It Takes Two to Tango: Overpayment and Value Destruction in M&A Deals

This study adds to the literature demonstrating the adverse market reaction to acquisitions by overconfident CEOs (e.g., Malmendier and Tate, 2008). In particular, it explores the parallel role played by overconfident target firm CEOs in explaining the premium paid, and value destruction in such deals, and, most importantly, the “perfect storm” of the interaction between the two overconfident parties. Our results indicate that overconfident CEOs tend to pay a higher premium in acquisitions than their non-overconfident counterparts. However, the premium paid when both acquiring firm and target firm CEOs are overconfident is between 7% to 9% higher than if neither, or only one, side of the deal manifests such behavioral bias. We also show how the adverse market reaction to deals by overconfident acquirers is augmented when target firm CEOs are similarly prone to this judgmental bias. In particular, we report how when both acquiring and target firm CEO overconfidence exist concurrently, the market marks down the acquirer‟s share price on bid announcement by around 11% to 12% compared with deals where neither, or only one, party is overconfident. It is the danse macabre of overconfident acquirer and target firm CEOs that seems to lead to the greatest overpayment and loss of shareholder value in takeovers. Our results suggest that the interaction between acquirer and target firm overconfidence may provide a possible explanation for the overpayment problem, well rehearsed in the finance literature, and, in particular, help to explain the most value destructive deals.