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Who makes acquisitions? CEO overconfidence and the market's reaction

  • Malmendier, Ulrike
  • Tate, Geoffrey

Does CEO overconfidence help to explain merger decisions? Overconfident CEOs over-estimate their ability to generate returns. As a result, they overpay for target companies and undertake value-destroying mergers. The effects are strongest if they have access to internal financing. We test these predictions using two proxies for overconfidence: CEOs' personal over-investment in their company and their press portrayal. We find that the odds of making an acquisition are 65% higher if the CEO is classified as overconfident. The effect is largest if the merger is diversifying and does not require external financing. The market reaction at merger announcement (-90 basis points) is significantly more negative than for non-overconfident CEOs (-12 basis points). We consider alternative interpretations including inside information, signaling, and risk tolerance.

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Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 89 (2008)
Issue (Month): 1 (July)
Pages: 20-43

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Handle: RePEc:eee:jfinec:v:89:y:2008:i:1:p:20-43
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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