Working Paper: NBER ID: w10813
Authors: Ulrike Malmendier; Geoffrey Tate
Abstract: Overconfident CEOs over-estimate their ability to generate returns. Thus, on the margin, they undertake mergers that destroy value. They also perceive outside finance to be over-priced. We classify CEOs as overconfident when, despite their under-diversification, they hold options on company stock until expiration. We find that these CEOs are more acquisitive on average, particularly via diversifying deals. The effects are largest in firms with abundant cash and untapped debt capacity. Using press coverage as "confident" or "optimistic" to measure overconfidence confirms these results. We also find that the market reacts significantly more negatively to takeover bids by overconfident managers.
Keywords: CEO Overconfidence; Mergers and Acquisitions; Market Reaction
JEL Codes: G34; G14; G32; D80
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Overconfident CEOs (M12) | Increased likelihood of conducting mergers (G34) |
| Increased likelihood of conducting mergers (G34) | Negative market reactions (G19) |
| Overconfident CEOs (M12) | Value-destroying mergers (G34) |
| Financial conditions (E66) | Increased likelihood of conducting mergers (G34) |
| Overconfident CEOs (M12) | Overpay for acquisitions (G34) |
| Overpay for acquisitions (G34) | Negative market reactions (G19) |
| Overconfidence (D83) | Misperception of firm value and merger synergies (G34) |