Darryl Laws

  Part I. Modeling greed and fear. There are two cognitive behaviors playing a part in the decision at one-shot prisoner’s dilemma game on the protagonist (any one of the two players) mind: (1) If player 2 cooperates and player 1 does not cooperate the gain received is (G− H), symbolizing GREED . (2) If player 2 does not cooperate and player 1 cooperates the loss is (S−L) which symbolizes FEAR . Similar models with different pay offs can be utilized to understand the variations of  GREED by changing the “L” (loss) and “G” (gain). Part 2. Modeling overconfidence. The experiment can be conducted on a new set of players to reduce any bias from the previous game. The underlying logic is that if a sense of comparative self-esteem is established among the new players, they will become more confident and show an overconfident cognitive behavior. To start I would note the payoff response to Player 1 at the end of game displayed in Table 1 followed by administering a short aptitude te...

  It is well known in the game theory that rational behavior of rational people can lead to collective irrationality, which gives rise to the argument that the solution to the conflict between individual rationality and collective rationality does not lie in the denying of individual rationality, but instead in the designing of a mechanism in order to reach collective rationality based on individual rationality (Zhang, 1996). Game theory modeling provides an insight into strategic human behavior interaction, rational and irrational, during in merger / acquisition negotiations of transactions with significant economic  outcomes. Contemporary game theory has two forms: non-co-operative game theory (Nash 1951) and co-operative game theory (Von Neumann and Morgenstern 1944; Shapley 1953; Shapley 1977; Shapley and Shubik 1954; Luce and Raiffa 1957; Aumann and Drèze 1974; Myerson 1977). Von Neumann and Morgenstern (1944) and Nash (1950; 1951) have suggested two game theory approache...

  Each participant will possess more than fifteen (15) years mergers and acquisitions experience in his / her respective filed of: M&A law, M&A corporate finance, M&A transactional structuring and mergers and acquisitions negotiation tactics and strategies with firsthand experience in working with and dealing with irrational human behaviors such as CEO overconfidence and exuberance. When conducting the five (5)  interviews the researcher will use a non-participant style as such as not to influence verbal responses and non-verbal reactions to open-ended questions. Directive input will only be used IF the researcher requires greater clarity to a response provided that the interviewee(s) is willing. The researcher will field test a sample questionnaire with several of his own private equity fund’s managing directors in order to ascertain whether or not the questions constructed for use in the study are situationally relevant and to ensure that the data extracted from ...

  Methodology design and methodology selection justification. John Criswell’s 5 th edition of Research Design, Qualitative, Quantitative and Mixed Methods Approaches, (2018), pgs. 13 and 122, Creswell states that qualitative designs using grounded theory is inquiry in which the researcher derives an abstract theory ground in the view of participants and further indicates that this process involves multiple stages of data collection and refinement of the interrelationships of the categories of information. He cites Charmaz 2006; Corbin & Strauss 2015. In compliment on Creswell (2018) states (pg. 122) that a quantitative purpose statement begins with identifying the proposed major variables in a study (independent, intervening, dependent) and their relationship, the participants and the research site; thus my selection of the use of a convergent mixed methods research design (Creswell, 2018, pg. 218-219) is appropriate to gain the valuable insight of practitioners using qualitat...

  20 / 20 Hindsight bias. 20 / 20 Hindsight bias, or alternatively they knew it-all-along effect and creeping determinism, is the inclination to see events that have already occurred as being more predictable than they were before they took place. It is a multifaceted phenomenon that can affect different stages of designs, processes, contexts, and situations. Hindsight bias may cause memory distortion, where the recollection and reconstruction of content can lead to false theoretical outcomes. It has been suggested that the effect can cause extreme methodological problems while trying to analyze, understand, and interpret results in M&A activities. A basic example of the hindsight bias is when a CEO believes that after viewing the outcome of a potentially unattractive merger that they knew it all along. Risk aversion. Aversion to losses is a central feature of prospect theory . Prospect theory is based on experimental evidence, of how people evaluate risk, Kateeinan and Tversk...

  Escalation of commitment / a.k.a. sunk cost fallacy. Escalation of commitment refers to the psychological condition whereby people continue to support or believe in something that is repetitively failing. In managerial decision-making escalation of commitment can refer to either continuing with a high-priced M&A bid. It may also refer to overestimating one’s own managerial capacity or ability. This is an extension of problem solving where the CEO does not accept they do not have a solution or they have to let go. With escalation of commitment there is a compulsion to not let go. Escalation of commitment was first described by Barry M. Staw (1976) in his article, Knee deep in the big muddy: A study of escalating commitment to a chosen course of action . More recently the term sunk cost fallacy has been used to describe the phenomenon where CEO justify increased investment in a merger / acquisition based on the cumulative prior investment, despite new evidence suggesting that ...

