Daniel Kahneman won the Nobel Prize for Economics in 2002, and is one of the most influential thinkers of this generation. In his recent book Thinking, Fast and Slow, this giant of behavioral economics addresses the world of M&A. Kahneman discusses optimism and overconfidence in business leaders, and how this effects companies and markets. Kahneman quotes a study by economists Malmendier and Tate that shows that optimistic CEOs – measured by the amount of stock they personally owned in the company – took excessive risks; for example, they were more likely to overpay for acquisitions, and to “undertake value-destroying mergers” (p.258).
Kahneman writes that “beliefs in one’s superiority have significant consequences. Leaders of large businesses sometimes make huge bets in expensive mergers and acquisitions, acting on the mistaken belief that they can manage the assets of another company better than its current owners do. The stock market commonly responds by downgrading the value of the acquiring firm, because experience has shown that efforts to integrate large firms fail more often than they succeed. The misguided acquisitions have been explained by a “hubris hypothesis”: the executives of the acquiring firm are simply less competent than they think they are.” (Daniel Kahnman, Thinking, Fast and Slow, 2011, p.258).
How can this common leadership fault be addressed? Part of the problem is that when senior management, especially a CEO, is excited by an M&A deal, it’s a rare and brave soul who stand up and say “this deal sucks”. Groupthink is very, very powerful. It’s what stopped people from preventing failures from Titanic and Pearl Harbor, to the Challenger and Deepwater Horizon. In the world of business, people rarely die from a failed M&A deal (happily, or business would be dangerous), but optimism and groupthink behave in just the same way. At organizations from the CIA and NASA, to Lehman and AIG, professionals are making faulty risk assessments and no one, not even the people whose job it is to do so, looks them in the eye and says ‘this is bad’.
For the world of M&A Kahneman says Gary Klein has the best solution, though it is only a partial remedy: conduct a premortem. When considering an acquisition, pretend now that the deal closed and you’re a year in the future, and the deal was a complete disaster. Now, write a brief history of this disastrous deal. A premortem allows – in fact requires – every member of the team to voice their doubts, to identify pitfalls, and this enables the acquirer to take at least some of the necessary steps to avoid the pitfalls they’ve anticipated.
Merjerz is doing something similar – instead of just requiring a few executives to suspend reality for a minute and find ways to tell their boss that she’s doing a stupid deal, Merjerz enables people who have no qualms or restrictions, no social barriers, to voice their opinions. This is the best way (we know of) to fight hubris, optimism and over-confidence in M&A.
Merjerz 