A Rationale for Hiring Irrationally Overconfident Managers

Oded Palmon () and Itzhak Venezia ()
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Oded Palmon: Rutgers Business, Rutgers University
Itzhak Venezia: School of Business, The Hebrew University

Chapter 69 in Encyclopedia of Finance, 2022, pp 1581-1598 from Springer

Abstract: Abstract The viability of managerial overconfidence is perplexing since it has been shown to lead managers to erroneous and costly decisions. This chapter addresses this issue by exploring the impact of managerial overconfidence on managerial effort, executive compensation, and the welfare of stockholders and managers. Overconfidence affects managerial effort directly and indirectly. The direct effect is that the optimal effort chosen by managers is positively related to their level of overconfidence. The indirect impact is through the influence on stockholders’ choices of contract parameters. Thus, managerial overconfidence helps mitigate the well-known conflict of interest between managers and stockholders that induces managers to exert effort levels that are lower than the socially optimal levels. We construct a measure of the combined welfare of managers and stockholders and show that it is positively related to managerial overconfidence, thus providing an explanation to the persistence of this bias.

Keywords: Behavioral biases; Incentive options; Managerial effort; Overconfidence; G3; G34 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:spr:sprchp:978-3-030-91231-4_69

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DOI: 10.1007/978-3-030-91231-4_69

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