Darryl Laws

 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 compared to its peers or to a rival bid (Allen and Morris, 1998).

Confirmation bias. In psychology and cognitive science, confirmation bias (or confirmatory bias) is a tendency to search for or interpret information in a way that confirms one’s preconceptions, leading to statistical errors. Confirmation bias is a type of cognitive bias and represents an error of inductive inference toward confirmation. It can also be viewed as a hubris related judgment bias in which strategy design lies in a subconscious resistance to critically testing hypotheses. Seeing only what we want to see is labeled ‘confirmation biases (Fredrickson and Mitchell, 1984). Experiments show we tend to seek confirmatory data and opinions, which leads on to systematic overconfidence in favored hypotheses. This type of general bias: investing more energy into looking for evidence that supports a hypothesis than into seeking signals that might contradict it. Confirmation and overconfidence in strategy can also partly result from (or reinforced by) other biases, such as group thinking. Group processes are sensitive to joint confirmation bias (Finkelstein, 1993).

Availability bias. Availability bias is when confronted with a decision in an merger / acquisition transaction, the CEO is influenced by what is personally relevant, salient, recent or dramatic (Staw, 1976). Put another way, the CEO estimates the probability of a merger or acquisition based on how easy that outcome is imagined. For instance, availability bias can result in CEO’s more attention to stocks covered heavily by the media, while the availability of information on a stock influences his tendency to perform a merger / acquisition. Market prices can deviate from fundamental value (e.g. the Internet’s dot.com bubble effect on financial markets during early 2000). Given the vulnerability of financial market valuations to environmental turbulences, unless a particular target has unique strategic value or offers significant synergies with the acquiring company, buyers would be well warned to assess critically the validity of comparable or relative valuations (Bruner, 2004).

Darryl Laws