Hubris

1. Hubris

It is an unwritten law of the stock market that corporations must keep growing, year after year, and for the executives of a company straining to meet these growth expectations, buying another company can look like an awfully attractive shortcut. But it’s an expensive shortcut. The source reports an average acquisition premium for public companies of 41%, which means that if the target company is valued by the stock market at $100 million, the acquirer will bid $141 million for it. Or, to translate that into human terms, the acquiring CEO is basically saying to the target CEO, “I can run your company at least 41% better than you can.”

As you might imagine, this self-confidence often proves unwarranted. Warren Buffett said, “In the past, I’ve observed that many acquisition-hungry managers were apparently mesmerized by their childhood reading of the story about the frog-kissing princess. Remembering her success, they pay dearly for the right to kiss corporate toads, expecting wondrous transfigurations.” Unfortunately, said Buffett, “We’ve observed many kisses but very few miracles.”

Two business-school professors, Mathew Hayward and Donald Hambrick, were puzzled by this phenomenon. Why do CEOs keep making pricey acquisitions that rarely pay off? The answer, they suspected, might have more to do with human flaws than with financial miscalculations. They theorized that the acquiring CEOs were being led astray by their own hubris.

Hubris is exaggerated pride or self-confidence that often results in a comeuppance. In Greek mythology, a hubristic protagonist often suffers humiliation. When Icarus ignored advice not to fly too close to the sun, his wax wings melted and he fell to his death. (By contrast, in American business, hubris is less damning. If Icarus had been a bank CEO, he’d have escaped with a $10 million golden parachute.)

Hayward and Hambrick speculated that executives’ hubris—their confidence that they could work magic with their acquisitions—would lead them to overpay for their targets. The researchers tested this theory by analyzing every large acquisition ($100 million or more) conducted in the public markets during a two-year period, a sample that contained 106 transactions. They examined whether the price paid was associated with three factors that might inflate the acquiring CEO’s ego. The excerpt ends before identifying those factors or reporting the results.