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Behavioral CEOs: The Role of Managerial Overconfidence †
Abstract
In this paper, we provide a theoretical and empirical framework that allows us to synthesize and assess the burgeoning literature on CEO overconfidence. We also provide novel empirical evidence that overconfidence matters for corporate investment decisions in a framework that explicitly addresses the endogeneity of firms' financing constraints.
... T his study investigates the overconfident behaviour of CEOs that directs their earnings management decisions. Malmendier and Tate (2015) suggested that CEOs' overconfidence influences future decision-making. Furthermore, Li and Hung (2013) and Schrand and Zechman (2012) supported Malmendier and Tate (2015) in finding that CEOs' overconfidence influences their behaviour in increasing earnings management. ...
... Malmendier and Tate (2015) suggested that CEOs' overconfidence influences future decision-making. Furthermore, Li and Hung (2013) and Schrand and Zechman (2012) supported Malmendier and Tate (2015) in finding that CEOs' overconfidence influences their behaviour in increasing earnings management. Nevertheless, this research only measured a firm's unit analysis, with a single estimate of the CEOs' overconfidence in only one country. ...
... Overconfidence measurements and future earnings management. This study posits Malmendier and Tate (2015) and Gong et al. (2009) by suggesting that the CEO's excessive overconfidence affects their firms' future decisions. It identifies the behaviour that emerges from the point of view of the individual CEO. ...
This study investigates the association between CEOs’ overconfidence and future earnings management. This research is designed to explain CEOs’ overconfidence with the serial logic of self-confidence and self-identity in constructing their overconfidence. The authors demonstrate the CEOs’ overconfidence using multiple measures exploratorily that criticise their behaviour to manage their firms’ earnings aggressively. The authors collected data from the Bureau Van Dijk and Refinitiv Thomson Reuters databases. They identified manufacturing firms listed on the stock exchanges of Singapore (SSE), Malaysia (KLSE), Thailand (SET), the Philippines (PSE), Indonesia (IDX), Vietnam (HOSE), Pakistan (PSE); Taiwan (TSEC); India (NSE) and China (SSE). They categorised developing countries as lower-middle and upper-middle-income. This study used Generalised Least-Square (GLS) regression to test all the hypotheses. This study finds this association robust in an international setting for developing countries. In other words, it shows some extant research that most CEOs in developing countries would intentionally like to manage future earnings. Furthermore, it identifies developing countries with lower-middle incomes and less competition due to emerging capital markets. Then, it highlights that CEOs in developing countries tend to be overconfident because of cognitive behaviour. Moreover, these CEOs assemble an organisational culture that can easily improve prospective performance. Therefore, this study infers that economic uncertainty causes CEOs to be overconfident, enhancing their boldness when managing earnings excessively. This study presents a novelty supported by three critical reasoning arguments. First, it explains the phenomenon of CEOs’ overconfidence through self-confidence (self-control). Second, the authors develop multiple measurements used in the study to mark the CEOs’ overconfidence as a combined product of self-confidence and self-identity. It uses capital expenditures to measure the CEOs’ overconfidence and firm overinvestment, the incremental debt-to-equity ratio, historical earnings persistence, historical stock price persistence, the magnitude of the related party’s transactions and political connections. Third, this study investigates CEOs’ overconfidence in an international setting.
... Managers are overly confident usually over-acknowledge company earnings (Malmendier & Tate, 2015). Overconfidence top management is also optimistic in determining the value of its assets or equity, thereby reducing conservatism (Ahmed & Duellman, 2013;Heaton, 2002). ...
... In terms of project appraisal or company equity, managers who overconfidence perceive a negative net present value as a positive net present value, causing mistakes in making business decisions (Heaton, 2002). On the other hand, companies also underestimate the impact of adverse events (negative) on the company's cash flow (Malmendier & Tate, 2015). Therefore, overconfidence distorts the company's financing decisions, investment, and accounting policies (Graham et al., 2005;Malmendier & Tate, 2015). ...
... On the other hand, companies also underestimate the impact of adverse events (negative) on the company's cash flow (Malmendier & Tate, 2015). Therefore, overconfidence distorts the company's financing decisions, investment, and accounting policies (Graham et al., 2005;Malmendier & Tate, 2015). ...
One of the determinants of conservatism is Board of Directors (BoD) characteristics. Several studies have examined the relationship between board characteristics and accounting conservatism. Nonetheless, previous empirical findings show heterogeneous and inconclusive results. This study aims to prove the role of board characteristics, namely board female, board expertise, board overconfidence, and board size in accounting conservatism. This study also examines institutional ownership
as moderating variable. This research was conducted on 118 manufacturing companies for three periods, namely 2017-2019. The data analysis technique used is Partial Least Square. The test results prove that board female and board expertise increase accounting conservatism, while board overconfidence reduces conservatism. However, there is no relationship between board size and accounting conservatism. This study
also indicates that institutional ownership strengthens the relationship between board females and board expertise to accounting conservatism. Contrary, institutional ownership fails as moderating variable between board size and accounting conservatism relationship. In testing the board overconfidence variable, the percentage of institutional ownership variable cannot be a moderating variable. Nevertheless, the interaction between board overconfidence and the number of institutional investors has
a negative effect on accounting conservatism.
... Whether managers paint a more positive or negative picture of their decision situations has been found to play a critical role in shaping firm strategy, such as new product development, organizational change, organizational search behavior, etc. (Liu et al., 2013;Plambeck, 2012;Thomas et al., 1993;Thomas & McDaniel Jr., 1990;Wowak & Hambrick, 2010). Extensive literature has discussed the implications of managerial positive cognitive bias for firm strategy and performance (e.g., Malmendier & Tate, 2015;Otto, 2014). Alternatively, given that individuals are more influenced by negative affect than positive affect (Taylor, 1991), an equally influential stream of literature is interested in exploring the effect of managerial negative cognition. ...
This study takes a managerial cognition perspective and investigates how managerial negative interpretation of the external environment infuences frm engagement in environmental CSR. We also explore how ownership structure and market
demand uncertainty afect this relationship. The analysis of survey data from 189
frms in China shows that when managers interpret their external environment in
a negative light, they frst increase their attention to frms’ environmental footprint
and then decrease their environmental commitment as the assessment of the external
environment becomes increasingly negative. Our results also suggest that both state
ownership and market uncertainty strengthen this curvilinear relationship.
... Whether managers paint a more positive or negative picture of their decision situations has been found to play a critical role in shaping firm strategy, such as new product development, organizational change, organizational search behavior, etc. (Liu et al., 2013;Plambeck, 2012;Thomas et al., 1993;Thomas & McDaniel Jr., 1990;Wowak & Hambrick, 2010). Extensive literature has discussed the implications of managerial positive cognitive bias for firm strategy and performance (e.g., Malmendier & Tate, 2015;Otto, 2014). Alternatively, given that individuals are more influenced by negative affect than positive affect (Taylor, 1991), an equally influential stream of literature is interested in exploring the effect of managerial negative cognition. ...
This study takes a managerial cognition perspective and investigates how managerial negative interpretation of the external environment influences firm engagement in environmental CSR. We also explore how ownership structure and market demand uncertainty affect this relationship. The analysis of survey data from 189 firms in China shows that when managers interpret their external environment in a negative light, they first increase their attention to firms’ environmental footprint and then decrease their environmental commitment as the assessment of the external environment becomes increasingly negative. Our results also suggest that both state ownership and market uncertainty strengthen this curvilinear relationship.
