A new measure of overconfidence: deducing the board perspective on overconfidence
Abstract:
This paper analyzes optimal compensation contracts when managers are overconfident. We separate the two dimensions of overconfidence: optimism (overestimation of expected firm value) and miscalibration (underestimation of the firm value’s volatility). We calibrate a stylized principal-agent model to the observed contracts of 2,705 CEO compensation contracts. The optimal contract shifts compensation to the states of the world which the overconfident CEO perceives to be more likely than they actually are. This model can explain the observed contracts much better than the benchmark model with rational CEOs. We thus derive a new, two-dimensional empirical measure for a CEO’s “implied level” of overconfidence, i.e., the degree of optimism and miscalibration, for which the optimal contract explains the observed contract best.
The seminar will be held in person.
Language: English
Supported by the Luxembourg National Research Fund (FNR) (2022/17573036)