Explaining the premiums paid for large acquisitions: evidence of CEO hubris

Explaining the premiums paid for large acquisitions: evidence of CEO hubris

Mathew L.A. Hayward

The famed investor, Warren Buffett, once said that many corporate acquirors think of themselves as beautiful princesses, sure that their kisses can turn toads into handsome princes. The acquirors pay substantial premiums over market value, believing that they can release the imprisoned princes. But, as Buffett said, “We’ve observed many kisses but very few miracles” (1981 Berkshire Hathaway Annual Report).(1) With acquirors making record numbers of takeovers at prices far above market levels, the comment Buffett made in 1981 has not lost its relevance for managers and students of organizations today. In fact, more acquisitions were announced in 1995 than in any prior calendar year. And between 1976 and 1990, 35,000 corporate acquisitions were completed in America, with a combined value of $2.6 trillion (Jensen, 1993). Yet, for all this activity, executives of acquiring companies generally fall to effect acquisition miracles. Acquisitions sometimes yield positive returns for acquirors (Lubatkin, 1987), but generally acquisitions have been found to have a neutral to negative effect on the shareholder wealth of acquiring firms (Bradley, Desai, and Kim, 1988; Jarrell, Brickley, and Netter, 1988; Berkovitch and Narayanan, 1993). Commonly, investors mark down the stock of acquirors following takeover announcements, indicating their belief that acquiring managers have overpaid (Shleifer and Vishny, 1991). This adverse market reaction is reinforced by findings that acquisitions lead to declines in the acquiror’s longer-term profitability (Fowler and Schmidt, 1988 Herman and Lowenstein, 1988; Ravenscraft and Scherer, 1987, 1988) and shareholder returns (Agrawal, Jaffe, and Mandelkar, 1992). Acquisitions are often resold later at a loss (Porter, 1987).

Acquisition premiums, defined as the ratio of the ultimate price paid per target share divided by the price prior to takeover news, have generally been ignored by strategy and organization researchers (Haunschild, 1994, and Sirower, 1994, are exceptions). Premiums are major statements by acquiring managers of how much additional value they can extract from the target firm. Premiums underscore acquiring managers’ convictions that the target’s preexisting stock price inadequately reflects the value of the firm’s resources and its prospects and that in the right hands — their hands — more value can be created. For example, in paying a 110 percent premium for Paramount Corporation, Viacom Corporation managers expected to extract al least 2.1 times more value from Paramount than could Paramount’s incumbent managers, a belief the stock market summarily dismissed. And such substantial premiums are common: Between 1976 and 1990, premiums averaged 41 percent, with many over 100 percent (Jensen, 1993).

Premiums are important not just as statements of pricing and acquirors’ expectations but because they affect ultimate acquisition performance. Sirower (1994) found that acquisition premiums inversely affected acquirors’ shareholder returns for up to four years following the acquisition date. Ceteris paribus, it is axiomatic that the higher the premium paid, the lower the ultimate returns to the acquiror from a given acquisition. Sometimes excessive premiums can be devastating: One year after Campeau paid a 124 percent premium to acquire Federated Department Stores, Campeau declared bankruptcy, unable to cover the debt it incurred for the deal (Kaplan, 1989; Haunschild, 1994). If substantial premiums often damage acquirors’ shareholder wealth over the short and long term, why do so many acquirors pay them? The answer, we believe, is that acquiring managers overestimate their ability to extract value from acquisitions because of their hubris (Roll, 1986).

THEORY AND HYPOTHESES

Acquisition Motives

Three main motives for takeovers have been advanced: poor target company management, synergy, and hubris (Walsh and Seward, 1990; Berkovitch and Narayanan, 1993). Advocates of the poor target management perspective, which is rooted in agency theory, claim that inefficient, self-serving incumbent managers who fail to maximize stockholder value will be forced out of office by acquirors attempting to extract such value (e.g., Fama, 1980). Premiums paid thus reflect the value that can be gleaned from eliminating the target company’s inefficiencies. Implicit in poor-management explanations is that the acquiror’s stockholders will benefit from takeovers through improved management of the acquired firm. But even if beliefs about poor management initially motivate transactions, two factors suggest that acquirors generally overestimate their ability to extract improvements: the common adverse market reaction to acquisition announcements and the poor subsequent performance of many acquisitions.

Tests of poor target performance in affecting premiums have been inconclusive. Although Varaiya (1987: 182) found some evidence that the target firm’s poor performance within its industry caused higher premiums, he concluded that there was only “weak support for the predicted effects of ex ante gains” and “the undermanagement variables are uniformly insignificant.” Slusky and Caves (1991) did not directly examine the underperformance hypothesis, but they found that premiums were not as large when the target’s stockholdings were relatively concentrated, presumably a condition in which managers were already closely monitored and less able to sustain poor management.

As noted, the ability of acquirors actually to attain the improvements they envision is questionable. According to Jensen (1984), takeovers are beneficial overall because they result in positive aggregate gains for the acquiror and for target company shareholders. But the positive aggregate returns are due almost totally to the large returns for target stockholders (because of the large premiums paid), not to better returns for acquiror stockholders (Jensen and Ruback, 1983).

As an explanation of takeover premiums, the poor-performance perspective is also limited by its underlying premise that inefficient target managers are the root cause of takeovers. Ultimately, takeovers reflect acquiring managers’ decisions. Therefore, the poor-performance premise unduly neglects the motives, profiles, and beliefs of the acquiring managers in explaining acquisition premiums. Perhaps takeovers occur not because of bad target management per se, but because acquiring managers perceive themselves as superior (Hambrick and Cannella, 1993).

According to the synergy perspective, commonalities or complementarities between the acquiror and target enable the combined value of the firms to exceed their value as two independent entities. Premiums should reflect the value to the acquiror of the expected synergies. This is a logical extension of research and theory on the benefits of related diversification and the application of core competencies (Rumelt, 1974; Barney, 1988; Prahalad and Hamel, 1990). Both Haunschild (1994) and Slusky and Caves (1991), however, found no association between the business similarity of acquirors and targets and acquisition premiums paid. And although Slusky and Caves (1991) observed that financial synergy, as reflected by the acquiror’s surplus debt capacity relative to the target, was related to premiums, overall variance explained by this factor was small. Thus, like poor target performance, synergy may partially motivate acquisitions but cannot adequately explain large takeover premiums or the common adverse stock market reaction to takeovers.

