Managerial Overconfidence and Self-Reported Success

47 Pages Posted: 3 Feb 2020

See all articles by Nikolaj Kirkeby Niebuhr

Nikolaj Kirkeby Niebuhr

Aarhus University - Department of Economics and Business Economics

Date Written: January 10, 2020

Abstract

I consider the optimal contract for an overconfident manager in a principal-agent model with moral hazard where the contract is written on the earnings of the firm. Overconfidence causes the manager to overestimate his ability to affect the outcome of the firm. Overconfidence first reduces cost of agency, and if the level of overconfidence is significant enough, it causes the manager to wager on his wrong beliefs. The accounting system obscures the outcome of the manager's effort, which attenuates the effect of significant overconfidence and decreases the principal's profit. Inducing the manager to truthfully communicate his self-observed success allows the principal to directly contract on the cause of disagreement, the manager's effect on firm outcome. This reduces the risk premium for a slightly overconfident manager and emphasizes the wager effect for a significantly overconfident manager. The value of communication is first decreasing in overconfidence for a slightly overconfident manager and then increasing in overconfidence for a significantly overconfident manager.

Keywords: Overconfidence; Moral hazard; Communication; Disclosure

JEL Classification: D83; D86; D91; M41

Suggested Citation

Niebuhr, Nikolaj Kirkeby, Managerial Overconfidence and Self-Reported Success (January 10, 2020). Available at SSRN: https://ssrn.com/abstract=3517188 or http://dx.doi.org/10.2139/ssrn.3517188

Nikolaj Kirkeby Niebuhr (Contact Author)

Aarhus University - Department of Economics and Business Economics ( email )

Fuglesangs Allé 4
Aarhus V, 8210
Denmark

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