Lecture 5: Ch. 10 & 11

Question 1

What is the hubris hypothesis?

Answer 1

Overconvidence and overoptimism drive synergy overestimation.
• This in turn may be driven by biased self-attribution [research shows that past deal success drives future take over activity]
• Fail to properly account for the Winners Curse

Question 2

What is market timing in the context of M&A

Answer 2

• Preserve temporary overvaluation by acquiring less overvalued targets or by buying undervalued targets.
• Catering to perceived synergies [thus Investor Sentiment]

Question 3

How can you see overconfidence in M&As?

Answer 3

1. Overconfident CEOs engage in more M&As (longholders -Malmendier & Tale, 2008)
2. Overconfident CEO’s typically find their stock to be
   undervalued by the market. If they do issue new equity to finance the deal,
   the signal of overvaluation is larger
3. CAR for companies with overconfident CEOs are lower as market is not stupid, everyone knows that you are overconfident
4. Firms with high P/B [=more likely to be overvalued],
   are less likely to pay with cash, and more likely to pay with stock

Question 4

What are documented effects on group process?

Answer 4

› Accuracy:
• Groups tend to outperform individuals in intellectual tasks [=Process Gain, see the Laughlin experiment]
• May not be true for judgmental [more subjective] tasks [=Process Loss, see the Stasser and Titus experiment]
› [Unwarranted] Acceptance:
• Referred to as ‘illusion of effectiveness’: perception that group’s decisionmaking is more effective than it actually is [link to overconfidence].
› Polarization:
• Groups may amplify individual preferences, such as risk tolerance [see the Whyte experiment]

Question 5

What are the drivers for group process losses?

Answer 5

› Groupthink
• Group members try to minimize conflict and reach group consensus (harmony) without critical realistic evaluation of alternative viewpoints.
• Collective form of confirmation bias
• People have strong drive for social conformity [See: Asch experiment]
› Poor Information Sharing
• People within groups tend to be ineffective in sharing information [even when all group members share a common goal]
• Drives confirmation bias at group level [so, may drive Groupthink]
• See: Stasser and Titus experiment
› Free rider behavior
• Sum of individual efforts in a group < Sum of efforts of same individuals when alone

Question 6

Describe Laughlin experiment and its results.

Answer 6

They had to match random coding of letters A-J to
numbers 0-9 [e.g. C=3] in as few trials as possible Each trial involved:
1. Proposing an equation [A+B=?]
2. Receiving a coded answer [A+B=F]
3. Proposing a solution [F=3]
4. Receiving feedback [“True” or ”False”]
5. Proposing all solutions [A-J=0-9]

Results:
The average group of 4 cooperating people solved the problems in fewer trials than any random set of 4 non-cooperating individuals. Groups performed better than the best of those individuals. They did so, among others, by proposing more complex equations -> Process gains

Question 7

The Stasser & Titus experiment

Answer 7

• A group of 4 ‘managers’ has to decide on three job canditates [A, B, or C]
• For each canditate 16 items of information were distributed.
• For canditate A, 8 items were clearly favourable, for B and C only 4.

Results:
When all managers had the same information individually, 67% favoured A before they met in a
group, and 85% after
->Process losses

When all managers had the same info collectively [but not individually] the pre-meeting individual preference that favoured B [61%], was NOT corrected in the group meeting, but even amplified [75%]
->Poor information sharing

Question 8

The Asch experiment

Answer 8

• > Many people surpress their own judgments and opinions to match the group consensus.
• > People experience stress when they deviate from a group

Results:
70% go along with the group when 3 out of 4 people give the wrong answer on purpose