Dissatisfaction with poor performance and synergy explanations of premiums have led organizational and finance researchers to consider takeovers as a domain in which individual, group, and social factors, not efficient strategic calculation, drive key decisions (Hirsch, 1986; Roll, 1986; Haunschild, 1994). After reviewing takeover evidence, Roll (1986: 199) concluded that economists should dismiss their assumption that “individual decision making has little predictive content for market behavior.” In this vein, Haspeslagh and Jemison (1991) concluded that acquiring managers’ egos frequently outpace their logic during a takeover campaign. As further evidence of social and institutional forces, Haunschild (1994) found that premiums paid by acquirors were highly related to those paid by other companies who shared their outside directors and to the premium paid by other firms using the same investment bank. Such findings underscore the importance of individual and social factors in takeover pricing and heighten the need to investigate the third, relatively neglected motive: hubris. According to the hubris hypothesis (Roll, 1986), takeovers occur because bidding managers infected with hubris overestimate their ability to manage the target firm and hence overpay for it. The hubris hypothesis helps overcome the limitations of other perspectives because it explicitly considers transactions from the perspective of the decision maker, namely, the acquiror, and it is consistent with evidence that premiums are excessive.

Acquiring Managers’ Hubris

Roll (1986) argued that the available evidence supported hubris as much as any other explanation for takeovers, but he provided neither a definition of hubris nor a methodology to test it. We use Webster’s Dictionary definition of hubris as “exaggerated pride or self-confidence, often resulting in retribution,” Hubris derives from Greek mythology in which it was considered man’s capital sin (Wiener, 1973). In Greek myth, those who were excessively confident, presumptuous, blindly ambitious or otherwise lacking humility were relentlessly struck down by the gods (Grimal, 1986). In our perspective, hubris infects extremely confident managers who highly estimate their ability to extract acquisition benefits and consequently pay large premiums.

The hubris motive has been relatively neglected by both the management and finance literatures. We have not found any research that has attempted to dissect and observe the operation of hubris within the management of the acquiror. Instead, prior research has used aggregate stockholder returns on the acquisition announcement as a surrogate for hubris, assuming that a negative market reaction indicates hubris (Firth, 1980; Berkovitch and Narayanan, 1993). Market reactions are far removed from the actual human dynamics of managerial confidence, however, and while retribution connotes hubris, its essential element is extreme confidence. To us, this is directly, even ideally gauged by the size of premium the acquiror chooses to pay.

Because acquisitions reflect individual acquirors’ decisions (March and Simon, 1958; Cyert and March, 1963), a study of premiums paid must use the decision maker, not the firm, as the unit of analysis. Complex decisions such as acquisitions are not made on a strictly technoeconomic basis, and managers are not optimizers (March and Simon, 1958). Rather, such decisions reflect decision makers’ premises, biases, and limitations. Unlike past research, our approach takes into account behavioral factors, including the individual profiles, backgrounds, self-images, and assumptions that acquiring managers bring to acquisition pricing (Hambrick and Mason, 1984). Such an approach is corrobarated by findings that premiums are greatly susceptible to human, interpretive, and social processes and are not strictly the result of economic calculations (Haunschild, 1994).

Who are the decision makers in acquisition pricing? Although an acquisition target may be identified by someone within the ranks of the organization (Bower, 1970), the final price paid for acquisitions, especially large ones, is determined by the top management group in conjunction with its principal advisers (Haspeslagh and Jemison, 1991). While final pricing of major acquisitions requires approval of the board of directors, boards rely heavily on guidance from top management (Mace, 1971).

Within the top management group, the chief executive officer (CEO) is pivotal in approving bids in large acquisitions. Since large acquisitions are invariably highly visible events, require high-level negotiations, involve major corporate outlays, and can materially alter firm size and future performance, the acquiring CEO will be extensively involved (Haspeslagh and Jemison, 1991). It is virtually inconceivable that terms of a major acquisition could proceed to the board without the CEO’S personal sponsorship. Hence, large acquisitions represent an appropriate domain for exploring CEOs’ dispositions and biases. For these reasons, we focus here on the role of CEO hubris in explaining the size of premiums paid for large acquisitions.

Unfortunately, there is no reliable instrument to measure CEO hubris directly. Therefore, we examine three more observable sources of hubris: recent organizational success, recent media praise for the CEO, and the CEO’s self-importance.

Sources of CEO Hubris

Recent organizational success. There is reason to believe that recent organizational success will foster CEO hubris. Research on attributions (e.g., Kelley, 1971; Meindl, Ehrlich, and Dukerich, 1985) has found a strong propensity to credit leaders with success even when such success could more objectively be attributed to other factors, and such attributions become more accentuated as success becomes more pronounced (Meindl, Ehrlich, and Dukerich, 1985). Favorable attributions become material sources of self-esteem (Brockner, 1988) and interorganizational prestige (D’Aveni, 1990), conferring ever more assurance to the actors attributed with success. Conversely, poor organizational performance is also often attributed to the leader, resulting in decreased top management power (Eisenhardt and Bourgeois, 1988), stigma (Sutton and Callahan, 1987), and often undermining the CEO’s authority and confidence.

A danger of success is that CEOs may become susceptible to organizational “simplicity” — relying on a narrow and rigid formula for managing (Miller, 1993). Successful managers have been found to place undue faith in the efficacy of their leadership, even becoming caricatures of their former selves (Miller and Chen, 1994). Moreover, success reinforces the CEO’s stature. The more successful the organization, the more likely it is to develop patterns of belief (Festinger, 1954) and justification (Staw, McKechnie, and Puffer, 1983) that support the CEO’s preexisting premises-or “givens” (March and Simon, 1958). In such enacted environments, attributions tend to be self-serving (Clapham and Schwenk, 1991) rather than self-critical (Schweiger, Sandberg, and Ragan, 1986), experimentation is diminished (Staw, 1976), and CEOS tend not to look beyond the perspectives, attitudes, and styles associated with their success (Starbuck and Milliken, 1988).

The CEO whose company has been recently successful is likely to receive favorable attributions by and the commitment of organizational actors. In turn, such attributions and commitment substantially enhance the CEO’s confidence (Brockner, 1988). This then causes the CEO to develop even greater expectations about his or her own ability (Jacobs, Berscheid, and Walster, 1971). Thus, the greater the recent success of the organization, the more likely the CEO is to be infected with hubris, leading to higher acquisition premiums:

Hypothesis 1: The better the recent performance of the acquiring firm, the higher the premium it will pay for a large acquisition.

