Can Strong Boards and Trading Their Own Firm’s Stock Help CEOs Make Better Decisions? Evidence from Acquisitions by Overconfident CEOs

Abstract

Little evidence exists on whether boards help managers make better decisions. We provide evidence that strong and independent boards help overconfident chief executive officers (CEOs) avoid honest mistakes when they seek to acquire other companies. In addition, we find that once-overconfident CEOs make better acquisition decisions after they experience personal stock trading losses, providing evidence that a manager’s recent personal experience, and not just educational and early career experience, influences firm investment policy. Finally, we develop and validate a new CEO overconfidence measure that is easily constructed from machine-readable insider trading data, unlike previously used measures.

Overconfidence and the Timing of Share Repurchases

“…Unclassified firms are those firms where the company CEO made zero personal purchases of company stock within the sample period 1993-2010. In accordance with the overconfidence measure of Kolasinski and Li (2013), CEOs are classified as moderately confident if they have an average non-negative 180-day abnormal return following the insider purchase. CEOs are classified as overconfident if they have an average negative 180-day abnormal return following the insider purchase.…”

Can Overconfident Executives Restrain Overinvestment?

“…Kolasinski A C [12] argues that mergers and acquisitions will improve when the overconfident executives have experienced personal failures in stock investment, which also implies the negative impact of overconfidence on M & A performance. In addition to capital investment and mergers and acquisitions, overconfident executives have higher R & D investment levels [3] [9], but it is possible to reduce long-term stock returns and financial performance, indicating that there are also over-investment issues in research and development [13].…”

Impact of the characteristics of CEO's overconfidence on the determination of incentive compensation

“…There is an increasingly large literature about the impact of the CEO's overconfidence on the company's policies. Overconfident CEOs are likely to overestimate the investment returns and underestimate the coming risks (Dittrich et al, 2005; Kolasinski andTate, 2005 and. However, we know that the nature of incentive contracts offered to overconfident managers or even companies tend to spend more precise compensation contracts, to match the manager's personality traits.…”