This post comes to us from Anand Goel, Assistant Professor of Finance at DePaul University, and Anjan Thakor, the John E. Simon Professor of Finance and a Senior Associate Dean at Washington University in St. Louis.
In our paper, Do Envious CEOs Cause Merger Waves?, which was recently accepted for publication in the Review of Financial Studies, we develop a theory which shows that merger waves can arise even when the shocks that precipitated the initial mergers in the wave are idiosyncratic.
We start with a simple premise: CEOs have preferences defined over both absolute and relative consumption, with relative-consumption preferences characterized by envy. Whenever we refer to a CEO, we mean the CEO of a bidding firm, and by envy, we mean that an individual’s utility is increasing in the difference between his consumption and that of the person he envies. There is now a large literature on the biological, sociological, and economic foundations for envy-based preferences, and substantial empirical evidence that preferences display envy. Assuming envy-based preferences generates a simple yet powerful intuition for why mergers come in waves. If CEOs envy each other based on relative compensation and CEOs of bigger firms get paid more, then a merger in the industry that increases firm size for one CEO will cause other envious CEOs to be tempted to undertake value-dissipating but size-enhancing acquisitions, thereby starting a merger wave.

