Do Overconfident CEOs Ignore Toehold Strategies?

In a toehold strategy, an acquirer buys a minority stake with the intention to gain control of a target later. Yet despite the claimed advantages toehold strategies offer, acquirers only rarely buy toeholds. This study presents a behavioural dynamic model and empirical evidence, showing that overconfidence of CEOs causes them to forgo the more prudent toehold strategy to make immediate controlling acquisitions instead. We find a negative relation between the likelihood of acquiring a minority stake and CEO overconfidence, revealed through measures based on the timing of their option portfolio and on external perception. Overconfident CEOs also purchase on average larger fractions of their targets. Furthermore, the acquirer returns on toehold announcements tend to be higher than majority stake acquisitions. We conclude that CEO overconfidence causes acquirers to forgo minority stake acquisitions, despite the advantages of minority stakes versus controlling acquisitions.