THE JOURNAL OF FINANCE•VOL.LXVII,NO.4•AUGUST2012
Are Overconfident CEOs Better Innovators?
DAVID HIRSHLEIFER,ANGIE LOW,and SIEW HONG TEOH∗
ABSTRACT
Previous empirical work on adver conquences of CEO overconfidence rais the
question of whyfirms hire overconfident managers.Theoretical rearch suggests a
reason:overconfidence can benefit shareholders by increasing investment in risky
projects.Using options-and press-bad proxies for CEO overconfidence,wefind
that over the1993–2003period,firms with overconfident CEOs have greater return
volatility,invest more in innovation,obtain more patents and patent citations,and
achieve greater innovative success for given rearch and development expenditures.
However,overconfident managers achieve greater innovation only in innovative in-
dustries.Ourfindings suggest that overconfidence helps CEOs exploit innovative
growth opportunities.
S TEVE JOBS,FORMER CEO of Apple Computers,was ranked by Business-Week as one of the greatest innovators of the last75years in a2004 article—written before Apple’s introduction of the path-breaking iPhone and iPad—becau“More than anyone el,Apple’s co-founder has brought digital technology to the mass.”Jobs is almost as famous for his lf-confidence. According to the same article,“He got hisfirst job at12after calling President Bill Hewlett and landing an internship.”After prodi-gious early success as cofounder of Apple Computers,“Jobs’cocky attitude and the lack of management skills contributed to Apple’s problems.He never both-ered to ”According to an article in Fortune,“Jobs likes to make his own rules,whether the topic is computers,stock options,or even pancreatic cancer.The same traits that make him a great CEO drive him to put his company,and his investors,at risk.”1
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∗Hirshleifer and Teoh are from The Paul Merage School of Business,University of California, Irvine.Low is from Nanyang Business School,Nanyang Technological University.We thank the Editor(Cam Harvey),the Associate Editor,two anonymous referees,Sanaz Aghazadeh,Robert Bloomfield,Peng-Chia Chiu,SuJung Choi,Major Coleman,Shane Dikolli,Lucile Faurel,Xuan Huang,Fei Kang,Kevin Koh,Brent Lao,Richard Mergenthaler,Alex Nekrasov,Mort Pincus, Devin Shanthikumar,and participants in the Merage School of Business,UC Irvine Workshop in Psychology and Capital Markets,the brown bag workshop at Nanyang Business School,Nanyang Technical University,and“The Interction of Economics and Psychology in Accounting Rearch Conference”at the McCombs School of Business,University of Texas at Austin for very helpful comments,and Peng-Chia Chiu and Xuan Huang for excellent rearch assistance.
1See“Steve Jobs:He Thinks Different,”BusinessWeek,November1,2004,and Koontz and Weihrich(2007,p.331).According to Fortune,“s smug superiority,...No CEO is more willful,or more brazen,at making his own rules,in ways both good and bad.And no CEO is more personally identified with—and controlling of—the day-to-day affairs of his business.”(“The Trouble with Steve Jobs,”Fortune,March5,2008).
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Is this combination of visionary innovation and extraordinary overconfidence a coincidence?Here,we examine a different possibility—that for CEOs,the two go hand in hand.
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A recent literature in corporatefinance examines how managers’psycholog-ical bias or characteristics affectfirm decisions(e,for example,Bertrand and Schoar(2003),Baker,Pan,and Wurgler(2009)).Our focus is on overconfi-dence,the tendency of individuals to think that they are better than they really are in terms of characteristics such as ability,judgment,or prospects for suc-cessful life outcomes(the last item is sometimes called“optimism”).Theoretical rearch analyzes why overconfidence exists(Benabou and Tirole(2002),Van den Steen(2004)).Psychological and other rearch indicates that people,in-cluding experts,tend to be overconfident along a variety of dimensions,but that there is substantial and persistent individual variation in the degree of confidence(e,for example,Oskamp(1965),Weinstein(1980),Wagenaar and Keren(1986),Brenner et al.(1996),and Puri and Robinson(2007)).
