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 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...