Mergers are back in style. Bank ofAmerica
A recent study by finance professors Geoffrey Tate of the University of Pennsylvania and Ulrike Malmendier of Stanford sheds some interesting light on CEOs and their frequent urge to merge. CEOs typically explain that they're doing a deal for the benefit of shareholders, as they expect the deal to boost the company's value. But various studies have demonstrated that mergers often don't boost a company's bottom line at all. Are these CEOs lying to us?
The answer appears to be. no, not intentionally, at least. Tate and Malmendier found that overconfidence seems to be a main culprit, not necessarily a desire to build an empire and preside (more lucratively) over a bigger domain.
The professors measured overconfidence by looking for CEOs who held options until expiration and for those cited in the financial press as overconfident (vs. cautious). That's because risk-averse CEOs tend to exercise options before expiration and someone who holds on until the end is demonstrating a continued faith in the company's future growth.
A Knowledge@Whartonreport explained that CEOs may "believe that their deal will trump all the mediocre ones that have come before. Their confidence -- critics might call it hubris -- blinkers them. That leads them to charge ahead with mergers, despite evidence that the transactions destroy shareholder value."
Tate and Malmendier's research suggests some ways companies might improve their operations. More independent board members, for example, might be effective in questioning a CEO's bullishness on a proposed merger. And if companies carry more debt, they may do fewer deals, as they'll have to go to the equity market and make a persuasive case for the merger. A takeaway for investors is to consider a company's board of directors, and how willing you think they'd be to challenge a CEO or ask tough questions in the face of a proposed merger. It would also be helpful to find out, if you can, how merger-happy the CEO has been in the past, at his current post and any previous ones.
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Longtime Fool contributor Selena Maranjian doesn't own shares of any companies mentioned in this article.