The Invisible Forces Behind M&A – Why Behavioral Finance Matters Part 1

Mergers and acquisitions (M&A) are often portrayed as calculated financial maneuvers—numbers on spreadsheets, deal multiples, and strategic rationales. But anyone who has lived through one knows the reality can be far more complex. The world of M&A is a tangled mix of competing interests, unique situations, and diverse objectives. Add money and different personalities into the mix, and things get even more complicated.

What often slips under the radar is the psychological turbulence these deals create. The human side of decision-making—biases, assumptions, and emotions—can quietly derail even the most promising transactions, leading to failed integrations, missed ROI targets, and strategic plans that never take shape. It’s no coincidence that roughly 70% of M&A deals underperform expectations, and behavioral blind spots are a significant reason why.

That’s where behavioral finance comes in. By examining how psychological factors influence financial decision-making, it provides dealmakers with a clearer lens—one that acknowledges the very human forces shaping outcomes.

Behavioral finance blends economics with psychology to explain why financial decisions often diverge from purely rational assumptions. In M&A, these dynamics are especially pronounced. High stakes, extended timelines, and strong personalities at the negotiating table mean outcomes are shaped just as much by behavior as by financial analysis.

Addressing these human factors from the start can smooth the post-merger process, increase the odds of hitting ROI targets, and set the stage for long-term success.

To understand how behavioral finance plays out in practice, it helps to examine three of the most common biases that shape dealmaking: overconfidence, confirmation bias, and herd behavior. Each distorts decision-making in different ways, yet all share a common thread—they quietly push leaders away from rational analysis and toward costly mistakes.

1. Overconfidence Bias

Overconfidence bias arises when executives overestimate their ability to create value beyond what fundamentals support. This often manifests as the Hubris Hypothesis—justifying inflated premiums with faith in managerial skill. The risk can intensify during market surges, as seen in the 2021 boom, when accommodative Federal Reserve policies, a record-high stock market (S&P 500: +26.9%), and abundant cheap financing emboldened executives to chase larger targets.

The risk isn’t limited to pricing. Overconfident leaders routinely underestimate integration complexity. A common form is cultural arrogance, where one company presumes its practices are superior and tries to impose them. This erodes collaboration, prompts talent flight, and undermines execution. Research shows that cultural misalignment drives 50–60% of deal failures, with a third of key employees leaving within the first year when integration is mishandled.

The table below distills these dynamics—defining overconfidence bias, illustrating its consequences, and pinpointing where it most often surfaces across the M&A process.

Appointing a devil’s advocate adds a critical layer of bias control. By questioning assumptions around pricing, cultural fit, and integration planning, this role sparks constructive debate, exposes blind spots, and compels the deal team to consider alternative scenarios. The result is a more rigorous decision-making process that surfaces potential challenges early, improving the odds of smooth integration and long-term value creation.

2. Confirmation Bias

Confirmation bias occurs when deal teams, having invested significant time and resources, become emotionally committed to a transaction prior to closing. This commitment distorts judgment: favorable data is emphasized, red flags are minimized, and due diligence becomes an exercise in validation rather than truth-seeking.

The risks of this bias are well documented. Bain & Company found that nearly 60% of disappointing M&A outcomes earlier this decade were tied to due diligence that overlooked critical issues. Unrealistic synergy projections are a common culprit—leaders assume cost savings and growth will materialize faster than is realistic, leading to overpayment and missed expectations. When results inevitably fall short, the consequences ripple across both organizations – eroding trust, weakening morale, and creating operational strain.

The table below presents a structured overview of confirmation bias in M&A, detailing its definition, the risks it poses, and the stages of a transaction in which it typically arises.

To mitigate confirmation bias, deal teams often use pre-mortem exercises, which encourage them to anticipate potential problems and take proactive steps before they arise. These exercises foster open dialogue by surfacing concerns early in the process. A straightforward three-step approach involves identifying what could go wrong, developing mitigation strategies, and assigning responsibility for addressing potential challenges. Research indicates that prospective hindsight—mentally envisioning an event as if it has already occurred—can improve risk anticipation by up to 30%, giving teams more time to act before issues materialize. Similar to the devil’s advocate method, pre-mortems bring hidden risks to light and enable timely, decisive action, grounded in the belief that the best time to ask difficult questions is before failure begins.

3. Herd Behavior

Herd behavior, also known as the peer effect, occurs when companies pursue acquisitions primarily because their peers are doing so. While it is rarely the main driver of deals, it can amplify market momentum—particularly during periods of volatility, such as the pandemic—when rivals’ actions are interpreted as signals of superior insight and high-profile announcements create competitive pressure.

A study by Zhejiang University analyzed quarterly data covering 79,207 observations of publicly-traded Chinese companies between 2005 and 2019 to examine the peer effect in M&A. It focused on firms’ transaction activity, including whether they engaged in deals, the number of deals, and their value relative to overall industry activity. The study revealed a clear M&A peer effect: both the volume and size of peer transactions increase a firm’s likelihood of pursuing deals and influence the scale of its own acquisitions. Firms in the same region also tend to mirror the transaction activity of local peers, reflecting a geographical peer effect. This behavior is often reinforced by social pressure and the fear of being left behind, particularly among firms with similar resources competing to maintain or strengthen their market position. External uncertainty, such as changes in economic policy, can amplify herd behavior. When the future is unclear, firms often lack confidence in their own information or judgment. To reduce perceived risk, they tend to mimic the actions of others, assuming that collective behavior reflects better-informed decisions. This reliance on the crowd makes periods of economic uncertainty prone to herd behavior.

Over time, however, the influence of peer effects diminishes as firms gain experience and increasingly rely on internal learning rather than imitation. For instance, the geographical peer effect weakens once a firm has completed three or more deals, making location-based imitation—copying local peers instead of relying on its own insights—largely insignificant. Without careful attention, though, reliance on imitation can overshadow strategy-driven decision-making, increasing the risk of overpayment or misaligned acquisitions.

The table that follows breaks down herd behavior—how peer-driven actions shape deal decisions, the risks they create, and the points in a transaction where imitation tends to occur.

Overconfidence, confirmation bias, and herd behavior are only the beginning. Each represents a hidden force that can distort deal decisions and compromise value. But as we’ve seen, strategies exist to counteract them.

In Part 2, we’ll explore three additional biases that plague dealmakers—loss aversion, the endowment effect, and anchoring—and the practical tools to keep them in check. Just as important, we’ll examine how a structured approach can embed these safeguards across every phase of the M&A process.