Media praise for the CEO. Meindl, Ehrlich, and Dukerich (1985), who found a striking propensity for the media to attribute organizational outcomes to individual leaders, also found that successful CEOS have a romantic aura in the media; they are often portrayed as “heroic” and larger than life. Further, Chen and Meindl (1991) found that, having formed favorable images of the CEO, media publications remain faithful to those images even if the leader’s performance diverges materially. “Romantic” CEO media portrayals in turn may influence the CEO’s self-image, fostering the impression that the CEO is in control, efficacious, perhaps even a miracle worker (Salancik, 1977; Salancik and Meindl, 1984). Favorable attributions to the CEO in the media are particularly salient because they not only crystallize and solidify the attributions of organizational members, but they diffuse the CEO’s prestige across wider audiences (Cameron and Whetten, 1983). This then reinforces the CEO’s inter- and intraorganizational power (Pfeffer, 1981), fostering CEOs’ perceptions of self-importance and esteem. Consequently, CEOs may come to believe their own press (New York Times, 1993). Thus media praise serves to reinforce the CEO’s confidence, increasing the likelihood that the CEO will be infected with hubris:

Hypothesis 2: The greater the recent media praise for the firm’s CEO, the higher the premium paid for a large acquisition.

CEO’s self-importance. Some CEOs have systemically inflated views of their abilities, perhaps due to demonstrable accomplishments or, as likely, to a relatively persistent personality trait of self-importance. Some CEOs seem to believe inherently in their abilities, often to the point of delusions of grandeur (Kets de Vries and Miller, 1984). Self-importance may be an aggregate construct, intersecting with or even composed of other personality traits such as self-esteem (Brockner, 1988), narcissism (Zaleznik and Kets de Vries, 1975), and need for power (House, Spangler, and Woycke, 1991). Evidence of self-importance may be revealed in perquisites or accoutrements the CEO bestows upon him- or herself, in the centralization of structural power (Miller and Droge, 1986), or in the CEO’s accumulation of titles (Finkelstein, 1992). But the most revealing manifestation of CEOs’ self-importance is their pay relative to the other executives in their firms (Frank, 1985). it is well known that CEOs have considerable influence over the setting of their own pay (Tosi and Gomez-Mejia, 1989) and great control over other executives’ pay. As an example of the use of such an indicator, Hambrick and D’Aveni (1992) found that a measure of the CEO’s dominance (the CEO’s pay divided by the average pay for other officers) was significantly greater for bankrupt firms five years before they failed than for a matched group of survivor companies.

Usually, CEOs receive between 30 and 50 percent more compensation than the next highest paid executive. When this differential is much larger, however, say 100 percent or more, the CEO’s sense of great personal importance is revealed. Not only does such a large gap reveal the CEO’s belief that executives vary widely in their contributions but also that he or she is extremely valuable (Hambrick and Cannella, 1993). Such a large gap may also indicate that the CEO has extraordinary power (Finkelstein, 1992). But, in our view, it takes both power and a certain personality trait for a CEO to be paid far out of proportion to his or her closest associates.(2) We expect that the greater the CEO’s relative pay, the greater the self-importance of the CEO and the more likely he or she is to be infected with hubris. In deciding on a price for an acquisition, we expect that such a CEO will think highly of the potential improvements he or she can bring to the target firm:

Hypothesis 3: The greater the CEO’s self-importance, as reflected by his or her relative compensation, the greater the premium paid for a large acquisition.

Weak Board Vigilance and the Exercise of CEO Hubris

So far, we have portrayed the overconfident CEO as unfettered when paying acquisition premiums. Circumstances may arise, however, in which the board of directors is particularly vigilant, potentially restraining the CEO from paying the large premium that his or her hubris might otherwise engender. Corporate governance research provides evidence that some observable board conditions can greatly affect such organizational phenomena as CEO dismissal (Boeker, 1992), CEO compensation (Tosi and Gomez-Mejia, 1989), and golden parachutes (Singh and Harianto, 1989). Weak board vigilance could allow the CEO to pay acquisition premiums. We focus on three indicators of weak board vigilance: the consolidation of the board chair and CEO positions, a high proportion of insiders on the board, and a small level of company stock holdings by outside members of the board. We anticipate that each of these three factors will accentuate the exercise of hubris in the payment of takeover premiums.

First, we expect that board vigilance is weaker when the CEO is also board chairman than when the posts are separated (Mace, 1971; Mizruchi, 1983). According to Geneen (1984), CEOs who are also board chairs cannot objectively judge or monitor their own performance. Instead, this duality is expected to allow a board-chair-CEO to advance and endorse personal preferences relatively unchecked (Kesner, Victor, and Lamont, 1986; Finkelstein and D’Aveni, 1994). Conversely, if the hubris-infected CEO has to deal with a separate board chair, the CEO’s readiness to pay a large acquisition premium may be reined in:

Hypothesis 4: When the board chair and CEO positions are consolidated, the relationship between sources of CEO hubris and acquisition premiums will be strengthened.

Second, research suggests that CEOs’ discretion is heightened when there is a high percentage of inside directors on the board (Hambrick and Finkelstein, 1987). A greater proportion of insiders, representing a lack of board independence, has been found to be associated with corporate payments of greenmail (Kosnik, 1987) and retaining the CEO during periods of poor performance (Weisbach, 1988). Research has shown that, following poor performance, the percentage of outsiders on the board increases, as shareholders and other institutions insist on greater vigilance (Hermalin and Weisbach, 1988; Mizruchi and Stearns, 1988). Inside manager-directors are more beholden to the CEO for their positions and thus are more likely to endorse the CEO’s initiatives. Boards with more inside directors are likely to be subservient to the interests of their CEOs, accommodating the exercise of hubris in acquisition premiums:

Hypothesis 5: The greater the proportion of inside directors, the stronger the relationship between sources of CEO hubris and acquisition premiums.

Third, board vigilance of the CEO is weakened when outside board members have little financial stake in the company, when their stockholdings are small (Eisenhardt, 1989; Kosnik, 1990). The majority of outside directors of large U.S. corporations are accomplished in their own fields, well-connected, and drawn to boards for further connections and prestige. For the most part, they are not significant owners of the companies on whose boards they sit (Lorsch, 1989). Because this can weaken a board’s vigilance, board reformers often advocate that directors hold company stock and that their compensation be partly in the form of stock (Jensen, 1993). We expect that companies with smaller board stockholdings will place fewer checks on the CEO’s exercise of hubris in acquisition premiums:

Hypothesis 6: The smaller the outside directors’ stockholdings in the firm, the stronger the relationship between sources of CEO hubris and acquisition premiums.