Overconfident individuals tend to overestimate the net discounted expected payoffs from uncertain endeavors,either becau of a general tendency to ex-pect good outcomes,or becau they overesti
mate their own efficacy in bringing about success.Furthermore,people tend to be more overconfident about their performance on hard rather than easy tasks(Griffin and Tversky(1992)).Ac-cordingly,we expect relatively overconfident CEOs to be especially enthusiastic about risky,challenging,and talent-and vision-nsitive enterpris. Innovative projects—which apply new business methods,develop new tech-nologies,or offer new products or rvices—are risky and challenging.We therefore expect managerial overconfidence to be potentially important for such undertakings.Reinforcing this conjecture,the outcomes of innovative projects take a long time to resolve,and overconfidence tends to be more vere in t-tings with ambiguous and deferred feedback(Einhorn(1980)).Adopting inno-vative projects may also be viewed as indicative of superior managerial“vision.”Innovative projects are thus likely to appeal to lf-aggrandizing managers. We therefore hypothesize that(even after including standardfirm-level con-trols and industry and yearfixed effects)firms with overconfident managers accept greater risk,invest more heavily in innovative projects,and achieve greater innovation.2The effect of overconfidence on project lection could come from either overestimation of expected cashflows or underestimation of risk. Whether overconfident CEOs will be better innovators after controlling for the level of spending on rearch and development(R&D)is less clear.On the one hand,overconfident managers who pursue innovation aggressively may undertake projects with low expected payoff.On the other hand,rational managers may,from the viewpoint of shareholders,excessively prefer the“D”
2Some studies fail tofind evidence of overconfidence in certain contexts(e,for example, Gigerenzer,Hoffrage,and Kleinbolting(1991)versus Griffin and Tversky(1992)).Although there are exceptions,the preponderance of evidence supports a general tendency toward overconfidence in various manifestations(e,for example,DeBondt and Thaler(1995)and Rabin(1998)).How-ever,it is not crucial for our purpos whether CEOs are,on average,overconfident.Our tests rely upon substantial differences in the degree of confidence across managers.
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Are Overconfident CEOs Better Innovators?1459 in R&D—fairly reliable projects rather than risky but more promising inno-vative ones.Overconfident managers can potentially achieve higher average innovative productivity by accepting good but risky projects.This benefit of managerial overconfidence is reflected in recent theoretical models(Goel and Thakor(2008),Gervais,Heaton,and Odean(2011)).As a result,we do not hypothesize the direction of the effect of overconfidence on the effectiveness of the CEO in generating innovation for given R&D expenditures.
The biggest puzzle raid by existing rearch on managerial beliefs and corporate policy is thatfirms often employ overconfident managers and give them leeway to follow their beliefs in making major investment andfinanc-ing decisions(Malmendier and Tate(2005a,2005b,2008)and Ben-David, Graham,and Harvey(2010)).This is counterintuitive,as we would normally view unbiad
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beliefs as preferable.Furthermore,Graham,Harvey,and Puri (2010)provide evidence of a matching of growthfirms with more confident managers(as proxied by height).This puts the most confident managers into thofirms where overconfidence can radically influence strategy,investment choices,and survival.By measuring ex post success,we suggest a possible so-lution to this overconfident manager puzzle:overconfident managers are better innovators.
气滞胃痛颗粒的功效与作用To test our hypothes,we u alternative proxies for managerial overconfi-dence bad on options exerci behavior or press coverage.The options exerci measure(Malmendier and Tate(2005a))builds on the idea that a manager who choos to be expod to thefirm’s idiosyncratic risk is likely to be confident about thefirm’s prospects.Under this approach,a CEO who voluntarily retains stock options after the vesting period in which exerci becomes permissible is viewed as overconfident.3Our cond measure of overconfidence is bad on the portrayal of the CEO in the news media,as developed by Malmendier and Tate(2005b,2008).This measure employs counts of words relating to over-confidence or its opposite in proximity to the company name and the keyword “CEO.”
We measure thefirm’s innovation-related investment by the level of R&D expenditures.Ourfirst measure of innovative output and R&D success is the number of patents applied for during the year f
rom the U.S.Patents and Trademarks Office.Patents differ greatly in their importance,so,following Trajtenberg(1990),our cond measure of innovative output is total citation count.This is the total number of citations subquently received by the patents applied for during the year,where citations are made by other newer patents. Wefind that over the1993–2003period,firms with overconfident CEOs have higher stock return volatility,consistent with their undertaking riskier projects.Overconfident CEOs invest more heavily in R&D and achieve greater innovation as measured by patent and citation counts.Greater innovative out-put is not just a result of greater resource input;overconfident CEOs achieve 3Malmendier and Tate(2005a,2008)develop measures of CEO overconfidence bad on options exerci behavior and insider net stock purchas.Billett and Qian(2008),Liu and Taffler(2008), and Campbell et al.(2011)also adopt this measurement approach.
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山西税务网上申报系统greater innovative success even after controlling for the level of R&D expendi-tures.Patenting may be less relevant for certain industries,either becau they are less innovative or becau,in the industries,innovation does not result in patents.Wefind that overconfident managers achieve greater total patents and citations than non-overconfident managers only in industries where in-novation is i
mportant.We also provide evidence that our results are not due to overconfident CEOs having private information about future profits or to overconfident CEOs just being more risk-tolerant.
