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.

How do risk attitudes affect measured confidence?

“…For example, findings of overconfidence in own performance relative to that of others (e.g., Svenson 1981) has motivated many studies by experimental economists on the relationship between relative confidence, relative ability, and willingness to take risks in strategic environments (e.g., Camerer and Lovallo 1999;Hoelzl and Rustichini 2005;Moore and Cain 2007;Niederle and Vesterlund 2007). Confidence about own abilities has been shown to affect many important spheres of economic behaviour including consumer decision making (Grubb 2015), trading in financial markets (Biais et al 2005;Kent and Hirshleifer 2015), innovative activity (Herz et al 2014), investment in education (Dunning et al 2004), and decision making among managers and CEOs (Malmendier and Tate 2015). Given this, it is not surprising that economists have shown interest in developing theoretical models to examine the implications of biases in confidence (e.g., Compte and Postlewaite 2004;Dubra 2004;Gervais et al 2011;Ludwig et al 2011).…”

Heuristics and Public Policy: Decision Making Under Bounded Rationality

“…In his criticism of nudges, Gigerenzer (2015, p. 371) gives a prominent role to overcon…dence, and discounts most of the existing evidence on overcon…dence. Although there are dif…culties in measuring overcon…dence, behavioral economics has documented impressive evidence on overcon…dence, using novel methods, not cited in Gigerenzer (2015); see for instance, the surveys in Malmendier and Taylor (2015), and Malmendier and Tate (2015). This evidence indicates that overcon…dence may harm people's self-interest.…”

Can Overconfident Executives Restrain Overinvestment?

“…In addition to capital investment and mergers and acquisitions, overconfident executives have higher R & D investment levels [3] [9], but it is possible to reduce long-term stock returns and financial performance, indicating that there are also over-investment issues in research and development [13]. But it is not hard to notice that overconfident CEO does not equate with the high level of investment.…”

“…However, agency X. B. Liu problems and overconfidence can also account for investment-cash flow sensitivity, therefore overinvestment and underinvestment can both be expressed as investment-cash flow sensitivity [13]. Investment cash flow sensitivity method depends entirely on the prior classification of the enterprise in determining the lack of investment and excessive investment, which indicate a great limitation of this method.…”