... They will provide SMEs that are short of funds with relatively high-interest loans. In addition, a large amount of research has examined the impact of factors, such as CEO personal traits [15,16,17], on financialization in non-financial firms. ...
Based on the registration information of 30 million Chinese enterprises, this study innovatively constructs a financialization index based on the text information of enterprise business scope. Then, the impact of digital finance on small and medium-sized enterprise (SME) financialization is examined. Specifically, this study screens out SMEs involved in financial transactions by counting the keyword information in their business scope. The level of SME financialization is measured at the provincial level, based on a large number of registration samples. Empirical results based on panel fixed effects show that digital finance significantly inhibits SME financialization. On average, for each standard deviation increase in digital finance, SME financialization decreases by 0.087 standard deviations. This conclusion remains valid after a series of robustness analyses. A mechanism analysis shows that digital finance inhibits SME financialization by alleviating financing constraints, especially by providing liquidity to SMEs with relatively high financing constraints. In addition, the risk consequences of SME financialization are further examined, and SME financialization is found to significantly increase bankruptcy risk, while digital finance alleviates financing constraints and thus reduces bankruptcy risk. This study provides a new perspective for the governance of SME financialization and the optimization of the survival environment for SMEs in the context of the digital economy.
... This study initially runs and tests the validity of measuring CEO overconfidence using a composite score index with other CEO overconfidence proxies (the use of dummy variables and partial measurements in the form of overinvestment, tone analysis and net emotion) toward investment decisions that have frequently been tested in previous studies (Malmendier and Tate, 2005;Malmendier and Tate, 2015) and a joint test. Investment is measured using the amount of capital expenditures divided by the total assets of the previous period (Biddle and Hilary, 2006). ...
Purpose
In the context of a two-tier governance system, this study aims to investigate whether CEO overconfidence affects firm risk. In addition, this study examines the moderating role of the founder CEO on CEO overconfidence and firm risk.
Design/methodology/approach
This study uses a composite score index of CEO overconfidence with a sample of nonfinancial firms listed on the Indonesia Stock Exchange from 2012 to 2019. It tests the research hypothesis with multiple linear regression analysis.
Findings
The findings indicate that CEO overconfidence reduces firm risk. In contrast, the founder CEO does not affect the relationship between CEO overconfidence and firm risk.
Research limitations/implications
This study supports the upper echelon theory that argues that firms’ top management affects firms’ outcomes and behaviors.
Practical implications
The top management team heavily affects firms’ outcomes and behaviors in a two-tier governance system. Furthermore, firms’ selection policy of overconfident CEOs will be improved because these CEOs can diversify firm risks more effectively.
Originality/value
To the best of the authors’ knowledge, this study is the first to examine the role of the founder in the relationship between CEO overconfidence and firm risk.
... In the context of markets, Grubb [2015] and Stone and Wood [2018] provide theoretical and empirical evidence of consumer and firm overoptimism, respectively. Malmendier and Tate [2015] offer insights into CEOs' overconfidence, while Daniel and Hirshleifer [2015] discuss WT's role in explaining investors' optimistic behavior in financial markets. Furthermore, Lovallo and Kahneman [2003] delve into the optimistic tendencies and overconfidence displayed by business executives and entrepreneurs in their decision-making processes. ...
We develop a model of wishful thinking that incorporates the costs and benefits of biased beliefs. We establish the connection between distorted beliefs and risk, revealing how wishful thinking can be understood in terms of risk measures. Our model accommodates extreme beliefs , allowing wishful-thinking decision-makers to assign zero probability to undesirable states and positive probability to otherwise impossible states. Furthermore, we establish that wishful thinking behavior is equivalent to quantile-utility maximization for the class of threshold beliefs distortion cost functions. Finally, exploiting this equivalence, we derive conditions under which an optimistic decision-maker prefers skewed and riskier choices. JEL classification: D01, D80, D84
... The relationship between overconfidence and corporate finance has been studied in various fields, including economics, corporate finance and psychology (Heaton, 2002;Malmendier and Tate, 2015). Following Hackbarth(2009) andMalmendier et al. (2011), overconfidence is used in the context of behavioral finance theory. ...
Purpose
This study aims to analyze how cultural variations impact the relationship between long-term debt use and managerial overconfidence. Investigate into how the relationship between growth prospects and the utilization of long-term debt is moderated by managerial overconfidence. In addition, the research explores the moderating effect of managerial overconfidence on cash flow levels.
Design/methodology/approach
The study used long-term debt as the dependent variable and used generalized method of moments–instrumental variables regression analysis to examine data from 356 firms across 11 Middle East and North Africa (MENA) countries and 5 industries between 2013 and 2021.
Findings
CEO overconfidence moderately boosts the link between long-term debt maturity and growth potential, particularly for firms with limited internal funding. Cultural factors, such as masculinity and uncertainty avoidance, play a significant role in moderating the relationship between managerial overconfidence and debt maturity choices.
Practical implications
To understand the impact of managerial overconfidence on a company’s debt maturity decision, it is essential for boards and shareholders to consider and monitor the CEO’s behavioral traits, particularly for growing companies. Regulators and policymakers must also be wary of the risk of internal control weakening due to overconfident managers, especially in MENA markets.
Originality/value
The authors’ contribution to the literature lies in exploring how managerial overconfidence moderates the agency conflict between shareholders and debtholders in MENA region firms, which has received minimal attention in previous studies. This study expands the knowledge of the impact of managerial overconfidence on emerging economies and provides evidence that national culture plays a vital role in determining debt financing decisions.
... Being (over)confident about one's knowledge can have serious consequences affecting people's judgments and decision-making (Ahmad, 2020;Cassam, 2017;Malmendier & Tate, mails (see also Li & Rao, 2022;Sarno & Neider,2022;. Other research showed that participants with IT background were overconfident in their ability to detect deep fakes (Sütterlin et al., 2022). ...
... Overconfident CEOs are likely to underestimate the risks associated with a merger and overestimate the expected return from a business combination. Malemenedier and Tate also demonstrate that overconfident CEOs tend to seek for acquisitions when their corporations have abundant resources [29]. Moreover, they demonstrate that the overconfident CEOs are more likely to use cash to finance their mergers compared with those rational CEOs. ...
An increasing number of professional studies are being published about the new field of behavioral finance. This paper offers an overview of behavioral finance and reviews literatures about its origin, content and rationale of this developing study. Some evidence has been given that behavioral finance exists in both developed financial markets and emerging markets. This paper focuses on how behavioral bias influences individual investment decisions and corporation' s capital structure.
... A fairly persuasive evidence indicates that many decisions of top-executives are typically biased by overconfidence (see Malmendier and Tate, 2015, for a survey). At the same time, as documented by Moore and Cain (2007), there are also a number of different domains in which top-executives are systematically underconfident, especially when they have to deal with difficult tasks (see also Bennet et al., 2017;Huffman et al., 2019). ...
This paper compares the welfare outcomes obtained under alternative unionization regimes (decentralized vs. centralized wage setting) in a duopoly market in which shareholders delegate strategic decisions to biased (overconfident or underconfident) managers. In such a framework, the common tenet that consumer surplus and overall welfare are always higher under decentralized wage setting is completely overturned. Indeed, in the presence of centralized unionization (industry-wide union), firm shareholders always prefer to hire more aggressive or less conservative managers and, as a result, output (consumer surplus) and overall welfare are larger than in a decentralized wage setting structure.
