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The Hubris Hypothesis of Corporate Takeovers*
Finally, knowledge of the source of takeover gains still eludes us. [Jensen and Ruback 1983, p. 47] I. Introduction
Despite many excellent research papers, we still do not fully understandthe motives behindmergers and tender offers or whether they bring an increase in aggregatemarketvalue. In their comprehensive review article (from which the above quote is taken), Jensen and Ruback (1983) summarize the empiricalwork presented in over 40 * The earlierdraftsof this paperelicited manycomments. It is a pleasureto acknowledgethe benefitsderivedfrom the generosity of so many colleagues. They corrected several conceptualand substantiveerrors in the previous draft, directed my attentionto other results, and suggestedother interpretationsof the empiricalphenomena. In general, they provided me with an invaluable tutorial on the subject of corporatetakeovers.The presentdraftundoubtedly constill tainserrorsandomissions,but this is due mainlyto my inability to distill and convey the collective knowledgeof the profession. Among those who helped were C. R. Alexander, Peter Bernstein, Thomas Copeland, Harry DeAngelo, EugeneFama, KarenFarkas,MichaelFirth, MarkGrinblatt, Gregg Jarrell, Bruce Lehmann, Paul Malatesta, Ronald Masulis, David Mayers, John McConnell, Merton Miller, StephenRoss, RichardRuback,SheridanTitman,and, especially, MichaelJensen, KatherineSchipper,WalterA. Smith, Jr., and J. Fred Weston. I also benefitedfrom the comments of the finance workshop participantsat the University of Chicago, the University of Michigan, and DartmouthCollege, and of the referees. (Journal of Business, 1986, vol. 59, no. 2, pt. 1) ? 1986 by The University of Chicago. All rights reserved. 002 1-9398/86/5902-0001$01.50 197
The hubris hypothesis is advanced as an explanation of corporate takeovers. Hubris on the part of individual decision makers in bidding firms can explain why bids are made even when a valuation above the current market price represents a positive valuation error. Bidding firms infected by hubris simply pay too much for their targets. The empirical evidence in mergers and tender offers is reconsidered in the hubris context. It is argued that the evidence supports the hubris hypothesis as much as it supports other explanations such as taxes, synergy, and inefficient target management.