Who makes acquisitions? CEO overconfidence and the market’s reaction. (2008)

“Overconfident CEOs over-estimate their ability to generate returns. As a result, they overpay for target companies and undertake value-destroying mergers. The effects are strongest if they have access to internal financing.

Malmendier, U., University of California, Berkeley
Tate, G., University of California at Los Angeles, Los Angeles

Journal of Financial Economics 89: 20-43.

Does CEO overconfidence help to explain merger decisions?

Overconfident CEOs over-estimate their ability to generate returns. As a result, they overpay for target companies and undertake value-destroying mergers. The effects are strongest if they have access to internal financing.

The authors test these predictions using two proxies for overconfidence: CEOs’ personal over-investment in their company and their press portrayal.

They find that the odds of making an acquisition are 65% higher if the CEO is classified as overconfident. The effect is largest if the merger is diversifying and does not require external financing.

The market reaction at merger announcement (-90 basis points) is significantly more negative than for non-overconfident CEOs (-12 basis points).

Access the full paper here: Who makes acquisitions? CEO overconfidence and the market’s reaction.