Explaining the premiums paid for large acquisitions: evidence of CEO hubris

Administrative Science Quarterly,  March, 1997  by Mathew L.A. Hayward,  Donald C. Hambrick

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Effects of CEO Hubris

Our results suggest that CEO hubris, manifested as exaggerated pride or self-confidence, plays a substantial role in the acquisition process, particularly in the decision of how much to pay. We have found that several sources of hubris have their own independent and additive effects on the premium the acquiror is willing to pay. First, the better the recent performance of the acquiring firm, the more that is paid for an acquisition. This represents a tendency to attribute organizational success to the CEO (Meindl, Ehrlich, and Dukerich, 1985) and for the CEO to deem that success as applicable to managing additional entities. The greater the CEO's confidence in his or her own abilities (as well as those of subordinates), the greater the benefits the CEO believes he or she can bring to an acquired entity and the higher the price paid.

Second, the greater the recent media praise for the CEO, the larger the premium paid for an acquisition. In our sample, every increment of media praise brought a 1.6 percent increase in acquisition premiums (see Table 2). Thus each highly favorable article about the CEO (receiving a score of 3 in our scheme) resulted, on average, in a 4.8 percent increase in premium paid. For a billion-dollar acquisition, this would be $48 million. Through glowing portrayals, the media not only conveys to the CEO an external validation of his or her capabilities, but it also broadcasts the message widely, disseminating a new level of CEO prestige outward to business and social circles. Acquaintances and business associates may start treating the CEO as more glorified (Chen and Meindl, 1991), further fostering his or her perceptions of personal ability. It seems that some CEOs who pay extremely large acquisition premiums, on the assumption that they have the talent to recoup the extraordinary outlays, literally come to believe their own press. Acquisition premiums thus seem an ideal arena for studying CEO hubris, because every increment of premium represents the CEO's belief in how much more valuable the target firm would be under his or her leadership.

Essentially all of the articles we coded about the acquiring CEOs were positive, even though our scale allowed for negative articles. Although we have no concrete benchmark, our sense is that some articles about CEOs are largely negative (Miller and Friesen, 1977; Chen and Meindl, 1991). Hence, the absence of negative press about these CEOs may be one more indication of hubris in the acquisition process, in that it affects the basic decision to make a large acquisition: It may be that only CEOs with considerable confidence (or perhaps simply a political foothold) will consider making a large acquisition. Then, among them, the greater the confidence, the greater the price paid.

The third indication of hubris in acquisition bidding is our finding that a measure of a CEO's self-importance was positively associated with premiums. Our measure was the ratio of the CEO's pay to that of the second-highest-paid executive in the firm, which we take to be a telling indicator of the CEO's own sense of potency and self-esteem. While we do not have longitudinal data, we would anticipate that this ratio shows strong consistency over time for a given CEO and may be considered a reflection of a basic personality trait rather than a conditional phenomenon. Some CEOs may have an extreme sense of potency, verging on arrogance, as part of their personal makeup (Kets de Vries and Miller, 1984), and these CEOs will be relatively likely to inject their arrogance into their strategic choices, including the prices they pay for large acquisitions.