Acquisition Risk and Psychology

46 Pages Posted: 8 Oct 2016 Last revised: 11 Oct 2016

See all articles by Ye Cai

Ye Cai

Santa Clara University - Leavey School of Business

Hersh Shefrin

Santa Clara University - Leavey School of Business

Date Written: September 1, 2016


This paper investigates how the combination of preferences and biases impact the risk-value profile of acquiring firms. We find strong evidence that prior losses impact acquisition risk as firms with negative prior returns are more prone to become acquirers and make value destructive acquisitions. These behavior patterns take place within the context of general corporate risk choices that conform to the aspiration-based March-Shapira model, modulated by psychological biases such as overconfidence and confirmation bias. To examine the impact of biases, the paper focuses on market reactions to acquisition announcements which are judged to be either bad or good. Consistent with confirmation bias, firms associated with extremely bad or extremely good acquisitions exhibit higher risk following acquisitions. As governance and monitoring strengthen, executives feel more pressure which exacerbates the psychological tendency to become more risk seeking. Firms with longholder CEOs, regarded as overconfident, take more risk than firms with non-longholder CEOs. While there is a differential longholder risk impact associated with extremely good acquisitions, there is none with extremely bad acquisitions. In addition, the risk response to prior returns for firms having longholder CEOs is muted relative to firms with non-longholder CEOs.

Keywords: Acquisition risk, Aspiration-based risk taking, Confirmation bias, Overconfidence

JEL Classification: G02, G34

Suggested Citation

Cai, Ye and Shefrin, Hersh, Acquisition Risk and Psychology (September 1, 2016). Available at SSRN: or

Ye Cai (Contact Author)

Santa Clara University - Leavey School of Business ( email )

500 El Camino Real
Santa Clara, CA California 95053
United States

Hersh Shefrin

Santa Clara University - Leavey School of Business ( email )

Dept. of Finance
Santa Clara, CA 95053
United States
408-554-6893 (Phone)
408-554-4029 (Fax)

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