The Diagnostic Value and Anchoring Effect of References in Acquisition Premium Decisions: The Influence of Overconfident and Powerful CEOs
| Published date | 01 October 2023 |
| Author | Shavin Malhotra,Phil Zhu,Taco H. Reus |
| Date | 01 October 2023 |
| DOI | http://doi.org/10.1111/1467-8551.12691 |
British Journal of Management, Vol. 34, 2138–2157 (2023)
DOI: 10.1111/1467-8551.12691
The Diagnostic Value and Anchoring Effect
ofReferences in Acquisition Premium
Decisions: The Inuence ofOvercondent
and Powerful CEOs
Shavin Malhotra,1Phil Zhu2and Taco H. Reus3
1Conrad School of Entrepreneurship and Business, University ofWaterloo, Waterloo, ON, N2L 3G1, Canada,
2School of Business, University ofSan Diego, San Diego, CA, 92110, USA, and 3Rotterdam School of
Management, Erasmus University, 3062 PA Rotterdam, The Netherlands
Corresponding author email: shavin.malhotra@uwaterloo.ca
CEOs often must make strategic decisions under extremeuncertainty. One way theydeal
with this uncertainty is by relying on references – that is, recent comparable decisions.
However, there is a conundrum that underlies these references: they can have diagnostic
value but also induce anchoring. We shed light on this conundrum by unpacking diag-
nostic value and anchoring effects of two commonly used references in acquisition pre-
mium decisions: an external reference (the premium paid forthe preceding acquisition in
the target industry) and an internal reference (the premium paid by a focal rm for its
preceding acquisition). We theorize that while external references have diagnostic value
and anchoring effects, internal references only have anchoring effects. Moreover, we ar-
gue that powerful and overcondentCEOs rely more on internal references. Our results,
based on a hedonic regression analysis of 3072 completed acquisitions, support these
hypotheses.
Introduction
Decisions about the size of acquisition premiums –
that is,the ‘percentage difference between the trad-
ing price of the target’s stock before the announce-
ment of the acquisition and price per share paid
by the acquiring rm’ (Haunschild, 1994, p. 393)
– have long been a focus ofattention. Synergy po-
tential in terms of superior revenue streams and
cost reductions due to acquisitions warrants rms
paying a higher premium (e.g. Laamanen, 2007).
Yet, because studies generally linked excessively
high premiums to negative post-deal performance
(Berkovitch and Narayanan, 1993; Haunschild,
1994; Sirower, 1997), and because ofthe high levels
of uncertainty surrounding these decisions, schol-
ars have considered how decision-makers, in par-
ticular CEOs, may differ in how they inuence the
premium decision-making process (e.g. Hayward
and Hambrick, 1997; Kim, Haleblian and Finkel-
stein, 2011).
CEOs may deal with this uncertainty by con-
sciously or unconsciously relying on references –
that is, recent comparable decisions. Acquisition
premium research has emphasized the roles of ref-
erence prices (e.g. Rappaport and Sirower, 1999)
and prior premium decisions by the focal rm, its
inter-organizational partners, boardmembers and
other acquirers (e.g. Beckman and Haunschild,
2002; Haunschild, 1994; Malhotra, Zhu and Reus,
2015; Zhu, 2013). Relying on referencesprovides a
cognitive shortcut for CEOs atpremium decisions.
Yet, currently, the literature reveals an unre-
solved conundrum. On the one hand, such ref-
erences can have diagnostic value – they provide
relevant information; CEOs learn about making
© 2022 British Academy of Management.
The Diagnostic Value and Anchoring2139
the premium decision vicariously from others in
similar situations (e.g. Beckman and Haunschild,
2002). On the other hand, such references can bias
premium decision-making – for example,by overly
relying on the reference in decision-making at the
expense of other relevant information (e.g. Mal-
hotra, Zhu and Reus,2015). The current literature
does not provide insight to distinguish references
as diagnostic value versus references as bias.
Moreover, premium studies focus on the inu-
ence of one type ofreference. In reality, CEOs
and other top managers will be exposed to mul-
tiple references with varying relevance (Whyte
and Sebenius, 1997). We still have a limited un-
derstanding of whether, why and when decision-
makers are drawn to some references over others.
This is surprising because reference prices can vary
considerably, and the impact on focal premium
decisions can differ considerably.
In the current study, we juxtapose two poten-
tially salient types of references: the previous ac-
quisition premium paid by another rm in the tar-
get industry – which we will refer to as the external
reference, and the previous acquisition premium
paid by the focal rm itself – which we will refer to
as the internal reference. We build on learning and
anchoring research to argue thatwhile the external
reference plays a diagnostic and biasing role, the
internal reference plays just a biasing role. We ex-
pect that CEOs can learn from external references
since those past acquisition premiums carry in-
formation about unobservable market dimensions
that are not easy to evaluate by the focal rm.