... Despite a plethora of empirical studies and the great popularity of the behavioral paradigm in economics and finance, several research areas within this field remain understudied. This includes behavioral corporate finance, which seeks to explain the existence of irrational managers and corporate decisions in a world of inefficient capital markets (Baker & Wurgler, 2004Malmendier & Tate, 2015). Various psychological phenomena may impact corporate decision-making, which in turn may translate into company management practices (e.g. ...
This study examined the role of the Big Five personality traits and risk perception profiles among a sample of corporate managers concerning their subjective wellbeing (SWB) and corporate management practices during the Covid-19 pandemic. Two hundred and fifty-five chief executive officers (CEOs) and chief financial officers (CFOs) of companies listed on the main market of the Warsaw Stock Exchange (WSE) in Poland participated in the study by completing the Satisfaction with Life Scale, Positive and Negative Affect Scale, Ten-Item Personality Inventory, Stimulation-Instrumental Risk Inventory, and a business survey on the Covid-19 pandemic's impact on company management. Latent profile analysis revealed the existence of diverse profiles among the participants regarding personality traits and risk perception, which were variously related to their SWB and managerial practices during the pandemic. It seems that individual differences in personality traits and risk perception not only matter for the individual life satisfaction of managers but may also translate into effective company management in times of crisis. The results of our study may be an adjunct to understanding underlying sources of managerial biases in corporate management as well as to developing more effective methods of psychological counseling of corporate managers, a topic that remains still a highly understudied research area.
... The option-based technique suggested by Malmendier and Tate (2005) is the broadly utilised managerial overconfidence measure in existing research (Campbell et al., 2011;Hsieh et al., 2018;Huang et al., 2016) and is the most robust compared to alternative interpretations (Malmendier & Tate, 2015). Thus, this study adopts the option-based method to measure CFO and CEO overconfidence. ...
This study explores the relationship between overconfident Chief Financial Officers (CFOs) and earnings management. Through the lens of upper echelons and overconfidence theories, and using a large sample of 14,156 observations of US firms from 1999 to 2021 inclusive, our study finds that overconfident CFOs are positively associated with earnings management. We show that overconfident CFOs use earnings management to reduce earnings volatility, given that a smooth performance can release their financing pressure. In doing this, we rule out another possible explanation of overconfident CFOs engaging in earnings management to pursue high compensation. Our findings pass a series of robustness tests, including entropy balancing, the Difference-in-Differences test based on the propensity score matching sample (PSM-DID), and alternative measures of main variables. Our study provides a new determinant of earnings management that has more explanatory power than CFO demographic traits – i.e. CFO cognitive biases. Our findings nonetheless show the “bright” side of CFO overconfidence, helping investors, regulators, and policymakers understand overconfident CFOs’ financial reporting decisions.
... Likewise, other related studies confirm that overoptimistic or overconfident managers choose high levels of debt and issue more debt than equity (Esghaier 2017;Hackbarth 2008;Hasani Alghar & Rahimian 2018;Malmendier & Tate 2008;Tan 2017). Furthermore, Malmendier and Tate (2015) posit that overconfident CEOs tend to shy away from equity as a form of financing in efforts to protect existing shareholders from perceived dilution. These findings suggest that the more confident a manager is regarding the prospects of their firm, the more they will be inclined to issue debt as a form of financing. ...
Background: In an attempt to enhance our understanding of the important determinants of the debt–equity choice, there is a need to explore the behavioural facets driving the decision to issue either debt or equity. Furthermore, the divergent set of implications of equity and debt issues on the share prices are empirical matters that need to be addressed.Aim: In this article the link is investigated between managerial confidence and the likelihood of issuing debt, as well as the share price implications of equity and debt issue announcements on the Johannesburg Share Exchange (JSE).Setting: The study is based on the equity bond issue announcements of JSE-listed firms for the period 2000–2020.Method: In this article, panel data regression and event study approaches are used in a sample of 81 and 113 bond and equity issue announcements, respectively, for 69 firms listed on the JSE.Results: The main findings of this article indicate that managerial optimism drives debt issuing activities on the JSE and that there are negative and significant abnormal returns associated with the announcement of equity issues.Conclusion: Overall, we conclude that behavioural finance is an important factor driving capital structure decisions, and that signalling, as well as market-timing concerns drive share price reactions on the JSE.Contribution: This article highlights the importance of behavioural factors in capital structure decisions and identifies the firm-specific channels through which managerial optimism drives leverage. Additionally, the article sheds light on the role of signalling and market timing in capital structure decisions.
... Managerial overconfidence is a concept that needs to be assessed carefully. A number of ways have been used to measure this attribute in previous studies, including upwardly-biased forecasts (Lin et al., 2005, Huang et al., 2011, options holding (Lambert et al., 1991;Meulbroek, 2001 andTate, 2005a, b;and Chen et al., 2020), the relative salary of executives (Malmendier and Tate, 2015), media coverage (Brown and Sarma, 2007), and textual analysis based on the linguistic tone of the annual report (Tran et al., 2020). This study introduces a novel method namely using voice pitch to measure overconfidence. ...
An incumbent employee competes against a new hire for bonuses or promotions. The incumbent's perception of the new hire's ability distribution is biased. This bias can result in overconfidence or underconfidence. We show that debiasing may be counterproductive in incentivizing efforts. We then explore whether a firm that values employees’ efforts should disclose an informative signal about the new hire's type and we characterize the conditions under which transparency or opacity is optimal for the firm. We further consider four extensions to the model. Our results contribute to the extensive discussion of confidence management and organizational transparency in firms.
Exploiting a screen display feature whereby the order of stock display is determined by the stock's listing code, we lever a novel identification strategy and study how the interaction between overconfidence and limited attention affect asset pricing. We find that stocks displayed next to those with higher returns in the past two weeks are associated with higher returns in the future week, which are reverted in the long run. This is consistent with our conjectures that investors tend to trade more after positive investment experience and are more likely to pay attention to neighboring stocks, both confirmed using trading data.
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Research in risk preference suggests that, in violation of economic man hypothesis, most investors are economically irrational, which is reflected through the phenomenon of preference reversal. However, there is a scant of study to measure the extent how irrational individuals are. Inspired by the way how efficient market is defined, this paper proposes a measurement of preference reversal and divides irrationality into two types. Furthermore, based on the data of market index and GARCH-M model, this paper finds that risk preference inconsistency always exists and investors in smooth time are weakly irrational.
Research on CEO overconfidence establishes its important effects on organizational strategy and performance. It can lead CEOs to overestimate their firm's capabilities and inaccurately assess the risk of new actions. Due to these effects, we argue that in need of the access to external knowledge, CEOs exhibiting greater overconfidence are more likely to pursue alliances. We also contribute to this ongoing conversation by linking CEO overconfidence to the suboptimal selection of alliance partners in the pursuit of external knowledge. Specifically, we demonstrate how greater overconfidence leads CEOs to discount organizational characteristics that have been shown to be beneficial in the alliance literature—greater knowledge base, knowledge impact, technology experience, and their own firm's knowledge dependence on potential alliance partners. With empirical tests of a broad sample of firms in healthcare-related industries tracked from 2001 to 2021, our work helps to integrate concepts of CEO overconfidence with the dynamics of partner selection in the knowledge and innovation domain.
Purpose
The role of chief executive officer (CEO) personal characteristics in shaping corporate policies has attracted increasing academic attention in the past two decades. In this review, the authors synthesize extant research on CEO attributes by reviewing 232 articles published in 29 journals from the accounting, finance and management literature. This review provides an overview of existing findings, highlights current trends and interdisciplinary differences in research approaches and identifies potential avenues for future research.
