Harnessing the Overconfidence of the Crowd: A Theory of SPACs
Dr. Martin Szydlowski
Carlson School of Management
University of Minnesota
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 efficient projects, but may be useful in separating good projects from bad ones. 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 inefficient projects. The model predicts different returns for short-term and long-term investors and overall underperformance, consistent with empirical evidence. We evaluate the impact of policy interventions, including eliminating redemption rights, mandating greater disclosure and transparency, limiting investor access, and restricting the rights offered.