It may also be that lack of board vigilance increases acquisition premiums, as a main effect. Without close monitoring, CEOs tend to seek an increased scale of operations and the accompanying enhanced prestige and compensation (Amihud and Lev, 1981; Myers, 1983; Walsh and Seward, 1990). Thus, while weak board vigilance may directly affect acquisition premiums, our thinking is that lack of vigilance interacts with CEO hubris to affect premiums, and we therefore limit our formal hypotheses to this view.

Effects on Shareholder Returns

While the essential denotation of hubris is “exaggerated self-confidence,” its connotation is that retribution will follow. Although our main focus has been on the effects of key sources of CEO hubris on acquisition premiums, we also examine the implications of hubris for company performance. For if the sources of hubris increase premiums, but do not damage corporate performance (i.e., are without retribution), there is doubt about whether the CEO’s confidence was “exaggerated.”

The literature on acquirors’ performance after acquisition is extensive, with evidence showing that, with some exceptions (Lubatkin, 1987), acquisitions tend to destroy value for acquiring firms’ shareholders. In an exhaustive study on the topic, Agrawal, Jaffe, and Mandelkar (1992) found that shareholders of acquiring firms suffer a 10-percent loss over a five-year postmerger period, a result robust across various specifications of acquiror and acquisition conditions. Sirower (1994) used postacquisition periods ranging from three days to four years and found a consistently significant negative association between premium size and subsequent returns. Following this research, we expect that:

Hypothesis 7: The larger the premium paid for an acquisition, the worse the subsequent performance of the acquiring firm.

The sources of CEO hubris we examine could be taken as surrogates for managerial quality, rather than exaggerated CEO self-confidence.(3) But such an argument seems weak for two main reasons. First, an acquisition, by its very nature, is a departure from what the CEO has already managed. To consider one’s abilities in one domain or company as efficacious in another is tenuous and is thought to account for many unfavorable consequences following acquisitions (Haspeslagh and Jemison, 1991). Second, CEOs, like others, probably have great difficulty objectively evaluating their abilities (Bazerman, 1990). They are swayed by recent successes or failures, others’ attributions about their abilities, and personality factors (Kets de Vries and Miller, 1984; Sutton and Callahan, 1987). As a result, a CEO’s self-confidence may stem from numerous factors, few of which will assure success in future endeavors.

We believe that the sources of CEO hubris we examine will have a detrimental effect on organizational performance following a completed acquisition. Hubris impairs a CEO’s judgment, causing overpayment of the acquisition. Such overpayment is a principal mechanism by which hubris ultimately damages performance following the acquisition. We expect that CEOs with hubris do not have more ability than other CEOs to recoup large acquisition premiums and that their firms will be penalized accordingly:

Hypothesis 8: The greater the CEO’s hubris, the worse the subsequent performance of the acquiring firm.

Figure 1 summarizes our arguments about the role of CEO hubris in large acquisitions. As shown, we expect the three sources of hubris to influence acquisition premiums positively. Hubris itself remains unobserved and so is shown in a dashed box. Lack of vigilance by the board of directors may accentuate the relationship between hubris and acquisition premiums such that a hubris-infected CEO may have greater discretion to pay an excessive acquisition premium if the board is not vigilant. Finally, large acquisition premiums are expected to impair shareholder returns. Although not shown in the model, we also test for direct and indirect effects of hubris on returns.

[FIGURE 1 ILLUSTRATION OMITTED]

METHODS

Sample

This study included all pairs of publicly traded firms involved in acquisitions in 1989 and 1992 with payments over $100 million, using the Securities Data Corporation’s Mergers and Acquisitions database. The years 1989 and 1992 were chosen to test for robustness over widely varying economic environments: 1989 was a boom year for mergers and acquisitions and the overall economy, while 1992 was a trough. Only acquisitions with payments over $100 million were included because we were concerned with major acquisitions in which CEOs must be centrally involved. The sample consisted of 53 and 59 pairs of firms for 1989 and 1992, respectively. After dropping transactions with missing data, the final sample consisted of 106 transactions.

Dependent Variables

Acquisition premiums. The Center for Research on Security Prices (CRSP) database was the source of stock price data for determining acquisition premiums. We used the Wall Street Journal Index to identify the first date on which a potential takeover of the target was announced. Thirty days prior to this date then formed the basis for the target’s pre-takeover, or “unaffected,” stock price. The purchase price was the price at which the acquisition was consummated. When the acquiror offered stock rather than cash, we used the market value of stock offered per target share as the numerator, as is conventional in acquisition studies. The acquisition premium is the purchase price minus the pre-takeover price, divided by the pre-takeover price. We adjusted the premium for the movement in the Standard and Poor 500 Index, removing that part of the stock price change attributable to market movement. This proved to be a relatively minor adjustment, correlated at over .90 with the unadjusted premiums.

Firm performance. Following prior research (Fama et al., 1969; Reinganum, 1985; Puffer and Weintrop, 1991), we used cumulative abnormal security returns (CAR) as the measure of firm performance. An abnormal return to a stock is “that part of the return that is unanticipated by a statistical or economic model of anticipated, normal returns” (Reinganum, 1985: 51). A positive abnormal return indicates that the security market has revised upward its expectations of future returns from the security; a negative return indicates that the market has lowered its expectations for the firm. The two measures we used are described more fully in the Appendix. Immediate returns is the cumulative abnormal returns for the period immediately surrounding the takeover news: from five days prior to the first takeover announcement to five days after the consummation of the acquisition. The other measure was one-year returns, the CAR for the period from 30 days prior to the first takeover news to 331 trading days later. Thus one measure gauges the market’s immediate assessment of the acquisition, and the other includes more delayed responses, presumably incorporating postacquisition developments. We also examined other short-term and long-term CAR windows, yielding results consistent with those reported here.

Independent and Moderating Variables

Recent acquiror performance was measured as stockholder returns for the twelve months prior to the date used to determine the unaffected stock price. Stockholder returns were calculated as stock price appreciation plus returns from dividends (assuming dividends are immediately reinvested in the stock), divided by the initial stock price. The Bloomberg and CRSP data bases were the sources of stockholder return data.

