Curbing Managerial Myopia: The Role of Managerial Overconfidence in Owner-Managed Firms and Professionally Managed Firms

Abstract

We develop and test a model in which managerial overconfidence offsets the underinvestment problem arising from managerial myopia. Using a three-period investment model in which we capture managerial myopia by hyperbolic discounting, we show that both overconfident owner-managers and professional managers who have myopic preferences can enhance firm value (up to a point) by increasing investment. This value-enhancing role of overconfidence is more evident for professional managers than for owner-managers. The results from simulation and empirical analyses support the model’s predictions. Thus, while managers’ cognitive biases, when considered separately, negatively impact firm performance, they can be beneficial when considered jointly.

Keywords: Overconfidence, Myopia, Present Bias, Hyperbolic Discounting, Firm Value, Investment, Owner-Manager, Professional Manager

JEL Classification: D03, D21, G32, L20