  Winner’s curse. Originally this euphemism was coined by oil companies bidding for offshore oil rights in the Gulf of Mexico,   the winner’s curses is a tendency for the winning bid in an acquisition to exceed the intrinsic value of the target company purchased is quite prevalent. Because of incomplete information, emotions or any other number of factors regarding the target company being acquired, bidders can have a difficult time determining the target’s intrinsic value. As a result, the largest overestimation of a firm’s value ends up winning the auction. When several bidders compete for the acquisition of the same target company, they may not know the target’s exact value. Where good  information in regard to the target company’s value is difficult to come by, or just uncertain, bidders are obliged to fall back on trying to estimate its value independently. When the company is worth the same to all bidders, the only thing that  distinguishes them will be their r...

  Anchoring bias. Anchoring is a term used to describe manager’s tendency to rely too heavily, or anchor on one trait or piece of information when making decisions. During normal decision-making in M&A transactions, individuals anchor, or overly rely, on specific information or a specific value and then adjust to that value to account for other elements of the acquisition that may have negative effects on the M&A’s success. An example. If an executive supported by advisors have to decide an offer price on a target. They may start from the basis of prices paid for similar companies, and then use multiples [e.g., enterprise value to EBITDA and Price/Earnings multiples] as their basis for refining their valuation of the company, rather than considering how well the target company and its strategy fit into the bidding company’s growth strategy. The valuation may suffer from related biases of representativeness, where the valuation is overly dependent on relative valuation compa...

  Some CEOs, however, do exactly the opposite. They hold options that are well “in the money” and buy, rather than sell, company stock. These CEOs bet their personal wealth on future company stock performance. One way to potentially measure overconfidence, then, is to look at CEOs who hold options beyond rational thresholds. Calibrations of the Hall and Murphy (2002) model (with CRRA utility, risk aversion of 3, and 67% of wealth in company stock) would suggest exercise entering the final year of duration when the option value exceeds 40%. The median option held to expiration is in excess of 200% in the money. Alternatively, we look at a common year beyond the vesting period for all of the options in our sample (year 5). Here, Malmendier and Tate use the Hall and Murphy model to calibrate a range of rational thresholds for exercise (varying risk aversion and diversification). Then, Malmendier and Tate (2005) consider a sub-sample of CEOs with options beyond these benchmarks and com...

  CEO Hubris / overconfidence bias. CEO hubris is generally defined as a CEO’s exaggerated self-confidence or pride. Prior research has studied the impacts of CEO hubris or overconfidence on firm decisions and outcomes including acquisition premiums (Hayward and Hambrick, 1997), investment distortion and venture failure (Hayward et al., 2006). The findings generally suggest that firms with overconfident CEOs pay higher premiums for acquisitions, rely on internal rather than external financing, miss their own forecasts of earnings, and often undertake more value-destroying mergers. Empirical evidence has shown that CEOs tend to be overconfident. This factor can be particularly true and tempting in the kind of environment that typically surrounds highly successful executives who may have already executed a string of accretive value transactions. This is managerial hubris, an unrealistic belief held by the bidding company’s managers that they can manage the assets of a target company...

  Agency Relationships. Many problems associated with the inadequacy of agency relationships, specifically irrational behavior of CEOs occurs in merger and acquisition transactions. Agency relationship is defined as condition under which one or more owners (the principal(s) engage managers (the agent) to perform a service on their behalf which involves delegating decision-making authority to the agent (Hill and Jones, 1992). If both parties to the relationship have the aim to maximize utility, the agent will not always act in the best interests of the principal. The principal can establish appropriate incentives for the agent and thus incur monitoring costs to limit the divergent activities of the agent. In most agency relationships the principal and the agent will incur positive monitoring and bonding costs, and in addition there will be some divergence between the agent’s decisions and those decisions which would maximize the welfare of the principal (Jensen, 1986). Since the rel...

  In the real world of uncertainty,  competitiveness, macro-economic change or competitor pre-emption may render apparently realistic targets unavailable or unattractively expensive (Bradley, 1988; Fredrickson & Mitchell, 1984). All management teams face the same dilemmas when making takeover decisions, any target carries the risk of overpayment, which may be founded on unconscious irrational justifications, such as an over-optimistic expectation of combined synergies or growth opportunities or becoming trapped in an escalating bidding contest (Ansoff , 1965). Underbidding, failing to pay the price required to secure a critical target may result from framing the opportunity in isolation by failing to recognize new growth options and to fully appreciate the value of a target as part of a larger consolidation strategy (Harford, 2005; Jensen, 1986). Research suggests that overconfident managers are more likely than other managers to destroy value (Smit & Moraitis, 2010)....

