Measuring CEO overconfidence: Evidence from acquisitions


Research articles suggesting that individuals are affected by various behavioural biases, particularly overconfidence, have received significant attention from both psychologists and finance researchers since early hubris theory and numerous articles linked overconfidence with various corporate crises. Overconfidence is especially relevant in relation to outcomes individuals believe to have under their control, such as mergers and acquisitions. CEOs have significant influence over such high-risk decisions and are actively involved in their process. In fact, CEO overconfidence has been established as one of the most common explanations behind value destruction in acquisitions.

A particular challenge, in research terms, is the lack of direct measurement when collecting data for CEOs. Given this limitation, researchers have developed several measures from secondary data to assess executive overconfidence. The most used measures of managerial overconfidence are CEO stock options, the number of press articles in leading business publications describing the manager as “confident/optimistic”, excessive compensation, acquirers involved in serial deals in a very short period, and premiums paid for target firms in mergers and acquisitions.

A recent study (Ismail and Mavis, 2022) proposes an alternative measure of CEO overconfidence directly related to the event in question (i.e., acquisition). It establishes a direct comparison between a forecast regarding operating synergies made by the CEO prior to the deal and the actual realised operating synergies after the acquisition deal in what is termed the synergies forecast error (SFE). The higher the forecasted synergies relative to the actual synergies the more overconfident the CEO is. Applied to the forecasted synergies for each deal from the U.S. Securities and Exchange Commission, the study offers a direct measurement method of CEO overconfidence, directly linking to the corporate decision in question using the CEO's estimations of synergies toward a specific deal, rather than outsiders' views. The forecasted operating synergies are subsequently assessed against the actual realised operating synergies; in other words, generated synergies approve or disapprove estimated-forecasted synergies made by the CEOs themselves.

Using this new measure of CEO overconfidence (SFE), research suggests that overconfident CEOs pay higher takeover premiums and destroy more value for the acquiring firm. More specifically, CEOs with higher SFE are shown to translate this into $294.29 million value destruction for the average acquiring firm in the sample, incur higher capital expenditures, generate equity issues, and lead to lower levels of innovation.

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