Media praise for the CEO was determined through content analysis of major, nationally distributed newspaper and magazine articles about the CEO for the three years leading up to the acquisition. Hubris is most likely to be activated by favorable press from nationally prestigious publications with high circulation. A favorable article in, say, the Wall Street Journal, is obviously read by more people and is more prestigious than an article in a locally distributed or trade paper. Therefore, we limited our newspaper search to articles from the following major newspapers, which have significant business coverage: Atlanta Constitution, Boston Globe, Chicago Tribune, Los Angeles Times, New York Times, Washington Post, and Wall Street Journal. We identified articles through Lexis/Nexis and ABI Inform databases for daily newspapers and magazines, respectively. We used only articles specifically attributing organizational outcomes to CEOs or otherwise commenting on CEOs’ performance. We did not use articles simply describing a company action, naming a CEO or quoting a CEO, because they contained no commentary of attributions thought to trigger hubris. In total, we identified 138 articles.

Two researchers (one coauthor and an assistant not otherwise associated with the study) independently read and coded each of the 138 articles, using the following scale: 3 points: the article was unequivocally favorable to the CEO; 2 points: the article was on balance favorable to the CEO but did contain some critical remarks; 1 point: the article was on balance neither positive nor negative about the CEO; -1 point: the article was on balance negative about the CEO but did contain some positive comments; -2 points: the article was unequivocally negative about the CEO; and zero points were given for those (45) CEOs who received no press reports. The interrater reliability was very high, with only six articles involving one-point disagreements between the coders. The coders then discussed those articles and reached an agreement about their coding.

The final measure of media praise for the CEO was the aggregate favorability of all CEO press accounts, the sum of the scores for all articles about a CEO. For example, a CEO who attracted two unequivocally favorable three-point articles received a media praise score of six; a CEO receiving no press commentary received a score of zero. We also developed other measures of media praise, including simple article counts, as well as various elaborate scores adjusted for article length, prominence, and journal prestige. All these other measures were highly correlated with the aggregate favorability measure and yielded similar results.

CEO relative compensation, a measure of CEO self-importance, was calculated as CEO cash compensation divided by the compensation of the second-highest-paid officer. Compact Disclosure and company proxy statements were the sources for this measure.

Additionally, we derived a composite measure of hubris (the “hubris factor”) from factor analysis of the three hubris indicators. With an oblique rotation method incorporating maximum likelihood procedure, the three variables formed a single factor with an eigenvalue of 1.48, explaining 50 percent of the variance. The factor loadings for the three variables were as follows: recent acquiror performance = 0.46, media praise = 0.85 and CEO relative pay = 0.74. These weightings were used to construct an overall hubris index, allowing a parsimonious analysis for testing some of the hypotheses (Lawley and Maxwell, 1971; Jolliffe, 1986).

Data on lack of board vigilance were all drawn from company proxy statements and Compact Disclosure. The board-chair/CEO combination was a dummy variable, coded 1 when the board chair and CEO were the same individual and 0 otherwise. Percentage of inside directors was defined as the number of executive directors divided by the total number of directors. Outside director holdings was the number of shares owned by all outside directors divided by the total number of company ordinary shares. Then, to convey “smallness of director holdings,” we used the natural logarithm of the reciprocal of outside director holdings.

Control Variables

We attempted to control for the target’s underperformance and synergy as explanations of takeover premiums, as well as for other potentially confounding factors. We examined underperformance motives in two ways. First, we included the target firm’s recent relative profitability, calculated as the target’s return on equity (ROE) for the full year prior to the acquisition minus the average ROE of the firm’s primary 4-digit Standard Industry Classification (SIC) code (using Compact Disclosure). Second, we included a measure of target company agency conditions: the percentage of stock held by the officers and directors, taken from proxies. When this variable, which we call target officer and board holdings, has a large value, underperformance is less easily attributable to managerial self-dealing or shirking (Jensen, 1993). Performance improvements in such cases may be difficult to achieve and, accordingly, premiums may be small. A contrary view might anticipate that when target officers and directors have large holdings, they may have a financial incentive to hold out for a very high price, causing consummated premiums to be large. To further control for target resistance to a takeover, we included a dummy variable for whether the target had a poison pill: 1 for companies with a pill; 0 for companies without it. Poison pills can materially affect the cost of an acquisition and so may influence both premiums and acquisition returns (Malatesta and Walkling, 1988). The source of information on poison pills was the Investor Responsibility Research Center, a Washington, D.C. organization that has collected data on shareholder rights plans since their inception.

To measure the potential for product synergy, we coded acquisitions on a four-point product relatedness scale: 4 = acquiror and target are in same business, sharing identical 4-digit SIC codes; 3 = acquiror and target share significant commonalities in their value chains or share 2-digit SIC codes; 2 = acquiror and target have some intangible commonalities; and 1 = acquiror and target are unrelated.

Two researchers collected and independently coded descriptions of company activities and SIC codes for the pairs of companies, using the above scale. Again, the interrater reliability was high, with one-point disagreements for 16 transactions, which were discussed and resolved.

Slusky and Caves (1991) found evidence for financial synergies that arise when acquisitions yield a more efficient capital structure. Consistent with Slusky and Caves (1991), we controlled for this effect by including a financial synergy variable: the debt/equity ratio of the target less the same ratio of the acquiror in the year prior to the acquisition, as found in Compact Disclosure. This measure indicates the capacity of an acquiror to transfer needed capital to the target. To control for a high-performing firm’s ability to pay a large premium, we controlled for the level of slack resources of the acquiror as reflected by its current asset ratio: the ratio of the acquiror’s current assets divided by its current liabilities.

Because takeover premiums may vary according to the method of acquisition payment (Slusky and Caves, 1991), we included a control variable for payment method. This was a 3-point ordinal scale: 1 = cash, 2 = a combination of stock and cash, and 3 = stock. The presence of competing bidders has been found to drive up acquisition premiums (Slusky and Caves, 1991; Haunschild, 1994), and we controlled for this with a dummy variable (1 = other bidders).

Because the relative size of the acquisition may have important direct or indirect effects on acquisition premiums, we included the revenues of the target divided by revenues of the acquiror in the year preceding the takeover. We also included a dummy for the year of the transaction (0 = 1989; 1 = 1992) to account for any systematic differences for the two years studied.

RESULTS

Table 1 presents descriptive statistics and correlations for the variables.

[TABULAR DATA 1 NOT REPRODUCIBLE IN ASCII]

Determinants of Premiums

The correlations provide preliminary support for hypotheses 1, 2, and 3: Acquisition premiums were positively correlated with recent acquiror performance, media praise, and the CEO’s relative pay. Additionally, premiums were highly related to the combined hubris factor.

A more definitive test requires multiple regression analysis, as reported in Table 2. Model 1 in the table includes only the control variables, yielding an [R.sup.2] of .14. The significant control variables are target board and officer holdings (positive) and the presence of competing bidders (positive).