Design/methodology/approach
To review the literature on CEO attributes, the authors manually collected peer-reviewed articles in accounting, finance and management journals from 2000 to 2021. The authors conducted in-depth analysis of each paper and manually recorded the theories, data sources, country of study, study period, measures of CEO attributes and dependent variables. This procedure helped the authors group the selected articles into themes and sub-themes. The authors compared the findings in various disciplines and provided direction for future research.
Findings
The authors highlight the role of CEO personal attributes in influencing corporate decision-making and firm outcomes. The authors categorize studies of CEO traits into three main research themes: (1) demographic attributes and experience (including age, gender, culture, experience, education); (2) CEO interactions with others (social and political networks) and (3) underlying attributes (including personality, values and ideology). The evidence shows that CEO characteristics significantly affect a wide range of specific corporate policies that serve as mechanisms through which individual CEOs determine firm success and performance.
Practical implications
CEO selection is one of the most crucial decisions made by corporations. The study findings provide valuable insights to corporate executives, boards, investors and practitioners into how CEOs’ personal characteristics can impact future firm decisions and outcomes that can, in turn, inform the high-stake process of CEO recruitment and selection. The study findings have significant practical implications for corporations, such as contributing to executive training programs, to assist executives and directors attain a greater level of self-awareness.
Originality/value
Building on the theoretical foundation of upper echelons theory, the authors offer an integrated theoretical framework to consolidate existing empirical research on the impacts of CEO personal attributes on firm outcomes across accounting and finance (A&F) and management literature. The study findings provide a roadmap for scholars to bridge the interdisciplinary divide between A&F and management research. The authors advocate a more holistic and multifaceted approach to examining CEOs, each of whom embodies a myriad of personal characteristics that comprise their unique identity. The study findings encourage future researchers to expand the investigation of the boundary conditions that magnify or moderate the impacts of CEO idiosyncrasies.
We study the effect of executives’ pledges of integrity on firms’ financial reporting outcomes by exploiting a 2016 regulation that requires holders of Dutch professional accounting degrees to pledge an integrity oath. We identify chief executive officers (CEOs) and chief financial officers (CFOs) required to take the integrity oath and find that firms reduce income-increasing discretionary accruals after executives took the oath. These firms also reduce discretionary expenditures, indicating that oath-taking executives reduce overall earnings management and do not merely substitute accruals-based with real-activities earnings management. These effects are concentrated in firms where the CFO took the oath. Overall, our results indicate that integrity oaths for executives improve firms’ financial reporting quality.
Data Availability: Data are available from the public sources cited in the text.
JEL Classifications: M40; M41.
The purpose of this paper was to explore the relationship between the characteristics of the chief executive officer (CEO) and corporate social responsibility (CSR) of banks operating in the Middle East and North African (MENA) countries. The study hypotheses was tested using a multiple linear regression model by examining data from a sample of 97 Islamic banks operating in the MENA region between 2015 and 2019. The results were robustly checked and the findings indicated that both CEO’s overconfidence, experience and education appear to have a significantly positive effect on the CSR disclosure. Furthermore, the results of multiple linear regressions showed that older CEO’s have a negative and significant impact on the level of CSR disclosure. This research bridges the gap between theory and practice in many aspects. Thus, although a substantial volume of research has examined sustainable advantage, one vital aspect of CSR has been largely unexplored. This study fills this void in the literature, namely the interaction between CEO’s characteristics and CSR disclosure. An explicit CSR disclosure may improve social well-being in emerging markets.
In this study, we investigate whether and how trust between board members and the CEO (board–CEO trust) affects the performance of mergers and acquisitions. Contrary to conventional wisdom, we find that firms with higher levels of board–CEO trust exhibit poor M&A performance. High trust is associated with low acquisition announcement returns, long-term stock return performance, and post-deal operating performance. This negative effect of board–CEO trust is more pronounced among acquiring companies prone to agency problems. Our results suggest that, in the institutional setting of corporate boards, high trust can be too much of a good thing.
We use innovation premium (IP), proposed by Forbes, as a proxy for firm innovation to present evidence that firm value is positively associated with IP. The positive impact of the IP on firm value is amplified by overconfident CEOs, particularly in the high‐tech and biotech industries with a high proportion of intellectual capital and intangible assets. In a series of tests, we confirm that the results hold after controlling for endogeneity. our findings are consistent with the notion that the beneficial effect of corporate innovations generated by overconfident CEOs exists primarily in industries where innovations are in critical demand.
Purpose
The main purpose of this paper is to look at the link between chief executive officer (CEO) behavior and corporate social responsibility (CSR) engagement with the moderating role of bank risk-taking behavior.
Design/methodology/approach
Based on a 13-year data set (2007–2019), the authors applied the feasible generalized least squares with panel data to test the hypotheses.
Findings
The findings reveal a positive and significant link between CEO behavior and CSR engagement. Based on these findings, it can be argued that the characteristics of the CEO of the banks would improve the CSR strategies. Furthermore, the study suggests a moderating effect of bank risk-taking in the link between psychological bias and corporate social responsibility engagement (CSR engagement).
Practical implications
As CEO behavioral characteristics are essential to understanding CSR practice, boards of directors should consider the behavioral traits of dominant and overconfident CEOs while designing CSR practices.
Social implications
If the bank behaves in a socially responsible manner, direct and indirect stakeholders may be able to evaluate the level of risk-taking in more detail.
Originality/value
This research highlights the importance of CEO behavior characteristics for CSR, which is a crucial application that supports the upper echelons theory; and fills a gap in literature research. It is one of the few studies examining the interaction between risk-taking, CEO behavior and CSR engagement.
This article analyzes the socially optimal liability allocation when strictly liable Cournot firms delegate their safety and output choices to managers whose potential biases are chosen by firm owners and consumers misperceive product risks. Firm owners always hire managers who are overconfident about their product safety’s effectiveness in reducing product-related accident risk. However, the extent of overconfidence depends on consumers’ risk perceptions and the allocation of liability. As a result, the socially optimal liability allocation hinges on whether consumers underestimate or overestimate product risk. When consumers overestimate product risks, firms should be held liable for all losses incurred by consumers. However, when consumers underestimate risk, firms should only be held liable for a part of consumer losses. We also show that, in some circumstances, negligence produces socially more desirable outcomes than strict liability (JEL: K13, L13, L14).
This paper revisits the endogenous choice between strategies (price and quantity) in a duopoly of firms inclined towards corporate social responsibility (CSR) with generalized biased managers. We primarily focus on the situation where managers evaluate the market size based on the weighted sum of their types. We show that when the weight on each manager's type is fixed, the area on the degrees of importance of CSR, such that Cournot competition can be observed in equilibrium, becomes larger as the degree of homogeneity between the goods produced by CSR firms increases.
We explore whether managers’ strong desire for good performance distorts their expectations and, consequently, corporate investment efficiency. We find that managers overweight favorable information and underweight unfavorable information, resulting in optimistic earnings guidance. We construct an ex ante measure of optimism and show that greater optimism is associated with a lower inventory investment efficiency: Managers overinvest in inventory, resulting in lower inventory turnover and increased incidence and severity of inventory writedowns. We also find motivational optimism influences firms’ financial reporting and is associated with an increased incidence of financial misreporting. Our results are consistent with the psychology theory of motivated reasoning, which emphasizes the distortive effects of preferences on beliefs and judgments.
JEL Classifications: M41; D91; G41; G31.
