Overconfidence, CEO Selection, and Corporate Governance
50 Pages Posted: 13 Mar 2006 Last revised: 12 Oct 2009
Date Written: August 29, 2006
We examine the interaction between corporate governance at two levels: internal organizational governance that is intended to distinguish among managers of a priori unknown abilities to determine who becomes CEO, and corporate governance at the board level that seeks to retain or fire the CEO based on observed performance. An overconfident manager has a higher probability than a rational manager of being promoted to CEO under value-maximizing internal governance. Moreover, the overconfidence of a risk-averse CEO enhances firm value up to a point, but the effect is non-monotonic and differs from that of lower risk aversion. Overconfident CEOs also underinvest in information production. Corporate governance at the board level depends on the interaction between perceptions of CEO ability and overconfidence. The board fires both excessively diffident and excessively overconfident CEOs. Finally, the Sarbanes-Oxley Act is predicted to improve the precision of information provided to investors, but reduce aggregate investment and possibly firm values.
Keywords: Leadership, Chief Executive Officer, CEO, Overconfidence, Corporate Governance, Leadership, Selection, Sarbanes-Oxley Act
JEL Classification: D82, G31, J30, M51
Suggested Citation: Suggested Citation