar limitation. The principal advantages of the paireddifference procedure come from its selected benchmark. By using the market's evaluation of a firm's own performance during some nonevent period as the appropriate benchmark, this procedure should provide an additional control for nonevent-related, firm-specific influences that may influence stock returns over much or all of the estimation period. (These influences were identified in the previous research issue section.) In addition, this procedure also should help minimize errors in the estimation of the regression coefficients that may result from problems with experimental design, for example, when the actual impact of the event occurs within the coefficient estimation period, and when the coefficients are influenced by multiple events. Finally, by allowing the impact period to be determined by the trend of a sample's time series of abnormal returns, the difference procedure recognizes that the time period when the impact an event has on returns is likely to vary systematically by sample characteristics. A recent study by Lubatkin (1986) provides initial empirical support for the difference procedure. He found the APD and CPD measures to be consistent in direction and magnitude with their counterparts (AR and CAR), but statistically more precise. In summary, it is argued that the traditional measures of abnormal return may not be appropriate for researchers in management. Aside from providing results that are less meaningful to managers as those provided by the difference measures, the traditional measures also may suffer from a number of potential biases.

Recommendations

to Researchers

In the sections on research issues, how the prevalent finance perspective has influenced the construction of the market-based performance measures was shown. It was stressed that researchers in finance have tended to view corporate events quite differently than do researchers in strategic management: finance views corporate events such as mergers in discrete, tactical terms rather than as an outcome of a series of related events. Finance measures, therefore, may be incomplete measures of strategic acts. Four research issues were identified to highlight this point. Within this framework, alternative procedures were introduced that are more consistent with the paradigms of strategic management. The following recommendations show how each can be used in conjunction with the others. In the process, the present authors hope to demonstrate how the principal empirical methodology used in finance studies can be adapted to the research objectives of management. The first issue concerns the selection of the relevant time frame to assess abnormal returns. Recent finance researchers favor short time horizons and, therefore, daily returns data because the researcher may effectively isolate one particular event with a known date. It was argued, however, that short horizons-while appropriate for assessing tactics-are inappropriate for assessing strategic acts because the flow of information regarding strategic events cannot be dated precisely. Rather, in these cases the relevant information is likely to be transmitted through a series of related events that occur over relatively long horizons. Therefore, using monthly returns data when investigating strategic acts is recommended. While the use of this data may reduce the precision of statistical tests, this loss can be minimized when used in conjunction with the benchmark employed by the paired-difference procedure. Discussed in the fourth research issue section, the properties of this benchmark are intended to add precision by providing a control for extraneous events. 508

The second issue concerns the selection of the relevant sample frame. Finance researchers favor a frame made up of events that are isolated-not preceded by or followed by other similar events. This sampling criteria helps to ensure that the regression coefficients estimated for each event reflect only the influence of that single event. It was argued, however, that in addition to reducing sample size, this frame may not permit inferences to be made about the general population when the element of interest represents a strategic event. With strategic events, the performance impact of each of a succession of similar events rnay be expected to differ. Therefore, a sample frame that is not restricted to isolated events is more appropriate. The selection of the unrestricted frame, however, may involve a tradeoff of reliability for generalizability. Therefore, where possible, the results of investigations of strategic acts should be presented for both sample frames. In this way, readers consider the separate effects of "contamination" and differences in sampling content. Of course, not all studies can report their results both ways: it would make little sense to employ the screen when the research objective is to study firms that merge frequently. However, to the extent that the contamination is captured over much or all of the estimation period, the benchmark used by the paired-difference procedure may be able to partially control for this bias. An additional control for this bias is the firmadjustment procedure. As described in the third research issue section, this procedure averages together the abnormal returns estimated for mergers that share a common acquiring firm and then treats each average as a single observation. Used together, the two procedures allow a researcher to employ a sample frame that better represents the population while minimizing (but not eliminating) the impact of contamination bias on sample statistics. The third issue is concerned with the appropriate statistical methods. Here, finance researchers make two assumptions that are inconsistent with the paradigms of strategic management.

First, they assume that the primary source of sampling dependencies is caused by temporal considerations, and, therefore, employ an adjustment procedure designed to correct for this problem. Inferred from the literature of strategic management, however, are firm-specific dea more important source pendencies-potentially of sampling dependencies, particularly in sample frames that contain nonisolated events. A firm-specific adjustment procedure was described to correct for this problem. This procedure is not appropriate, however, for all research objectives. For example, it makes little sense to average abnormal returns across events completed by the same firm when the objective is to test for a relationship between a firm's experience with an event and the performance outcome it received from the event. In this case, the paired-difference procedure is recommended as an alternative to control for firmspecific influences. Researchers who have other objectives are confronted with a choice. While the two adjustments can be computed simultaneously, the result-an average taken across time and firmshas questionable meaning for hypothesis testing in strategic management. It is suggested, therefore, that the best procedure is to test dependency on a sample-by-sample basis, since the level of sampling dependencies of both types will vary with the sampling procedures. In cases where both are present, the results should be presented in both forms. A second statistical assumption made by finance researchers is that events such as mergers represent a homogeneous occurrence. In contrast, the literature of strategic management supports the position that performance differences are likely to be observed when a sample of events are stratified along a number of prescribed dimensions. Here, the recommendation is straightforward: to the extent that events differ along various dimensions, it is of primary impor-

tance for researchers to group them by similar characteristics before applying standard statistical techniques to the respective firm's performance measures. The final research issue has to do with the selection of the proper benchmark of normal returns when calculating abnormal returns. Finance researchers assume that the correct benchmark is some general index of market returns. It was argued that this benchmark may not account for other nonevent-related, firmspecific influences that may influence stock returns over much or all of the estimation period. A paired-difference procedure was described to control for these extraneous influences. It is recommended that this procedure be used as a final verification of the measurement of a corporate event's impact on stockholder wealth. As suggested, the properties of the benchmark make the procedure used with the difference procedure ideally suited for those studies where research objectives require long time horizons (Research Issue 1);those that prevent the explicit recognition of the potential combined effects of "contamination" and sample bias (Research Issue 2); and those that prevent the use of the firmadjustment procedure (Research Issue 3). To summarize, the preceding recommendations were presented as guidelines to assist researchers in strategic management. It is intended that they be used in conjunction with each other. The objectives of the research, however, will determine which procedures can be employed. The position taken in this paper has been that market-based performance measures can provide researchers of strategic management with a powerful test of corporate performance, though not the only test. This discussion, however, underscores the necessity for researchers to question the assumptions underlying the techniques of another discipline before borrowing them.

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Michael Lubatkin is Assistant Professor of Business Environment and Policy in the School of Business Administration, University of Connecticut, Storrs. Ronald Shrieves is Professor of Finance in the School of Business Administration, University of Tennessee, Knoxville.

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