The greater innovative output for given R&D input achieved by overconfi-dent CEOs does not necessarily translate into higherfirm value.Hall,Jaffe, and Trajtenberg(2005)show that,on average,patent citations are positively correlated withfirm value,but overconfident CEOs could be overpaying to achieve incread citation counts(possibly using resources other than R&D expenditures),reducingfirm value.A possible way to address this issue is to regressfirm value on CEO overconfidence or the innovation that results from it.However,such a test is subject to endogeneity problems.Instead,using an instrument for exogenous growth opportunities,we examine a more limited question:are overconfident CEOs better at translating external growth oppor-tunities intofirm value?Wefind that the answer is yes,and that this relation is especially strong among industries where innovation is important. Throughout,wefind that the effect of overconfidence on innovation is mainly found among innovative industries.Since innovative industries should contain more good risky growth opportunities,our results are consistent with models such as tho of Goel and Thakor(2008)and Gervais,Heaton,and Odean (2011)that imply high benefits to overconfidence when such opportunities are prent.
Recent work identifies other important effects of managerial overconfidence onfirm investments.Malmendier and Tate(2005a)propo that overconfident managers are optimistic about investment opportunities,but overestimate the value of theirfirms’equity and therefore the cost of externalfinancing.This implies thatfirms with overconfident CEOs will have greater investment–cash flow nsitivity.Their evidence is consistent with this prediction.Ben-David, Graham,and Harvey(2010)document thatfirms who CFOs are overcon-fident in the n of having miscalibrated beliefs undertake greater capital expenditures.Our paper differs from the contributions in focusing on inno-vative investments,for which we would expect overconfidence to be especially important,and on the effectiveness of this investment as measured by patent and citation counts for a given level of innovative investment.
With regard to otherfirm behaviors,Hribar and Yang(2011)find that overconfident managers are more likely to issue optimistically biad fore-casts.Schrand and Zechman(2010)find that overconfidence is associated with a greater likelihood of earnings management andfinancial fraud.Graham, Harvey,and Puri(2010)document a relation between managerial traits,in-cluding confidence,and a variety of corporate policies.Malmendier,Tate,and Yan(2011)find that overconfident managers are less likely to u external finance,and issue less equity.Malmendier and Tate(2008)find that CEO
Are Overconfident CEOs Better Innovators?1461 overconfidence is associated with making acquisitions,and with more negative market reactions to acquisition announcement.Most of thefindings add to the puzzle of whyfirms are willing to hire overconfident managers.4
The paper proceeds as follows.We describe the data and variable construction in Section I.In Section II,we examine the relation between overconfident CEOs and stock return volatility,while in Section III,we test the relation between overconfident CEOs and innovative activities.We provide veral extensions and consider alternative explanations for ourfindings in Section IV.In Sec-tion V,we test whether overconfidence is associated with incread innovative efficiency andfirm value.We conclude in Section VI.
I.Data and Descriptive Statistics
A.The Data
We u veral databas to construct our sample.Standard and Poor’s Ex-ecucomp databa provides information on CEOs and their compensation,and we u the data on option compensation to construct one of our two measures of CEO overconfidence.The cond overconfidence measure relies on keyword arches of the text of press articles in Factiva.All accounting data are from Comp
ustat and stock returns are from CRSP.Patent-related data are from the 2006edition of the NBER patent databa.
幼儿数字The sample consists offirms in the interction of Execucomp,Compustat, CRSP,and the patent databa.All Execucompfirms that operate in the same four-digit SIC industries as thefirms in the patent databa are included;the sample is therefore not limited tofirms with patents.Firm-years with miss-ing data on any of the control variables and dependent variables are deleted. We further require that there be information on at least one of the CEO over-confidence measures.Since the measures are lagged by1year,we require that the CEO be the same one in the prior year to ensure that we obrve the characteristics of the CEO in place at the time the innovation is being measured.Financialfirms and utilities are excluded.Thefinal sample con-sists of2,577CEOs from9,807firm-year obrvations between1993and2003. Of the obrvations,8,939firm-years have information on the options-bad measure,while7,762firm-years have information on the press-bad measure of overconfidence.
4After developing this paper,we became aware of a recent paper that examines the relation between managerial overconfidence and innovation(Galasso and Simcoe(2010)).Our papers differ in veral ways.We examine how overconfidence affects risk-taking as well as innovation,and we show that the
effects of managerial overconfidence come solely from innovative industries. We also examine the effects of overconfidence onfirm performance.To ensure the robustness of our conclusions,we u the press-bad measure of overconfidence as well as the options-bad measure.Finally,our time period and sample size differ substantially.Our time period,1993to 2003,encompass the millennial high-tech boom,and overlaps little with their1980–1994sample. Our sample is also much larger,as it is drawn from the top1,500firms covered by Execucomp.In particular,our sample consists of1,771firms and9,807firm-year obrvations,while their sample covers290firms and3,648firm-years.