Based on a unique and extensive dataset of top executives, this study explores the effect of top executives’ attributes on firm performance through strategic choices for capital structure and investments. The big five personalities and top executives’ other four essential personal attributes are identified from over 970,000 observations in Japanese firms. We applied structural equational modeling to test the hypothesized mediation models and the differences across large, medium, and small-sized firms. The results show that top executives in small and medium-sized enterprises (SMEs) present stronger linkages with strategic choices, significantly mediating the relationship between top executives’ attributes and firm performance. Specifically, top executives with higher conscientiousness, decisiveness, and financial prudence tend to choose conservative strategies, while those with higher neuroticism, openness, and agreeableness tend to adopt risky and innovative strategies. In contrast, top executives’ attributes can hardly predict firm strategies and outcomes for large firms, and neither fails to predict firm outcomes in SMEs given the inconsistent mediation.
Access to the radio spectrum is vital for modern digital communication. It is an essential component for smartphone capabilities, the Cloud, the Internet of Things, autonomous vehicles, and multiple other new technologies. Governments use spectrum auctions to decide which companies should use what parts of the radio spectrum. Successful auctions can fuel rapid innovation in products and services, unlock substantial economic benefits, build comparative advantage across all regions, and create billions of dollars of government revenues. Poor auction strategies can leave bandwidth unsold and delay innovation, sell national assets to firms too cheaply, or create uncompetitive markets with high mobile prices and patchy coverage that stifles economic growth. Corporate bidders regularly complain that auctions raise their costs, while government critics argue that insufficient revenues are raised. The cross-national record shows many examples of both highly successful auctions and miserable failures. Drawing on experience from the UK and other countries, senior regulator Geoffrey Myers explains how to optimise the regulatory design of auctions, from initial planning to final implementation. Spectrum Auctions offers unrivalled expertise for regulators and economists engaged in practical auction design or company executives planning bidding strategies. For applied economists, teachers, and advanced students this book provides unrivalled insights in market design and public management. Providing clear analytical frameworks, case studies of auctions, and stage-by-stage advice, it is essential reading for anyone interested in designing public-interested and successful spectrum auctions.
We analyze the incentives for showing off, which we model as a costly signaling game, and study the consequences of norms against such behavior. Prior to competing in a contest, a newcomer can signal his talent to an incumbent. In equilibrium, costly signaling of ability occurs only when the newcomer is exceptionally talented. In such situations signaling benefits both contestants: the newcomer for obvious reasons; the incumbent by economizing on wasted effort in the contest. Our results rationalize the emergence of norms against showing off in settings where total effort is important. When selection efficiency matters, such norms decrease welfare. (JEL D82, D83, D91, Z13)
We consider a polluting Cournot duopoly within a managerial delegation framework and examine conflicting environmental concerns in which the owners pursue strategic environmental corporate social responsibility (ECSR) while the managers undertake diverged environmental R&D (ER&D) investment. We investigate the effects of cooperation in both ECSR and ER&D on a firm's profitability and social welfare and find that managerial coordination has a critical effect on industry emissions, profits, and welfare. In the context of an optimal emissions tax, we show that managerial coordination failure might not occur, but it reduces welfare if the environmental damage is relatively high. We conclude that a pro-environmental government should encourage cooperative ER&D, especially when owners adopt cooperative ECSR.
The literature posits that some CEO overconfidence benefits shareholders, though high levels may not. We argue that adequate
controls and independent viewpoints provided by an independent board mitigates the costs of CEO overconfidence. We use the
concurrent passage of the Sarbanes-Oxley Act and changes to the NYSE/NASDAQ listing rules (collectively, SOX) as natural experiments,
to examine whether board independence improves decision making by overconfident CEOs. The results are strongly supportive:
after SOX, overconfident CEOs reduce investment and risk exposure, increase dividends, improve postacquisition performance,
and have better operating performance and market value. Importantly, these changes are absent for overconfident-CEO firms
that were compliant prior to SOX.
We develop a model that shows that an overconfident manager, who sometimes makes value-destroying investments, has a higher likelihood than a rational manager of being deliberately promoted to CEO under value-maximizing corporate governance. Moreover, a risk-averse CEO's overconfidence enhances firm value up to a point, but the effect is nonmonotonic and differs from that of lower risk aversion. Overconfident CEOs also underinvest in information production. The board fires both excessively diffident and excessively overconfident CEOs. Finally, Sarbanes-Oxley is predicted to improve the precision of information provided to investors, but to reduce project investment.
164 undergraduates rated the degree to which various traits represented desirable characteristics and the degree to which it was possible for a person to exert control over each of these characteristics. From these initial ratings, 154 trait adjectives for which 4 levels of desirability were crossed with 2 levels of controllability were selected. 88 undergraduates then rated the degree to which each of these traits characterized the self and the average college student. Results support the prediction that self-ratings in relation to average college student ratings would be increasingly positive as traits increased in desirability and that in conditions of high desirability, self-ratings in relation to average college student ratings would be greater for high- than for low-controllable traits, whereas in conditions of low desirability the opposite would occur. Results are discussed in terms of the adaptive advantages of maintaining a global self-concept that implies that positive characteristics are under personal control and that negative characteristics are caused by factors outside of personal control. Mean preratings of desirability and controllability are appended. (29 ref) (PsycINFO Database Record (c) 2012 APA, all rights reserved)
Recent work indicates that people hold a variety of self-serving biases, believing themselves more capable than they are in fact. Such biases, if extended to the organizational level, would lead to overly optimistic planning for the future. This prediction was tested with 2 groups of management students (37 freshmenn and 35 seniors and with 48 male corporate presidents in 3 studies. Management students consistently overestimated their abilities; in a marketing exercise, they likewise indicated that a hypothetical firm, of which they were sales managers, would quickly overtake established competition. Executive Ss also predicted inordinate success; the latter group, however, moderated projections somewhat if prior planning experience had been unsatisfactory. The importance of managerial myopia to considerations of marketing, resource management, and demarketing is discussed. (PsycINFO Database Record (c) 2012 APA, all rights reserved)
A review of the evidence for and against the proposition that self-serving biases affect attributions of causality indicates that there is little empirical support for the proposition in its most general form. Some support was found for the contention that individuals engage in self-enhancing attributions under conditions of success, but only minimal evidence suggested that individuals engage in self-protective attributions under conditions of failure. Moreover, it was proposed that the self-enhancing effect may not be due to motivational distortion, but rather to the tendency of people to (a) expect their behavior to produce success, (b) discern a closer covariation between behavior and outcomes in the case of increasing success than in the case of constant failure, and (c) misconstrue the meaning of contingency. (60 ref) (PsycINFO Database Record (c) 2012 APA, all rights reserved)
Managers and corporate directors need to recognize two key behavioral impediments that obstruct the process of value maximization, one internal to the firm and the other external. I call the first obstruction behavioral costs. Behavioral costs, like agency costs, tend to prevent value creation. Behavioral costs are the costs associated with errors that people make because of cognitive imperfections and emotional influences. The second obstruction stems from behavioral errors on the part of analysts and investors. These errors can create gaps between fundamental values and market prices. When they do, managers may find themselves conflicted, unsure of how to factor the errors of analysts and investors into their own decisions. Proponents of value based management emphasize that with properly designed incentives, managers will maximize the value of the firms for which they work. As such, either they treat behavioral costs as simply another form of agency costs, or they deny the relevance of cognitive errors. In contrast, proponents of behavioral finance argue that behavioral costs are typically large, and cannot be addressed though incentives alone. This is not to say that incentives are immaterial. On the contrary, incentives are of critical importance. The point, however, is that there are limits to incentives. If employees have a distorted view of what is in their own self-interest, or if they have a mistaken view of what actions they need to take in order to maximize their self-interest, then incentive compatibility, although necessary for value maximization, will not be sufficient.
