Overconfidence behaviour
Financial Markets - Thesis Proposal
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Kryˇtof Cern´, Jelena Markovi´, Yerzhan Sadakbayev s c
IES FSV UK
November 29, 2012
Introduction
Literature Review
Chief Executive Officers (CEOs) have a crucial role, in terms of corporate governance, for firm’s successful development. Their personal attributes can make either value-destroying investments or, vice versa, can enhance firm’s value. Goel and Thakor (2008) developed a model which demonstrates the influence of
CEO’s investment decisions on the effectiveness of corporate governance. Regardless the trend that most of their decisions are value-destroying, overconfident managers have higher chances to be promoted to a CEO status. Authors also emphasize the fact, that the effect of CEO’s overconfidence doesn’t have a monotonic behavior, but depends on various factors. Both excessively diffident and excessively overconfident CEOs are undesirable and can be fired by the board (Gervais, Heaton, and Odean (2007)). However, Sironi and
Suntheim (2012) give some evidence of the trend, that high ratio of female board members to the total number of board members results in lower chance of hiring overconfident CEOs.
Effect of internal organizational governance on corporate governance is significant due to the fact, that internal governance selects the most able managers and suggests the board to appoint them as a
CEO. The model explains the paradox, that CEOs, who are generally winners, sometimes make valuedestroying investments. According to the model it is more likely to find overconfident CEOs in firms in riskier industries and in firms emphasizing merit-based promotions.
The term ”overconfidence” comes from the field of behavioral finance and may improve the existing moral hazard framework and influence decision making. Skala (2011) reports about features of overconfidence and discusses its results, namely, that it makes managers overestimate future returns, underestimate risks and falsely presume some level of control
ˇ y
Kryˇtof Cern´, Jelena Markovi´, Yerzhan Sadakbayev s c
IES FSV UK
November 29, 2012
Introduction
Literature Review
Chief Executive Officers (CEOs) have a crucial role, in terms of corporate governance, for firm’s successful development. Their personal attributes can make either value-destroying investments or, vice versa, can enhance firm’s value. Goel and Thakor (2008) developed a model which demonstrates the influence of
CEO’s investment decisions on the effectiveness of corporate governance. Regardless the trend that most of their decisions are value-destroying, overconfident managers have higher chances to be promoted to a CEO status. Authors also emphasize the fact, that the effect of CEO’s overconfidence doesn’t have a monotonic behavior, but depends on various factors. Both excessively diffident and excessively overconfident CEOs are undesirable and can be fired by the board (Gervais, Heaton, and Odean (2007)). However, Sironi and
Suntheim (2012) give some evidence of the trend, that high ratio of female board members to the total number of board members results in lower chance of hiring overconfident CEOs.
Effect of internal organizational governance on corporate governance is significant due to the fact, that internal governance selects the most able managers and suggests the board to appoint them as a
CEO. The model explains the paradox, that CEOs, who are generally winners, sometimes make valuedestroying investments. According to the model it is more likely to find overconfident CEOs in firms in riskier industries and in firms emphasizing merit-based promotions.
The term ”overconfidence” comes from the field of behavioral finance and may improve the existing moral hazard framework and influence decision making. Skala (2011) reports about features of overconfidence and discusses its results, namely, that it makes managers overestimate future returns, underestimate risks and falsely presume some level of control
References: 1. Ben-David, I., Graham, J. R. , Harvey, C. R., 2007, ”Managerial Overconfidence and Corporate Policies”, Working Paper 13711 2. Brickley, J. A., Coles, J. L., and Terry, R. L., 1994, ”Outside directors and the adoption of poison pills”, Journal of Financial Economics 35, 371–390 3. Brown, R., Sarma N., 2007, ”CEO overconfidence, CEO dominance and corporate acquisitions”, Journal of Economics and Business 4. Doukas, J. A., Petmezas, D., 2007, ”Acquisitions, Overconfident Managers and Self-attribution Bias”, European Financial Management, Vol 5. Elder Jr., G. H., Gimbel, C., Ivie, R., 1991, ”Turning Points in Life: The Case of Military Service and War”, PP 6. Gervais, Simon, Heaton, J.B., and Odean T., 2007, ”Overconfidence, investment policy, and manager welfare”, Working paper, Duke University 7. Goel, A. M., Thakor, A. V., 2008, ”Overconfidence, CEO Selection and Corporate Governance”, The Journal of Finance 8. Hirshleifer, D., Low, A., and Teon, S. H., 2012, ”Are Overconfident CEOs Better Innovators?”, The Journal of Finance 9. Malmendier, U., Tate, G., 2005, ”CEO Overconfidence and Corporate Investment”, The Journal of Finance 10. Malmendier, U.,Tate, G., and Yan, J., 2011, ”Overconfidence and Early-Life Experiences: The Effect of Managerial Traits on Corporate Financial Policies”, The Journal of Finance 11. Sironi, A., Suntheim, F., 2012, ”CEO Overconfidence in Banking”, Bocconi University 12