Managerial overconfidence and corporate policies. (2007)

“…companies with overconfident CFOs use lower discount rates to value cash flows, and that they invest more, use more debt, are less likely to pay dividends, are more likely to repurchase shares, and they use proportionally more long-term, as opposed to short-term, debt.

Ben-David, I., University of Chicago Graduate School of Business
Graham, J.R., Harvey, C.R., Duke University, Fuqua School of Business

NBER (National Bureau Of Economic Research) Working Paper No. 13711.

Miscalibration is a standard measure of overconfidence in both psychology and economics. Although it is often used in lab experiments, there is scarcity of evidence about its effects in practice. The authors test whether top corporate executives are miscalibrated, and whether their miscalibration impacts investment behavior.

Over six years, they collected a unique panel of nearly 7,000 observations of probability distributions provided by top financial executives regarding the stock market. Financial executives are miscalibrated: realized market returns are within the executives’ 80% confidence intervals only 38% of the time.

We show that companies with overconfident CFOs use lower discount rates to value cash flows, and that they invest more, use more debt, are less likely to pay dividends, are more likely to repurchase shares, and they use proportionally more long-term, as opposed to short-term, debt.

The pervasive effect of this miscalibration suggests that the effect of overconfidence should be explicitly modeled when analyzing corporate decision-making.

Download the abstract or purchase here: Managerial overconfidence