  Mergers and Acquisitions. There are mainly two sublevels in micro level analysis, of which one is concerned with the behavioral analysis about M&A transaction motives and M&A performances, and the other is concerned with the driving factors upon both sides of the M&A enterprises in the capital market, and the effect analysis of the M&A mechanism on the reallocation of resources. However, both the macro- and micro level analysis eventually traces back to the analysis of the microstructure, as the M&A objective is on the enterprise, and the buyer’s research fundamentally aims to analyze the problem of individual enterprise’s utility maximization, output maximization, cost minimization or profit maximization  (Andrade, Mitchell, and Stafford, 2001). Thus, the M&A decision is a micro-economic decision. In sum, theories for M&A include the management synergy theory, the different efficiency theory, the scale economy theory, the scale effect hypothesis,...

  The ‘better than average’ effect also affects the attribution of causality. Because individuals expect their behavior to produce success, they attribute outcomes to their actions when they succeed and to bad luck when they fail (Miller and Ross, 1975; Feather and Simon, 1971). This self-serving attribution of outcomes reinforces overconfidence. They find that overconfident CEOs are more likely to pursue acquisitions when their firms have abundant internal resources. They further report that overconfident CEOs are significantly more likely than other CEOs to undertake a diversifying merger. Finally, they observe that overconfident CEOs use cash to finance their mergers more often than other CEOs who leverage their company’s stock as if it were a check book. Malmendier and Tate (2008) examine the extent to which overconfidence can help to explain merger decisions and various characteristics of the deal itself. They find that overconfident CEOs are more likely to pursue acquisitions...

  Overconfidence bias . Overconfident decisions often indicate a loss of contact with reality and an overestimation of one’s own competence or capabilities, especially when the person exhibiting it is in a position of power. One of the most interesting facts that I have observed in thirty-five years of professional experience in mergers and acquisitions is that those individuals whose intellectual and interpersonal capability are the  weakest are most likely to overestimate their ability and performance. They are very likely to have confirmation biases in their decisions where they seek out information that reaffirms their choice. Example; behavioral corporate finance studies show that start-up entrepreneurs usually have overly optimistic views of their venture’s potential for success and an idealistic perspective of its enterprise value. Doukas and Petmezas (2007) argue that managerial overconfidence results from a self-attribution bias. Specifically, overconfident CEOs feel ...

  What are the factors that influence or cause irrational behavior?  Greed. “ Opportunistic behavior that is self-serving has been the central idea of agency theory in M&A transaction which states that agents (hired managers) and principal’s (owner) objectives do not match and agents make decision which are based on self-interest rather than company shareholder’s interest. This type of greedy decision is self- serving and is irrational for the firm” (Dhir, Mital, 2012). The information available to the agent / manger may be complete, but the decision is not in the interest of the firm. Greed may be for monetary or nonmonetary benefits and thus principals can both provide incentives (and incur agency cost) or apply a controlling mechanism (which incurs agency cost) to the agents / managers to do away with greedy decisions and ensure normative decision-making by its managers / agents. “Studies depict that managers / agents with high self-esteem (nonmonetary greed?) are more ...

  Methodology for conducting literature search for review.  The vast majority of the research papers that I selected were found using Google Scholar to find specific authors whom were listed in the respective bibliographies of papers which were designated as course readings. Example. Global Business and the Economics of Information (EDBA 798 C1 & C2), Prof. David Smith assigned an article written by Prof. Vincent P. Crawford; entitled New Directions for Modeling Strategic Behavior: Game Theory Models of Communication, Coordination and Cooperation in Economic Relationships (2016) that gave me the inspiration to tackle the topic of  behavioral economics and game theory. The refence list in Professor Crawford’s paper led me to articles by: Robert Aumann, Matthais Blodenski, Prof. Gary Charness, Prof. Prof. David Cooper and Prof. John Nash amongst others. I then turned to accessing articles online via the various platforms associated with the Pepperdine library, SCOPUS, ...

  Problem statement. Aside from the fact that there are significant gaps in the literature currently available addressing irrational human behavior and its impact on decision-making processes during mergers and acquisitions process, there is an plethora of literature written that is focused upon CEO overconfidence and his / her impact upon the company’s board of directors and or “the market’s” reaction to CEO decisions and not upon the various behaviors that have cause and effect upon the economic outcomes in mergers and acquisition transactions. Examples of these articles that I read are; Who Makes Acquisitions? CEO Overconfidence and the Market’s Reaction  (2004) and Behavioral CEO: The Role of Managerial Overconfidence (2015), both papers written by Malmendier and Tate. Thus, there is a need to extend the topic so that mergers and acquisitions industry practitioners; M&A lawyers, M&A investment bankers, private equity buyout fund managers and corporate CEOs have a b...