Overconfidence, Compensation Contracts, and Capital Budgeting

  • Author(s): SIMON GERVAIS, J. B. HEATON, TERRANCE ODEAN
  • Published: Sep 21, 2011
  • Pages: 1735-1777
  • DOI: 10.1111/j.1540-6261.2011.01686.x

ABSTRACT

A risk‐averse manager’s overconfidence makes him less conservative. As a result, it is cheaper for firms to motivate him to pursue valuable risky projects. When compensation endogenously adjusts to reflect outside opportunities, moderate levels of overconfidence lead firms to offer the manager flatter compensation contracts that make him better off. Overconfident managers are also more attractive to firms than their rational counterparts because overconfidence commits them to exert effort to learn about projects. Still, too much overconfidence is detrimental to the manager since it leads him to accept highly convex compensation contracts that expose him to excessive risk.

Jump to menu

Main Navigation

Search the Site / Journal

Search Keywords

Search Tips

Members' Login

Credentials

Members' Options

Site Footer

View Mobile Version