Darryl Laws

 Who Makes Acquisitions? CEO Overconfidence and The Market’s Reaction.  Ulrike Malmendier and Geoffrey Tate, 2008, Journal of Financial Economics, Elsevier

Abstract. Overconfident CEOs over-estimate their ability in numerous ways. One of which is their over estimation to generate returns (ROE, cash dividends) to their companies. Often, they undertake mergers or acquisitions that destroy their own company’s value. Overconfident CEOs often perceive outside financing cost to be over-priced.  Malmendier and Tate (2008) classify CEOs as overconfident when they hold their options in their own company’s stock until expiration. The authors find; 1) that these CEOs are more acquisitive on average, particularly via diversifying acquisitions transactions which are not germane to their core business, 2) the effects are more ostensible on firms with abundant cash and untapped debt capacity, 3) that the measure of overconfidence used, media (press) coverage as confident or optimistic to measure overconfidence, confirms their results. Further, the authors found that the capital markets react significantly more negatively to takeover bids by overconfident CEOs.

Mergers and acquisitions are among the most significant and disruptive activities undertaken by large corporations. The staggering economic magnitude of these deals has inspired a significant research on their causes and consequences. Most theories focus on the efficiency gains that motivate takeover activity. Empirical results on returns attributed to mergers / acquisitions are mixed. This suggest that mergers / acquisitions may not create value on average. Moreover, gains from mergers / acquisitions do not appear to accrue to the shareholders of the acquiring company. By way of the process typically there is a significant positive gain in a target company’s value once an announcement of a bid has been made or a form 13-D is filed with the U.S. Securities Exchange denoting that the filer has aggregated more than five percent of the shares in a public company. More often there is a significant loss in value of the acquiror’s company stock. These findings suggest that mergers / acquisitions are often not in the interest of the shareholders of the acquiring company.

Google Scholar references the Malmendier and Tate’s (2008) article as having been cited 2,528 times by other authors of which approximately 250 are citations contained in FT50 top ranked publications. By way of example, Who Makes Acquisitions? CEO Overconfidence and the Market’s Reaction has been cited in: The Journal of Finance and Journal of Financial economics more than fifty times and in excess of 379 times in various economic publications. (EconPapers Citations). 

  I chose this particular article to review because the topic aligns with my dissertation research topic; What causes irrational human behavior in mergers and acquisitions and to what economic extent does these behaviors impact the premium price paid / sold for the acquisition?  The author’s two independent variables that are relative to my research question are: CEO overconfidence and CEO hubris. Furthermore, their article fits the academic paper selection criteria because it uses a binary logistic regression method as the main empirical methodology to look at the impact on the dependant variable, the premium price paid for acquiring companies. 

Darryl Laws