From Bias to Discipline – How to Mitigate Behavioral Risk in M&A Part 2

In Part 1, we examined how overconfidence, confirmation bias, and herd behavior influence M&A outcomes—and how tools such as devil’s advocates, pre-mortem analyses, and diverse committees can help mitigate their effects. Yet these represent only part of the behavioral challenge. Equally influential are loss aversion, the endowment effect, and anchoring, which can distort value perceptions and impede disciplined decision-making. A clear understanding of these biases, coupled with the implementation of structured countermeasures, is critical for preserving value in high-stakes transactions.

Loss Aversion

Loss aversion occurs when sellers resist accepting lower offers because doing so would mean realizing a “loss.” Rather than cutting their losses, they often hold out for unrealistic valuations, which can delay or even derail transactions. For buyers, loss aversion can manifest as a tendency to bid conservatively to avoid overpaying. They may heavily discount uncertain cash flows or potential synergies. The result is that such buyers can become less competitive in auctions or negotiations, particularly when other bidders are less risk averse.

Research underscores how costly this can be. A 2024 Business Psychology study found that loss aversion delayed 18% of strategic investments, as executives waited for validating signals while ignoring contradictory data. The case of METRO AG, a leading international food wholesaler, illustrates this effect. In 2006, METRO AG acquired 85 Walmart locations in Germany and 26 Géant hypermarkets in Poland, consolidating them under a new hypermarket chain called Real. The acquisitions were intended to enhance profits and accelerate growth, with METRO AG specifically targeting the struggling Walmart locations to capitalize on market challenges. However, the chain failed to achieve profitability. Hoping for a turnaround, METRO AG retained the division for years, ultimately resulting in a $525 million impairment charge in 2019. When the company eventually divested the business, it sold the assets at a fraction of the original investment and incurred over $269 million in divestiture-related costs.

The table below presents a structured overview of loss aversion in M&A, outlining its potential impacts and the M&A phases in which it most commonly arises.

A disciplined valuation framework can help counteract loss aversion by grounding decisions in objective benchmarks rather than gut instinct or fear. By establishing valuation ranges and walk-away prices ahead of time, managers gain a clear sense of when to step back, reducing the temptation to pursue a deal simply to avoid the feeling of loss. Complementing this approach with scenario analysis and sensitivity testing, which considers base, upside, and downside outcomes, further clarifies potential risks, allowing investors to anticipate losses and respond thoughtfully instead of reacting emotionally.

At the same time, synergies in M&A, while often a key driver of value, carry uncertainty that can lead to over- or underestimating their impact. Engaging an experienced investment banking firm helps anchor these assumptions in evidence. Through careful evaluation of synergies and the application of risk-adjusted frameworks, advisors offer an objective perspective that ensures decisions are guided by the company’s true underlying value rather than by cognitive biases or emotion.

Endowment Effect

The endowment effect occurs when sellers overvalue their businesses simply because they own them. Emotional attachment, legacy, and insider knowledge can inflate expectations beyond market reality. As a result, they may discount or reject offers that accurately reflect market conditions but feel subjectively “too low.”

Data confirms its significance: according to the 2024 Pepperdine Private Capital Markets Report, 29% of deals fail to close, and in nearly half of those cases (49%), valuation gaps—often rooted in the endowment effect—were the decisive factor. The effect is amplified in closely held businesses, where owners may have spent decades building the company and view its worth through the lens of personal sacrifice, legacy, and insider knowledge.

The table below outlines the endowment effect in M&A, its strategic implications, and the M&A phases it most affects.

Third-party valuations counteract the endowment effect by removing emotional attachment and applying objective, transparent methodologies. By relying on market data, comparable transactions, and financial analysis, they provide a realistic, evidence-based value, helping owners avoid overpricing and enabling fairer, more rational negotiations.

Anchoring Bias

Anchoring bias occurs when dealmakers fixate on reference points—such as public comparables, precedent transactions, or early valuations—when determining a company’s value. This tendency is pronounced during market uncertainty, as estimating a company’s intrinsic value depends on assumptions that are particularly challenging when the outlook is volatile. Intrinsic value is assessed using the discounted cash flow (DCF) method, which determines an investment’s perceived worth by discounting projected future cash flows to their present value.

While public comparables and precedent transactions can provide useful guidance, overreliance on them may result in significant mispricing: sellers frequently anchor to historical highs, while buyers often lean heavily on comparables to avoid appearing “out-of-market,” potentially creating a gap between perceived and true value.

The table below summarizes anchoring bias in M&A, highlighting its effects and the points in the M&A process where it typically emerges.

Anchoring is best mitigated through forward-looking methods such as discounted cash flow (DCF) analysis. Unlike comparables, DCF forces explicit assumptions about future performance and risk. Although this transparency can feel riskier for decision-makers, it provides a clearer lens on long-term value. When paired with independent valuations, DCF serves as a powerful counterbalance to anchoring distortions.

At Watermark Advisors, every client engagement is guided by our “M&A Bridge Approach,” a proprietary framework designed to bring structure, discipline, and clarity to the M&A process. Spanning the full transaction lifecycle—from preparation through post-closing integration—the Bridge helps mitigate behavioral finance biases that can undermine deal success.

Sell-Side M&A

For sell-side clients, the Bridge includes multiple steps designed to ensure sellers achieve fair deals while mitigating behavioral biases. One of the first steps is the M&A Preparation Report, which simulates a buyer’s due diligence process. By timing this early in the Preparation Phase instead of the Transaction Phase, it allows sellers to uncover potential red flags that exist but are not affecting the company’s financial performance, providing the opportunity for sellers to address these issues in plenty of time before actual buyer due diligence.

Watermark also provides integration services, recognizing that many deals include contingent payments, with sellers often receiving future consideration through an earnout, seller note, or rollover equity. Because sellers’ influence over the company’s performance typically evaporates after closing, our post-transaction integration consulting helps mitigate potential biases between target and buyer management, supporting a smoother and more successful transition.

The following illustrates Watermark Advisors’ sell-side M&A Bridge.

Buy-Side M&A

For buy-side clients, the M&A Bridge guides buyers through a structured, bias-aware approach to executing transactions successfully. At the heart of this process is the Transaction Phase, where thorough due diligence uncovers potential red flags that might otherwise be missed due to overconfidence or other behavioral biases—risks that could later disrupt integration and threaten deal outcomes. Equally critical is professional integration planning, including synergy identification, led by trusted experts. By partnering with experienced integration teams, Watermark helps clients mitigate bias, allocate resources strategically, and focus on areas that are meaningful but often underserved. The result is a more disciplined, informed, and value-creating acquisition process that maximizes ROI.

Below is a visual representation of Watermark Advisors’ buy-side M&A Bridge.

By combining comprehensive guidance, expert financial insight, and with a commitment to integrity, Watermark ensures clients—whether buying or selling—navigate each transaction with confidence, achieve fair outcomes, and maximize long-term value.

Many M&A failures are driven less by market dynamics or strategic shortcomings and more by predictable cognitive biases. The ability to recognize and mitigate these biases is a decisive factor in transaction success. Behavioral finance offers an evidence-based framework for understanding investor behavior, helping to inform the development of more effective financial strategies. In M&A, this is not just an academic concept but a strategic imperative. Executives who address these biases proactively can make sharper capital allocation decisions, execute deals with greater discipline, and significantly reduce the risk of costly integration failures. By partnering with Watermark Advisors, companies gain a trusted advisor with the expertise and structured approach needed to counteract these biases, safeguard value, and guide transactions from preparation through integration with clarity and precision.