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Overconfidence, CEO Selection, and Corporate Governance

Authors

  • ANAND M. GOEL,

  • ANJAN V. THAKOR

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    • Anand Goel is at DePaul University and Anjan Thakor is at Washington University, St. Louis. The helpful comments of Arnoud Boot; Fenghua Song; Josh Coval; an associate editor; an anonymous referee; the editor Rob Stambaugh; and Simon Gervais, the discussant of the paper at the American Finance Association's 2007 annual meeting in Chicago, are gratefully acknowledged.

ABSTRACT

We develop a model that shows that an overconfident manager, who sometimes makes value-destroying investments, has a higher likelihood than a rational manager of being deliberately promoted to CEO under value-maximizing corporate governance. Moreover, a risk-averse CEO's overconfidence enhances firm value up to a point, but the effect is nonmonotonic and differs from that of lower risk aversion. Overconfident CEOs also underinvest in information production. The board fires both excessively diffident and excessively overconfident CEOs. Finally, Sarbanes-Oxley is predicted to improve the precision of information provided to investors, but to reduce project investment.

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