CEO Overconfidence and the Valuation Effects of Corporate Diversification & Refocusing Decisions
68 Pages Posted: 14 Jan 2017
Date Written: January 12, 2017
This study presents a theoretical model that links CEO overconfidence to the value loss of corporate diversification and the undertaking of post-diversification refocusing decisions. Consistent with the model’s prediction, findings show that diversified firms run by overconfident CEOs experience 12.5 to 14.1 percent value loss compared to diversified firms run by their rational counterparts. Further, the model predicts a heightened corporate refocusing activity by overconfident CEOs, who pursued diversified investments in the past, once realized returns fail to match the initial expectations. In this respect, the empirical odds of corporate refocusing decisions are 67 to 98 percent higher when past diversifications are made by overconfident than rational CEOs. Overall, this study proposes CEO overconfidence as a unified and consistent explanation of why firms pursue value-destructive corporate diversification policies and later on adopt refocusing policies aiming to restore value.
Keywords: CEO Overconfidence, Diversification, Refocusing, Diversification Discount, Firm Performance
JEL Classification: G34, G30
Suggested Citation: Suggested Citation