I present evidence consistent with theories that small boards of directors are more effective. Using Tobin's Q as an approximation of market valuation, I find an inverse association between board size and firm value in a sample of 452 large U.S. industrial corporations between 1984 and 1991. The result is robust to numerous controls for company size, industry membership, inside stock ownership, growth opportunities, and alternative corporate governance structures. Companies with small boards also exhibit more favorable values for financial ratios, and provide stronger CEO performance incentives from compensation and the threat of dismissal.
In this study subjects were asked about their competence as drivers in relation to a group of drivers. The results showed that a majority of subjects regarded themselves as more skillful and less risky than the average driver in each group respectively. This result was compared with similar recent findings in other fields. Finally, the consequences for planning and risk taking of seeing oneself as more competent than others were discussed briefly.
We develop a model that shows that an overconfident manager, who sometimes makes value-destroying investments, has a higher likelihood than a rational manager of being deliberately promoted to CEO under "value-maximizing" corporate governance. Moreover, a risk-averse CEO's overconfidence enhances firm value up to a point, but the effect is "nonmonotonic" and differs from that of lower risk aversion. Overconfident CEOs also underinvest in information production. The board fires both excessively diffident and excessively overconfident CEOs. Finally, Sarbanes-Oxley is predicted to improve the precision of information provided to investors, but to reduce project investment. Copyright (c) 2008 The American Finance Association.
Research in behavioral corporate finance takes two distinct approaches. The first emphasizes that investors are less than fully rational. It views managerial financing and investment decisions as rational responses to securities market mispricing. The second approach emphasizes that managers are less than fully rational. It studies the effect of nonstandard preferences and judgmental biases on managerial decisions. This survey reviews the theory, empirical challenges, and current evidence pertaining to each approach. Overall, the behavioral approaches help to explain a number of important financing and investment patterns. The survey closes with a list of open questions.
This paper shows that managers' personal beliefs and individual characteristics explain a large share of the substantial time-variation of derivative use beyond firm, industry, and market fundamentals. We construct a panel data set of foreign currency derivative holdings and currency exposures for U.S. non-financial firms. We use a novel approach to build a firm-specific foreign exchange return. We find that managers adjust derivatives notional amounts in response to past foreign exchange returns, as if they were forming views on future currency prices. We then construct an empirical measure of speculative behavior for each firm to investigate the profile of the speculator. Firms where the CEO holds an MBA degree, is younger, and has less previous working experience speculate more. These results are consistent with overconfident managers taking more risk.
There is mounting evidence of the influence of personal characteristics of chief executive officers (CEOs) on corporate outcomes. In this paper we analyze the relation between military service of CEOs and managerial decisions, financial policies, and corporate outcomes. Exploiting exogenous variation in the propensity to serve in the military, we show that military service is associated with conservative corporate policies and ethical behavior. Military CEOs pursue lower corporate investment, are less likely to be involved in corporate fraudulent activity, and perform better during industry downturns. Taken together, our results show that military service has significant explanatory power for managerial decisions and firm outcomes.
I demonstrate that acquisitions are accompanied by large, permanent increases in Chief Executive Officer (CEO) compensation, which create strong financial incentives for CEOs to pursue acquisitions earlier in their career. Accordingly, I document that a firm's acquisition propensity is decreasing in the age of its CEO: a firm with a CEO who is 20 years older is ∼30%∼30% less likely to announce an acquisition. This negative effect of CEO age on acquisitions is strongest among firms where CEOs likely anticipate or can influence high post-acquisition compensation, and is absent for other investment decisions that are not rewarded with permanent compensation gains. The age effect cannot be explained by the selection of young CEOs by acquisition-prone firms, nor by a story of declining overconfidence with age. This paper underscores the relevance of CEO personal characteristics and CEO-level variation in agency problems for corporate decisions.
Prior stock price peaks of targets affect several aspects of merger and acquisition activity. Offer prices are biased toward recent peak prices although they are economically unremarkable. An offer's probability of acceptance jumps discontinuously when it exceeds a peak price. Conversely, bidder shareholders react more negatively as the offer price is influenced upward toward a peak. Merger waves occur when high returns on the market and likely targets make it easier for bidders to offer a peak price. Parties thus appear to use recent peaks as reference points or anchors to simplify the complex tasks of valuation and negotiation.
A common view is that there is little correlation between firm performance and CEO pay. Using a new fifteen-year panel data set of CEOs in the largest, publicly traded U. S. companies, we document a strong relationship between firm performance and CEO compensation. This relationship is generated almost entirely by changes in the value of CEO holdings of stock and stock options. In addition, we show that both the level of CEO compensation and the sensitivity of compensation to firm performance have risen dramatically since 1980, largely because of increases in stock option grants.
We examine how executives’ behavior outside the workplace, as measured by their ownership of luxury goods (low “frugality”) and prior legal infractions, is related to financial reporting risk. We predict and find that CEOs and CFOs with a legal record are more likely to perpetrate fraud. In contrast, we do not find a relation between executives’ frugality and the propensity to perpetrate fraud. However, as predicted, we find that unfrugal CEOs oversee a relatively loose control environment characterized by relatively high probabilities of other insiders perpetrating fraud and unintentional material reporting errors. Further, cultural changes associated with an increase in fraud risk are more likely during unfrugal (vs. frugal) CEOs’ reign, including the appointment of an unfrugal CFO, an increase in executives’ equity-based incentives to misreport, and a decline in measures of board monitoring intensity.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
We show theoretically that optimism can lead a risk-averse Chief Executive Officer (CEO) to choose the first-best investment level that maximizes shareholder value. Optimism below (above) the interior optimum leads the CEO to underinvest (overinvest). Hence, if boards of directors act in the interests of shareholders, CEOs with relatively low or high optimism face a higher probability of forced turnover than moderately optimistic CEOs face. Using a large sample of turnovers, we find strong empirical support for this prediction. The results are consistent with the view that there is an interior optimum level of managerial optimism that maximizes firm value.
Consistent with the recent literature on the importance of personal managerial attributes for corporate decisions, this paper empirically examines the effect of managerial optimism on earnings smoothing. Optimists tend to exhibit an upward bias in their assessment of future earnings and therefore are willing to "borrow" more aggressively from future earnings than rational managers in order to report higher earnings in bad states than their rational counterparts. Since the adding-up constraint applies in the long run, reported earnings and true economic earnings must converge, this means that when future earnings do turn out to be high, the optimistic managers have to report lower earnings than they would have, had they not "over-reported" earnings in previous periods. This generates the testable hypothesis that optimistic managers smooth earnings more on average than rational managers do. Moreover, this smoothing difference arises because optimistic managers are less likely than rational managers to report earnings that fall short of analysts' forecasts by much or exceed them by a substantial amount, and are more likely than rational managers to show small (negative or positive) earnings surprises. This hypothesis is tested using existing optimism measures and supporting evidence is found. I examine a variety of alternative explanations to check the robustness of the results.
