Paradigm conflict and the wealth effects of blockholder formation in private target acquisitions

Abstract

Decision making in public companies follows an organized structure dominated by risk aversion. The decisions in private entrepreneurial firms tend to be driven by overconfidence and reliance on trial and error. Such entrepreneurial attitudes are reinforced by high levels of profitability. The authors argue that this difference in decision-making paradigms limits the wealth effect of blockholder formation by the profitable private target's owners in mergers and acquisitions. Blockholder formation by private target owners is associated with substantial acquirer shareholder gains in the acquisitions of targets with relatively low and moderate profitability levels. To the opposite, the market reacts to blockholder formation by the owners of highly profitable targets with skepticism. Such announcements are associated with insignificant wealth effects overall and substantial acquirer losses in acquisitions in human capital-intensive sectors whereby disagreements are likely to be consequential. Acquirers understand these wealth effects and reduce the extent of stock financing when acquiring highly profitable targets.