Table 2 Acquisition Premiums: Results of Multiple Regression Analysis(*)

Variable Model 1 Model 2 Model 3

Intercept .001 -.267 .082

(.263) (.245) (.271)

Relatedness .082 .046 .038

(.050) (.046) (.056)

Target’s relative profitability .001 -.000 .001

(.001) (.001) (.001)

Target financial synergies .028 .034 .030

(.043) (.040) (.042)

Target poison pill .004 -.028 .018

(.090) (.053) (.086)

Acquiror liquidity .027 -.037 -.038

(.041) (.038) (.039)

Target officer and board holdings .391(**) .324(**) .370(**)

(.182) (.161) (.176)

Competing bidders .231(**) .127 .155

(.101) (.089) (.097)

Relative size of target .003 .003 .001

(.002) (.002) (.002)

Payment method .018 .050 .019

(.052) (.044) (.049)

Year of transaction .088 .109 .101

(.087) (.075) (.085)

Recent acquiror performance .004(**)

(.001)

Media praise for CEO .016(**)

(.008)

CEO relative pay .152(**)

(.081)

Hubris factor .170(**)

(.037)

Combined Ceo/chair .113

(.090)

% Inside directors .134

(.252)

Smallness of outside director .022

holdings (.021)

N 106 102 100

R square .142 .319(**) .326(**)

(*) p [is less than] .10; (**) p [is less than] .05;

(***) p [is less than] .01.

(*) Standard errors are in parentheses. Model 1: control variables; model 2: control variables and hubris variables. and model 3: control variables, hubris factor, and board vigilance variables.

Model 2 adds the three hubris variables, yielding a substantial increment in [R.sup.2], to .32. Premiums were positively associated with the acquiror’s recent performance, recent media praise for the CEO, and the CEO’s relative pay, our gauge of self-importance.

In model 3, we included the hubris factor, and this was positively associated with premiums. Overall, therefore, Roll’s hubris hypothesis received considerable support. Three different sources of hubris — recent organizational success, media praise for the CEO, and the CEO’s self-importance — as well as the hubris factor were significantly and positively associated with the size of acquisition premiums.

Model 3 also included the three variables measuring lack of board vigilance, none of which had main effects on premiums. Hypotheses 4, 5, and 6 predicted interaction effects, however, based on the argument that the manifestation of CEO hubris in large acquisition premiums would be accentuated when board vigilance was weak. To test these hypotheses, we estimated three regressions, alternately adding each (hubris factor x lack of vigilance) interaction term to model 3. The results for these three interactions are presented in Table 3.

Table 3 Acquisition Premiums: Interaction Terms between Hubris and Board Vigilance(*)

Interaction Standard

Interaction term coefficient error [R.sup.2]

Hubris factor x combined

CEO/chair .364(***) .157 .367(***)

Hubris factor x % of

inside directors .620(***) .242 .374(***)

Hubris factor x smallness of

outside director holdings .020 .029 .330(***)

(*) p [is less than] .10;

(**) p [is less than] .05;

(***) p [is less than] .01.

(*) The results are for the addition of respective interaction terms to model 3; reported are coefficients, standard errors, and R squares.

Two results for the interactions were significant: those involving combined board chair and CEO positions and the percentage of inside directors. When there was a combination of hubris and the CEO was also board chair, or when there was hubris and a large percentage of inside directors, the premiums were particularly large. The other interaction term, smallness of outside directors’ holdings, was not significant. These results support our expectations about board vigilance.

Effects on Shareholder Returns

The immediate returns and the one-year returns following the acquisitions were -4 percent and -11 percent, respectively (see Table 1). Both means were significantly less than zero (p [is less than] .05). Thus, in line with considerable prior research, these acquisitions in general reduced shareholder value (Agrawal, Jaffe, and Mandelkar, 1992). The correlation between acquisition premiums and immediate and one-year returns were -.09 (n.s.) and -.26 (p [is less than] .01), respectively. This provides some preliminary evidence that larger premiums harm the acquiror’s shareholder wealth.

Table 4 shows the results of the regressions for post-acquisition performance. Models 4 and 6 include all control variables. Of those, only the financial synergy variable was associated with subsequent shareholder performance and only for one-year returns (p [is less than] .01). None of the board vigilance variables had main or interaction effects on shareholder returns, nor did they alter the effects of other variables. Therefore they are not included in the performance models presented.

[TABULAR DATA 4 NOT REPRODUCIBLE IN ASCII]

Models 5 and 7 add premiums. In support of hypothesis 7, premiums were significantly negatively related to one-year returns, but there was no association with immediate returns. Since no analyses yielded any significant predictors of immediate returns, no additional such models are reported.

In model 8, we inserted the hubris factor and omitted premiums to predict one-year returns. The hubris factor was significantly negatively associated with one-year returns, indicating that, among companies making large acquisitions, CEO hubris tends to damage shareholder returns. From the preceding regression models and our accompanying theory and hypotheses, we observe the chief mechanism by which this performance impairment occurs: the payment of large acquisition premiums.

An important final test was to examine the possible effects of hubris on performance that are distinct from its effects due to driving up acquisition premiums. Namely, it may be that our hubris indicator reflects true managerial quality, and even though high-quality executives pay more for acquisitions, they have superior talents to recoup these amounts. To test for this, we treated model 7 as a first-stage regression, allowing the effects of premiums on one-year returns to be fully absorbed. Then, as a second-stage (with the residuals from model 7 as the dependent variable), we added the hubris factor. If the hubris factor were a reflection of managerial quality, it would be positively related to returns in this model. Instead, this test revealed a negative but not significant relationship between the hubris factor and the model 7 residuals. Thus the hubris factor did not have any positive effects on performance to countervail the negative effects that were due to inflated premiums. Overall, the results suggest that hubris tends to damage one-year stockholder returns, and this occurs primarily through the payment of high premiums. We found no evidence that managers with a lot of hubris have generally superior talent for recouping the large premiums they pay.

DISCUSSION

Human factors clearly manifest themselves in large corporate acquisition decisions (Roll, 1986; Haspeslagh and Jemison, 1991; Haunschild, 1994), and the role of executive dispositions may be even greater in acquisitions than in other strategic decisions. Acquisitions involve considerable ambiguity in means,-ends relationships, with eventual outcomes extremely uncertain. Hence, the condition of bounded rationality (Cyert and March, 1963) applies, and human bias can be expected to intervene in such choices (Mischel, 1977). Moreover, acquisitions, particularly large ones, are inevitably ego-involving for all parties. With a single transaction, a CEO can radically transform the size and profile of the firm, perhaps instantly enabling it to enter the Fortune 500 list, move up greatly on such a list, or enter an exciting industry. A CEO will have difficulty remaining detached and dispassionate about these kinds of possibilities (Haspeslagh and Jemison, 1991). Also, an acquisition, even the most friendly, involves an air of conquest — of winner and loser, dominance and submission (Hirsch, 1986; Hambrick and Cannella, 1993).

