The Misvaluation Curse in Mergers and Acquisitions

Date01 January 2016
DOIhttp://doi.org/10.1002/jcaf.22116
Published date01 January 2016
11
© 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.

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