The Diagnostic and Anchoring Effects of Internal and External References in M&A Premium Decisions

Abstract

Managers involved in acquisition premium decisions commonly must make choices armed with incomplete and uncertain information. One way they deal with this uncertainty is by relying on references – i.e., comparable choices made in the past. While such references have diagnostic value, overemphasizing on these references can also have an anchoring effect. In this study, we articulate how and when two potentially salient references in acquisition premium decisions: the previous acquisition premium paid by another firm in the target industry (external reference), and the premium paid by a focal firm for its own preceding acquisition (internal reference) influences focal acquisition premium decisions. We theorize that while the external reference plays both a diagnostic and biasing role, the internal reference likely plays just a biasing role. We also extend this work by theorizing on how more powerful and overconfident CEOs will rely more on internal references than on external references. Our results based on a hedonic regression analysis of 3,237 completed acquisitions provide support for our hypotheses. By clarifying and elaborating the nuanced influence of multiple references, this study synthesizes and extends recent work both in the acquisition premium literature and the anchoring literature more broadly.