Acquisitions Signal CEO Dominance

CEOs may try to acquire other companies in order to signal dominance within their firm.  At least this is my interpretation of this article in the Sept. Journal of Economics and Business:

Logistic regression and Australian data ... suggest that both CEO overconfidence and CEO dominance are important in explaining the decision to acquire another firm. When compared to existing US studies, the evidence on CEO overconfidence is robust across two different financial and corporate governance systems. Our results also indicate that CEO dominance is at least as significant as CEO overconfidence in the decision to undertake an acquisition.

Humans constantly struggle to achieve and signal dominance over each other.  Since in equilibrium more dominant CEOs are in fact better able to push through an acquisition, doing so is a credible way to signal that you do in fact dominate decision making in your firm.   And since signals must always "overdo" it to be credible, this may explain why acquisitions appear to be "overconfident."

Btw, I've been wondering: what fraction of a CEO pay is for the value he adds to key decisions, versus the value he adds by being an impressive person for employees to look up to, outsiders to meet, admire, feel comfortable with, and so on? 

Comments

[Howard]

Except in a very few cases, CEO salary it has very little to do with the individual. It's just a vicious circle.

The board remueration committee reflects on how hard hard they've serched for an "above average" performer for the role, and therefore naturally wants to pay "above average" to the appointee to proclaim their sucess to the market. That raises the average for the next peer survey, and around we go.

Plus it never hurts (from the boards perspective) to improve the Director's Fees to CEO Compensation ratio. The more He gets paid, the easier it is to sell the next increase in Board Comp...

[Eliezer Yudkowsky]

Unless you think that modern CEOs add much more value to key decisions or are much more impressive for employees to look up to, the amount paid for this can be bounded by the total amount paid to CEOs before the salaries started skyrocketing.

[tobbic]

I'm inclined to think that 1) most strategic decisions are made by the board of directors 2) Short-term tactical decisions are pretty much reducible to analytical models. Thus, I'd say the average CEO in a big company doesn't add much value as decision maker. OTHO, the average CEO in a small company probably adds a lot of value as a tactical decision maker because small companies don't have sophisticated models at their disposal.

[Alex]

Object lesson; Sun Microsystems. Great company, great products, but in 25 years of propagandising, Scott McNealy is no closer to persuading everyone to chuck out their general-purpose, von Neumann architecture computers and go thin client. Clearly, the secret of their success is not Scott.

[Carl Shulman]

"Unless you think that modern CEOs add much more value to key decisions or are much more impressive for employees to look up to, the amount paid for this can be bounded by the total amount paid to CEOs before the salaries started skyrocketing."
Eliezer,

This could be achieved simply by economic growth and economies of scale. If corporate decisions have impact roughly proportional to the resources they direct, and inspiration can be done on a one-to-many basis, then the economic value of the same actions will increase with scale. The effect would be similar to the increase in musician earnings (at the very top) driven by digital recording technology.

Also, the correlations between company performance and certain measures of CEO psychology suggests that there are meaningful differences in CEOs: http://online.wsj.com/article/SB118839767564312197.html?mod=hps_us_whats_news.

[Carl Shulman]

Additional measures beyond the ones Robin mentioned, that is.

[Eliezer Yudkowsky]

I've never heard that CEO pay was increasing in proportion to the size of the companies directed. Has it?

I'm sure that CEOs correlate to company performance. The question is whether they are actually being paid for this, or simply having money dumped on them by agent failure. Is there evidence that better-performing CEOs are better-paid? And why were earlier CEOs paid so much less - were they all such worse performers? And most of these correlations are with negative performance - a CEO can screw up a company easily enough; can they save it?

Of course we are totally threadjacking here, but Robin should have known better than to put in that last sentence if he didn't want this post threadjacked. Then again, I can probably read about this whole debate more effectively elsewhere.

[Robin Hanson]

Eliezer, yes in fact CEO pay relative to corporate profits has been relatively constant over recent decades. But I don't see how this is relevant to my last question, which was about the fraction of this pay to attribute to different factors.

[Eliezer Yudkowsky]

Eliezer, yes in fact CEO pay relative to corporate profits has been relatively constant over recent decades.

Oh. Cool. Never mind, then.

But I don't see how this is relevant to my last question, which was about the fraction of this pay to attribute to different factors.

Assuming that at least part of CEO pay is pay for value, if CEO pay increases relative to corporate profits, then either the added value of the CEO is increasing, or CEOs have more bargaining power in negotiations, or they are getting money dumped on them by agent failures. That's why I asked whether modern CEOs are adding more value by decisionmaking or inspiration than past CEOs. Though it's also possible that, somehow, the balance of power in negotiations has shifted to CEOs so that they capture more of their added value. But if CEO pay is a constant fraction of corporate profits over time, my attempted point is moot.

Incidentally, when you asked that question, how did you expect your readers to answer it?

[Barkley Rosser]

I fully agree that CEO egomania has a lot to do with what the evidence suggests is an
uneconomic degree of merger activity (which always involves one firm taking over the other
one, despite this more neutral implication of this term "merger"). That evidence has long
been known and is best symbolized by the tendency of the value of the stock of acquiring
firms to fall while that of the acquired firm rises during such activities.

However, I do not think it is just signaling within a firm, if it is that at all. At least
as important is signaling and social status among CEOs. I have had conversations with the
various CEOs who clutter up the Executive Advisory Board of the College of Business at James
Madison University over the years. I have lost count of the number of times I have hears one
CEO put another one down on the basis that the putter-downer has more employees under him
than does the putter-downee. One upmanship on the golf course and at the country club.

[Robin Hanson]

Eliezer, I guess I was hoping to hear from people who actually worked with CEOS and boards who hire them.

Barkely, yes, CEOs treating number of employees as a measure of importance seems to be an important element.

[Nancy Lebovitz]

Alternate theory: uneconomic mergers mostly happen because the people who promote mergers and acquistions pick up some money off those large transactions. They're only able to talk companies into making those frequently unprofitable mergers and acquistions because they're able to hook some basic human motivations, but the companies wouldn't bother to do nearly as much of m & a on their own.

Be warned: this theory is based on my general feeling of how things work, not specific knowledge.

[Firozali A Mulla MBA PhD]

While I read this, the global warming comes to forefront and I see the CEO name rephrased to CEO, Chief Environment Officer renaming the CEO Chief Executive Officer as archived
Can this set a stage for a real wealth that is in the pipeline?

I thank you
Firozali A Mulla MBA PhD
P.O.Box 6044
Dar-Es-Salaam
Tanzania
East Africa