Executive Compensation, Hubris, Corporate Governance: Impact on Managerial Risk Taking and Value Creation in UK High-Tech and Low-Tech Acquisitions

Abstract

While the traditional agency model assumes managerial risk aversion and under-investment in high tech opportunities, the behavioural agency model allows for risk seeking by managers leading possibly to over-risky investments. Corporate governance mechanisms can correct both under- and over-risky investment thereby ensuring value enhancing high tech acquisitions. Our study builds an empirical optimal risk model to identify the drivers of managerial risk taking by comparing UK high tech and low tech acquisitions. We then classify actual acquisitions into optmally risky, over-risky and under-risky acquisitions. We test whether under-risky and over-risky acquisitions underperform optimally risky ones in terms of 3-year post-acquisition shareholder wealth gains. Our main results demonstrate that almost none of the compensation contracts has an impact on managerial risk preferences in acquisitions while LTIP share awards discourage high risk acquisitions. Good past performance, stock market glamour status and flattering media profile that enhance managerial hubris make acquirer managers risk-seekers. Corporate governance structure does not have a material impact on managers' acquisition risk preferences. We find that over-risky investments create more value than under-risky or optimally risky acquisitions especially during the stock market boom of the late 1990s. During such a boom strategic use of stock as acquisition currency seems to avoid value destruction but not in other time periods.

Keywords: Executive compensation, mergers and acquisitions, corporate governance, behavioural bias, risk taking

JEL Classification: G34, J33