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Harnessing the overconfidence of the crowd: A theory of SPACs

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  • Banerjee, Snehal
  • Szydlowski, Martin

Abstract

In a SPAC transaction, a sponsor raises financing from investors using redeemable shares and rights. When investors are sophisticated, these features dilute the sponsor's stake and can lead to underinvestment in profitable targets. However, when investors are overconfident about their ability to respond to interim news, the optionality in such features is overpriced, and SPACs can lead to over-investment in unprofitable targets. Consistent with empirical evidence, the model predicts different returns for short-term and long-term investors and overall underperformance. While some policy interventions (e.g., eliminating redemption rights, limiting investor access, and restricting warrants) improve returns for unsophisticated investors, others (e.g., increased disclosure) can be counterproductive.

Suggested Citation

  • Banerjee, Snehal & Szydlowski, Martin, 2024. "Harnessing the overconfidence of the crowd: A theory of SPACs," Journal of Financial Economics, Elsevier, vol. 153(C).
    • Handle: RePEc:eee:jfinec:v:153:y:2024:i:c:s0304405x24000102
    DOI: 10.1016/j.jfineco.2024.103787
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    Citations

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    Cited by:

    1. Hori, Keiichi & Osano, Hiroshi, 2024. "Information production in start-up firms: SPACs vs. Traditional IPOs," Journal of Corporate Finance, Elsevier, vol. 85(C).
    2. Tasawar Nawaz, 2024. "The iSPAC," Review of Quantitative Finance and Accounting, Springer, vol. 63(1), pages 311-324, July.

    More about this item

    Keywords

    SPACs; Overconfidence; Redeemable shares;
    All these keywords.

    JEL classification:

    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General

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