CEO Home Bias And Corporate Acquisitions
Emory University – Department of Finance
T. Clifton Green
Emory University – Goizueta Business School
Emory University – Goizueta Business School
June 15, 2016
We find that CEOs are significantly more likely to purchase cross-state targets from their birth state, consistent with either informational advantages or familiarity bias. Evidence from bidder announcement returns supports the latter view. Acquirer returns are significantly lower for CEO home state acquisitions, and the relation is robust to controls for firm and industry characteristics. The negative announcement effect is stronger for poorly-governed firms, when the target is located further away, and when the CEO has a deeper birth-state connection. CEOs’ post-acquisition trading behavior also supports a familiarity bias interpretation. Our findings suggest CEO home bias influences firm investment.
CEO Home Bias And Corporate Acquisitions – Introduction
In 2010, after considering roughly 400 possible targets, Indiana-based manufacturer of funeral caskets Hillenbrand Inc. announced a plan to acquire K-Tron International Inc., a Pitman, New Jersey firm which engineers industrial coal crushers and feeding equipment (including a machine to shoot raisins into breakfast cereal). Despite the considerable difference in product lines, K-Tron provided Hillenbrand CEO Kenneth Camp with a unique benefit. Although Camp said the location in Pitman had no influence on his decision to buy the company, he acknowledged: “When I heard it was in Pitman I thought people would say I spent all this money to go see my mother.” Camp was raised in Pitman and his mother Edith still lived nearby in his childhood home.
In this article, we study the effects of CEO home bias on corporate acquisitions. Specifically, we analyze whether CEOs are more likely to acquire companies located in their birth state. We explore whether CEO home bias acquisitions are in the best interest of shareholders, and we examine whether home bias mergers reflect beneficial information advantages, potential private benefits to the CEO, or an underlying bias towards the familiar.
A well-established literature in equity markets finds that investors like to invest close to home, and evidence is mixed regarding whether local preferences reflect informational advantages or a bias towards the familiar. Coval and Moskowitz (2001) and Ivkovic and Weisbenner (2005) find that investors’ local stock holdings outperform, and Kang and Stulz (1997) find that foreign investors avoid stocks with high information asymmetry. On the other hand, Seasholes and Zhu (2010), and Pool, Stoffman, and Yonker (2012) find no benefits to local investing, and they observe a greater propensity to invest locally among less experienced investors, which is more consistent with familiarity bias.
As with equity investments, a local preference for corporate investment may occur for informational reasons. For example, CEOs’ educational or professional network connections may cluster geographically, which could lead to worthwhile investment opportunities close to home (e.g. Cohen, Frazzini, and Malloy, 2008; Cai and Sevilir, 2012). Cultural awareness of a geographic region may also facilitate the process of merging, which could also lead to more local mergers (Ahern, Daminelli, and Fracassi, 2015).
On the other hand, CEOs may also be susceptible to familiarity bias. Place attachment and place identity are well-established concepts in environmental psychology (e.g. Manzo, 2003), and familiarity is viewed as a central cognitive element of place attachment (Scannell, and Gifford, 2010). Familiarity has been linked to confidence in risky gambles (Heath and Tversky, 1991), and measures of CEO overconfidence have previously been linked to corporate investment (e.g. Malmendier and Tate, 2008; Hirshleifer, Low, and Teoh, 2012; and Ben-David, Graham, and Harvey, 2013). We consider CEOs’ regional upbringing as a source of deep-seated familiarity, and we study whether a CEO’s birth state location influences the firm’s acquisition behavior.
As part of our identification strategy, we distinguish between in-state and cross-state acquisitions, and we also classify targets as being near or far from the acquirer based on geographic distance. The rationale is that we expect the effect of CEO home bias on target selection, either through unique information channels or a bias toward the familiar, to be incrementally stronger when the target is further away from acquirer.
We find evidence that CEO home bias influences cross-state corporate acquisitions. Following an approach similar to Rhodes-Kropf and Robinson (2008), we compare actual targets to hypothetical targets with similar characteristics. The evidence suggests that actual cross-state targets are roughly one third more likely to be from the CEO’s birth state than in the control group. We find no incremental increase in the likelihood of in-state mergers for home CEOs, relative to in-state mergers by outside CEOs. Perhaps not surprisingly, the findings suggest that the effects of CEO home bias are more pronounced when the target and the acquirer are not from the same state.
To help distinguish between informational advantages and potentially detrimental familiarity-based explanations for CEO home bias in corporate acquisitions, we examine bidder returns around the announcement of the deal. We find bidder announcement returns for cross-state home bias mergers are significantly lower when the CEO was born in the target state. The magnitude of the effect is also economically significant: after controlling for firm and deal characteristics, we find that these acquisitions are associated with a negative CAR of -1.67%. In contrast, we find no significant value effect in cross-state mergers with no CEO home bias, with an estimated bidder announcement return of 0.09%. We also find no significant effect of home bias on bidder returns for in-state mergers, which reinforces the view that CEO home bias is more important when the target is further away from the acquirer.
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