Daily Management Review

Mergers and Acquisitions: Escalation of Commitment Bias


05/27/2020


Escalation of commitment bias is particularly prevalent, in high risk strategic decisions, such as mergers and acquisitions (M&A).



The acquisition process not only implies technical dimensions but also social, psychological and behavioral dimensions. Mergers and acquisitions involve several actors in intense and complex relationships (fears, stress, anxiety, expectations), where emotions and psychological dimensions play an important role. Acquisition decisions and therefore decisions regarding company takeovers are the perfect setting for an escalation of commitment. Beyond the characteristics common to all strategic decisions (Laroche 1988; Schwenk 1995), most research work agrees that in a high-pressure situation, time is often a luxury managers cannot afford. Managers are in a fast-changing environment that asks them to take actions faster than ever. They are invaded by tons of data (financial, fiscal, legal, organizational, marketing) that we are incapable to interpret and analyze to make informed decisions. These lead them, sometimes to make bad choices. This risk is higher during mergers and acquisitions, given the emergency context surrounding this type of operation, its high degree of visibility and the asymmetrical nature of the relationship. Even if the manager has surrounded himself with a high-caliber team, his contribution and his direct involvement are essential both to set the price of the acquisition and to complete the development of the operation (Kitching 1967; Haspeslagh and Jemison 1991; Hayward and Hambrick 1997). The central position of the manager can be explained by the organizational roles he plays in the acquisition decision and its implementation: decision-making role, role of information inside and outside the firm, role as a spokesperson but also as a manager during the integration phase.

Escalation of engagement is understood to mean a process leading to actors (who have long been engaged in the conduct of a project), losing their analytical skills by speeding up the conclusion of the agreement, beyond all objective reasons (Jemison and Sitkin1986). This bias is all the stronger as the efforts agreed by the group (in terms of resources mobilized), the buy-in and support of the main components of the organization, the involvement of the staff, make it difficult to justify the lack of implementation (Haspeslagh and Jemison 1991). The latter occurs when more effort and impetus are given to a project following bad signs (Coulon &Wolf, 1980; Staw, 1976; Staw & Ross, 1978; Whyte, 1986) with the view of preventing these signs from damaging the effective realization of a project on which the actors have to spend significant time and resources. M&A Managers have external and internal influence from society, peers, and employees, which can significantly alter their perception on what factors realistically matter when making decisions.

The evaluation phase of the M&A process tends to create a dynamic within the management teams, which often makes it impossible for the managers to turn back from the deal, even if their intuition calls for caution (Self-justification theory). Due diligence is a process of verification, investigation, or audit of a potential deal to confirm all relevant facts and financial information. It allows the buyer to verify anything else that was brought up during an M&A deal. By gathering this information (debts, leases, long-term customer agreements, employment contracts...), the buyer feels better equipped to close the deal with a sense of certainty. But the activity of making a good decision does not protect from failure. Sometimes, rather than creating rationality, due diligence creates false beliefs. The critical spirit disappears in favor of collective dynamics. M&A Managers act irrationally but align with previous decisions and actions (cumulative prior investment). They become attached to the transaction, by eliminating the other strategic alternatives. They become proud of seeing their company's colours paraded before a mass audience. Enthusiasm and "the will to do well" take precedence over lucidity and clairvoyance. The takeover project can, in this way, be continued despite its lack of pertinence (Staw & Ross, 1978) and the appearance of negative information (Caldwell & O’Reilly, 1982).

Avoiding these mind traps (cognitive bias) is quite difficult as they are unconscious processes. M&A Managers can limit their negative effects if they acknowledge they are subject to them. It is important to remain calm in an emergency situation and take a step back from the risk of acceleration and precipitation.

Olivier Meier
Full Professor
University of Paris Est (LIPHA)