We will write a custom Critical Writing on CEO Overconfidence and the Market’s Reaction specifically for you
301 certified writers online
Malmendier and Tate (2006) attempted to analyze the tendency for acquisitions among overconfident CEOs. The authors stated that the overconfidence model was able to predict the active acquisitiveness of the overconfident CEOs whose companies had unexhausted debt capacity or were rich in cash; the prediction was also made about the subset of value-destroying mergers (Malmendier & Tate, 2006).
Ways to define self-confidence
First of all, the objective of the researchers was to find a reliable way to determine overconfidence. For that, they used such characteristics as the CEOs’ decision to wait with their options till the year of expiration or using Holder 67 measure that estimates the level of confidence connecting it to the length the decision-makers wait to proceed with their portions. In turn, the overconfidence is matched to the rates of acquisitions made throughout the terms of the CEOs.
The authors conclude that the decisiveness in terms of acquisitions is directly linked to overconfidence (Malmendier & Tate, 2006). The readiness of the CEOs to wait with their acquisition options is a determiner of their confidence level; however, it is unlikely to be the only factor contributing to it. That way, it is possible to criticize the method chosen by the authors as that with limited reliability.
Further, Malmendier and Tate (2006) pointed out that the overconfidence patterns may vary within CEOs’ behaviors while being in charge of one firm. Practically, these criteria imply the limitations of the sample of the evaluated CEOs and the firms they manage.
Moreover, the researchers found that there is a correlation between the criteria of undervaluation and the length of waiting; based on this finding, the authors conclude that the CEOs who are classified as overconfident tend to possess a higher sensitivity to the market undervaluation; in other words, the phenomenon known as the investor sentiment is the key driver of the decision-making process in terms of mergers and acquisitions (Malmendier & Tate, 2006).
Apart from building their theory as to the predictors of overconfidence, the authors rely on the images of the CEOs as reflected in the recent press coverages. It is important to point out that the analysis of the opinions presented by the press is not the most reliable approach to the CEOs’ behavioral patterns because the presentation may be biased and incomplete. In that way, both of the methods the researchers employ to assess the overconfidence and its contributing factors and determiners are flawed, limited, and unreliable. All in all, the authors form a series of predictions and then attempt to support them using estimations, statistical data, and analysis. The authors conclude that all of their initial hypotheses are confirmed by the data collected and its analysis.
To sum up, the major strength of the paper is what its findings imply for the world of business – a series of behaviors criteria and tendencies that allow the firms to evaluate the CEOs based on their recent activities, self-presentation, and performance and determine whether or not they are overconfident. In turn, the authors connect overconfidence with the CEOs’ tendency to destroy value for the shareholders using frequent and risky acquisitions. At the same time, the main weakness of the paper is presented by the limitations that exist within each hypothesis and approach used by the authors inflicted by the narrow focus and small sample.
Malmendier, U., & Tate, G. (2006). Who makes acquisitions? CEO overconfidence and the market’s reaction. Journal of Financial Economics, 89(1), 20-43.