Daniel Kahneman [Archive.org URL]

[The hubris] hypothesis was proposed by a famous professor of finance to explain why so many mergers and acquisitions among large firms fail. The idea is that you look at the other firm, and it seems to be floundering. So you think, “Oh, those managers are inept — I could do better.” That motivates you to buy their company, usually at an inflated price, because you think that you can make that firm perform so much better than it’s currently doing.

That’s the hubris hypothesis. Quite often, however, management appears to be floundering not because they’re inept, but because they face a problem they cannot solve. If that is the case, you’ll face the same problem when you acquire the company, and you won’t do any better.

If people are failing, they look inept. If people are succeeding, they look strong and good and competent. That’s the “halo effect.” Your first impression of a thing sets up your subsequent beliefs. If the company looks inept to you, you may assume everything else they do is inept. Then you don’t want to change your mind because of the confidence you feel.