As a general rule, the more optimistic and overconfident executives are, the more they engage in acquisitions and the more they leave their investors vulnerable to experiencing the winner’s curse. In situations where the market value of a firm roughly measures its intrinsic value, excessively optimistic and overconfident executives overestimate the synergy from acquisitions but believe their own firms to be undervalued. As a result, these executives favor paying for target firms using cash instead of stock.

A longholder is an executive who holds his or her stock options until very near expiration. Executives who are excessively optimistic and overconfident according to press coverage and the longholder criterion are especially prone to engage in acquisitions and prefer to pay in cash instead of stock. Moreover, they tend to discount the negative market reaction to their acquisition announcements.

Acquirers who always trust prices leave themselves vulnerable to the winner’s curse during times when investors are irrationally exuberant about target firms. WorldCom’s acquisitions serve as an example. Targets who always trust prices and accept payment in the form of the acquirer’s stock leave themselves vulnerable to seller’s remorse, the flipside of the winner’s curse. Time Warner provides such an example.

Managers who participate in acquisitions often do so when they perceive themselves to be operating in the domain of losses. H-P’s acquisition of Compaq illustrates this phenomenon. The H-P–Compaq example also serves to illustrate the psychological phenomena that guide the thinking of executives and directors.