Darryl Laws

 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 approaches to resolve bargaining problems: axiomatic or strategic. The axiomatic approach (co-operative theory) assists by providing a set of valuable axioms. On the other hand, the strategic dominant approach model depicts outcomes in a non-co-operative game in a M&A context. Mergers and acquisitions fall under the premise of zero sum or non-cooperative two player game.

The two-person merger / acquisition model is an incomplete information game between the acquirer and the target (seller), where both players must agree to a price that will be suitable to them for the sale of the target company to the acquirer and behavior, rational and irrational will manifest itself. The Prisoner’s Dilemma game structure is ideally suited to model the effects of irrational behavior emotions this depicted: greed, fear and overconfidence during the strategic decision-making process. The players have to choose between the option to cooperate or not-cooperate with the other player, based on the known payoff matrix of both players. The frequency of cooperation and non-cooperation becomes empirical knowledge with the changing payoff structure in the one-shot prisoner’s dilemma game (Table 1). The game theory model of behavioral interaction can be presented in two parts; first, to measure of greed and fear in strategic decision-making and second is to measure overconfidence in strategic decision-making. Note: in prisoner dilemma games, not co-operate is the dominant strategy.

A game theory modeler can easily operationalized greed, fear and overconfidence by using the following prisoner’s dilemma model in Table II in which: S = satisfactory, L = Loss, G = gain and H = happy. Where, G > H > S > L, shown in the Table II.