Darryl Laws

 Introduction. The biggest challenge for the analysis of CEO overconfidence is; “How to construct a plausible measure of overconfidence?” Biased beliefs naturally defy direct and precise measurement (Malmendier and Tate, 2004). Malmendier and Tate’s (2004) previous work proposes two approaches to measurement; 1) the first is a revealed beliefs argument. They infer CEOs’ beliefs about the future performance of the company from their personal portfolio of stock options transactions, (incentive compensation), 2) the second approach captures how outsiders, the public and press, perceive the CEO. They classify CEOs as overconfident based on their portrayal in the press. This measure was proposed by Malmendier and Tate in 2005, builds on the perception of outsiders. The authors conducted a study of Forbes 500 companies which was comprised of their collecting data on how the press portrays each of the CEOs during a sample period 1980 to 1994. They search articles referring to the CEOs in The New York Times, Business Week, Financial Times, The Economist and The Wall Street Journal. For each CEO and sample year, they recorded the number of articles containing the words confident or confidence; the number of articles containing the words optimistic or optimism; and the number of articles containing the words ‘reliable’, cautious, conservative, practical, frugal, or steady. Then they hand-checked the terms that were used to describe the CEO in question describing the CEO as not confident or not optimistic. They then constructed an indicator, TOTAL dummy, equal to 1 if a CEO is more often described as confident and optimistic or as reliable, cautious, conservative, practical, frugal, or steady. They found that This alternative indicator of CEO confidence is significantly positively correlated with their portfolio measures.

Mergers and Acquisitions. Literature on mergers and acquisitions identifies three main motivations for takeovers; first the creation of synergies so that the value of a new combined entity is greater than the sum of its previously separate values (Bradley,1988; Dyer, 2004 and Tease, 1986), the second motivation exists because of agency issues (Eisenhardt, 1989) between managers and shareholders. Jensen (1986) suggests that managers may rationally pursue their own objectives at the expense of shareholder’s interests, and the third motivation for takeovers is managerial hubris (Roll, 1986) and behavioral bias. Roll’s hubris hypothesis suggests that managers of acquiring firms make valuation errors because they are too optimistic about the potential of combined synergies in a buyout or takeover. As a result, CEOs often overbid for target firms to the detriment of their stockholders.

Darryl Laws