Acquiring a Company

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Acquiring a Company
Suppose you are considering acquiring a target
company (T). The value of T is worth anywhere
from 0 to 100 per share (depends on result of
oil exploration). The value of T under your
management will be 150 its value under the
existing management Obviously, T will only accept
your bid if it is at least as high as the value
under Ts management How much should you bid?
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Acquiring a Company
Value to Target
Target says no
Yes!
100
b
0
Bid from Acquirer
When Target says yes, they are worth b/2 on
average
Therefore they are worth 3/2 (b/2) 3/4 b
on average
But 3/4 b lt b! So on average, the acquirer
loses money!
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Perspective Biases
Many negotiation errors arise from our inability
to see things from the other sides
perspective. 1) We have a hard time taking
into account information available to the other
side. Acquiring a company Competitive
bidding
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Perspective Biases
2) We are biased to think that we are in the
right. Confirmation bias/biased
assimilation One-sided evidence B P
D J jurors for Pltf 10.6 12.1 8.5
11.5 egocentric assessments of fairness
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Perspective Biases
3) We are biased to be suspicious of what the
other side is offering. Fixed pie
bias/lose-lose agreements Reactive
devaluation
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Reactive Devaluation
The tendency to devalue offers and concessions
merely because they were made by the other side
E.g. Apartheid divestment at Stanford partial
divestment (PD) reward companies that divest
(RD)
T1 PD gt RD T2 RD gt PD
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90 Confidence Interval
3,213,752 autos 77.7 billion 5.8 billion 67,900
sq. miles 4.16 million 195.7 billion 68.5
inches 1,749,129 vol. 728.9
billion 290,400
1. The number of GM cars produced in 1990 2.
IBMs assets in 1989 3. Total number of 5 bills
in circulation in 1990 4. Total area in square
miles of Lake Michigan 5. Total population of
Barcelona, Spain in 1990 6. The amount of taxes
collected by the IRS in 1970 7. The average
annual snowfall in Anchorage, AK 8. The number of
bound volumes in all 26 branches of the San
Francisco Public Library 9. The dollar value of
outstanding consumer credit at the end of
1988 10. The median price of existing
single-family homes in Honolulu, HI in 1990
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Positive Illusions
Many negotiation errors arise from our tendency
to maintain an overly optimistic view of our own
attributes, motivation, and ability to secure
favorable outcomes. 1) Overconfidence 2)
Self-enhancing biases
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Anchoring Insufficient Adjustment
Oftentimes our assessment of what constitutes a
fair or reasonable offer is skewed by salient
numbers that have been introduced in the course
of negotiating. demonstration Real
estate brokers
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Framing Effects
Our willingness to accept deals and our
aggressiveness bargaining is often affected by
the way in which offers are packaged and
described.
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Descriptive Theory of Value Prospect Theory
1) Reference dependence people are sensitive to
losses and gains relative to their reference
state (e.g., the status quo). The reference
state can be manipulated through framing. 2)
Diminishing sensitivity people are less and less
sensitive to each additional dollar gained or
lost (i.e., the value function is concave for
gains and convex for losses). 3) Loss aversion
losses loom larger than gains (i.e., the
value function is steeper for losses
than for gains).
value
gains
losses
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Status Quo Bias (Hershey et al, 1990) Auto
Insurance Policies
NEW JERSEY no-fault () PENNSYLVANIA right to
sue ()
23 buy right to sue 53 retain right
lose right vs. gain
gain right vs. (-gain )
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Descriptive Perspective Prospect Theory
Note that the value function predicts risk
aversion for gains
risk seeking for losses
value
v(100) v(50)
v(50) gt 1/2 v(100)
-100 -50
gains
losses
50 100
v(-50) v(-100)
1/2 v(-100) gt v(-50)
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Cognitive and Motivational Biases in Negotiation
Summary
1) Perspective Biases Problem People have
great difficulty compensating for their unique
point of view. They tend to overestimate the
appeal of their own point of view, minimize
concessions made by the other side, and fail to
appreciate the impact of other peoples
information on outcomes, falling prey to the
Winners Curse. Solution In your
preparation, try to play devil's advocate by
carefully considering the strengths of the other
side's case, and especially the weaknesses of
your own. Do your best to investigate the
information available to others that may
influence their behavior. During the
negotiation, critically evaluate concessions made
by the other side, and be wary of your own bias
to underappreciate them.
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Cognitive and Motivational Biases in Negotiation
Summary
2) Positive Illusions Problem Most people
are overconfident in their accuracy estimating or
forecasting uncertain values, and in their own
ability to get projects accomplished and deals
secured most people have an unrealistically
positive view of their own abilities and
motivations. Solution In your
preparation, try to take the outside view by
considering base rates. Recognize your own
limitations and the extent of your own biases.
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Cognitive and Motivational Biases in Negotiation
Summary
3) Anchoring insufficient adjustment
Problem We often inadvertently allow a salient,
focal value to skew our perception of what is
fair or feasible in negotiation more than we
should. Solution Prepare for negotiations
by deciding in advance your reservation values,
aspiration values and your best guess of your
opponents reservation values. Consciously
question whether the opponents values offered in
the course of bargaining should cause you to
reevaluate.
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Cognitive and Motivational Biases in Negotiation
Summary
4) Framing Problem Risk attitudes,
desirability of outcomes, and willingness to make
concessions can be influenced by the way in which
outcomes are framed--as losses or gains, and in
different mental accounts. Solution Try
to view outcomes in terms of a consistent,
positive frame, for example, by translating all
outcomes into dollars or utility points. Try
to encourage your counterpart to frame outcomes
in a way that is advantageous to you.