CEO Overconfidence in Banking

Abstract

This study empirically investigates bank risk taking from a behavioral perspective. More specifically, we analyze the impact of an overconfident CEO, defined as one who has systematically upward biased beliefs about the returns of his investment projects, on bank performance and risk taking. Overconfidence is measured using a sample of international banks from 1997 to 2008 with full information on CEO option holdings. Ingersoll (2006) determines the optimal exercise time for undiversified option holders under realistic assumptions on risk aversion. Following Malmendier & Tate (2005) classify CEOs as overconfident if they keep their options too long to be considered rational. We find that banks with overconfident CEOs did not perform worse during the financial crisis but had higher risk throughout the sample period. However, active boards seem to mitigate this effect.

Keywords: Banking, CEO overconfidence