Darryl Laws

 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). It is important to capture not only the extent of CEO irrational behaviors such as overconfidence (hubris) but also the effect of CEO behavioral biases which is the ability of the CEO to impose his or her overconfident views on the decisions of the firm (Scharfstein and Stein, 1990). The concept was first posited by Hambrick and Mason (1984) as Upper Echelon Theory.

Managerial / agency costs and behavioral bias may be more likely to occur in the case of diversifying acquisitions. Morck (1990) finds that a significant negative abnormal return accrues to bidding firms upon the announcement of a diversifying acquisition. Maquiera (1998) and Bhagat (1990) provide further empirical evidence that acquiring firm stockholders gain less from diversifying acquisitions than from non-diversifying acquisitions. In addition, there is evidence that diversified firms trade at a discount to stand-alone entities in the same line of business. The existence of a diversification discount has often been interpreted as evidence that diversify- cation destroys value. Scharfstein and Stein (2000) suggest that there may be increased agency costs in diversified firms. Findings on the diversification discount have been the subject of a debate that was summarized by Martin and Sayrak (2003). Diversifying acquisitions have, therefore, been linked to the existence of agency costs as diversification may benefit managers (Morck, 1990), and to the existence of managerial overconfidence. Behavioral researchers have identified a tendency of managers to consider themselves above average on positive characteristics (Haleblian and Finkelstein, 1993). This may lead executives to be overly optimistic about their assessments of integration plans, change their ability to appropriate targets and scenarios to realize synergies, and thus to over value targets. This overconfidence goes hand-in-hand with over optimism and illusions of control, where uncertainty in extraneous factors or strategic uncertainty is underestimated (Langer, 1975). These tendencies tend to lead to systematic executive overconfidence in an

acquisition situation, resulting in CEOs / managers selecting due diligence evidence that confirms and supports their proposed acquisitions. Actively seeking and evaluating discounting information and factoring such data into their calculations, would minimize the risk of confirmation bias. ‘Group think’ situations can lead to collective overconfidence reinforcing the unwarranted acceptance of confirmatory evidence and disregard for any contradictions, as well as to the danger of shareholders becoming polarized.

Darryl Laws