The Diagnostic Value and Anchoring Effect of References in Acquisition Premium Decisions: The Influence of Overconfident and Powerful CEOs

Abstract

CEOs often must make strategic decisions under extreme uncertainty. One way they deal 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 diagnostic value and anchoring effects of two commonly used references in acquisition premium decisions: an external reference (the premium paid for the preceding acquisition in the target industry) and an internal reference (the premium paid by a focal firm for its preceding acquisition). We theorize that while external references have diagnostic value and anchoring effects, internal references only have anchoring effects. Moreover, we argue that powerful and overconfident CEOs rely more on internal references. Our results, based on a hedonic regression analysis of 3072 completed acquisitions, support these hypotheses.