Bidder Hubris and Founder Targets

The literature on mergers and acquisitions, starting with Roll (1986) has often addressed the issue of managerial hubris leading to overpayment in acquisitions. For example, the observation of statistically and economically significant negative bidder returns for public bidder acquisitions is frequently attributed to the winner’s curse, managerial overconfidence, and thus overpayment. However, in our paper, Bidder Hubris and Founder Targets, which was recently made publicly available on SSRN, we argue that positive bidder gains are not necessarily inconsistent with overpayment, nor are negative bidder returns always a direct consequence of overpayment.

Insofar as managerial hubris leads to overpayment in acquisitions, it is important to note that this overconfidence derives from two non-mutually exclusive sources: (i) the target’s stand-alone value under bidder’s control is overestimated or (ii) synergies from the combined entity are overestimated. To the best of our knowledge, this is the first paper that tries to disentangle these two factors, while not relying on proxies for overconfidence or focusing exclusively on average bidder gains as evidence of managerial hubris. In this paper, we provide a unique test of the first source of overpayment by isolating a part of the target’s ex-ante value that is attributable to a founder CEO and relating this to bidder gains.

We show that target firms exhibit a significant founder CEO effect similar to those shown in the literature for generic firms analyzed with panel data. Using an endogenous switching model, we show that firm-level measures of the founder effect, which can be interpreted as the value of the founder’s human capital, exhibit a strong negative correlation with bidder gains and with total gains (synergy returns). Our method allows us to separate high target values per se from high target values that are explicitly due to the presence of a founder CEO. Our evidence is consistent with hubris-infected bidders underestimating the value of this specialized resource in the target firm, which is likely to undergo a significant decline after the acquisition, and consequently overestimating the value of the target as a stand-alone firm under the bidder’s control.

Surprisingly, we find no evidence of a difference in the relation between the value of the target firm’s founder human capital and bidder gains on the basis of whether the CEO is retained or not by the bidder after the acquisition. This may imply that the market is skeptical about the contribution of a founder CEO after an acquisition even if he is retained by the bidder. Finally, we find no evidence suggesting that founder CEOs have more bargaining power and appropriate a larger share of the total gains.

The full paper is available for download here.