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Corporate America has been called to task for losing sight of the proper goals of the business: generating economic returns, obtaining the resources and setting strategy for competitiveness and long-run growth, briskly fending off competition within NAFTA and from overseas, and in all other ways ensuring benefits for all stakeholders of the enterprise. Instead, CEOs and Boards have been distracted in their roles of ‘corporate raiders’ or defenders at the drawbridge as they fend off unexpected attacks. Worse still, takeovers have often been followed by stripping and selling off “unrelated” or “underperforming” operations; as a result, the combined value of merged businesses went down in the medium term.
Announcements of takeover bids usually perk up stock markets and generate favorable press because of the underlying rationale that they make economic sense. Strategically, the acquiring company may be looking to gain valuable R & D strengths, enlarged market share (and hence, greater leverage in the marketplace), goodwill, established brands, greater operational scale, and broader distribution reach, among others.
Roll (1986) offers the “hubris” hypothesis as an alternative explanation for takeovers judged by capital markets to diminish shareholder value.
Coming from the Greek for “overweening pride or arrogance” that propels the rich and mighty to tragically flawed decisions. In the context of mergers and takeovers, Roll’s hubris hypothesis is a compelling explanation for takeover bids that erroneously exceed book and market value.
The author suggests that there is empirical support for executive hubris explaining exaggerated valuation just as well as tax benefits, corporate synergy, and turning around inefficient operations do.
Going by an examination of a decidedly nonrandom sample of takeovers, the author contends that hubris is the only explanation for company boards pursuing tenders above the market price – absent any economic benefits – when, in fact, they do the rational thing and avoid tenders when valuations are below the market price.
Roll suggests that a hubris hypothesis has predictive value because, around the time when a bid is announced and is pending approval of both sets of shareholders, hubris supports such phenomena as “…
- the combined value of the target and bidder firms should fall slightly,
- the value of the bidding firm should decrease, and
- the value of the target should increase” (1986, p. 213).
Perhaps this theory could have benefitted from new data about mergers and takeovers since the work was published in the mid-1980s. At the time, however, the empirical observations available to Roll suggested mixed results. Combined value increased in some cases but fell in others. The stock value of the bidding firm increased at statistically significant rates in certain instances but decisively dropped in other cases.
Yet, the author dismisses these inconsistencies by arguing that the market that is the source of value perceptions does not always receive access to perfect information from either the bidding or target firm.
Since market valuation is an imperfect criterion, the author bolsters his case for the rigor of the hubris hypothesis by contending, first of all, that the available evidence does not reject the implication of hubris.
Second, the hypothesis does not imply that corporate boards consciously act against the economic interests of shareholders. Rather, they do so de facto by tendering share prices beyond those prevailing in the marketplace and already discounting future value of, say, investments in new product development and market penetration.
Thirdly, hubris does not posit systematic bias in market prices. Rather, the author contends, the possibility that anyone company may be either bidder or takeover target cancels out that possibility. Finally, Roll counters that hubris does not discount strong form efficiency. Instead, it is likelier that the big picture of rational decisions made by profit-maximizing firms is diluted in the long run by the non-economic prices and allocations of hubris-motivated enterprises.
References
Roll, R. (1986). The hubris hypothesis of corporate takeovers. The Journal of Business, 59 (2), 197-216.
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