Economic rationale suggests that the bidder in a corporate takeover situation expects the acquisition to generate positive returns. The “winner’s curse” hypothesis suggests, however, that in the event of competition for a takeover candidate, the successful bidder will tend to be the one that most overestimates the target’s value. In that case, subsequent returns may not be significantly positive and may, in fact, be negative.

An examination of 96 acquisitions completed between 1974 and 1983 reveals that the winning bid premium did, on average, overstate the market’s estimate of the expected takeover gain. Furthermore, the cumulative average excess return to the winning bidder, measured over the period from 20 days before to 100 days after the acquisition announcement, was significantly negative. For the 58 per cent of the acquisitions in which the bid premium overstated expected takeover gain, average excess return to the winning bidder was –14 per cent; in the cases in which the bid premium did not overstate expected gain, average excess return was a positive 13.4 per cent.

To counteract the winner’s curse, bidders should bid less (proportionate to their value estimates) as the degree of uncertainty about the size of takeover gains and the degree of competition for control of the target increase.