Thursday, March 27, 2014

"A Man Hears What He Wants to Hear and Disregards the Rest"

The title comes from lyrics to one of my favorite songs by my favorite singer-songwriter, The Boxer by Paul Simon.  It also describes the subject of today's post: confirmation bias and how it might relate to acquisitions.  "Confirmation bias" is the tendency to overweight evidence that supports our views.  No sooner do you read the definition than you think of the countless ways this could apply to mergers and acquisitions.

First and foremost, consider the CEO determined to grow the company.  A possible target opportunity is identified and before beginning the analysis, the CEO has a favorable view. Being prudent, he or she state, "But let's see what the numbers say."  The danger is that he or she will overweight evidence that supports a positive  position.  It doesn't take much manipulation to change a negative net present value to a positive result.

While the CEO is generally not the person doing the analysis, we all know that when mangement asks "How much is 2 + 2?" the safest answer is "How much do you want it to be?"  That kind of bias leads to disastrous acquisitions.   Synergies, often used to justify deals,  are easy to imagine and tougher to realize.  

Confirmation bias can also be related to the frequency illusion, the odd feeling that some new thing you have just learned about is suddenly catching your attention more far more than seems probable.  Frequency illusion is thought to occur because we all have selective attention.  There are often far more sensory inputs occuring than we can process.  Consequently, our mind focuses on some pattern of interest and records that, ignoring much of the rest.  The pattern of interest, is likely to be the recently learned 'new thing' or information that conforms to our hopes and expectations.  Each new occurrence of the item increases our belief that our analysis and ideas are correct.

The solution, in the case of mergers or in any business decision is to ruthlessly challenge all assumptions, to stress test all analyses, to encourage and nurture dissenting views and to be constantly aware of they types of biases that can distort our thinking.

(For other posts on behavioral bias, see Behavioral Biases in Acquisitions - The Anchoring Effect and Roll's Hubris Hypothesis and Behavioral Bias.)

All the best,


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