We use the August 2007 crisis episode to gauge the e¤ect of …nancial contracting on real …rm behavior. We identify heterogeneity in …nancial contracting at the onset of the crisis by exploiting ex-ante variation in long-term debt maturity structure. Using a di¤erence-in-di¤erences matching estimator approach, we …nd that …rms whose long-term debt was largely maturing right after the third quarter of 2007 cut their investment-to-capital ratio by 2.5 percentage points more (on a quarterly basis) than otherwise similar …rms whose debt was scheduled to mature after 2008. This drop in investment is statistically and economically signi…cant, representing one-third of pre-crisis investment levels. A number of falsi…cation and placebo tests suggest that our inferences are not confounded with other factors. For example, in the absence of a credit contraction, the maturity composition of long-term debt has no e¤ect on investment. Moreover, long-term debt maturity composition had no impact on investment during the crisis for …rms for which long-term debt was not a major source of funding. Our analysis highlights the importance of debt maturity for corporate …nancial policy. More than showing a general association between credit markets and real activity, our analysis shows how the credit channel operates through a speci…c feature of …nancial contracting.
We show that measurable managerial characteristics have significant explanatory power for corporate financing decisions. First, managers who believe that their firm is undervalued view external financing as overpriced, especially equity. Such overconfident managers use less external finance and, conditional on accessing external capital, issue less equity than their peers. Second, CEOs who grew up during the Great Depression are averse to debt and lean excessively on internal finance. Third, CEOs with military experience pursue more aggressive policies, including heightened leverage. Complementary measures of CEO traits based on press portrayals confirm the results.
We show that measurable managerial characteristics have significant explanatory power for corporate financing decisions beyond traditional capital-structure determinants. First, managers who believe that their firm is undervalued view external financing as overpriced, especially equity. Such overconfident managers use less external finance and, conditional on accessing risky capital, issue less equity than their peers. Second, CEOs with Depression experience are averse to debt and lean excessively on internal finance. Third, CEOs with military experience pursue more aggressive policies, including heightened leverage. Complementary measures of CEO traits based on press portrayals confirm the results.
We administer psychometric tests to senior executives to obtain evidence on their underlying psychological traits and attitudes. We find U.S. CEOs differ significantly from non-U.S. CEOs in terms of their underlying attitudes. In addition, we find that CEOs are significantly more optimistic and risk-tolerant than the lay population. We provide evidence that CEO’s behavioral traits such as optimism and managerial risk-aversion are related to corporate financial policies. Further, we provide new empirical evidence that CEO traits such as risk aversion and time preference are related to their compensation.
We develop a model of the dynamic interaction between CEO overconfidence and dividend policy. The model shows that an overconfident CEO views external financing as costly and hence builds financial slack for future investment needs by lowering the current dividend payout. Consistent with the main prediction, we find that the level of dividend payout is about one-sixth lower in firms managed by CEOs who are more likely to be overconfident. We document that this reduction in dividends associated with CEO overconfidence is greater in firms with lower growth opportunities and lower cash flow. We also show that the magnitude of the positive market reaction to a dividend-increase announcement is higher for firms with greater uncertainty about CEO overconfidence.
Do acquirors profit from acquisitions, or do acquiring CEOs overbid and destroy shareholder value? We present a novel approach to estimating the long-run abnormal returns to mergers exploiting detailed data on merger contests. In the sample of close bidding contests, we use the loser’s post-merger performance to construct the counterfactual performance of the winner had he not won the contest. We find that bidder returns are closely aligned in the years before the contest, but diverge afterwards: Winners underperform losers by 50 percent over the following three years. Existing methodologies, including announcement effects, fail to capture the acquirors’ underperformance.
This paper shows how chief executive officer (CEO) characteristics affect the performance of acquirers in diversifying takeovers. When the acquirer's
CEO has previous experience in the target industry, the acquirer's abnormal announcement returns are between 1.2 and 2.0 percentage
points larger than those generated by a CEO who is new to the target industry. This outcome is driven by the industry-expert
CEO's ability to capture a larger fraction of the merger surplus. Industry-expert CEOs typically negotiate better deals and
pay a lower premium for the target. This effect is stronger when information asymmetry is high and in bilateral negotiations
compared to auctions. We also find that industry-expert CEOs on average select lower surplus deals. This evidence is consistent
with industry-expert CEOs having superior negotiation skills.
A detailed analysis of 49 firms subject to AAERs suggests that approximately one-quarter of the misstatements meet the legal standards of intent. In the remaining three quarters, the initial misstatement reflects an optimistic bias that is not necessarily intentional. Because of the bias, however, in subsequent periods these firms are more likely to be in a position in which they are compelled to intentionally misstate earnings. Overconfident executives are more likely to exhibit an optimistic bias and thus are more likely to start down a slippery slope of growing intentional misstatements. Evidence from a high-tech sample and a larger and more general sample support the overconfidence explanation for this path to misstatements and AAERs.
We find that firms behave consistently with how their CEOs behave personally in the context of leverage choices. Analyzing data on CEOs' leverage in their most recent primary home purchases, we find a positive, economically relevant, robust relation between corporate and personal leverage in the cross-section and when examining CEO turnovers. The results are consistent with an endogenous matching of CEOs to firms based on preferences, as well as with CEOs imprinting their personal preferences on the firms they manage, particularly when governance is weaker. Besides enhancing our understanding of the determinants of corporate capital structures, the broader contribution of the paper is to show that CEOs' personal behavior can, in part, explain corporate financial behavior of the firms they manage.
It is well known that firms are more likely to issue equity when their market values are high, relative to book and past market values, and to repurchase equity when their market values are low. We document that the resulting effects on capital structure are very persistent. As a consequence, current capital structure is strongly related to historical market values. The results suggest the theory that capital structure is the cumulative outcome of past attempts to time the equity market.
We argue that managerial overconfidence can account for corporate investment distortions. Overconfident managers overestimate the returns to their investment projects and view external funds as unduly costly. Thus, they overinvest when they have abundant internal funds, but curtail investment when they require external financing. We test the overconfidence hypothesis, using panel data on personal portfolio and corporate investment decisions of Forbes 500 CEOs. We classify CEOs as overconfident if they persistently fail to reduce their personal exposure to company-specific risk. We find that investment of overconfident CEOs is significantly more responsive to cash flow, particularly in equity-dependent firms.
This paper explains why seemingly irrational overconfident behavior can persist. Information aggregation is poor in groups in which most individuals herd. By ignoring the herd, the actions of overconfident individuals (“entrepreneurs”) convey their private information. However, entrepreneurs make mistakes and thus die more frequently. The socially optimal proportion of entrepreneurs trades off the positive information externality against high attrition rates of entrepreneurs, and depends on the size of the group, on the degree of overconfidence, and on the accuracy of individuals' private information. The stationary distribution trades off the fitness of the group against the fitness of overconfident individuals.
Are the attitudes and beliefs of chief executive officers (CEOs) linked to their firms' innovative performance? This paper uses a measure of overconfidence, based on CEO stock-option exercise, to study the relationship between a CEO's “revealed beliefs” about future performance and standard measures of corporate innovation. We begin by developing a career concern model where CEOs innovate to provide evidence of their ability. The model predicts that overconfident CEOs, who underestimate the probability of failure, are more likely to pursue innovation, and that this effect is larger in more competitive industries. We test these predictions on a panel of large publicly traded firms for the years from 1980 to 1994. We find a robust positive association between overconfidence and citation-weighted patent counts in both cross-sectional and fixed-effect models. This effect is larger in more competitive industries. Our results suggest that overconfident CEOs are more likely to take their firms in a new technological direction.
This paper was accepted by Kamalini Ramdas, entrepreneurship and innovation.
