In 2010, after considering 400 possible targets, Indiana-based funeral casket manufacturer Hillenbrand Inc. announced a plan to acquire K-Tron International Inc., a Pitman, New Jersey firm which makes 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. Camp was raised in Pitman and his mother Edith still lived nearby in his childhood home. 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.”
We study 8,000 mergers by publicly traded acquirer firms and examine whether CEO’s display a bias towards home in their target selection, and if so, whether these deals are value enhancing or reflect an unwarranted bias toward the familiar. Research from equity markets indicates that investors like to invest close to home, both within and across countries. Evidence is mixed regarding whether this “home bias” reflects informational advantages, which could result in improved stock selection and out-performance, or a bias toward familiar companies, which could lead to reduced diversification and potentially lower investment returns.
As with equity investments, a home bias in 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. Cultural awareness of a geographic region may also facilitate the process of merging, which could also lead to more local mergers (Camp attended Temple University in Philadelphia, 20 miles from K-Tron’s headquarters).
On the other hand, CEOs may also be susceptible to familiarity bias. Place attachment and place identity are well-established concepts in psychology, and familiarity is viewed as a central element of place attachment. In experimental settings, familiarity has been linked to confidence in risky gambles, and measures of CEO overconfidence have previously been shown to be related to corporate investment. 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.
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.
Our analysis suggests CEO home bias does influence cross-state corporate acquisitions. We compare actual targets to hypothetical targets chosen with similar characteristics (such as industry and firm size), and our evidence suggests that actual cross-state targets are roughly one third more likely to be from the CEO’s birth state than expected by chance. We find no difference in the likelihood for in-state mergers. In other words, the likelihood that a New York firm takes over another New York firm does not hinge on where the CEO grew up, but a New York firm is more likely to purchase a Texas-based company if the CEO grew up in the Lone Star State.
To help distinguish between informational advantages and potentially detrimental familiarity-based explanations for CEO home bias in corporate acquisitions, we examine how the market responds to the deal announcement. Positive bidder announcement returns support a value-maximization story, while negative announcement are more consistent with familiarity bias. Our evidence supports the latter view, with bidder announcement returns for cross-state home bias mergers being significantly lower when the CEO was born in the target state.
The magnitude of the home bias announcement effect is economically significant. After controlling for firm and deal characteristics, we find that these acquisitions are associated with a negative three-day return of -1.67% (e.g. Hillenbrand experienced abnormal returns of -2.5% in the three days around the announcement of the K-Tron acquisition). On the other hand, we find no significant value effect in cross-state mergers when the CEO did not grow up in the target state. We also find no effect of home bias on bidder returns for in-state mergers. Our evidence suggests that CEO home bias is more important when the target is further away from the acquirer.
We also consider measures of home bias based on geographic distance, as some cross-state mergers may be geographically close for firms in small states or those near state borders. Consistent with the home state results, we find stronger negative bidder returns when the target is close to the CEO’s hometown (less than 100 miles) yet far from the acquirer headquarters (greater than 500 miles).
We conjecture that CEOs that attended college in their birth state or resided there in early adulthood will hold stronger regional attachments. Consistent with a familiarity interpretation, we find that bidder firm announcement returns are significantly lower for home bias cross-state mergers when the CEOs attended college in the target state or lived there after college.
Moreover, we observe that CEOs are roughly twice as likely to purchase company stock following the announcement of a home bias merger relative to non-home bias mergers, and we find no analogous trading pattern for board members or other company executives. The evidence that CEOs purchase company stock following home bias merger further supports the view that CEO home bias cross-state/faraway mergers are influenced by familiarity-based optimism.
Finally, we find good corporate governance appears to reduce the likelihood of bad home bias mergers. We use common measures of manager entrenchment to proxy for firm governance (staggered boards, low independent ownership, etc.), and we find stronger evidence of negative bidder announcement returns for home bias acquisitions among poorly governed firms.
Taken together, our findings suggest that CEO familiarity influences corporate investment, and that good corporate governance can help mitigate the effects of behavioral biases on corporate decision-making.
The preceding post comes to us from Kiseo Chung, T. Clifton Green, and Breno Schmidt, who are respectively a Doctoral Candidate, an Associate Professor of Finance, and an Assistant Professor of Finance at Emory University – Goizueta Business School. The post is based on their paper, which is entitled “CEO Home Bias and Corporate Acquisitions” and available here.