Executive over-confidence and compensation structure. (2016)

“…firms tailor compensation contracts to individual behavioral traits such as overconfidence.”

Mark Humphery-Jenner, UNSW Business School, Australia;
Ling Lei Lisic, George Mason University, Virgina;
Vikram Nanda, Rutgers University New Jersey and University of Texas;
Sabatino Dino Silveri, University of Memphis.
Journal of Financial Economics, 119(3), 533-558.

From the Science Daily review; The study found that companies offer incentive-heavy compensation contracts to overconfident CEOs to ‘exploit’ their positively-biased views of the firms’ prospects.

The notion is that if managers and shareholders – represented by the board – have a different take on a firm’s prospects and CEO talent, there will be greater use of incentive pay that the managers value highly, but the board regards as less costly.

….Using CEO compensation data between 1992 and 2011, the researchers identified managers who were exhibiting behavior that was overconfident compared to other CEOs. They conducted empirical tests to explore the relationship between CEO overconfidence and incentive compensation.

….They found that

• CEO overconfidence increases the proportions of total compensation that comes from both option grants and equity grants, compared to other executives
• Overconfident CEOs receive even greater option and equity intensity in innovative and risky firms
• Overconfident non-CEO executives also receive higher levels of options and equity.

Overconfident CEOs were defined as being prone to overestimate returns to investments and underestimate risks. They may use extremely positive words in the media or tend to invest more than a typical manager in the industry.

“It’s good to have your enthusiasm and your confidence,” researcher Dr. Vikram Nanda said. “The question is, if it’s too strong, is there something the firm can do – such as giving you incentive contracts, or monitoring your behavior, or constricting what you can do – to bring out the good side and constrain the bad aspects?”

Access the full paper here: Executive overconfidence and compensation structure.

Access the review here: CEO personality traits play role in incentive pay, compensation.