Do confident CEOs increase firm value under competitive pressure?

ABSTRACT

Traditional studies show that CEOs’ overconfidence can mitigate underinvestment problem that occurs due to risk-aversion. To extend this argument, we investigate whether investment by overconfident CEOs always increases firm value. Theoretically and empirically, we show that investment by overconfident CEOs and firm value is positively related for firms in more competitive industries. For firms in less competitive industries, the relation is insignificant. Our findings suggest that CEOs’ overconfidence can be a desirable managerial trait for shareholders under certain conditions.

KEYWORDS:

• CEO overconfidence
• investment
• firm value
• competitive industry

JEL CLASSIFICATION:

• D43
• D81
• G32

Acknowledgments

Author Hyeong Joon Kim acknowledges financial support from NRF (National Research Foundation of Korea) Grant funded by the Korean Government (NRF-2018H1A2A1060309-Global Ph.D. Fellowship Program).

Disclosure statement

Author Kyumin Cho declares that he has no conflict of interest.

Author Hyeong Joon Kim declares that he has no conflict of interest.

Author Seongjae Mun declares that he has no conflict of interest.

Author Seung Hun Han declares that he has no conflict of interest.

Notes

¹ We also assume that the CEO and shareholders have the same time preferences but different risk preferences (Epstein and Zin 1989).

² As a result, corresponding $\sigma$ = 0.29, 0.32 and 0.35 for Low, Moderate, and High uncertainty, respectively, in Figure 1.

³ Additionally, we use industry volatility and product similarity for the robustness tests (Panels A and B in Table 3). We calculate industry volatility as the standard deviation of return on assets of firms within an industry in the fiscal year. Product similarity, which is calculated by Hoberg and Phillips (2016), exhibits how similar each firm is to every other firm by calculating firm-by-firm pairwise word similarity scores using the 10-K product words.

⁴ We measure ‘industry volatility’ in Panel A of Table 3 by calculating the standard deviation of return on assets of firms within an industry in the fiscal year. We thank an anonymous referee for suggesting this industry-level earnings volatility, for $\sigma$ in our model, as an alternative proxy.