Takeover Process

a) The bidding firm identifies a potential target firm.

b) A "valuation" of the equity of the target firm is
undertaken. The valuation would incorporate any
estimated economies due the synergy effect or the
negatives like a weak management (that will cause a
discount in the target's market price).
c) This 'value' is compared to the current market price of
the target firm. If the value is below the price, the bid is
abandoned. However, if the value is above the market
price, a bid is made.

 Now consider a case when there is no

synergies or gains, but the bidding firm
believe it exist.
A random variable is compared with the
target market price.
But when there aren't any sources of gains
for the bidding firm, the takeover premium
is a mistake made by the bidder.

Such behaviour rests on the assumption that

individual are rational beings. A typical
individual bidder believes that the valuation is
right and is convinced that the market does
not reflect the full economic value of the
combined firm. This is the underlying premise
of the Hubris Hypothesis - When there are no
actual aggregate gains in a takeover, the
takeover can be explained by the overbearing
presumption of bidders that their valuations
are correct.

The hubris (or pride) hypothesis (Roll, 1986) implies that

managers seek to acquire firms for their own personal
motives.
Roll (1986) states that if the hubris hypothesis explains
takeovers, the following should occur for those takeovers
motivated by hubris:
a) The stock price of the acquiring firm should fall after the
market becomes aware of the takeover bid.
b) The stock price of the target should increase with the
bid for control
c) The combined effect of the rising value of the target
and the falling value of the acquiring firm should be
negative. This takes into account the costs of
completing the takeover process.

Unrealistic price paid for the target

Difficulties in Cultural Integration
Poor business fit
High Leverage
Boardroom split
HR Issues