MERGERS, ACQUISITIONS, HUBRIS AND BEHAVIOURAL CORPORATE FINANCE
Over 30 years ago, academics began to document the degree to which merger and acquisition (M&A) activity destroyed value. In this regard, Richard Roll wrote a seminal article on this theme which he titled ‘The Hubris Hypothesis of Corporate Takeovers’. According to the hubris hypothesis, hubris on the part of acquiring firms’ executives and boards induces them to overpay for targets, a phenomenon known as “the winner’s curse”.
Hubris is a psychological trait, and for this reason Roll’s hubris hypothesis forms part of behavioural corporate finance, a subfield which focuses on the role that psychology plays in corporate financial decisions.
Sceptics of behavioural finance sometimes argue that the behavioural approach is flawed because people eventually learn. It is true that people can learn. However, oftentimes that learning is slow and painful, which speaks to the importance of appreciating the behavioural approach.
Even though more than three decades have passed since Roll introduced the hubris hypothesis, readers will still find many articles discussing the major reasons why most M&A activity results in failure.
Besides hubris, there is a virtual laundry list of items that characterise failed M&A. The list includes: (i) adverse selection stemming from the additional knowledge that target firms’ executives and boards have about their own intrinsic value relative to that held by the executives and boards of acquirers; (ii) executives having personal interests that are at odds with value maximisation; (iii) biased estimates of integration costs; (iv) disparate corporate culture; (v) errors in negotiation; and (vi) difficulties predicting changes in external circumstances. That said, hubris dominates the list because hubris prevents corporate leaders from taking full account of the others.
Oct-Dec 2019 Issue
Santa Clara University