Board Governance: The Board Challenge

Full transcript

Imagine a CEO proposing a major acquisition. The board must decide whether to approve it. The stakes are enormous. Moeller and colleagues examined over 4,000 acquisitions and documented a net 240-billion-dollar decline in acquiring shareholders' wealth around deal announcements. Just 87 deals accounted for 397 billion dollars in losses, while the remaining deals contributed a positive 157 billion dollars. These were market reactions at announcement, not realized post-acquisition losses. Why might this happen? Roll's hubris hypothesis points to CEO overconfidence, suggesting overconfident CEOs may systematically overbid for target companies. Malmendier and Tate found that overconfident CEOs had 65 percent higher odds of making acquisitions, with average announcement returns of minus 0.90 percent versus an insignificant minus 0.12 percent. But where is the board? Hayward and Hambrick studied 106 large acquisitions and found that the link between CEO hubris and acquisition premiums was stronger when CEOs also chaired the board, or when more directors were insiders. So why doesn't formal oversight always guarantee effective challenge? Board theory helps explain.