Roll proposed a fascinating hypothesis about takeover motives. He believed that hubris has a role in explaining takeovers. It refers to the pride of the administrators in the acquiring firm. This hypothesis states that administrators and managers want to acquire firms for their self-interest and that the pure economic advancement to the acquiring firm is not the only intent or even the dominant motive in the acquisition.
Along with other researchers, Roll used the hypothesis to understand the reason behind managers paying a lot for a firm that the market has already valued. Managers would rather lay their own valuation over one that is accurately and objectively determined by the market.
According to them the pride of the management lets them believe that their own valuation is a cut above the markets. This hypothesis implicitly shows that the efficient market can provide the best indicator of the firm’s value. But many wouldn’t believe this. Here are some pieces of evidence
Empirical Evidence of Hubris Hypothesis
Various studies over a quarter of a century show evidence of the hubris hypothesis explaining many takeovers. Early research aimed to know if the advertisements of deals caused the target’s price to increase, the acquirer’s to decrease, and a mix of the two to result in a net negative effect.
Early Research
A study by Dodd concluded that statistically significant negative returns to the acquirer after the announcement of the planned takeover. Other studies have similar results, although there are others that demonstrate the opposite. For instance, Paul Asquith failed to find a consistent pattern of declining stock prices following the announcement of a takeover.
There is more proof of positive price effects for target stockholders who experienced wealth gains after takeovers. In a study by Bradley, Desai, and Kim, tender offers led to gains for target firm stockholders.
Greater changes should be produced by the hostile nature of tender offers in the stock price than friendly takeover offers. But most studies show that target stockholders gain following both friendly and hostile takeover bids.
Bidders tend to overpay, according to a study by Varaiya. The relationship between the bid premium and the combined market values of the bidder and the target was examined. The results demonstrated that the premium paid by bidders was too immense relative to the worth of the target to the acquirer.
The hubris hypothesis is not supported by the analysis of the joint impact of the uphill movement of the target’s stock and the downhill movement of the acquirer’s stock. This was done by Malatesta and the findings showed that that the long-run sequence of events culminating in the merger has no net impact on the combined shareholder. However, it could be said that Malatesta’s failure to find positive combined returns does support the theory.
Later Research of Hubris Hypothesis
The hubris hypothesis is supported by later research in a different way. Hayward and Hambrick used a sample of 106 large acquisitions. In the sample, they found that CEO hubris positively associated with the sum of premiums paid.
The company’s recent performance, the CEO self-importance, and other variables were used to measure hubris. They also took into account the independent variables, as the CEO inexperienced according to the years in the position, along with board vigilance, as measured by the number of inside directors versus outside directors.
Takeover Theory of US Firm
Other research provides support for the theory for the takeover of U.S. firms by foreign corporations. Seth and Song used shareholder wealth effect responses similar to those proposed by Roll in a sample of 100 cross-border deals from 1981 to 1990. The researchers found that hubris, along with synergy, managerialism, and other factors play a huge role in these deals. role. Managerialism is somewhat similar to hubris, in that both may involve overpaying for a target.
Managerialism is kind of similar to hubris since both entail overpaying for a target. The former, however, considers that the bidder’s management knowingly overpays so as to pursue their own gains even if it comes at the expense of their shareholders to whom they have a fiduciary obligation. In a study by Malmendier and Tate, the role that overconfidence played in the deal was examined using a sample of 394 large companies.
They measured overconfidence by the tendency of CEOs to overinvest in the stock of their own companies and their statements in the media. Results showed that doing acquisitions was 65% more likely for the overconfident group of CEOs in their sample. They also determined that these CEOs were more likely to make lower-quality, value-destroying acquisitions.
Acquisition History
In another study by Billett and Qian further studied. This using the acquisition history of 2,487 CEOs and 3,795 deals over the years 1980–2002. CEOs with a positive experience with acquisitions were more likely to pursue acquisitions. The net purchases of their company’s own stock were higher. Before the next series of deals than they were before the first deals. This result was interpreted as the CEOs being overconfident and attributing the success of the original deal to their own managerial abilities and superior insight.
CEOs Aktas, de Bodt, and Roll presented that overconfident and hubris-filled CEOs were more likely to do deals quickly and there is less time between their deals. Where the CEOs who had done more deals in the past tended to act faster and have less time between their deals. This learning effect is complementary to other studies of the same authors.
Aktas, et al.’s’ study and other research showed that the cumulative abnormal returns of serial acquirers. Therefore, it is a decline as a function of the number of acquisitions they do. For instance, some researchers, indicate hubris since the CEOs still pursue deals. In other words, it produces much lower returns to shareholders. Others, however, opine that the declining returns could just be a function of less productive opportunities available in the marketplace. Although this is justifiable, it still seems that the CEOs. Who are hubris-filled should avoid pursuing an acquisition program. When the returns fall below some certain targeted return.
© Image credits to Dids