Summary:
This article presents the growing research area of
Behavioral Corporate Finance in the context of one specific example:
distortions in corporate investment due to CEO overconfidence. We first review
the relevant psychology and experimental evidence on overconfidence. We then
summaries the results of Malmendier and Tate (2005a) on the impact of
overconfidence on corporate investment. We present supplementary evidence on
the relationship between CEOs’ press portrayals and overconfident investment
decisions.
This
alternative approach to measuring overconfidence, developed in Malmendier and
Tate (2005b), relies on the perception of outsiders rather than the CEO’s own actions.
The robustness of the results across such diverse proxies jointly corroborates previous
findings and suggests new avenues to measuring executive overconfidence.
Keywords
are behavioral corporate finance, CEO overconfidence & corporate investment.
The
literature in behavioral economics and behavioral finance departs from the
traditional economic model to incorporate psychological evidence on
non-standard preferences and beliefs, such as loss aversion, sunk-cost fallacy,
or overconfidence. As economists we are interested in market interactions. In
the market, high-stake incentives and repeated transactions might discipline overconfidence
is to construct a plausible measure of overconfidence. Biased beliefs naturally
defy direct and precise measurement. In our previous work, we propose two
approaches. The first is a ‘revealed beliefs’ argument. We infer CEOs’ beliefs
about the future performance of their company from their personal portfolio
transactions. The second approach captures how outsiders perceive the CEO.deviations.
The analysis of overconfidence relates several branches of the psychology
literature. First, an extensive experimental literature documents the tendency
of individuals to consider themselves ‘above average’ on positive characteristics.
The better than average effect also affects the attribution of causality.
Because individuals expect their behavior to produce success, they attribute
outcomes to their actions when they succeed and to bad luck when they fail.
This self-serving attribution of outcomes reinforces overconfidence. The
biggest challenge for the analysis of overconfidence. While overconfidence about
the firm’s projects may be less likely in external board members. Another
important issue is the selection of board members.
http://eml.berkeley.edu/~ulrike/Papers/07_eufm_006.pdf
http://eml.berkeley.edu/~ulrike/Papers/07_eufm_006.pdf