Effects of CEO Hubris

Our results suggest that CEO hubris, manifested as exaggerated pride or self-confidence, plays a substantial role in the acquisition process, particularly in the decision of how much to pay. We have found that several sources of hubris have their own independent and additive effects on the premium the acquiror is willing to pay. First, the better the recent performance of the acquiring firm, the more that is paid for an acquisition. This represents a tendency to attribute organizational success to the CEO (Meindl, Ehrlich, and Dukerich, 1985) and for the CEO to deem that success as applicable to managing additional entities. The greater the CEO’s confidence in his or her own abilities (as well as those of subordinates), the greater the benefits the CEO believes he or she can bring to an acquired entity and the higher the price paid.

Second, the greater the recent media praise for the CEO, the larger the premium paid for an acquisition. In our sample, every increment of media praise brought a 1.6 percent increase in acquisition premiums (see Table 2). Thus each highly favorable article about the CEO (receiving a score of 3 in our scheme) resulted, on average, in a 4.8 percent increase in premium paid. For a billion-dollar acquisition, this would be $48 million. Through glowing portrayals, the media not only conveys to the CEO an external validation of his or her capabilities, but it also broadcasts the message widely, disseminating a new level of CEO prestige outward to business and social circles. Acquaintances and business associates may start treating the CEO as more glorified (Chen and Meindl, 1991), further fostering his or her perceptions of personal ability. It seems that some CEOs who pay extremely large acquisition premiums, on the assumption that they have the talent to recoup the extraordinary outlays, literally come to believe their own press. Acquisition premiums thus seem an ideal arena for studying CEO hubris, because every increment of premium represents the CEO’s belief in how much more valuable the target firm would be under his or her leadership.

Essentially all of the articles we coded about the acquiring CEOs were positive, even though our scale allowed for negative articles. Although we have no concrete benchmark, our sense is that some articles about CEOs are largely negative (Miller and Friesen, 1977; Chen and Meindl, 1991). Hence, the absence of negative press about these CEOs may be one more indication of hubris in the acquisition process, in that it affects the basic decision to make a large acquisition: It may be that only CEOs with considerable confidence (or perhaps simply a political foothold) will consider making a large acquisition. Then, among them, the greater the confidence, the greater the price paid.

The third indication of hubris in acquisition bidding is our finding that a measure of a CEO’s self-importance was positively associated with premiums. Our measure was the ratio of the CEO’s pay to that of the second-highest-paid executive in the firm, which we take to be a telling indicator of the CEO’s own sense of potency and self-esteem. While we do not have longitudinal data, we would anticipate that this ratio shows strong consistency over time for a given CEO and may be considered a reflection of a basic personality trait rather than a conditional phenomenon. Some CEOs may have an extreme sense of potency, verging on arrogance, as part of their personal makeup (Kets de Vries and Miller, 1984), and these CEOs will be relatively likely to inject their arrogance into their strategic choices, including the prices they pay for large acquisitions.

Fourth, hubris is an unobservable construct that may be considered a composite of recent organizational success, media praise for the CEO, and the CEO’s self-importance. As a composite, derived through factor analysis, the hubris factor was highly associated with acquisition premiums and negatively associated with performance.

Lack of Board Vigilance

We further posited that the effect of CEO hubris on acquisition premiums would be accentuated by a lack of board vigilance. We expected that boards that are least alert to shareholder interests and more beholden to the CEO would particularly foster CEO hubris and the accompanying large premiums. The results largely supported this line of thought. First, the greater the percentage of inside directors, the more heightened the effects of the hubris factor on acquisition premiums. Despite the mixed conclusions in prior research about the effects of inside vs. outside board composition (Mizruchi, 1983; Boeker, 1992), it appears that insiders may be co-opted by the CEO in acquisitions or perhaps even share the confidence of the hubris-infected CEO, allowing large acquisition prices. Conversely, outsiders may help to protect shareholder interests, contributing to moderation in acquisition bids.

The consolidation of the board chair and CEO positions also had the expected effect of amplifying the association between CEO hubris and premiums. Some research has questioned whether the consolidation of board chair and CEO positions has much effect on organizational performance or governance (Finkelstein and D’Aveni, 1994). Our results suggest that such a power concentration is consequential, at least in the context of acquisitions. It appears that the hubris-infected CEO who is also board chair has relatively free rein to pay a large acquisition premium.

Outside directors’ stockholdings had no main or interactive effect on acquisition premiums, This absence is perplexing, since there is evidence that outside directors’ holdings affect corporate behavior (Tosi and Gomez-Mejia, 1989; Kosnik, 1990). Our tentative conclusion is that outsiders may blunt the exercise of hubris, but they do not do so in proportion to their stockholdings. Conceivably, major owners could become swayed by the CEO’s successes and acclaim, acceding to the payment of large premiums. Our results suggest that, in the context of acquisitions, efforts to require outsiders to own more stock may not yield any improvements in board vigilance (Jensen, 1993).

Control Variables

Two control variables were associated with acquisition premiums and warrant brief discussion. First, the stockholdings of the target company’s officers and directors were positively associated with premiums, perhaps due to the more aggressive, cohesive bargaining position that accompanies a large financial stake. The reverse expectation, rooted in agency theory, was that small holdings by target officers and directors would signal that there could be managerial shirking or self-serving, and, in turn, that performance improvements might be relatively easy to achieve. That expectation was not borne out. Second, consistent with prior studies, the presence of competing bidders was positively associated with acquisition premiums. We found no evidence to support target underperformance or synergy as determinants of acquisition premiums, Rather, the most powerful explanation of acquisition premiums, in our data at least, lies in CEO hubris.

The amount of improvement that a CEO believes he or she can bring to an acquired entity is a highly personalized determination. Partly traceable to the CEO’s observable accomplishments, to the external attributions that are bestowed upon him or her, and even to manifestations of inherent personality, hubris appears to drive up acquisition prices. Considered in tandem with Haunschild’s (1994) finding that acquisition premiums are related to the premiums paid by board-interlocked firms, the evidence is substantial that this exceedingly “economic” phenomenon acquisition pricing, typically involving huge sums of money — is due more to social, psychological, and institutional forces than to financial optimization.

