Darryl Laws

 Their model is binary because there are two kinds of variation that they use to identify the effect of overconfidence on acquisitiveness, cross-sectional and within-company variation. Malmendier and Tate (2008) solve their regression equation using three estimation procedures: 1) a logit regression, makes use of both types of variation, 2) a logit regression with random effects, also makes use of both types of variation but, it explicitly models the effect of the firm, rather than the CEO, on acquisitiveness. I noted that if the estimated effects of overconfidence in the logit equation are due to company effects, they should expect to see a decline in their estimates if they include random effects. The remainder of their solution uses a logit regression with fixed effects. This regression equation makes use only of the second type of variation, the effect of overconfidence on acquisitiveness using only variation between overconfident and rational CEOs within a particular firm. For the estimate of the fixed effects model they use conditional logit. 

Weakness. Deviance is closely related to the log likelihood (-2LL). To my surprise Malmendier and Tate (2008) did not calculate the coefficients of the fixed effects themselves to obtain consistent estimates of the remaining coefficients. According to Malmendier and Tate (2008) the fixed effects approach eliminates any time invariant company effect on average acquisitiveness. My opinion is that this is a weakness in their model. It introduces sample selection bias. Only firms that conduct at least one merger during the sample period and that had at least one overconfident and one non-overconfident CEO are included in their fixed-effects estimation. In so doing the sample size of the number of firms is reduced to 184 companies when they change from the logit to a fixed effects logit  model. 

Model for Acquisition Decision of an Overconfident CEO. An overconfident CEO overestimates the future value in his company’s stock that he can generate. Their model, overconfidence implies bVA > VA and bV (c) − V (c) > bVA − VA for some cash payment c. As a result, the value of a merger to an overconfident manager depends on the means of financing. In particular, an overconfident manager perceives a cost to financing with undervalued shares. Since the target shareholders, like the capital markets, believe that the merged company will be worth V (c), they demand a share s of the merged company such that sV (c) = VT − c. Whenever bV (c) > V (c), the acquiring CEO believes that issuing new equity entails a loss to current shareholders of ( VT −cV (c) − VT −c􀁥 V (c) )bV (c). He undertakes the merger despite this perceived cost if he believes the value of the diluted shares in the merged company to A’s current shareholders is greater than the value of A forsaking the merger. That is, he undertakes the merger if and only if (1 − s)bV (c) > bVA for some c ≤ ¯c. Substituting for s, he acquires Tiff bV (c) − (VT − c) − [ 􀁥 V (c)−V (c)](VT −c) V (c) > bVA for some c.