CEO Overconfidence and International Merger and Acquisition Activity

In the paper, CEO Overconfidence and International Merger and Acquisition Activity, forthcoming in the Journal of Financial and Quantitative Analysis, we examine the role that CEO overconfidence plays in an explanation of international mergers and acquisitions during the period 2000-2006. Although the causes and performance of mergers have been extensively examined in the literature, few studies focus on the overconfidence of CEOs and managers as a factor in explaining merger activity. In the few studies that do, virtually none examines the effect that overconfidence might have on international merger and acquisition activities. Indeed, existing studies examine overconfidence in the context of U.S. mergers and ignore its international characteristics. Because managerial overconfidence is shaped in part by national cultures, we expect that the dispersion of overconfidence among CEOs will vary across the globe. As noted by La Porta et al. (1998, 1999, 2000), Stulz and Williamson (2003), Doidge, Karolyi, and Stulz (2007), and Griffin et al. (2009), national culture involves dimensions such as language, religion, and legal heritage. These factors can be expected to influence the extent to which overconfidence affects managerial decision-making. Consequently, national cultures are likely to be important for an understanding of how overconfidence is related to global merger activity.

In this study, we ask two fundamental research questions concerning overconfidence and international merger activity. The first focuses on whether there exist country or country group patterns in the distribution of CEO overconfidence. Comparable legal systems and national cultures or shared standards of business practices might produce similarities in managerial decision-making as we examine our sample of international mergers.

Our second question investigates whether the results reported by Malmendier and Tate (2008) regarding U.S. mergers by overconfident managers hold internationally and focuses on how overconfident managers conduct their mergers. Do overconfident CEOs make more acquisition offers than their less confident counterparts? Do overconfident CEOs acquire targets that are more frequently outside of their firm’s core business than other CEOs? Do overconfident CEOs finance their acquisitions differently from other CEOs? Given significant international differences in the regulation of corporate merger activity and the availability of capital to support acquisitions, it is uncertain whether the results reported for the U.S. apply to the broader set of global mergers.

For a sample of mergers involving the Fortune Global 500 firms over the period 2000-2006, we document a number of demographic and country patterns in the global distribution of overconfident CEOs. We determine that overconfidence is most commonly observed in CEOs leading firms head-quartered in Christian countries. We also find that the Hofstede measures of national culture help to explain geographical patterns in the dispersion of overconfident CEOs. Specifically, we discover that individualism positively influences the likelihood that a CEO will be overconfident. CEOs operating in countries whose cultures emphasize a long-term orientation tend to be less overconfident. We conclude that CEO overconfidence is an international phenomenon, although there are distinct patterns in its global distribution.

This study also shows that overconfidence is related to different aspects of merger activity. We find that overconfidence is an important factor in explaining the number of offers made by a CEO. This result is robust even after controlling for firm size, the availability of internal resources, firm’s investment opportunities, and total press mentions about the CEO. We confirm that overconfidence is a significant influence in the decision by CEOs to acquire an unrelated target and this appears to be a global phenomenon. We also determine that overconfidence’s role in selecting the deal’s financing method is robust and holds for both U.S. and international mergers. Specifically, we find that overconfident CEOs prefer cash for acquiring a target because of their general belief that their firm’s equity is undervalued.

We conclude from our empirical analysis that overconfidence is a factor in the global market for corporate acquisitions. It is not a solely a U.S. or western European phenomenon. The presence of CEO overconfidence in the international merger market indicates that behavioral considerations might occupy an increasing importance in our understanding of executive decision-making and the nature of agency conflict within the firm. Our findings also contribute to the growing, but still immature literature establishing the importance of human psychological characteristics in understanding corporate decision-making.

The full paper is available for download here.