Security analysts tend to bias stock recommendations upward, particularly if they are affiliated with the underwriter. We analyze how investors account for such distortions. Using the NYSE Trades and Quotations database, we find that large traders adjust their trading response downward. While they exert buy pressure following strong buy recommendations, they display no reaction to buy recommendations and selling pressure following hold recommendations. This “discounting” is even more pronounced when the analyst is affiliated with the underwriter. Small traders, instead, follow recommendations literally. They exert positive pressure following both buy and strong buy recommendations and zero pressure following hold recommendations. We discuss possible explanations for the differences in trading response, including information costs and investor naiveté.
We employ a certainty-equivalence framework to analyze the cost, value and pay/performance sensitivity of non-tradable options held by undiversified, risk-averse executives. We derive “executive value” lines, the risk-adjusted analogues to Black–Scholes lines. We show that distinguishing between “executive value” and “company cost” provides insight into many issues regarding stock option practice including: executive views about Black–Scholes values; tradeoffs between options, restricted stock and cash; exercise price policies; option repricings; early exercise policies and decisions; and the length of vesting periods. It also leads to reinterpretations of both cross-sectional facts and longitudinal trends in the level of executive compensation.
Does CEO overconfidence help to explain merger decisions? Overconfident CEOs over-estimate their ability to generate returns. As a result, they overpay for target companies and undertake value-destroying mergers. The effects are strongest if they have access to internal financing. We test these predictions using two proxies for overconfidence: CEOs’ personal over-investment in their company and their press portrayal. We find that the odds of making an acquisition are 65% higher if the CEO is classified as overconfident. The effect is largest if the merger is diversifying and does not require external financing. The market reaction at merger announcement (-90 basis points) is significantly more negative than for non-overconfident CEOs (-12 basis points). We consider alternative interpretations including inside information, signaling, and risk tolerance.
This chapter summarizes the empirical and theoretical research on executive compensation and provides a comprehensive and up-to-date description of pay practices (and trends in pay practices) for chief executive officers (CEOs). Topics discussed include the level and structure of CEO pay (including detailed analyses of annual bonus plans, executive stock options, and option valuation), international pay differences, the pay-setting process, the relation between CEO pay and firm performance (“pay-performance sensitivities”), the relation between sensitivities and subsequent firm performance, relative performance evaluation, executive turnover, and the politics of CEO pay.
Miscalibration is a form of overconfidence examined in both psychology and economics. Although it is often analyzed in lab experiments, there is scant evidence about the effects of miscalibration in practice. We test whether top corporate executives are miscalibrated, and study the determinants of their miscalibration. We study a unique panel of over 11,600 probability distributions provided by top financial executives and spanning nearly a decade of stock market expectations. Our results show that financial executives are severely miscalibrated: realized market returns are within the executives’ 80% confidence intervals only 33% of the time. We show that miscalibration improves following poor market performance periods because forecasters extrapolate past returns when forming their lower forecast bound (“worst case scenario”), while they do not update the upper bound (“best case scenario”) as much. Finally, we link stock market miscalibration to miscalibration about own-firm project forecasts and increased corporate investment.
A common view is that there is little correlation between firm performance and CEO pay. Using a new fifteen-year panel data set of CEOs in the largest, publicly traded U.S. companies, we document a strong relationship between firm performance and CEO compensation. This relationship is generated almost entirely by changes in the value of CEO holdings of stock and stock options. In addition, we show that both the level of CEO compensation and the sensitivity of compensation to firm performance have risen dramatically since 1980, largely because of increases in stock option grants. © 2000 the President and Fellows of Harvard College and the Massachusetts Institute of Technology
No. This paper investigates the relationship between financing constraints and investment-cash flow sensitivities by analyzing
the firms identified by Fazzari, Hubbard, and Petersen as having unusually high investment-cash flow sensitivities. We find
that firms that appear less financially constrained exhibit significantly greater sensitivities than firms that appear more
financially constrained. We find this pattern for the entire sample period, subperiods, and individual years. These results
(and simple theoretical arguments) suggest that higher sensitivities cannot be interpreted as evidence that firms are more
financially constrained. These findings call into question the interpretation of most previous research that uses this methodology.
Two dominant features emerge from a simple model of corporate finance with excessively optimistic managers and efficient capital markets.First,optimistic managers believe that capital markets undervalue their firm ’s risky securities,and may decline positive net present value projects that must be financed externally.Second,optimistic managers overvalue their own corporate projects and may wish to invest in negative net present value projects even when they are loyal to shareholders.These results establish an underinvestment- overinvestment tradeoff related to free cash flow without invoking asymmetric information or rational agency costs.
We present a framework for determining the information that can be extracted from stock prices around takeover contests. In only two types of cases is it theoretically possible to use stock price movements to infer bidder overpayment and relative synergies. Even in these two cases, we argue that it is practically difficult to extract this information. We illustrate one of these generic cases using the takeover contest for Paramount in 1994 in which Viacom overpaid by more than $2 billion. Our findings are consistent with managerial overconfidence and/or large private benefits, but not with the traditional agency-based incentive problem.
The benefits of stock options are often not large enough to offset the inefficiency implied by the large divergence between the cost of options to companies and the value of options to risk-averse, undiversified executives and employees. Moreover, the benefits of options can often be achieved more effectively and economically through other means. Why are options so prevalent? Several explanations include changes in corporate governance, reporting requirements, taxes, the bull market and managerial rent-seeking. We offer an alternative hypothesis: boards and managers incorrectly perceive stock options to be inexpensive because options create no accounting charge and require no cash outlay.
Die Arbeit untersucht die Anreize von CDO-Managern hinsichtlich der Auswahl der einem Pool zugrunde liegenden Forderungen und identifiziert Anreizkonflikte zwischen diesen und den Investoren der unterschiedlich subordinierten Tranchen. Es wird aufgezeigt, dass CDO-Manager unabh�ngig von ihrer Risikoeinstellung einen Anreiz zur Maximierung der Konzentration des zu verwaltenden Referenzportfolios besitzen. Bez�glich der Ausfallwahrscheinlichkeit und der Recovery Rate der Assets besteht f�r Manager dagegen nur dann ein Anreiz zur Maximierung des Portfoliorisikos, wenn der Anteil der Incentive Fee an der Gesamtverg�tung vergleichsweise hoch ist oder eine gewisse Managementbeteiligung an der Equity Tranche vorliegt. Hierbei sind die Risikoanreize umso schw�cher, je st�rker die Risikoaversion eines Managers ausgepr�gt ist. Neben der Gestaltung der Verg�tung und der Eigenkapitalbeteiligung wird das Risikoverhalten von CDO-Managern durch die Transaktionsstruktur beeinflusst. In diesem Zusammenhang wird festgestellt, dass durch die Gestaltung von Overcollateralization Tests Risk Shifting-Anreize von Asset Managern abgeschw�cht bzw. verhindert werden k�nnen. Hinsichtlich der Pr�ferenzen der Investoren zeigt sich eine Interessensdivergenz zwischen den Investoren der vorrangigen Tranchen und denen der Equity Tranche. Die Investoren der Senior und Mezzanine Tranchen pr�ferieren einen Forderungspool mit einem m�glichst geringen Risiko, die der Equity Tranche einen Pool mit einem m�glichst hohen Risiko. Es ergibt sich somit ein Risikoanreizproblem zwischen dem Asset Manager und den Debt Investoren einer CDO-Transaktion, wenn f�r den Manager ein Anreiz zur Maximierung des Portfoliorisikos besteht. Demgegen�ber liegt ein Interessenkonflikt zwischen dem Manager und den Equity Investoren vor, wenn der Manager keinen Risk-Shifting Anreiz besitzt. Hierbei sind die f�r die Investoren aus einem bestehenden Anreizkonflikt resultierenden Wertverluste umso gr��er, je gerin