Darryl Laws

 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 relationship between the stockholders and the CEO / managers of a merger and acquisition transaction fits within this definition of a pure agency relationship, it should come as no surprise to discover that the issues associated with the separation of ownership and control in today’s business environment. Many reasons can be realized for the disappointing outcome of an acquisition. A negative return to stockholders in acquiring firms could be researched by agency costs: that is, the manager of acquiring firms favor takeovers because their power, wealth and status are increased. Behavior of Such a manager may be deemed to be rational but is not necessarily in the interests of the stockholders.

Behavioral biases. A negative return to the acquirer’s stockholders often can be explained by hubris accompanied by overconfidence on the part of the CEO of the acquiring firm. This explanation suggests that the CEO may sincerely believe that a merger is in the best interests of the stockholders but that this belief is not rationally based. Apart from hubris bias, there are several other biases which may be prevalent in CEO’s undertaking a merger and acquisition transaction. This has been a lacuna in much of the present research studies to explain erratic acquisitions which diminish shareholders’ value. 

From a practitioner’s perspective the following biases can provide a fresh look at behavior of CEO’s apart from agency and hubris studies conducted till date in acquisition literature.

Darryl Laws