Question

Chapter 12 talks about the hubris hypothesis. This suggest that managers continue to engage in acquisitions, even though on average they do not generate economic profits, because of the unrealistic belief that they can manage a target firm’s assets more efficiently than that firm’s current management. Usually this type of non-rational thinking does not last too long in competitive market conditions. Firms led by managers with these unrealistic beliefs change, are acquired, or go bankrupt in the long run. Do you think that the hubris hypothesis is a legitimate reason for why there continues to be a lot of acquisition activity? Why or why not? Are there other reasons that could explain why so many firms are involved in M&A?

Answer 1

Yes, hubris hypothesis is a legitimate reason for why there continues to be a lot of acquisition activity. This is because, and as per hubris hypothesis, in many cases managers seek to acquire other firms for their own personal motives as well. It should be noted that hubris hypothesis states that pure economic gains are not always the sole and the primary motivation in case of acquisitions. Several of the acquisition activities are driven by non-rational reasons like arrogance and excessive confidence and this leads to irrationality. Presence of irrationality is what drives most of the acquisition activity and is the primary reason for spurt of majority of acquisition deals.

Other reasons also exist for the involvement of a large number of firms in the M&A space. These reasons are legitimate reasons like looking for a quick way of expansion, seeking inorganic growth, making use of available free cash, the need to consolidate market position, quest for globalization and diversification. All these reasons and factors also cause several firms to get involved in M&A.