Published November 6, 2019
Multinational conglomerate Berkshire Hathaway buys CEO Warren Buffett’s struggling hometown newspaper. Amazon acquires Whole Foods, which is headquartered in the same state where CEO Jeff Bezos grew up and owns a home.
New research from the School of Management shows these deals aren’t coincidences.
Companies are 2.5 times more likely to acquire firms headquartered in the state where their CEO grew up than similar firms located elsewhere, the study found. But whether this hometown bias is a valuable skill or a major problem depends on the scrutiny the transaction receives.
“Most of us hold fond memories of the place where we grew up,” says study author Feng (Jack) Jiang, associate professor of finance. “But what are the consequences of this nostalgia when it influences acquisition decisions?”
Published in the Journal of Financial and Quantitative Analysis, the study examined 5,505 mergers and acquisitions from 1992-2014 representing more than 2,200 companies and 4,200 CEOs, and used Social Security data to determine the executives’ home state.
After controlling for a variety of factors — such as the firms’ size, industry and financial leverage, and the CEOs’ age, gender and years of tenure — the researchers found a company was 83% more likely to acquire a firm based in the state where its CEO grew up.
Moreover, the study showed this hometown bias was even more pronounced when CEOs lived in their home state longer, went to college there or currently hold a board seat there.
“There are many reasons a CEO may acquire firms from their home state,” Jiang explains. “On one hand, they have hometown advantage and can exploit their knowledge of the local culture and market to make a good deal. But CEOs may also look home for personal reasons, whether that’s for selfish gain, like increased status or access to government officials, or to selflessly lift up a distressed community using corporate resources.”
To isolate these potential motivations, the researchers divided the data between public and private deals. If a hometown deal is made for corporate gain, it’s more likely to be a public acquisition, which faces intense scrutiny from investors, media and regulators, and is often much larger — 10 times the size of the average private deal in the study. By contrast, small private deals may be associated with weaker corporate governance, making them more likely to be driven by — and suffer from — a CEO’s ulterior motives.
The study found that public home-state deals outperformed similar deals by 2%, translating into about $100 million more in average shareholder value. Additionally, thanks to the CEO’s local background, companies saw average gains in operating performance for the three years after the acquisition, and were less likely to experience major losses (no public hometown deals lost $1 billion or more, while 10% of other public deals do).
By contrast, private hometown deals underperformed by 1.5%, translating into a $22 million loss in average shareholder value.
“Our study is the first to document that corporate managers exhibit a home bias when making real investment decisions in mergers and acquisitions,” Jiang says. “Corporate monitors should be leery of small, private hometown deals, but should also recognize that a hometown advantage could benefit a company — if it has strong corporate governance in place.”
Jiang worked on the project with Yiming Qian, professor and Toscano Family Chair in Finance at the University of Connecticut School of Business, and Scott E. Yonker, associate professor and Lynn A. Calpeter Sesquicentennial Faculty Fellow in Finance at Cornell University.