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Due Diligence Failure as a Signal Detection Problem

Strategic Organization, Forthcoming

50 Pages Posted: 5 Jun 2006  

Phanish Puranam

INSEAD

Benjamin C. Powell

Harbir Singh

University of Pennsylvania - Management Department

Abstract

In conducting due diligence during corporate acquisitions, acquirers obtain new and usually negative information regarding targets' values. Because such information is noisy, acquirers must balance the risk of withdrawing from a value-enhancing acquisition against the risk of persisting with a value-destroying acquisition. Drawing on signal detection theory - a rational choice theory of decision making under uncertainty - we propose that the relative importance acquirers place on these two risks affects how they utilize information obtained during due diligence. To assess this proposition, we undertook an experimental study of decision making in due diligence. The results are consistent with the assertion that the initial value acquirers attach to the acquisition opportunity affects 1) the impact that negative information from due diligence has on their valuations of targets and 2) their final acquisition decision.

Keywords: corporate acquisitions, due diligence, escalation of commitment, signal detection theory

JEL Classification: D8, M21, M10

Suggested Citation

Puranam, Phanish and Powell, Benjamin C. and Singh, Harbir, Due Diligence Failure as a Signal Detection Problem. Strategic Organization, Forthcoming. Available at SSRN: https://ssrn.com/abstract=905925

Phanish Puranam (Contact Author)

INSEAD ( email )

1 Ayer Rajah Avenue
Singapore, 138676
Singapore

HOME PAGE: http://www.insead.edu/facultyresearch/faculty/profiles/ppuranam/

Harbir Singh

University of Pennsylvania - Management Department ( email )

The Wharton School
Philadelphia, PA 19104-6370
United States
215-898 6752. (Phone)
215-898 0401 (Fax)

No contact information is available for Benjamin Powell

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