Overoptimistic Managers and Market Misvaluation: Implications for Method of Payment and Subsequent Returns of Corporate Acquisitions

I classify CEOs as overoptimistic based on their option exercise behavior, and find that overoptimistic CEOs are more likely to pay with cash when market-wide valuations are (moderately) above their long-term trend, but not when market valuations are low. In contrast to rational CEOs, overoptimistic CEOs view their stock as overly costly and prefer cash payment, even during times of high market valuation. I show that stock, but not cash acquisitions of overoptimistic CEOs therefore outperform those of rational CEOs during times of high market valuation. These findings suggest an important interaction between CEO overoptimism and market misvaluation when analyzing corporate decisions such as the method of payment in acquisitions. JEL-Classification: G34