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CEO Overconfidence and Corporate Investment

76 Pages Posted: 14 Dec 2002  

Ulrike Malmendier

University of California, Berkeley - Department of Economics; University of California, Berkeley - Haas School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); Institute for the Study of Labor (IZA)

Geoffrey A. Tate

University of North Carolina Kenan-Flagler Business School; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: October 13, 2002

Abstract

We explore behavioral explanations for sub-optimal corporate investment decisions. Focusing on the sensitivity of investment to cash flow, we argue that personal characteristics of chief executive officers, in particular overconfidence, can account for this widespread and persistent investment distortion. Overconfident CEOs overestimate the quality of their investment projects and view external finance as unduly costly. As a result, they invest more when they have internal funds at their disposal. We test the overconfidence hypothesis, using data on personal portfolio and corporate investment decisions of CEOs in Forbes 500 companies. We classify CEOs as overconfident if they repeatedly fail to exercise options that are highly in the money, or if they habitually acquire stock of their own company. The main result is that investment is significantly more responsive to cash flow if the CEO displays overconfidence. In addition, we identify personal characteristics other than overconfidence (education, employment background, cohort, military service, and status in the company) that strongly affect the correlation between investment and cash flow.

Suggested Citation

Malmendier, Ulrike and Tate, Geoffrey A., CEO Overconfidence and Corporate Investment (October 13, 2002). AFA 2003 Washington, DC Meetings. Available at SSRN: https://ssrn.com/abstract=354387 or http://dx.doi.org/10.2139/ssrn.354387

Ulrike Malmendier (Contact Author)

University of California, Berkeley - Department of Economics ( email )

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HOME PAGE: http://www.econ.berkeley.edu/~ulrike/

University of California, Berkeley - Haas School of Business ( email )

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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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Geoffrey Tate

University of North Carolina Kenan-Flagler Business School ( email )

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Chapel Hill, NC 27599-3490
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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