Managerial overconfidence and corporate takeovers

Purpose - The purpose of this paper is to model the announcement returns of merging firms based on managerial overconfidence about merger synergy. Design/methodology/approach - The paper applies continuous‐time real options techniques and game theoretic concepts. Managerial overconfidence and strategic interaction between the bidder and the target are incorporated into the model. Findings - This model implies that: abnormal returns to bidding shareholders will be negative with a high degree of managerial overconfidence; combined returns to shareholders are usually positive; and both the bidder's and the target's abnormal returns are related to industry characteristics, the degree of managerial overconfidence, and the way merger synergies are divided. Originality/value - This paper, for the first time, reconciles theoretically the following stylized facts: combined returns to shareholders are usually positive; and returns to the acquirer are, on average, not positive. In addition, the model generates new predictions relating these returns to industry characteristics and the degree of managerial overconfidence.