Wednesday, June 25, 2008

Systematic Errors in Processing Information in M&As

Deals Without Delusions. By: Lovallo, Dan, Viguerie, Patrick, Uhlaner, Robert, Horn, John,
Harvard Business Review,
Dec 2007, Vol. 85, Issue 12

Our work has shown that companies that aggressively leverage acquisitions for growth are at least as successful in the eyes of the capital markets as those that focus on purely organic ways to grow. Nevertheless, recent research from McKinsey & Company reveals that approximately half of acquiring companies continue to pay more for acquisitions than they're worth.

when executives take a targeted debiasing approach to M&A, deals can be more successful. The approach requires executives first to identify the cognitive mechanisms at play during various decision-making steps and then to use a set of techniques to reduce bias at specific decision points, thereby leading to sounder judgments.

Confirmation bias.
Underestimation of cultural differences.
The planning fallacy.
Conflict of interest.

The Bidding Phase: Avoiding the Winner's Curse
McKinsey survey suggested that successful acquirers are much more likely to exit when competitors initiate a bidding war: 83% of the successful companies withdrew at least sometimes, compared with only 29% of the unrewarded (not so successful)companies.

One technique for avoiding the winner's curse is to tie the compensation of the person responsible for the deal's price to the success of the deal - for example, to the percentage of estimated synergies realized.

The Final Phase biases

Once an initial bid is accepted, the acquirer has an important opportunity for additional due diligence, since it now has much greater access to the target's books. The final negotiation phase also encompasses the deal's legal structuring (for example, the exact composition of payment cash or stock). In this final phase of due diligence, the goal is to honestly evaluate the investment case in light of the more detailed information now available from the target. Two biases can come into play.

The first stems from a tendency to underreact to surprising news.
The sunk cost fallacy can cause an acquirer to continue pursuing the target even when it shouldn't.

Dan Lovallo ( is a professor of management at the University of Western Australia Business School in Perth and a senior adviser to McKinsey & Company. He is a coauthor of "Delusions of Success: How Optimism Undermines Executives' Decisions" (HBR July 2003).

Patrick Viguerie ( is a director in McKinsey's Atlanta office.

Robert Uhlaner ( is a partner in the firm's West Coast office.

John Horn ( is an associate in its Washington, DC, office.

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