Effects on Shareholder Returns

Our results support prior evidence that acquisitions tend to damage acquirors’ performance, as reflected by shareholder wealth. Not only did the acquiring firms lose value in general, but the larger the premium paid, the greater the loss (over a one-year postacquisition period). We also found a negative relationship between hubris and shareholder returns. Thus hubris has unfortunate implications for shareholders in the context of large acquisitions.

Warranting discussion is our finding that hubris and premiums have no effect on immediate shareholder returns but are negatively related to one-year returns. The shorter window is in keeping with the typical event-study methodology; the longer window accommodates subsequent market adjustments, but with the drawback that it is more influenced by factors other than the acquisition. Several prior studies have examined extended (one year or more) windows on postacquisition shareholder returns, and most have found significant losses (e.g., Bradley, Desai, and Kim, 1988; Agrawal, Jaffee, and Mandelkar, 1992; Sirower, 1994). Research examining both immediate and longer-term market reactions indicates, in line with our results, that the immediate reaction to acquisitions is significantly negative and that the losses become larger over the first year and even larger still over the next three years (Magenheim and Mueller, 1980; Sirower, 1994). For example, Sirower found that acquisition premiums were negatively associated with immediate returns (in comparison to our nil result) and that premiums had about four times as much negative effect on one-year returns. Coupled with our findings, these results suggest that unfavorable investor reactions mainly tend to occur after acquisitions are consummated.

We consider this delayed effect as two sides of a coin. On the one side, it appears that the market tends to underestimate all the negative implications of acquisitions at the time they are transacted. One explanation for this is that the market is itself impressed by the track record, acclaim, and seeming potency of the hubris-infected CEO, also believing that he or she has the ability to recoup a large premium. Thus, at the outset, even though the market is somewhat skeptical, t may still give management some benefit of the doubt. On the other side of the coin, adverse postacquisition developments may cause the market to respond negatively. Such developments might include performance slippage in the firm’s original core business, due to managerial preoccupation with the newly acquired entity, particularly if a very large premium has been paid. Also, there may be unexpected problems with the acquisition itself, possibly the departure of key executives or difficulties in integrating the new entity, which, again would be most likely to occur if the parent were operating under the pressure of a large premium (Hambrick and Cannella, 1993, Sirower, 1994). Or it may be that, with the passage of time, the excessiveness of the premium simply becomes clearer to the market. These interpretations are consistent with the “weak form” of the efficient market hypothesis: that the market is responsive to all available information but not prescient about subsequent developments.

Hubris and Agency Theory

Our findings also can be considered from the standpoint of agency theory. Since Manne (1965), agency theorists have viewed takeovers — the threat and the event — as a key means of disciplining poorly performing or self-dealing incumbent executives. With this pro-takeover bias, the early work of agency theorists focused on the principal-agent problem in target firms, paying less attention to the principal-agent problem in acquiring firms (e.g., Jensen, 1984). Yet, consistent with other studies, we found no evidence that poor performance of the target company influenced takeover premiums or postacquisition performance (Varaiya, 1987, Slusky and Caves, 1991). In keeping with more recent agency perspectives, our study focuses more on conditions in acquiring firms (e.g., Morck, Shleifer, and Vishny, 1990). Hubris, as we have conceptualized it, represents the acquiring CEO’s degree of self-confidence, which almost surely covaries with the CEO’s power and penchant for self-aggrandizement. Boards of directors thus face a considerable challenge when presented with acquisition proposals by CEOs with hubris. These CEOs may be overconfident, very powerful, very greedy, or some combination of all three. Our results suggest that the boards best able to resist these CEOs have large percentages of outside directors and board chairs other than the CEO. These board characteristics are consistent with those widely recommended by corporate governance reformers concerned with agency issues (e.g., Jensen,1993).

In recent years, scholars have examined a wide array of executive personality dimensions, including locus of control, tolerance for ambiguity, charisma, and risk-propensity. In our view, not enough attention has been paid to executive hubris, an individual-level construct — perhaps part enduring trait, part conditional or temporary phenomenon — that may have major effects on a variety of organizational outcomes. In addition to its effects on acquisition premiums, hubris may affect executive behavior after an acquisition, including the treatment of acquired executives and the degree of integration imposed. Much more research is needed to explore the fuller, longer-term effects of managerial hubris on broader organizational performance and other variables. There may be any number of other business situations in which some CEOS are sure they can extract handsome princes while others simply see toads.

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APPENDIX: Measures of Acquisition Performance

Cumulative abnormal returns (CAR) were measured using Fama et al.’s (1969) market model approach, as repeated in Puffer and Weintrop (1991). The approach is as follows:

[R.sub.jt] = [a.sub.j] + [b.sub.j][R.sub.mt] + [e.sub.jt],

where

[R.sub.jt] = the continuously compounded return of security j over period t (i.e., normal expected return);

[a.sub.j] = E([R.sub.jt]) – [b.sub.j]E([R.sub.mt])Nar([R.sub.mt]);

[b.sub.j] = cov ([R.sub.jt], [R.sub.mt])Nar([R.sub.mt]);

[R.sub.mt] = the continuously compounded rate of return on the equally

weighted market index over period t;

[e.sub.jt] = the disturbance term of security j over period t;

and E([e.sub.jt]) = 0.

The abnormal return or prediction error is:

[AR.sub.jt] = [R.sub.jt] – [a.sub.j] – [b.sub.j][R.sub.mt],

where a and b were estimated over the 300 trading days prior to the last unaffected stock price.

Cumulative abnormal return was calculated as follows:

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII]

where n equals the 11 days surrounding the announcement (5 days prior, 5 days after, and the actual announcement date) for the immediate performance effect and 331 trading days after the last unaffected stock price for the 12-month performance effect.

(*) We gratefully acknowledge helpful suggestions from Warren Boeker, Joel Brockner, Jerry Davis, John Hartman, Batia Wiesenfield, and symposium participants at Columbia, Dartmouth and MIT.

(1) We thank Mark Sirower for bringing Buffett’s remarks to our attention.

(2) Discussions with several prominent executive compensation consultants support the view that the ratio of the CEO’s pay to that of the second-highest paid officer reflects a personal trait that the consultants variously called “ego,” “megalomania,” and “chutzpa.”

(3) One financially minded seminar participant referred to this as “inside information” that the acquiring CEO possesses about his or her true skill level.

COPYRIGHT 1997 Cornell University, Johnson Graduate School

COPYRIGHT 2004 Gale Group