Valuation Effects of Overconfident CEOs on Corporate Diversification and Refocusing Decisions

71 Pages Posted: 7 Mar 2019

See all articles by Panayiotis C. Andreou

Panayiotis C. Andreou

Cyprus University of Technology

John A. Doukas

Old Dominion University - Strome College of Business

Demetris Koursaros

Cyprus University of Technology - Department of Commerce

Christodoulos Louca

Cyprus University of Technology

Multiple version iconThere are 2 versions of this paper

Date Written: January 12, 2019

Abstract

This study presents a theoretical model that links chief executive officer (CEO) overconfidence to the value loss of corporate diversification. Consistent with the model’s prediction, the findings show that diversified firms run by overconfident CEOs experience value loss compared to diversified firms run by their rational counterparts. Empirically, the value loss is economically significant and ranges between 12.5% and 14.1%. In addition, the model predicts heightened corporate refocusing activity by overconfident CEOs who pursued diversified investments in the past once realized returns fail to match initial expectations. The empirical odds of corporate refocusing decisions are 67% to 98% higher when past diversifications are undertaken by overconfident rather than rational CEOs. Another prediction of the model is that overconfident CEOs exhibit preference for diversified investments, especially in the presence of ample internal funds. This prediction is also strongly supported by the data. Overall, this study proposes CEO overconfidence as a unified and consistent explanation of why firms pursue value-destructive corporate diversification policies and later adopt refocusing policies aiming to restore value.

Keywords: CEO Overconfidence, Diversification, Refocusing, Diversification Discount, Firm Performance

JEL Classification: G34, G30

Suggested Citation

Andreou, Panayiotis C. and Doukas, John A. and Koursaros, Demetris and Louca, Christodoulos, Valuation Effects of Overconfident CEOs on Corporate Diversification and Refocusing Decisions (January 12, 2019). Journal of Banking and Finance, 2019. Available at SSRN: https://ssrn.com/abstract=3335806

Panayiotis C. Andreou

Cyprus University of Technology ( email )

School Of Management and Economics
P.O. Box 50329
Lemesos, 3036
Cyprus

HOME PAGE: http://www.pandreou.com

John A. Doukas (Contact Author)

Old Dominion University - Strome College of Business ( email )

2080 Constant Hall
Suite 2080
Norfolk, VA 23529-0222
United States
757-683-5521 (Phone)

HOME PAGE: http://www.efmaefm.org/0DOUKAS/doukas.php

Demetris Koursaros

Cyprus University of Technology - Department of Commerce ( email )

Pavlou Mela
Limassol
Cyprus

Christodoulos Louca

Cyprus University of Technology ( email )

Limassol, 3603
Cyprus

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