The key assets driving many of today’s mergers and acquisitions are people. Since knowledge increasingly has become the most promising source of sustainable competitive advantage in today’s knowledge-based economy, a company’s strength is often determined by its employees—better known in economic circles as human capital. Valuable talent can be hard to find—and keep—in tight labor markets, making it that much more challenging to build solid work teams. Consequently, many acquisitions take place in human-capital intensive industries such as business services, real estate brokerage, software and health services.

But the rewards of potentially strengthening a company’s knowledge base in this way also come with risks. In his paper “Human Capital, Shared Expertise, and the Likelihood of Impasse in Corporate Acquisitions,” Russell Coff, an associate professor of organization and management at Emory University’s Goizueta Business School, analyzes the risks involved with acquisitions in human capital-intensive industries and explores whether a shared expertise between the two companies mitigates these hazards. “This paper looks at the dilemmas buyers have when they lack shared expertise,” explains Coff. “Buyers with similar expertise may be more adept at evaluating a knowledge-intensive target.”

Coff’s findings suggest that transactions involving unrelated buyers of human capital-intensive targets are less likely to close. Companies that want to diversify their services and build their knowledge base through acquisition, Coff says, need to recognize the hazards of their type of deal and work to safeguard against them.

There are many reasons buyers should be concerned about overbidding in these situations. One of the greatest hazards of buying a company for access to its human capital is the threat of talent turnover. How much less is an empty shell worth to the buyer [once key employees have left]?

The risk of overbidding also stems from the buyer’s ability to understand and, accordingly value, the target’s key assets – the people. New and dynamic technologies seem to drive today’s wildly fluctuating markets. Buyers must evaluate the target’s knowledge base and determine whether it is a winner or the modern equivalent of a buggy whip. Bidders risk overpaying, says Coff, when the target is hard to evaluate since they must rely on target management for information.

Buyers can respond to the risk of overpaying in two ways. “If you low-ball, either the target won’t like the price because it is unfair, or one of your rivals might see that the company is worth more and enter the bidding process,” explains Coff. “An alternative is to bid high and then do your best to understand the business through due diligence. Here, you are more likely to back out of the deal if you discover unanticipated risks – there is no buffer for such errors.”

Companies need not waste valuable time and resources targeting and wooing a human capital-intensive business if they evaluate the situation up-front and recognize the strength of shared expertise in either making or breaking the deal. “If a target is knowledge-intensive and you don’t share that type of knowledge, you’re in trouble. You risk either overpaying or the deal falling through,” explains Coff. “You’ve got to understand the people, know who will stay and who will go.”

Coff notes a complex effect of shared expertise. On one hand, says Coff, it may indicate whether the target management feels threatened by the buyer. In a deal where the companies share expertise, the buyer may be less dependent on the target’s management team once the transaction has closed. In other words, members of the target’s management team could well be out of a job if the acquisition succeeds. As a result, the target may resist the acquisition – reducing the likelihood that it will close.

On the other hand, related expertise can increase the likelihood that the transaction will close, says Coff. If the buyer has similar expertise, he says, “management may be in a relatively strong position to evaluate the target’s human capital and assess its synergy potential.” Related buyers may be better equipped to understand the nature of the target’s business.

Coff proposes that these opposing effects of related expertise can be reconciled by recognizing that related expertise is most likely to help close a deal for knowledge-intensive targets where related expertise is most critical in understanding the target. A savvy buyer who understands the business and the people to be acquired may also know how to avoid a management shakeup.

“Human Capital, Shared Expertise, and the Likelihood of Impasse in Corporate Acquisitions” is intended, says Coff, as a starting point for additional research. It has implications, he believes, for strategic management theory, such as resource-based theory and corporate diversification, which focuses on expertise, asymmetric information and capabilities in firms that are hard to imitate.

Coff’s findings also have important implications for managers. “Managers have a tendency to get very attached to a given acquisition,” explains Coff. “The risk of escalating commitment is high. If you find out a company is worth less than you thought, you had better back out. You haven’t failed or had a bad strategy.”

If a company does want to diversify into a new line of business, Coff says managers need to recognize the knowledge deficit and look for ways to fill it. One-time chemical giant Monsanto, which is now a biotechnology firm, gained experience in biotech over a 20-year period rather than jumping too quickly into this new field. “It built up its capability slowly and went through a learning process before throwing money at biotech,” explains Coff. By developing its internal biotech expertise, Monsanto could better understand potential takeover targets. This is a necessary strategy, says Coff, in a knowledge-based economy.