Working paper
CEO Overconfidence, Moral Hazard, and Investment
SSRN
08/25/2020
DOI: 10.2139/ssrn.3680313
Abstract
Using an agency theory framework, we examine the effect of managerial overconfidence on the interaction between planning and control problems. We consider a typical setting in which a manager makes an investment decision involving project selection and a production decision to implement the chosen project. Thus, adverse selection and moral hazard problems affect different facets of management decision making, which allows us to examine how overconfidence affects the interaction between adverse selection and moral hazard. We show that overall welfare implications depend on the kind of overconfidence: productivity-related or state-related. When the agent overestimates the productivity of his effort, the principal can actually exploit the overconfidence and induce him to provide more effort at lower cost. However, overconfidence can either exacerbate an existing overinvestment problem or it can mitigate an existing underinvestment problem. We show that productivity-related overconfidence unequivocally improves the principal's welfare. On the contrary, state-related overconfidence aggravates the effort incentive problem but can ameliorate the underinvestment problem. Overall, state-related overconfidence decreases investor welfare, consistent with the negative connotation we often ascribe to overconfidence
Details
- Title: Subtitle
- CEO Overconfidence, Moral Hazard, and Investment
- Creators
- Ramji Balakrishnan - University of IowaGeorge Drymiotes - Texas Christian UniversityShiva Sivaramakrishnan - Rice UniversityJoyce Tian - University of Waterloo
- Resource Type
- Working paper
- Publisher
- SSRN
- DOI
- 10.2139/ssrn.3680313
- Number of pages
- 40 pages
- Language
- English
- Date posted
- 08/25/2020
- Academic Unit
- Accounting
- Record Identifier
- 9984380600502771
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