But internal references provide little opportunity
for learning, since any market information observ-
able to top managers during their past acquisition
should also be accessible during the focal acqui-
sition decision. Additionally, previous research on
anchoring has found that both relevant and irrele-
vant environmentalcues can bias decisions (Ariely,
Loewenstein, and Prelec, 2003; Schwarz, 1994). As
such, we expect CEOs to overlyrely on and thus be
biased by internal and external references.
Scholars generally agree that CEOs are cen-
tral in acquisition premium decisions (Hambrick
and Mason, 1984; Malhotra et al., 2018). In the
current study, we extend this work by theorizing
how certain CEOs may be drawn to one reference
over the other. We argue that more powerful
and overcondent CEOs dictate decision-making
more than less powerful and less condent CEOs.
This increased centrality of decision-making re-
duces the inuence of external information and
reections by others, resulting in more powerful
and overcondent CEOs overly relying on internal
references that have less diagnostic value to begin
with. Our analyses support these hypotheses.
This study contributes to research on acquisi-
tion premiums, strategic decision-making and the
broader anchoring literature. First, while scholars
have already pointed to the inuence ofreferences
in strategic decisions (Baker, Pan and Wurgler,
2012; Malhotra, Zhu and Reus, 2015), these
studies tend to focus on their biasing effects. We
complement this work by using a novel approach
to decompose from these references the diagnostic
information CEOs should use from its biasing
elements (Schwarz, 1994). This decomposition al-
lows us to reconcile both earlier (Slovic, Fischhoff
and Lichtenstein, 1977; Tversky and Kahneman,
1974) and more recent developments (Bingham
and Eisenhardt, 2011; Gigerenzer and Todd,1999)
in behavioural decision theory by offering a more
nuanced understanding of how and when the use
of cognitive shortcuts (reference prices) can bias
or enable strategic decision-making.
Second, we provide novel insight into how CEO
overcondence and power relate to CEOs’ ten-
dency to rely on different references. We illustrate
an interplay between CEOs’psychological and po-
sitional characteristics and their use of cognitive
shortcuts. Finally, unlike much of the anchoring
literature in management and psychology that has
focused on the effect of single references, we juxta-
pose external and internal references.
Theory and hypotheses
Acquisition premiums
Because of information asymmetries between ac-
quiring and target managers, and uncertain out-
comes, it is generally difcult for acquiring man-
agers to assess the true value of a target rm
(Reuer, Shenkar and Ragozzino, 2004). This is fur-
ther compounded due to the likelyconictof inter-
est between acquiring and target rm stockhold-
ers.While managers ofthe acquirer seek to acquire
the target for the lowest price possible, the target,
on the other hand, seeks to sell itself at the high-
est price possible. As a result, targetrm managers
will likely over-emphasize their rms’ desirable
characteristics and downplay those less desirable.
© 2022 British Academy of Management.
Get this document and AI-powered insights with a free trial of vLex and Vincent AI
Get Started for FreeStart Your 3-day Free Trial of vLex and Vincent AI, Your Precision-Engineered Legal Assistant
-
Access comprehensive legal content with no limitations across vLex's unparalleled global legal database
-
Build stronger arguments with verified citations and CERT citator that tracks case history and precedential strength
-
Transform your legal research from hours to minutes with Vincent AI's intelligent search and analysis capabilities
-
Elevate your practice by focusing your expertise where it matters most while Vincent handles the heavy lifting
Start Your 3-day Free Trial of vLex and Vincent AI, Your Precision-Engineered Legal Assistant
-
Access comprehensive legal content with no limitations across vLex's unparalleled global legal database
-
Build stronger arguments with verified citations and CERT citator that tracks case history and precedential strength
-
Transform your legal research from hours to minutes with Vincent AI's intelligent search and analysis capabilities
-
Elevate your practice by focusing your expertise where it matters most while Vincent handles the heavy lifting
Start Your 3-day Free Trial of vLex and Vincent AI, Your Precision-Engineered Legal Assistant
-
Access comprehensive legal content with no limitations across vLex's unparalleled global legal database
-
Build stronger arguments with verified citations and CERT citator that tracks case history and precedential strength
-
Transform your legal research from hours to minutes with Vincent AI's intelligent search and analysis capabilities
-
Elevate your practice by focusing your expertise where it matters most while Vincent handles the heavy lifting
Start Your 3-day Free Trial of vLex and Vincent AI, Your Precision-Engineered Legal Assistant
-
Access comprehensive legal content with no limitations across vLex's unparalleled global legal database
-
Build stronger arguments with verified citations and CERT citator that tracks case history and precedential strength
-
Transform your legal research from hours to minutes with Vincent AI's intelligent search and analysis capabilities
-
Elevate your practice by focusing your expertise where it matters most while Vincent handles the heavy lifting
Start Your 3-day Free Trial of vLex and Vincent AI, Your Precision-Engineered Legal Assistant
-
Access comprehensive legal content with no limitations across vLex's unparalleled global legal database
-
Build stronger arguments with verified citations and CERT citator that tracks case history and precedential strength
-
Transform your legal research from hours to minutes with Vincent AI's intelligent search and analysis capabilities
-
Elevate your practice by focusing your expertise where it matters most while Vincent handles the heavy lifting