Overconfidence, Compensation Contracts, and Capital Budgeting

Journal Article (Journal Article)

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. © 2011 the American Finance Association.

Full Text

Duke Authors

Cited Authors

  • Gervais, S; Heaton, JB; Odean, T

Published Date

  • October 1, 2011

Published In

Volume / Issue

  • 66 / 5

Start / End Page

  • 1735 - 1777

Electronic International Standard Serial Number (EISSN)

  • 1540-6261

International Standard Serial Number (ISSN)

  • 0022-1082

Digital Object Identifier (DOI)

  • 10.1111/j.1540-6261.2011.01686.x

Citation Source

  • Scopus