Decision‐making for mergers and acquisitions: the role of agency issues and behavioral biases

• DOI: http://doi.org/10.1002/jsc.1895
• Author: Sanjay Dhir,Amita Mital
• Published date: 01 February 2012
• Date: 01 February 2012

Strat. Change 21: 59–69 (2012)

Published online in Wiley Online Library

(wileyonlinelibrary.com) DOI: 10.1002/jsc.1895 RESEARCH ARTICLE

Copyright © 2012 John Wiley & Sons, Ltd.

Strategic Change: Brie ngs in Entrepreneurial Finance

Strategic Change

DOI: 10.1002/jsc.1895

Decision-Making for Mergers and Acquisitions:

The Role of Agency Issues and Behavioral Biases1

Sanjay Dhir

Indian Institute of Management Lucknow, India

Amita Mital

Indian Institute of Management Lucknow, India

Introduction2

 e literature on mergers and acquisitions (M&As) identi es three main motiva-

tions for takeovers.  e  rst being creation of synergies so that the value of a new

combined entity is greater than the sum of its previously separate values (Bradley

et al., 1988; Dyer et al., 2004; Tease, 1986).  e second motivation exists because

of agency issues (Eisenhardt, 1989) between managers and shareholders. Jensen

(1986) suggests that managers may rationally pursue their own objectives at the

expense of shareholder’s interests. Finally, the third motivation for takeovers is

managerial hubris (Roll, 1986) and behavioral bias. Roll’s hubris hypothesis sug-

gests that managers of acquiring  rms make valuation errors because they are too

optimistic about the potential synergies in a takeover.

As a result, they overbid for target  rms to the detriment of their stockholders.

 us, there are two main theories — rational responses to agency costs and non-

rational response to managerial hubris — that have been detrimental to explain

why managers make value-destroying acquisitions. Although the hubris hypothesis

has considerable intuitive appeal, and has been discussed in the literature for three

decades, it has only been lesser subjected to empirical testing. Behavioral assump-

tions such as overcon dence have become common in the asset pricing literature

but the corporate  nance literature has largely neglected behavioral assumptions

in models of managerial decision-making (Barberis et al., 2003).

The research from developed

nations suggests that

overconfident managers are

more likely than other

managers to destroy value.

Agency costs and behavioral

bias may be more likely in the

case of diversifying

acquisitions.

Diversifying acquisitions have,

therefore, been linked to the

existence of agency costs as

diversification may benefit

managers, and to the

existence of managerial

overconfidence.

Game theory perspective can

encourage rational decisions,

justify takeover premiums for

certain acquisitions and bid

for target companies

successfully.

Rational and dynamic strategies can be formed by applying game theory

along with real options tools for incorporating bias analysis in takeover

decisions.

1 JEL classi cation codes: C7, C9, D81, G34, H32.

2  e authors thank Professor Carlo Milana, editor of Strategic Change journal, for his

helpful and thoughtful suggestions and comments on an earlier version of this paper.