The Misvaluation Curse in Mergers and Acquisitions

• Author: Luis E. Pereiro
• Date: 01 January 2016
• DOI: http://doi.org/10.1002/jcaf.22116
• Published date: 01 January 2016

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© 2016 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22116

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The Misvaluation Curse in Mergers

and Acquisitions

Luis E. Pereiro

With the finan-

cial crisis

now waning

in the United States,

merger and acquisi-

tion (M&A) deals

are again on the rise.

Do such moves actu-

ally pay? Compre-

hensive studies (e.g.,

Bruner, 2002) have

concluded, alas, that

close to 60% of all

M&A deals destroy

value for acquirers.

What is it that

triggers bad acqui-

sitions? One reason is the

bidder misvaluation curse:

value-destroying takeovers

are decided by honest manag-

ers who mistakenly believe

substantial synergies exist in

a deal, bid at excessive prices,

and pay for targets more than

they are actually worth. But

misvaluation cuts both ways: it

can also prevent the creation of

corporate value if the managers

in charge are persistently timid,

misprice opportunities on the

low side, downplay their bids,

and thus bypass, on a regular

basis, potentially profitable

M&A deals.

It appears that cognitive

biases are at the root of misval-

uation. While these distortions

are essentially unconscious, and

therefore difficult to curb, we

suggest in this article a number

of practical ways to deflect the

misvaluation predicament.

THE CURSE OF

OVERVALUATION

Overvaluation occurs when

bidders inadvertently misjudge

the value of a target

on the high side,

overbid, and overpay

for it. Overvalu-

ation leads to what

is called a winner’s

curse: When several

acquirers are bidding

for the same target,

the bidder with the

largest overvaluation

wins the contest

but, having paid

too much, destroys

its own economic

value; nonwinners

may have overval-

uedthetarget, too, but destroy

no value since they lose the

auction.

Why would an acquirer

overestimate a target’s value?

One explanation is that acqui-

sitions are loaded with so

many uncertainties, manag-

ers’ cognitive abilities are

overwhelmed. Managers react

to the challenge by using

heuristics— cognitive shortcuts

that simplify information pro-

cessing. The problem is that

heuristics may trigger severe,

systematic judgmental errors,

called biases, which tilt manag-

ers away fromoptimal decision

When corporate acquirers become self-mystified

by an overly optimistic picture of potential merger

gains, they end up trapped in high-sided valu-

ations, overbid, and eventually overpay for

targets—and so destroy their shareholder’s value.

But there is a flip side too: pessimistic acquirers

who systematically underbid end up consistently

bypassing potentially profitable acquisition deals.

Both faces of misvaluation are rooted in cognitive

biases which, being reflex rather than volitional,

are difficult—but not impossible—to curb. We

suggest four strategies to dilute the misvaluation

curse. © 2016 Wiley Periodicals, Inc.

Editorial Review

This article is a condensation of Pereiro

(2015). Full references to previous studies

will be found here.