Avoid “a Cooked Duck Flying Away”: CEO Family Attributes, Pseudo-endowment Effect, and M&A Premiums

Wang Xiaoying; Jia Yinhua; Ma Zhenzhen

doi:doi:10.16538/j.cnki.fem.20210409.202

Summary

Mergers and acquisitions（M&As）are an important channel for Chinese companies to acquire strategic assets and improve their competitiveness. Wind statistics show that the amount of domestic M&As in China has increased from 28.2 billion yuan in 2001 to 2, 211.8 billion yuan in 2019, and the total scale of M&As has increased by 7798%. Among them, more than 70% of transactions ended with M&As. That is, the price paid by M&A companies is higher than the market value of target companies. M&A premiums are also common in developed countries, ranging from 30% to 50%. However, most M&A companies will experience a decline in stock prices or lower earnings after overpaid M&As, which is the “winners’ curse”. Even so, why are a large number of companies still willing to pay a premium? In M&A-related news, reporters often describe M&A failure as “a cooked duck flying away”. Will companies pay a premium to avoid “a cooked duck flying away”? From the perspective of CEO individual psychological deviation, this paper holds that the buyer CEO psychological ownership deviation is one of the causes of M&A premiums. Psychological ownership deviation effect（or pseudo-endowment effect）refers to an individual systematic behavior deviation that is willing to overpay due to avoiding the loss of the future ownership of the target. Before the announcement of M&As, the CEO of M&A companies will invest a lot of resources to screen, interview and investigate target companies. In other words, the opportunity cost of giving up the “cooked duck” is prohibitively high. To avoid such potential losses, the CEO’s willingness to pay is likely to be higher than the market value of target companies. Furthermore, according to the principal-agent theory and the social-emotional wealth theory, family CEOs are more likely to have psychological ownership of target companies, and their loss aversion is stronger. Therefore, family CEOs will perform a stronger pseudo-endowment effect than professional CEOs（non-family CEOs）. Based on 1, 321 M&A premium events of China’s A-share listed companies from 2003 to 2018, this paper uses CEO family attributes as the proxy variable of the heterogeneity of pseudo-endowment effect, and uses the IV-2SLS estimation method to control the potential endogenous problems. The result finds that:（1）Compared with non-family CEO companies, family CEO companies will pay higher M&A premiums.（2）The more the potential competitors, the larger the relative scale of M&As, or the longer the duration of M&As, the stronger the positive correlation between CEO family attributes and M&A premiums. This paper breaks through the traditional theoretical framework based on the assumption of rationality and rational expectation. Starting from the important fact of ownership transfer, this paper explores the impact of CEO individual cognitive bias on its M&A pricing decision, and provides a new theoretical perspective for the abnormal phenomenon of premiums. It not only expands the research boundary of M&A premiums and family business, but also has practical implications for companies to improve the accuracy of M&A pricing. First of all, family CEO companies need to take measures to reduce the individual cognitive bias of CEOs, such as increasing the voice of independent directors or employing professional third-party evaluation agencies. Second, when the scale of M&As is larger or the duration is longer, the willingness to pay of professional CEOs is more rational, and their decision-making efficiency is higher than that of family CEOs.