The role of procedural rationality in debiasing acquisition decisions of overconfident CEOs

Abstract

AbstractResearch SummaryIn corporate acquisitions, overconfident chief executive officers (CEOs) often make biased decisions, subsequently paying unjustifiably high acquisition premiums. We investigate the predeal process in which the acquisition premium is decided upon and, drawing from procedural rationality theory, argue that the pursuit of greater procedural rationality through slow‐paced predeal processes reduces the tendency of overconfident CEOs to inflate acquisition premiums. The empirical results based on a sample of acquisitions involving publicly held US firms show that overconfident CEOs tend to pay high acquisition premiums, replicating earlier findings of such a relationship. More importantly, the results show that the tendency of overconfident CEOs to overpay for acquisitions decreases under conditions in which the predeal processes are slower in pace.Managerial SummaryCEOs often exhibit excessively high levels of confidence in their ability to make successful corporate acquisitions. Driven by the belief in their ability, overconfident CEOs often end up overpaying for acquisitions. Our study provides suggestive evidence that setting a slow acquisition process pace is an important prerequisite for an acquiring firm and its board of directors to attenuate the inflating effect of CEO overconfidence on acquisition premiums. Our arguments and results imply that boards of directors should slow the pace of predeal acquisition processes if their CEO is exhibiting signs of overconfidence.